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Summary
The global financial crisis of 2008 has put the role of regulators, auditors and
management under increased scrutiny by investors. Managers are challenged as never before
to address a multitude of issues that goes far beyond the single profit motive. Over the past
decade, there has been an increasing debate on the topics like sustainability, social
Financial statements and disclosures made under the traditional financial reporting paradigm
is subject to increased objection by the users. Consequently, financial reporting standards are
revised and updated – requiring companies to disclose detailed information about their
business affairs. This has also increased the importance of the role of BOD.
This paper attempts to perform the detailed financial statement analysis of McDonalds
Corporation and assess the readiness of its corporate governance structure. Detailed trend and
ratio analysis will be conducted to determine how the company is performing in different
areas (liquidity, profitability, solvency, market position) over time and as compared to the
industry level. Based on the analysis, the areas where the company may be vulnerable to
potential SEC action shall be identified and a recommendation will be made to improve the
performance. The second part of paper deals with assessing the corporate governance rigor of
McDonalds Corporation. This involve assessing the independence of BOD, audit committee
and linking their compensation with the performance to determine whether or not there are
McDonalds Corp. is a fast food chain of restaurants. It operates more than 6,900
locations in over 100 countries. Headquartered in Illinois, United States, the company is
among one of the top fast food sellers in the world – with average annual revenue of about
and solvency position of a business to determine whether or not the management has created
value for stakeholders i.e., one of the outcome of effective corporate governance is the
increase in value (net worth) of the organization – represented by the present value of future
cash flows discounted at the firm’s cost of capital. Although financial statement analysis
useful insights about the company’s performance, but at the same time, the published
accounts are also subject to fraudulent adjustments. For instance, accountants may exploit the
loopholes in financial reporting standards to their advantage i.e., boosting profits through fair
expense etc. and other similar methods used to “dress-up” the financial statements so that
they can give the desirable view to investor and other regulatory bodies.
whether due to fraud, error or other secret motives. Identifying key trends and analysing them
to find out deviations over time will greatly help in spotting key areas where the company
might be vulnerable to fraud and thus, a likely SEC action. The research attempts to analyse
both financial and non-financial indicators to determine whether or not McDonald’s liquidity,
profitability and overall solvency position warrants a sustainable growth in revenues, market
An analysis of the financial statements, ratios and related notes of McDonalds reveals
some inconsistencies and irregularities that could be a sign of potential fraud or concealed
misstatement. Discussion regarding past 05 year key business ratios (KBR), industry
comparison and trend analysis appears below. Ratios are reflected in Appendix-2.
Running Head: CFO PROJECT – MCDONALDS 4
Liquidity & Efficiency: Cash and cash equivalents as a percentage of total assets
remained, on an average, in the range of 6% – 7% of total assets over the past 05 years
except 2015 and 2016. The 2015’s closing balance was up almost 270% from 2015 and
consequently, cash declined by 84% from 2015. Part of this can be attributed to increase
in long-term loan and treasury stock account as per balance sheet. Overall, the liquidity
position appears to be in-line with the industry average. However, receivables, inventory
and payables turnover have fluctuated significantly and are unusually over or below the
Profitability: ROIC and ROA ratio shows stable trend over the past 05 years. ROIC is in-
line with the industry trend but ROA is about 5% above from the overall restaurant
industry average. However, despite the fact that revenues have constantly declined on
year-on-year (YOY) basis since 2014, the net profit ratio remained broadly consistent
(within the range of 17% - 20%). Vertical analysis in Appendix-2 reveals that no other
operating cost and expense item has declined in the same trend that could explain this
anomaly. Overall, the ROE is negative since 2016 as net equity amount is negative
Debt management and solvency: Analysis of cash flow statement reveals that net cash
flow from financing activities is consistently negative since last 05 years. However, net
cash outflow from investing activities is only a very small fraction of net cash outflows
from financing activities. It implies that the most of the cash flow received from issuing
debt securities is used to repurchase the shares and up to some extent, to pay the
dividends and repayments of existing debt. This is also reflected in debt ratio i.e., the
percentage of interest bearing debt to total assets has increased from around 39% to 80%
Running Head: CFO PROJECT – MCDONALDS 5
over the past 05 years. However, despite this, the interest coverage remains consistent
with industry average as shown in Appendix-2. Overall, the debt position of McDonalds
Market & Valuation Ratios: Price to Earnings ratio (P/E) has improved since 2013 and
now sits above the industry average. Dividend yield has deteriorated during 2017 to 2.3%
as compared to 3.0% for 2016. However, the ratio was almost in-line with the industry
from 2013 to 2016. Dividend Pay-Out ratio of McDonalds is also above the industry
average and overall, the dividends declared per share has increased since last 05 years
according to the financial statements retrieved from SEC. Currently, the market cap of
McDonalds is about $124 billion (Yahoo Finance). As per 2017 financial statements the
outstanding shares (807.4 million) × current price ($157.6 per share) equals $127 billion
which is almost $3 billion above the book value – implying that the share price may be
The notes to the financial statements of recent 10K annual report has been analysed
and following points are identified that may require attention and additional disclosure.
