McDonald's vs. Wendy's - Inventory Case Study

Investing Lesson 3 - Analyzing a Balance Sheet

Calculating Inventory Turnover on the Balance Sheet - McDonald's Example
Inventory turn, or inventory turnover, tells you how fast a company sells through the inventory on its balance sheet. The faster, the better because that ties up less money, freeing up cash for other investments. McDonald's Corporation

When I first wrote this investing lesson on balance sheet analysis more than fifteen years ago, I originally had a discussion about inventory turn in this section using two of the world's most prominent fast food franchises, McDonald's and Wendy's.  In the time that has passed, both have transformed.  McDonald's conducted a split-off of Chipotle Mexican Grill, making it an independent company, while Wendy's was acquired by roast beef chain Arby's, which then reorganized the business, sold the Wendy's division to Roark Capital Group in Atlanta, and emerged as a "new" Wendy's.

 (If you pull the Form 10-K for Wendy's for the present Wendy's Company, you're not going to get the figures I used in this lesson because the old Wendy's - the one Dave Thomas started - is now non-existent and buried in the SEC archives.  You'd have to dig.  Instead, you'd really be looking at the Arby's historical figures.  It's one of those life-is-stranger-than-fiction things.  Wall Street is no more or less immune to it than anywhere else people are involved.)

In any event, as I revisit and update my discussion on inventory turn on the balance sheet, the concept itself is timeless so I've decided, partly for the sake of simplicity and partly for the sake of nostalgia, to leave the old figures from the original lesson here as the practice calculation, pulling from the years 1999 and 2000.  The inventory turn calculation hasn't changed, so there is no disadvantage to doing so.  

Calculating Inventory Turn By Comparing McDonald's and Wendy's

It's easy to see how a higher inventory turn than competitors translates into superior business performance.

McDonald's is unquestionably the largest and most successful fast food restaurant in the world. That shows up in the historical numbers; the superior execution, the better returns on capital, the benefits of its real estate structure.

Use the inventory turn formula (cost of goods sold divided by the average inventory values) to come up with the number of inventory turns for each business using the historical balance sheets at the bottom of this page.

Have your answers?  Good.

If you did the math correctly, you'd have calculated that between 1999 and 2000, McDonald's had an inventory turn rate of 96.1549, incredible for even a high-turn industry such as fast food. This means that every 3.79 days, McDonald's goes through its entire inventory. Wendy's, on the other hand, has a turn rate of 40.073 and clears its inventory every 9.10 days.

This difference in efficiency can make a tremendous impact on the bottom line (and it did). By tying up as little capital as possible in inventory, McDonald's can use the cash on hand to open more stores, increase its marketing support, or buy back shares. It eases the strain on cash flow considerably, allowing management much more flexibility in planning the future of the business.  This is a positive for long-term investors.

Some Final Thoughts on Balance Sheet Inventory

In most cases, investors want as little money as possible tied up in inventory. It is fine to have a lot of inventory on the balance sheet if it is being sold at a fast enough rate there is little risk of becoming obsolete or spoiled or there is some major competitive advantage in keeping a large stockpile but those are usually not the case.

Great companies have excellent inventory handling systems so they only order products when they are needed, seeking to never buy too much or too little of something. Businesses that have too much inventory sitting on the shelves or in a warehouse are not being as productive as they could be.  Had management been wiser, the money could have been kept as cash and used for something that benefited shareholders more.

McDonald's vs. Wendy's Inventory Turnover Calculation

McDonald's
 20001999
Inventory on Balance Sheet$99,300,000$82,700,000
Cost of Goods Sold on Income Statement$8,750,100,000 
   
Wendy's
 20001999
Inventory on Balance Sheet$40,086,000$40,271,000
Cost of Goods Sold on Income Statement$1,610,075,000