Grade: C — Some Red Flags, Investigate
Framework: Schilit *Financial Shenanigans* + Beneish M-Score + forensic accounting principles
Data: SEC EDGAR 10-K (Filed 2025-10-07) + Yahoo Finance
Auditor: KPMG LLP — Clean opinion
One-line verdict: Costco is one of the most predictable, cash-generative businesses in retail — $275.2B revenue, $8.1B net income, $13.3B operating cash flow, and 914 warehouses worldwide. The single red flag is technical: accounts receivable outpaced revenue growth for two consecutive years (A2 check). But with DSO at just 4.2 days and a business model where nearly all sales are cash or card at the register, this is a false positive driven by the small absolute AR base ($3.2B against $275B in revenue). The more meaningful signal is the SG&A/Gross Profit ratio at 70.6%, reflecting Costco's intentionally razor-thin margins — this is a feature, not a bug, of the membership warehouse model. With no goodwill, 0.6x Debt/EBITDA, and an M-Score of -2.66, Costco's earnings quality is among the cleanest in retail.
| Metric | Result |
|---|---|
| Red Flags | **1** |
| Watch Items | **1** |
| Checks Completed | **17/18** (1 N/A) |
| Beneish M-Score | **-2.66** (below -2.22 — unlikely manipulator) |
| F-Score (Fraud Probability) | **0.60** (0.22% probability) |
| Altman Z-Score | **2.66** (safe zone) |
| Auditor | KPMG LLP — Unqualified opinion |
| Fiscal Year | 2025 (52 weeks ended August 31, 2025) |
| Report Date | 2026-04-05 |
The Membership Warehouse Model
Costco's business model is elegantly simple, as the 10-K describes: "We operate membership warehouses and e-commerce sites based on the concept that offering low prices on a limited selection of nationally-branded and private-label products in a wide range of categories will produce high sales volumes and rapid inventory turnover."
The filing reports operating 914 warehouses worldwide at August 31, 2025, up from 890 at September 1, 2024, and 861 at September 3, 2023.
Revenue from the consolidated income statement:
| Line Item | FY2025 | FY2024 | FY2023 | YoY Growth |
|---|---|---|---|---|
| Net Sales | $269,912M | $249,625M | $237,710M | +8% |
| Membership Fees | $5,323M | $4,828M | $4,580M | +10% |
| **Total Revenue** | **$275,235M** | **$254,453M** | **$242,290M** | **+8%** |
The filing highlights: "Net sales increased 8% to $269,912, driven by an increase in comparable sales and sales at new warehouses; Membership fee revenue increased 10% to $5,323, driven by new member sign-ups and membership fee increases."
Geographically, the U.S. generated $200,046M in total revenue (73% of total) and Canada contributed $36,923M.
Profitability: Thin Margins by Design
| Metric | FY2023 | FY2024 | FY2025 | Trend |
|---|---|---|---|---|
| Revenue | $242,290M | $254,453M | $275,235M | +8% YoY |
| Gross Profit | $29,704M | $32,095M | $35,349M | +10% |
| Gross Margin | 12.3% | 12.6% | **12.8%** | Improving (+20bps) |
| Operating Income | $8,114M | $9,285M | $10,383M | +12% |
| Net Income | $6,292M | $7,367M | $8,099M | +10% |
| Net Margin | 2.6% | 2.9% | 2.9% | Stable |
| EPS (diluted) | — | $16.56 | $18.21 | +10% |
Per the filing: "Gross margin percentage increased 20 basis points; 11 basis points excluding the impact of gasoline price deflation on net sales." The improvement came from "increases in core merchandise categories and warehouse ancillary and other businesses."
"SG&A expenses as a percentage of net sales increased 11 basis points... three basis points excluding the impact of gasoline price deflation." SG&A expenses totaled $24,966M in FY2025 vs. $22,810M in FY2024.
Costco's margins are intentionally thin. The company uses membership fees ($5.3B, virtually 100% margin) to subsidize low product prices. This is not a weakness — it is the core competitive moat.