During December 2015, the BOD of company approved a $15 billion share
repurchase program but in July 2017, the program was terminated and replaced with a
new share repurchase program, with no specified expiration date. The complete
the notes to the financial statements of 10K report does not contain significant
Running Head: CFO PROJECT – MCDONALDS 6
The company runs a complex share-based compensation program for its employees
and executives. During 2017, the company recognized about $345 million share based
explanation for only $131 million. The details of remaining $214 million ($345 -
McDonalds record certain assets and liabilities at fair value and management exercise
employee benefits, businesses held for sale, impairment, litigation accruals, certain
derivate assets, liabilities and hedges. During 2017, a debit entry of $167 million in
derivate Miscellaneous Other Assets (non-hedging) and $76 million of loss in foreign
additional details about the former entry are provided whereas the loss recognized is
more than 200% as compared to the previous year. However, no other details
For the year 2017, a gain of $1600 million is recognized in Other Comprehensive
compared to the gain of $654.9 recognized in 2016. Explicit reasons for this unusual
changes are not explained in the financial statements and related notes.
Finally as per proxy statement, the company has increased its tax liability further to
the assessment recently completed by IRS. This could lead to paying of amounts that
are uncertain. However, the effect of this is not stated in financial statements
Vulnerabilities Identified
Significant fluctuation in cash and cash equivalents: Cash and cash equivalent account
shows significant fluctuation over the past three years. As depicted in the below figure,
cash rose by almost 270% in 2018 and then declined by 184% in 2016.
-25.8% 2014
269.9% 2015
-84.1% 2016
101.4% 2017
-150.0% -100.0% -50.0% 0.0% 50.0% 100.0% 150.0% 200.0% 250.0% 300.0%
Unusual change in the cash balance is one of the red flags that may indicate fraud i.e.,
significant amount of cash moved out to subsidiaries as a loan near the year-end may be
to conceal the unrecorded revenues and to bring the cash balance in-line with revenue
growth and receivable turnover. Conversely, unusual increase may be done to ordinarily
improve the liquidity position in order to get loan from bank (Singleton, 2010).
Scrupulous entry in “Other Operating Income / Expense”: Financial statements for the
year ended 31st December 2017 show an entry of $1,163 million as other income which
relates to the sales of company owned restaurants. Although the company has been
reducing owned restaurants and using franchising since last 05 years, but the addition of
-$247.20 2013
$18.60 2014
$209.40 2015
$75.70 2016
-$1,163.20 2017
Putting significant amounts in other liabilities, other income / expense and other
miscellaneous accounts is one way to conceal scrupulous non-cash provisions with the
objective to keep profit margins in agreement with the trend (Singleton, 2010). Therefore,
NP ratio remains stable despite declining revenues: As discussed in ratio analysis, the
revenues of McDonald has declined consistently since last 05 years. However, net profit
17.3%
2014
-2.4%
40.8%
2015
-7.4%
19.0%
2016
-3.1%
17.8%
2017
-7.3%
accountants use to manipulate financial statements so that it gives a desirable view to the
Recommendations
Adequate disclosures and reporting should be made regarding the environment i.e.,
explained in the notes to financial statements. The note shall explicitly describe the
company strategy for environmental protection, its workplace health and safety policy
and corroborate it with the facts and figures. Environmental audit and attestation fees
are rarely disclosed. Thus, it is recommended to disclose this if any (Gray, 2004).
