How Costo makes money

Understanding financial statements helps you understand how businesses make money. Let’s learn how to do that by reading Costco’s annual report.

Costco makes money by coordinating five roles:

1. Suppliers
2. Stores
3. Members
4. Employees
5. New Stores

1. Suppliers

Costco sources its merchandise from suppliers, but does so very differently from most retailers. By limiting itself to around 4,000 products and buying them in bulk through its own centralised teams, Costco gains pricing power that few competitors can match.

These purchases appear in the annual report as merchandise costs, showing what Costco paid suppliers for inventory over the year.

2. Stores

Costco sells its inventory through more than 900 warehouse stores worldwide, deliberately limiting product markups to never more than 14%. Limiting its supplier product mix allows Costco to pass savings to members, driving volume, scale and repeat purchasing. This flywheel is the Costco strategy.

These sales appear in the annual report as net sales. The profit Costco makes on those sales, known as gross profit, is calculated as the difference between net sales and merchandise costs.

3. Members

Costco charges members an annual fee, roughly $65, for the right to shop in its stores. In exchange, members receive low prices and clear value, which drives renewal rates of around 90%. Membership fees make up over 50% of Costco’s total profits.

These fees appear in the annual report as membership fees and are largely pure profit. This income subsidises low merchandise margins, drives loyalty and is core to its strategy.

4. Employees

Most of Costco’s non-merchandise operating expenses are spent on employees who run its stores and buying teams. Its warehouse model requires fewer staff, but Costco chooses to pay them significantly more than most retailers, resulting in lower turnover and higher efficiency.

11 of Costco’s 13 executive leadership team members started their careers at Costco. Its current CEO, Ron Vachris, started as a forklift driver.

If you hire good people, give them good jobs, and pay them good wages, generally something good is going to happen.

Jim Sinegal, Costco Co-Founder

These costs appear in the annual report as selling, general and administrative expenses.

5. New Stores

Costco reinvests the cash it generates from selling high-volume products and membership fees into new warehouses, including land, construction and equipment. This spending appears in the cash flow statement as additions to property and equipment.

Each new store increases scale, enabling Costco to buy more from suppliers who produce more efficiently, and pass those savings back to members.

6. Working capital and cash conversion

Costco is rarely out of pocket for the inventory it sells. Products typically sell before suppliers need to be paid, which reduces discounting, limits cash tied up in inventory, and supports close to 100% cash flow conversion of profit.

Inventory turnover and paying suppliers

Costco sells inventory quickly, with an average turnover of about 28 days, while paying suppliers on attractive 30 day terms. This balance allows Costco to treat suppliers with respect, unlikely retailers that stretch payments to 90 days or more.

Inventory turnover measures how often a company sells through its stock in a year. It is calculated by dividing merchandise costs from the income statement by average merchandise inventories from the balance sheet. In 2025, Costco’s inventory turned over about 13.2 times, meaning it sold through its inventory roughly once every 28 days.

Supplier payment terms can be inferred by comparing accounts payable on the balance sheet to merchandise costs on the income statement. This shows Costco pays suppliers in roughly 30 days.

In addition, deferred membership fees from the balance sheet also show that Costco benefits from members paying their annual membership fees upfront, which again helps fund cash payments to suppliers on attractive terms.

What really makes Costco valuable

Costco’s financial strength works because of its culture.

Costco’s mission is simple: to provide members with quality goods and services at the lowest possible prices.

To achieve that, it enshrines four key principles in its Codes of Ethics:

1. Obey the law
2. Take care of our members
3. Take care of our employees
4. Respect our suppliers

If Costco does those four things well, shareholders are rewarded as a result.

References

• Costco Annual Reports
• Costco Mission Statement & Code of Ethics