Cash Flow: Excellent Quality
| Metric | FY2023 | FY2024 | FY2025 |
|---|---|---|---|
| Operating Cash Flow | $11,068M | $11,339M | $13,335M |
| Net Income | $6,292M | $7,367M | $8,099M |
| **CFFO / Net Income** | **1.76** | **1.54** | **1.65** |
| CapEx | -$4,323M | -$4,710M | -$5,498M |
| Free Cash Flow | $6,745M | $6,629M | $7,837M |
Cash flow quality is outstanding. CFFO has exceeded net income in every year — ratios of 1.76, 1.54, and 1.65 over the past three fiscal years. The gap is driven by favorable working capital dynamics: depreciation and amortization of $2,426M, stock-based compensation of $860M, and the fact that Costco "often sell[s] inventory before we are required to pay for it, even while taking advantage of early payment discounts."
FCF of $7.8B comfortably exceeds net income. Capital expenditure of $5.5B reflects continued warehouse expansion (24 net new locations in FY2025).
The $15 Special Dividend and Shareholder Returns
The filing states: "Dividends in 2024 included a special dividend of $15 per share, resulting in a payment of approximately $6,655." In April 2025, Costco "increased our quarterly cash dividend from $1.16 to $1.30 per share."
The Board also authorized a $4,000M share repurchase program expiring January 2027. In FY2025, repurchases totaled $903M. Between special dividends, regular dividends, and buybacks, Costco returns substantial capital to shareholders — funded entirely by free cash flow.
Balance Sheet: Fortress
| Metric | FY2025 | FY2024 |
|---|---|---|
| Cash + Short-term Investments | $15,284M | $11,144M |
| Total Debt | $8,173M | $8,169M |
| Cash/Debt Coverage | 1.87x | 1.36x |
| Debt/EBITDA | 0.6x | — |
| Interest Coverage | 67.4x | — |
| Goodwill | $0 | $0 |
No goodwill. Zero. The cleanest balance sheet in large-cap retail. Costco has never pursued a major acquisition strategy. The filing shows long-term debt with "fixed interest rates was $5,805." The Altman Z-Score of 2.66 places Costco in the safe zone.
The filing discloses the fair value of long-term debt at approximately $5,370M and $5,412M for 2025 and 2024. "Repayments of long-term debt in 2025 totaled $103, as compared to $1,077 in 2024."
The 18-Point Screening
| # | Check | Result | Detail |
|---|---|---|---|
| A1 | DSO Change | PASS | DSO 4.2 days, change +0.3 days YoY. Near-zero receivables |
| A2 | AR vs Revenue Growth | **FAIL** | AR outpaced revenue for 2 consecutive years |
| A3 | Revenue vs CFFO | PASS | Revenue +8.2%, CFFO +17.6%. Cash exceeds revenue growth |
| B1 | Inventory vs COGS | PASS | Inventory -2.8% vs COGS +7.9%. Inventory well-controlled |
| B2 | CapEx vs Revenue | PASS | CapEx growth 16.7% vs revenue 8.2%. Warehouse expansion |
| B3 | SG&A Ratio | WATCH | SG&A/Gross Profit = 70.6%, exceeds 70% threshold |
| B4 | Gross Margin | PASS | Gross margin 12.8%, change +0.2pp. Stable |
| C1 | CFFO vs Net Income | PASS | CFFO/NI = 1.65. Strong cash backing |
| C2 | Free Cash Flow | PASS | FCF $7.8B, FCF/NI = 0.97 |
| C3 | Accruals Ratio | PASS | Accruals ratio = -6.8%. Negative — excellent |
| C4 | Cash vs Debt | PASS | Cash $15.3B covers debt $8.2B. 1.87x coverage |
| D1 | Goodwill + Intangibles | PASS | No goodwill. Clean balance sheet |
| D2 | Leverage | PASS | Debt/EBITDA = 0.6x. Interest coverage 67.4x |
| D3 | Soft Asset Growth | PASS | Other assets +3.8% vs revenue +8.2%. Normal |
| D4 | Asset Impairment | N/A | No write-off data |
| E1 | Serial Acquirer FCF | PASS | FCF positive after acquisitions (minimal acquisition activity) |
| E2 | Goodwill Surge | PASS | No goodwill |
| F1 | Beneish M-Score | PASS | M-Score = -2.66 (< -2.22). Unlikely manipulator |
A2 Red Flag Context: False Positive
The A2 fail (AR outpaced revenue for 2 consecutive years) warrants context. Costco's DSO is 4.2 days — nearly all sales are collected at the point of sale. The absolute accounts receivable balance is approximately $3.2B against $275B in revenue. Small percentage fluctuations in AR at this base can trigger the check mechanically. The DSRI component of the Beneish M-Score is 1.088 — slightly elevated but not alarming. With DSO at 4 days and no credit-based business model, this is a technical flag with no substantive concern.