(expense) and comprehensive income items should be given in the notes to financial
statements. This will contribute towards greater transparency and enable investors to
each different item (like debt, hedging, leasing) is not provided. It is recommended
reported that only 7% companies in food processing industry hires the Certified Fraud
Examiner. It implies that organizations are most vulnerable to SEC action when their
recommended to get the internal controls audited from an external, independent fraud
examiner certified from the recognized institution like ACFE (Singleton, 2010). The
The company earns a substantial portion of revenue in Non-USD currency and thus,
The trust of investors and other users of financial statements has deteriorated
significantly after the global financial crisis of 2008. For instance, the Enron scandal has
focused the attention of public from companies to auditors and regulators and board of
directors who are responsible for designing and implementing an effective corporate
governance system which investors (as well as lenders, trading partners, customers and
employees) can depend on. The goal of corporate governance is to ensure that management
should act in the best interest of shareholders. An effective corporate governance model
should foster the spirit of transparency, a culture of accountability and the participation of
structure and management’s adherence with applicable regulations such as SOX act,
environmental laws and other industry practices. In addition, the independence of audit
committee and board of directors shall be assessed. An effective corporate governance model
According to the most recent proxy statement, McDonalds Board of Directors is made
up of 12 individuals and 06 other executive officers. Except for Easterbrook, the CEO of
company, all other directors are independent. However, all of the six (06) executive officers
are non-independent (Morning Star). The board has established the following Committees
i.e., (a) Audit & Finance (b) Compensation (c) Governance (d) Public Policy & Strategy (e)
Sustainability & Corporate Responsibility and (f) Executive. All board committees, except
for the executive committee, are chaired by the independent directors. The company separates
the role of chairman and CEO so that the Chairman can focus on providing leadership to the
Board and in corporate governance matters while the CEO may focus on providing direction
The company only pay compensation to the non-management directors. For the year
ended December 31, 2017, executive compensation for 06 personnel totalled $44.94 million
of which $4.17 million (9.28%) was attributable to salary, $18.50 million (41.15%) to equity
based compensation and remaining to other non-equity based compensation which include
short-term cash incentive (STIP – 16.29%) and company’s contribution under 401K plus
Executive payouts are dependent on performance targets that are linked with certain financial
metrics including operating income growth, net income growth, return on incremental
invested capital (ROIIC), and total shareholder return (TSR) (Proxy Statement).
Ernst and Young (E&Y) served as an independent auditor of the company for the year
ended December 31, 2017. The lead audit partner changes every five years and the Chair of
audit committee is directly involved in the selection of engagement partner. Audit committee
is made up of four independent, non-executive directors who are solely responsible to assess
Running Head: CFO PROJECT – MCDONALDS 12
the auditor’s independence and determine fees to be paid for audit and other ancillary
services. Fees for audit and other related services totalled $12.5 million and $14.2 million for
the years 2017 and 2016 respectively. Audit and Finance Committee meets with the lead
partner (without involving other members of management) and conduct executive session
(with only the Committee members present) to assess the firm’s effectiveness and
independence. The same auditor has served the company since 1964 (Proxy Statement)
McDonalds maintain share-based compensation plan for its executives and directors. The
number of shares reserved for issuance under this scheme is 51.5 million at December 31,
2017 whereas the no. of shares was 31 million for 2016. Increase in the number of shares to
be issued under stock option plan and a consistent increase in treasury stock may indicate the
warning sign i.e., executives may be tempted to initiate programs to buy back shares in order
to reduce the equity (denominator) which will lead towards improving some performance
ratios like return on equity (ROE), ROIC and other shareholder ratios.
