Category Archives: business

First In, First Out

FIFO has become the most popular accounting method U.S. businesses use to determine both the cost of the goods they sell and the value of the goods they have in their inventories. With about 53% of firms in the S&P 500 (Index: SPX) using the accounting method, which plays a big role in determining how profitable they are on paper, it's high past time we took a closer look at how the First In, First Out (FIFO) accounting method works!

For a really good introduction, here's Excel spreadsheet guru Leila Gharani's eight-and-a-half minute video explaining how the First-In-First-Out (FIFO) accounting method is used to calculate the Cost of Goods Sold (COGS) for a business.

While her examples reflect how a modest amount of inflation can affect a business' cost of goods sold, how might a surge of inflation like what the U.S. has experienced during the past two years affect how profitable it appears to be on paper?

For the answer to that question, let's turn to Breaking Bad Accounting's shorter video from September 2020, which compares how the different the net earnings (or profit) results are for firms using the different accounting methods. Given what happened after inflation was unleashed in 2021, it's somewhat prophetic (although their example is more fun to talk about!):

Under FIFO accounting rules, reported profits soar in an inflationary environment because the calculated Cost of Goods Sold lags behind the rising cost of replenishing their inventories with higher cost goods.

About 16% of the firms making up the S&P 500 use the Last In, First Out (LIFO) accounting method. The remaining firms utilize variations of the Average Cost method. Firms that use the LIFO method see much lower profits than FIFO firms report, while Average Cost firms come out somewhere in between these extremes.

During periods of deflation, the opposite pattern develops. LIFO firms will report the highest profits, FIFO firms will report the lowest, and Average Cost firms come out in the middle again. If prices were stable however, all three methods would produce identical results.

The United States is somewhat unique in allowing firms to utilize any of these methods, and the LIFO method in particular, which is banned under International Financial Reporting Standards. Despite that prohibition, major accounting firms like Price Waterhouse Coopers have recommended private U.S. firms adopt the practice because of the high inflation environment established during the past two years.

Gross and Net Profits

Woman reading Profit First - Photo by Natasha Hall via Unsplash: https://unsplash.com/photos/o8KUqjk9gqE

Investors have made Apple (NASDAQ: AAPL) worth more than $2 trillion dollars. But how profitable is the company?

That depends on how you measure profit. If you want a raw number, calculating a company's gross income is a good place to start. That's just the difference between its total sales and its total cost of goods sold, ignoring its other costs of doing business. This figure is useful for comparing the basic profitability of a company's core business with that of other companies like it. It's also useful if you track it over time. If you see a company's gross profit swinging wildly from one period to the next, that can be a sign its core business is either highly volatile or, in the worst case, is not well managed. Which if you're going to invest in the company, is probably something you ought to know.

As an investor however, that's not enough information to tell you how profitable the company really is. For that, you need to take its operating costs, how much it pays in interest expenses, how much it pays in taxes, and its other income and expenses into account. Doing that will tell you the company's net income (sometimes called its net earnings), which is the real bottom line. A company with positive net income is making money and a company with negative net earnings is losing money.

For comparing companies, you will find its useful to standardize these measures of profitability by dividing each by the company's total sales revenue and expressing the result as a percentage. For gross income, the result of that math is called the gross profit margin and for net income, the result is called the net profit margin. These percentages will let you directly compare the profitability of companies with very different amounts of profit. And of course, will let you assess trends in a single company's profitability performance if you follow it over time.

All that said, we've built a tool to make it easy for anyone to do this math. All you need is the business' income statement. In the tool below, the default data comes from Apple's December 2022 10-K SEC filing [also available in PDF format], so the tool's results will tell you just how profitable Apple was at the end of 2022. If you're reading this article on a site that republishes our RSS news feed, please click through to our site to access a working version of the tool.

Income Statement Data
Input Data	Revenues	Expenses
Total Net Sales
Total Cost of Sales
Total Operating Expenses
Interest Expenses
Income Taxes
Other

Gross and Net Profits
Calculated Results	Income	Profit Margin
Gross
Net

Of course, you're more than welcome to substitute the financial data for other companies in the tool to assess their profitability.