Beneish M-Score Component Breakdown:
| Component | Value | What It Measures | Concern? |
|---|---|---|---|
| DSRI | 1.088 | Days Sales in Receivables | Slight increase, but DSO is 4 days |
| GMI | 0.982 | Gross Margin Index — margins improved | Good |
| AQI | 0.940 | Asset Quality Index — hard assets | Good |
| SGI | 1.082 | Sales Growth Index — 8% growth | Normal |
| DEPI | 1.008 | Depreciation Index | Normal |
| SGAI | 1.012 | SG&A Index | Normal |
| TATA | -0.068 | Total Accruals to Assets — negative | Excellent |
| LVGI | 0.940 | Leverage Index — deleveraging | Good |
Key Risks from the 10-K
1. California Concentration
The filing warns: "Within the U.S., we are highly dependent on our California operations, which comprised 26% of U.S. net sales in 2025. Our California market, in general, has a larger percentage of higher volume warehouses as compared to our other domestic markets."
2. Competitive Pressures on Margins
Per the filing: "factors that could adversely affect gross margin include... competitive pricing pressures, inflationary pressures, changes in the mix of products sold, issues with the quality and integrity of products sold, and changes in supplier arrangements." Costco's 12.8% gross margin has minimal room for error.
3. Labor and Inflation
SG&A expense growth outpaced revenue growth. The filing notes increasing compensation costs and a tight labor market. As a labor-intensive retailer, Costco faces persistent wage pressure.
4. Cybersecurity and IT Systems
The filing states: "Availability and performance of our IT systems are vital to our business. Failure to successfully execute IT projects and have IT systems available to our business would adversely impact our operations."
5. International Risks
Other International segment operations face "different cultures and languages, and uncertainty regarding the acceptance of our membership and warehouse model... currency and exchange rate fluctuations, and other potential disruptions."
Key Financial Trends (4-Year)
| Metric | FY2022 | FY2023 | FY2024 | FY2025 |
|---|---|---|---|---|
| Revenue | $226,954M | $242,290M | $254,453M | $275,235M |
| Net Income | $5,844M | $6,292M | $7,367M | $8,099M |
| Gross Margin | 12.1% | 12.3% | 12.6% | 12.8% |
| Net Margin | 2.6% | 2.6% | 2.9% | 2.9% |
| ROE | 28.3% | 25.1% | 31.2% | 27.8% |
| CFFO | $7,392M | $11,068M | $11,339M | $13,335M |
| CFFO/NI | 1.26 | 1.76 | 1.54 | 1.65 |
| FCF | $3,501M | $6,745M | $6,629M | $7,837M |
| Cash | $11,049M | $15,234M | $11,144M | $15,284M |
| Total Debt | $9,039M | $8,884M | $8,169M | $8,173M |
| Warehouses | — | 861 | 890 | 914 |
Summary
Grade: C. One technical red flag and one watch item — both easily explained by the business model.
Costco is a financial fortress. $13.3B in operating cash flow backs every dollar of the $8.1B net income with $1.65 in cash. There is no goodwill on the balance sheet. Debt/EBITDA is 0.6x with 67x interest coverage. The M-Score of -2.66 clears the company of manipulation concerns. The Altman Z-Score of 2.66 sits in the safe zone.
The A2 flag (AR outpacing revenue) is a technical false positive — with 4-day DSO and a cash-register-based business, there is no substantive receivables concern. The SG&A/Gross Profit ratio of 70.6% reflects Costco's deliberately thin margins: the company earns less than 13 cents of gross profit per dollar of sales, so even modest SG&A eats a large share of that.
The real story is Costco's durability: membership fee revenue grew 10%, comparable sales are positive, margins are slowly expanding, and the company returns billions to shareholders through dividends and buybacks. This is one of the cleanest earnings reports in the market.
**Disclaimer**: This report is based on Costco's fiscal year 2025 10-K filed with the SEC on October 7, 2025. This is NOT investment advice.
**About EarningsGrade**: We screen earnings reports for financial red flags using an 18-point forensic framework. Grade C means some red flags were detected that warrant investigation — in this case, the flags are technical in nature.