The company operates a defined benefit pension plan for its employees. Under this
arrangement, the company has recognized the gain of $16.3 million during 2017. However,
during the previous year, a loss of $47.1 was recognized. Details are not sufficient to
determine whether this change is due to the change (curtailment or settlement) in plan. The
company also entered into derivate contracts to hedge market driven changes in some of his
employee benefit liabilities. This involves making judgements regarding the fair value of
Weaknesses Identified
Executive pay and compensation is linked with certain key metrics including ROIC,
growth operating margin growth and net profit growth which provide them an opportunity
performance to achieve assigned targets and thus, earn more money accordingly. For
example, since the revenue from franchised restaurants is recognized after the receipt of
initial fee, the management may use accruals to manipulate the timing of recording the
One of the directors, Ian Borden, has served both as a president of foundational markets
and also as a CFO of McDonalds, Asia Pacific. However, segregation of duties and
control is one of the most important feature of effective corporate governance. For
example, a person in charge of cash should not be given the control of accounting and / or
As per the proxy statement, one of the shareholders required details of charitable
proposal on the grounds that it will incur unnecessary expense without providing any
meaningful benefit to shareholders and citing that the company have effective checks in
place that provide oversight of charitable contributions at limit the amount of contribution
contributions is listed as one of the corporate governance practice in the same proxy
Executive compensation totalled $44.9 million for the year 2017. However, the break-up
The company’s CEO, Mr Easterbrook holds the highest number of common stock
(320,817) in the company. Therefore, any decrease in the share price will effectively
reduce the net worth and reputational capital of the CEO. Therefore, it may induce him
to take decisions which results in increase of share price even though it may involve
fraudulently adjusting the financial statements to give a favourable view about company’s
SOX prohibits corporations to extend credit to executive officers or directors unless (a)
the loan terms are same as offered to general public and (b) the company is a financial
institution that issue credit in the ordinary course of business. However, although this is a
good initiative, but empirical studies indicate that this will cause organizational politics to
Both SOX act and International Standard on Auditing (ISAs) requires the auditor to
communicate to the audit committee and the board about the scope and limitation of
audit, going concern uncertainties, changes in accounting policies, risk exposure and
other items requiring disclosure. Since E&Y is the company’s auditor since 1964, the
requires that internal audit function should be outsourced as it improves the auditor
Firms reported that the cost of being public has more than doubled since the introduction
primarily attributable to higher audit, assurance and compliance fees. Overall, although
the SOX has contributed towards improved corporate governance (benefitting investors)
Most of the accounting activities and other business operations at Starbucks are ethical
and involve the contribution and analysis by other shareholders. The company has a set of
strict rules that curb fraudulent activities and misconduct among its accounting team,
which have improved confidence among the shareholders. However, to ensure adequate
compliance with the Sarbanes-Oxley Act of 2002, Starbucks employ an external audit
team to assess its accounting systems annually to identify and counteract potential fraud
in timely manner (Haloulakos, 2012). Nonetheless, the company should ensure that the
audit team is free from influence by any its parties and stakeholders. Starbucks should
further comply with the SOX act provisions by disclosing and remitting its financial
Recommendations
framework for adherence with legislations and regulations. Given the weaknesses identified,
Part of the executive pay should be linked to the aspects of corporate governance i.e.,
Build a culture of transparency and integrity i.e., executives should ask hard questions
and demand adequate answers. The BOD is charged with the responsibility to
Running Head: CFO PROJECT – MCDONALDS 16
— the gap between what stakeholders believe is important for them to know and what
Recruit and retain quality staff. This will provide multiple benefits i.e., (a) reduced
risk of non-compliance, (b) trigger of early warning signals (c) allowing the
organization to qualify for favourable treatment in cases that would otherwise result in
Carry out the surprise inspection of internal audit function and implement multiple
with other firms that do business with McDonalds. Relationships with other firms can
Finally the audit committee should not be given the whole responsibility for risk
Conclusion
Analysis of financial statements and accounting policies (in the spirit of forensic
analysis) reveals that there are some areas like share repurchase arrangements, significant
amounts charged to other comprehensive income, other operating income and gains
recognized on sale of the business in Hong Kong in China may indicate the potential fraud
i.e., since sales are falling, other income may be fraudulently increased through fair value
topic of convergence of accounting standards will provide streamlining many of the country
specific GAAP with IASs – thus providing an integrated framework for financial reporting.
