Financial statements are crucial in any business undertaking. They are records or registers showing how money has moved within the business enterprise or persons. They must be authentic, easy and presented in a manner that is clear to understand. In a nutshell quality should be upheld in coming up with these statements. The financial health of a business may be indicated by use of calculated financial ratios such as the profitability ratios, growth ratios, stability ratios and the shareholders returns ratios.
The authenticity of financial statements of any company depends on the techniques of measuring the trend and the performance of a company within the industry it operates. This paper will discuss the financial statements of two major listed companies; Sainsbury Ltd and its main competitor, Tesco company Ltd in the food retail industry using the financial ratios. The ratios were calculated using the company’s recent balance sheet and income statements of both Sainsbury Ltd and Tesco Company Ltd.
J. Sainsbury Ltd Background
The company is in the retail food industry, incorporated in 1922 and listed in the London stock exchanges market. It was started 125 years ago, and it is one of the largest food and wine retailer in Britain. According to a nationwide survey, it is the largest and the most respected retailer of food and wine. Sainsbury ltd has earned and retained top or near top ratings for services and product quality. Its overall financial performance, superior management, advertising, marketing and competitive pricing have made the company a market leader in the industry.
In the late 1970’s, due to forces and competition in the grocery industry, the company started programs of diversification as this competition threatened to squeeze their profit margins. It formed a joint venture with British Home stores which had a chain of hypermarkets. By 1980, it became a subsidiary. By mid 1990s, it had acquired many stores including Shaw’s Supermarkets, store in Massachusetts, New Hampshire and 50% of Giant Food Inc. its sale has been increasing drastically. By the end of 2001, the company had 453 outlets in UK and the second largest supermarket chain as it was undertaken by Tesco. It has over 141 000 employees and sales of £10.6 billion (Drake & Fabozzi, 2010).
Tesco Company Background
Tesco is a listed food retailer company which operates 923 stores in UK and oversees countries. Out of this 702, stores are in the UK. Currently it employs about 240,000 people. In the 1990s, it used to be behind Sainsbury, but now it is the leading in the UK market with the largest market share. It has a market share of 16.2% in the countries it operates and 4% market share in UK with is worth 25 billion. It has expanded its markets by opening up new stores in Asia and Central Europe (Drake & Fabozzi, 2010).
In this section, financial statements will be analyzed through the use of financial ratios of Sainsbury ltd Company in 2010 and the preceding year 2011. In this case, the performance of Sainsbury is compared with that of its competitor, Tesco, and the trend it has been following. Financial ratios are the performance indicators which can be used by management in their decision making by the investors when making investment decisions. A number of ratios which are to be used in our financial analysis such profitability ratios, asset utilization ratios, liquidity ratios, growth ratios and stability ratios. In addition, all the ratios and calculations of financial analysis are shown in the appendices.
The main objective of the Sainsbury ltd is to maximize profit while minimizing cost thus this ratio is a good indicator if the company is achieving its objective. Profitability ratios measure how the company is fairing in making returns and profits.
Gross Profit Ratio
This indicates the gross profit earned from the total sales made. In 2010, Sainsbury’s sales profit was 4.4% of the sale, and in 2011, profit rose to 4.5%, thus indicating an improvement although slight change. This can be an improvement in the management of cost of sale (purchases and stock). It competitor Tesco was doing much better with a profit of 8% from its sales in 2010 and 2011. Thus, Sainsbury showed potential for improvement to compete effectively with Tesco (Kramer & Johnson, 2009).
Net Income to Sales Ratio
This ratio indicates how the company is making a profit out of sales. This is a better indicator of firm profitability as it includes the expenses made in making sales. Sainsbury made profit which was 2.1% of the net sales in 2010, and 2.95 of the net sales in 2011. This marked an increase in realized net income from the sales. This also indicated that it was improving in managing sales expenses. Tesco had a high profitability ratio than Sainsbury of 5.6% and 5.8% in 2010 and 2011 respectively. Thus, this indicated thatSainsbury was behind it competitor and efforts should be made to increase sales relative to its expenses or manage its expenses.
Return on Assets Ratio (ROA)
This indicates the effectiveness in utilization of assets in generation of returns before the contractual payments is made (Fraser & Ormiston, 2008). Sainsbury had a return of 7.9% from its total assets in 2010, and a return of 11% in 2011 from its assets. This indicated an improvement in utilization of its assets. Tesco had 8.2% and 8.5% in 2010 and 2011 respectively. This indicates that Sainsbury is more efficient in using its assets to generate profits in that industry.
Return on Equity (ROE)
This ratio indicates and measures the returns made on the shareholder fund; for instance how much return does the shareholders fund generate? The high returns indicate that the shareholders funds are being efficiently utilized. Sainsbury has an increase in this ratio from 11.8% to 16.3%. Potential investors are much interested with this ratio as it shows them how their funds generate returns. Tesco has a much higher return on equity and investors may prefer it to Sainsbury. Its ROE is 23% for both years.