We've made a point of the importance of tracking a company's gross and net profit margins over time, so to that end, we'd like to point you to a very useful resource. Macrotrends features an online application that will chart a company's gross, operating and net profit margins over its recent history using information from its database. Follow this link to see where they've done that for Apple's profit margins going back to December 2009.

Image Credit: Photo by Natasha Hall on Unsplash. The book being read in the photo is Profit First by Mike Michalowicz, which has the enchanting subtitle "Transform Your Business from a Cash-Eating Monster to a Money-Making Machine". At this writing, the book has 7,091 reviews on Amazon, with 85% giving it five stars. Goodreads gives it a 4.27 rating, 51% of which are five star reviews. Most of the critical reviews point out the whole concept of the book could be summarized in five pages or less. Or perhaps just one blog post, but that's a challenge for another day.

Costco Food Court Inflation

Costco (NYSE: COST) recently made the news because of something the company didn't do. The wholesaler refused to raise the price of hot dogs sold at its food court:

Costco CFO Richard Galanti revealed last Thursday that its famous hot dog-and-soda combo deal of $1.50 will remain in place despite record-high inflation.

At an earnings call, Galanti said the profit margins the company is seeing in the gas and travel sectors allow Costco to make up for losses at the food court.

That's not necessarily news. Back in 2018, Costco's CEO Craig Jelinek approached company founder Jim Sinegal about raising the price of the company's hot dog and soda combo above the $1.50 price it has been held at since 1985. Here's what happened next:

“I came to (Jim Sinegal) once and I said, ‘Jim, we can’t sell this hot dog for a buck fifty. We are losing our rear ends.’ And he said, ‘If you raise the effing hot dog, I will kill you. Figure it out.’ That’s all I really needed. By the way, if you raised (the price) to $1.75, it would not be that big of a deal. People would still buy (it). But it’s the mindset that when you think of Costco, you think of the $1.50 hot dog (and soda).

“What we figured out we could do is build our own hot dog-manufacturing plant (in Los Angeles) and make our own Kirkland Signature hot dogs. Now we are doing so much hot dog business that we’ve opened up another plant in Chicago.

“By having the discipline to say, ‘You are not going to be able to raise your price. You have to figure it out,’ we took it over and started manufacturing our hot dogs. We keep it at $1.50 and make enough money to get a fair return.”

It's amazing what a CEO can do when properly motivated!...

But we wondered how other items on Costco's food court's menu have fared during the last several years, which includes both 2020's coronavirus pandemic that forced the company to shut down its food courts before being allowed to reopen them in 2021 when they were impacted by President Biden's inflation. To find out, we tracked down the following photo of a Costco food court menu with prices, which we think is from 2018 because it still shows the option of a Polish sausage along with the hot dog - they were eliminated from the menu in 2018:

2018 Costco Food Court Menu with Prices - Source: Associations Now February 2020

Here's a more recent version of Costco's food court menu with prices from 17 October 2022:

2022 Costco Food Court Menu with Prices, 17 October 2022

We quickly find that prices for the twisted churros, mocha freezes, smoothies, ice cream, sodas, and chicken bakes have all increased. But if you look closer at the two menus, you'll find other changes as well.

In 2018, for example, you could get four different kinds of pizzas at Costco's food court: cheese, pepperoni, sausage, or a combo (featuring pepperoni, sausage, onions, and green peppers). In 2022, the available options have dwindled to just cheese and pepperoni.

You could also get a Chicken Caesar Salad in 2018. That choice is gone in 2022.

Let's take a closer look at Costco's hot dogs. In 2018, you weren't limited to ordering a hot dog - you could substitute a Polish sausage. You can't do that in 2022. Also notice the condiment selection shown on the 2018 menu photo - you could add pickle relish, onions, ketchup, mustard, or deli mustard to your order. The 2022 menu photo shows no condiments, but we can verify you can still put ketchup or mustard (but not deli mustard, pickle relish, or onions) on your Costco hot dog.

But wait, there's more! Several reports suggest the quality of Costco's continuing food court menu items have also declined over the last several years.