Running Head: CFO PROJECT – MCDONALDS 17
The inadequacy of disclosures is one of the most frequently cited problem in the current
paradigm. Hence, the company should consider giving more detailed disclosures.
company’s top management philosophy and strategy. SOX and other related regulations has
made it mandatory for the board of directors to design and maintain an effective system for
internal control which identify and report deviations (whether due to fraud or error) in an
include lack of attention towards environmental management, keeping the same auditor since
1964, in-house internal auditing function which is not independent and complex executive
Incentive Plans (STIP) and Stock Option schemes the details of which are not fully disclosed.
recommendation section.
References
DiPiazza Jr, S. A., & Eccles, R. G. (2002). Building public trust: The future of corporate
reporting. John Wiley & Sons.
Singleton, T. W., & Singleton, A. J. (2010). Fraud auditing and forensic accounting (Vol.
Robinson, T. R., Hennie van Greuning, C. F. A., Henry, E., & Broihahn, M. A.
(2008). International financial statement analysis (Vol. 22). John Wiley & Sons.
Running Head: CFO PROJECT – MCDONALDS 18
Gray, R., & Milne, M. (2004). Towards reporting on the triple bottom line: mirages, methods
and myths. The triple bottom line: Does it all add up, 70-80.
Farber, D. B. (2005). Restoring trust after fraud: Does corporate governance matter?. The
Romano, R. (2004). The Sarbanes-Oxley Act and the making of quack corporate
Abbott, L. J., Parker, S., Peters, G. F., & Rama, D. V. (2007). Corporate governance, audit
quality, and the Sarbanes-Oxley Act: Evidence from internal audit outsourcing. The
Appendices
Horizontal Analysis
Consolidated Income Statement
2017 2016 2015 2014
REVENUES
Sales by Company-operated restaurants -16.8% -7.2% -9.3% -3.7%
Revenues from franchised restaurants 8.3% 4.5% -3.7% 0.4%
Total revenues -7.3% -3.1% -7.4% -2.4%
OPERATING COSTS AND EXPENSES
Food & paper -17.6% -11.8% -9.4% -3.6%
Payroll & employee benefits -14.7% -6.0% -7.5% -1.4%
Occupancy & other operating expenses -22.4% -8.9% -8.6% 0.2%
Franchised restaurants-occupancy expenses 4.2% 4.3% -3.0% 4.5%
Selling, general & administrative expenses -6.4% -2.0% -2.2% 4.3%
Other operating (income) expense, net -1636.6% -63.8% 1025.8% -107.5%
Total operating costs and expenses -21.4% -7.6% -6.3% 0.8%
Operating income 23.3% 8.4% -10.1% -9.3%
Interest expense-net of capitalized interest 3.9% 37.7% 12.4% 9.2%
Nonoperating (income) expense, net -1019.0% -87.0% -6162.5% -97.5%
Income before provision for income taxes 24.9% 4.7% -11.1% -10.1%
Provision for income taxes 55.1% 7.6% -22.5% -0.2%
Net income 10.8% 3.5% -4.8% -14.8%
Running Head: CFO PROJECT – MCDONALDS 20
Horizontal Analysis
Consolidated Statement of Cash Flows
2017 2016 2015 2014
Operating activities
Net income 10.8% 3.5% -4.8% -14.8%
Charges and credits:
Depreciation and amortization -10.1% -2.5% -5.4% 3.7%
Deferred income taxes -93.2% 38371.4% -98.5% -459.9%