So let's review what Costco's CEO has figured out for the wholesaler's food court menu between 2018 and 2022:

To keep hot dog prices the same, Costco built two factories to make its own hot dogs. [Side note: the company used a similar strategy to hold down the cost for its popular rotisserie chickens.]
Costco raised prices for six other food and drink items it sells at its food court. Most of those price increases have taken place since 2020.
Costco has eliminated options it previously offered for pizzas and condiments.
Costco has degraded the customer-perceived quality of the food items it sells at its food courts. This can be considered a type of "shrinkflation".

Sounds like the CEO needs to figure it out some more.

The Biggest Grocery Store Chains in the U.S.

As part of our usual day-to-day analysis, we sometimes come across fascinating information that deserves attention all to itself. That's the case with today's data visualization featuring the 20 biggest grocery store chains in the United States by number of store locations.

Largest Grocery Store Chains in the U.S. by Number of Store Locations (as of 6 July 2021)

For the visualization, we've omitted several convenience store operators who operate large numbers of stores that are better known as places to refuel motor vehicles than they are as places to buy food and pantry items. We have however included drug store operators because they make a point to regularly advertise these kinds of grocery items in their weekly ads.

By far, the most numerous chains are represented by Dollar General with 17,266 locations and Dollar Tree with 15,685 outlets, which are followed by drug stores CVS with 9,960 outlets and Walgreens with 9,021 stores. Walmart ranks fifth by number of outlets, with 5,342, but ranks first in food sales.

But the largest supermarket operator (which omits Walmart under that classification) is the Kroger family of stores, with 2,742 locations across the U.S.

In the chart, we've highlighted the grocery store chains where you can regularly buy an iconic No. 1 "picnic" (or 10.75 oz) can of Campbell's Condensed Tomato Soup in red. That omits warehouse wholesaler Costco, which often carries Campbell's Chicken Noodle Soup (but not Tomato!). It also omits German-owned discount grocers Aldi and Trader Joes, as well as U.S.-based organic grocers like Amazon's Whole Foods and Sprouts Farmers Market, none of which carry Campbell's Soups (though you can buy it through Amazon's web site).

The biggest surprise for us was to find that Dollar General and Dollar Tree did not sell Campbell's condensed tomato soup in its most iconic packaging either. While these value-oriented grocery stores do in fact sell Campbell's Condensed Tomato Soup, they do so in larger volume cans. As a final personal finance tip, if you're looking for the most tomato soup for your money, you'll get the best value in buying the 15.2 and 14.3 oz cans of Campbell's Condensed Tomato Soup that these discount grocers carry in place of the 10.75 oz can.

Update 29 January 2022: We're happy to report that discount grocer Aldi is indeed a purveyor of Campbell's Condensed Tomato Soup's 10.75 oz. cans! We've updated the chart above to indicate that status (here is the original version of the chart that showed Aldi's bar as blue rather than red).

Reference

Supermarket News. Top 50 food and grocery retailers by sales. [Online Article]. 6 July 2021.

Growth of Average Farm-Raised Turkeys Starts to Stagnate

In 2020, the average live weight of a turkey raised on a U.S. farm was nearly unchanged from 2019's final recorded average of 32.7 pounds per bird. That stagnation ended what had been a 40 year long trend of growth in the average size of turkeys produced on U.S. farms.

Average Live Weight of Turkeys Raised on U.S. Farms, 1929-2020 with Estimate for 2021

In the chart above, we've shown that new trend of stagnation continuing based on early signs that production factors such as the rising costs of feed, fuel, and labor for producing turkeys in the U.S. will affect the growth of the average turkey much the same as it did during the inflationary 1970s. Should the finalized data for 2021 confirm that's the case when it is released next year, it will indicate U.S. turkey producers are dealing with today's inflation similarly to how they did during that period of relative stagnation for the U.S. economy.

References

U.S. Department of Agriculture National Agricultural Statistics Service. Livestock Historic Data. [Online Database: Survey - Animals & Products - Poultry - Turkeys - Production - Turkeys Production Measured in Head - Total - National - US Total - 1929-2021 - Annual - Year]. Accessed 14 November 2021.

U.S. Department of Agriculture National Agricultural Statistics Service. Livestock Historic Data. [Online Database: Survey - Animals & Products - Poultry - Turkeys - Production - Turkeys Production Measured in LB - Total - National - US Total - 1929-2021 - Annual - Year]. Accessed 14 November 2021.