Share-based compensation -10.5% 19.4% -2.5% 26.6%
Net gain on sale of restaurant businesses 272.0% 89.6% - -
Other 157.8% 19.4% -7.6% 1278.7%
Changes in working capital items:
Accounts receivable 114.3% -12.0% -768.9% -52.0%
Inventories, prepaid expenses and other current assets -232.7% -37.4% -1016.3% -89.0%
Accounts payable -166.5% -698.7% -79.9% 23.1%
Income taxes -333.6% -363.5% -2051.5% -102.1%
Other accrued liabilities -481.3% -90.0% -2778.3% -220.2%
Cash provided by operations -8.4% -7.3% -2.8% -5.5%
Investing activities
Capital expenditures 1.8% 0.4% -29.8% -8.5%
Purchases of restaurant businesses -29.7% -22.1% -17.5% -5.8%
Sales of restaurant businesses -0.1% 186.0% -15.4% -8.4%
Proceeds from sale of businesses in China and Hong Kong
Sales of property 101.2% -61.1% 145.5%
Other 124.6% 455.8% -51.8% -62.2%
Cash provided by (used for) investing activities -157.3% -30.9% -38.4% -13.8%
Financing activities
Net short-term borrowings 267.0% -148.5% 15.5% -373.7%
Long-term financing issuances 25.1% -63.0% 563.4% 8.7%
Long-term financing repayments 100.4% -22.0% 92.4% -21.2%
Treasury stock purchases -58.1% 83.2% 90.7% 79.9%
Common stock dividends 1.0% -5.3% 0.4% 3.3%
Proceeds from stock option exercises 52.6% -5.6% 34.7% 0.9%
Excess tax benefit on share-based compensation -100.0% -27.9% -23.4%
Other 583.3% -94.9% 358.6% 8.5%
Cash provided by (used for) financing activities -52.8% -1631.7% -115.9% 14.2%
Effect of exchange rates on cash and equivalents -354.6% -58.0% -53.2% -999.3%
Cash and equivalents increase (decrease) -117.0% -212.1% -878.0% -255.8%
Change in cash balances of businesses held for sale -200.0%
Cash and equivalents at beginning of year -84.1% 269.9% -25.8% 19.8%
Cash and equivalents at end of year 101.4% -84.1% 269.9% -25.8%
Supplemental cash flow disclosures
Interest paid 1.3% 36.3% 11.8% 7.6%
Income taxes paid 16.7% 20.3% -16.9% -6.2%
Running Head: CFO PROJECT – MCDONALDS 23
Industry
Description of ratio 2017 2016 2015 2014 2013
Average*
Liquidity & Efficiency
Current ratio 1.84 1.40 3.27 1.52 1.59 1.74
Cash to current liabilities 0.85 0.35 2.60 0.76 0.88 0.68
Cash Flow from operations (CFO) to revenue 24.3% 24.6% 25.7% 24.5% 25.3% 20.5%
CFO to total assets 16.4% 19.5% 17.2% 19.7% 19.4% 14.8%
Receivable Turnover (Times) 6.4 10.4 12.7 15.0 14.3 31.4
Inventory Turnover (Times) 68.6 83.1 55.5 55.7 51.4 42.9
Payables Turnover (Times) 4.4 6.5 6.3 7.1 5.9 12.1
Profitability
Return on Assets (ROA) 15.4% 15.1% 11.9% 13.9% 15.3% 10.4%
Return on Equity (ROE) -158.9% -212.6% 63.9% 37.0% 34.9% 33.3%
Return on Invested Capital (ROIC) 23.5% 23.5% 16.4% 19.2% 20.4% 21.0%
Net profit to gross profit 27.6% 23.8% 22.8% 22.3% 25.7% 23.7%
Gearing / Solvency
Debt ratio 87.4% 83.7% 63.6% 43.6% 38.6% 80.7%
Financial leverage (10.34) (14.07) 5.35 2.66 2.29 3.93
Debt to equity (9.12) (11.85) 3.44 1.18 0.90 1.24
Interest coverage 6.6 6.3 8.0 9.3 11.6 6.1
* Retrieved from IBIS, D&B, CSI Markets, Yahoo Finance and Morning Star.