Trend in the company’s ROE ratio
Asset Utilization Ratios
These ratios indicate how the assets of the company are being utilized in generating returns. They include:
This ratio indicates the number of times the company manages to sell its finished good stock within a financial year. Drake & Fabozzi (2010) observe that high stock turnover has a direct indication of efficient management of stock. This may include minimization of obsolete stock and stock out costs. On the other hand, low stock turnover indicates inefficiency in stock management which may include high purchasing costs and slow moving stock. This ratio also indicates the number of days the inventories are held before being sold. Sainsbury has decreased the number of days of holding finished goods in storage before being sold from 29 to 26 days in 2010 and 2011 respectively. Its competitor, Tesco improved from19 days in 2010 and 12 days in 2011. Thus, this shows that Tesco is more efficient in management of its stock.
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These ratios measure the liquidity of a firm on a daily basis. They measure the ability of a company to meet its financial obligations and short term financial obligations. They are essential to the company creditors as these indicate the firm’s risk in meeting their financial obligation. The most used liquidity ratios are the current ratio, quick ratio and the working capital.
It is a ratio of current assets to current liabilities. High current ratio indicates lower risk to people extending short term credits to the firm. On the other hand, owners of equity prefer lower current ratio as this indicates that the firm is using the assets to grow the business (Drake & Fabozzi, 2010). Different industries prefer different current ratio. In the food retail industry, a high current ratio will be preferred. The problem with the use of current ratio is that the stock may be difficult to liquidate as required or may have uncertain values for liquidation. Sainsbury has a current ratio of 0.35 in 2010 and 0.42 in 2011. Thus, increase in current asset to current asset. On the other hand, Tesco has a high current ratio of 0.73 in 2010 and 0.65 in 2011. Short term creditors may prefer giving Tesco credit to Sainsbury. Shareholders may prefer Sainsbury to Tesco.
The ratio is a good indicator of a company’s liquidity position, and the ability to meet its short term financial obligations. Company financial statistics shows that Sainsbury quick ratio has significantly improved steadily over the past three years from 1.27 in 2009 to 1.44 in 2011.
Trend in the Company’s Quick Ratio
The analysis reveals the ratio is likely to improve, further, in the future as the company continues to hold significant liquid funds in the form of insurance. The increase in quick ratio implies a lower liquidity risk to the company, since the higher the ratio the higher the company’s working capital (Drake & Fabozzi, 2010). The industry quick ratio is of between 1 and 2. In our scenario, Sainsbury has a quick ratio of 0.14 in 2010 and 0.218 in 2011. This is below the industry quick ratio. The company has improved in 2011. Tesco is better off as it has a quick ratio of 0.73 in2010 and 0.65 in 2011. Both the companies may have financial problems when it comes to payments of financial obligations as they fall due.
This measures the company’s efficiency and ability to pay its short term financial obligations. AA company is healthy financially if it has a positive working capital. When it has a negative working capital, it means that it cannot meet its short term financial obligation using its current assets. This can also be used to indicate the signs of bankruptcy. In this case, Sainsbury has a negative working capital in both years that is -2188 in years 2010 and -2280 in years 2011. This is because the firm’s sales volume are decreasing; hence debtors are becoming smaller and smaller. A higher working capital may also be a sign of inefficiency. A lot of cash may be held idle instead of being used in expanding the business. Its rival also has a negative working capital in both years of -4250 in 2010 and -6293 in 2011 (Fraser & Ormiston, 2008).
This ratio measures the financial leverage of a firm. It shows the degree to which the firm’s activities are financed by the owner equity versus creditor’s funds. The higher this ratio is the risky the firm is. The firm with high leverage is more vulnerable to the business cycle downturns as the company has to pay their debt regardless of how sales are. In this case, two ratios have been used to explain the leverage. These are the debt/equity ratio and the leverage ratio. Sainsbury has a lower debt equity ratio of 0.25:1 in 2010 and 0.228:1 in 2011 marking a reduction in the long term loans. Thus, the firm is less risky compared to Tesco which has a higher debt equity ratio of 0.8:1 in 2010 and 0.5:1 in 2011. The two companies are doing well as their ratios are below 1:1 (Kramer & Johnson, 2009).
Using the leverage ratio, Sainsbury had a lower leverage ratio of 6.1% in 2010 and 6.2% in 2011. On the other hand, Tesco had a leverage ratio of 41.4% in 2010 and 39.9% in 2011.
This ratio measures how the company is growing in terms of assets, sales and profit in our scenario, we analyze the sales growth, profit growth and asset growth of Sainsbury.
Sainsbury has a profit growth of 16% in year 2011 compared to 2010 (from 16.5% in 2010 to 32.5% in 2011). This may be attributed to increase in efficient management of the company. On the other hand, Tesco also had a profit growth of 2.4 % (10.2% in 2011 and 7.8% in 2010). Investors are extremely concerned with this ratio as it measures the ability of the company to pay them their dividend as this must be paid from the retained earnings. The more the profit a company makes, the more the retained earnings. Both Tesco and Sainsbury are listed in the stock exchange market thus they should be concerned on their profit growth.
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Sainsbury has a slight increase in the sale of 1% in the year 2011 i.e. from 5.6% in 2010 to5.7% in2011. Efforts should be made to increase their sales as it rival is doing better than it. Tesco has an increase in the sale of 2.3% from 4.8% in2010 to 7.1% in 2011. Sales growth should be proportional to profit growth. In this scenario, this is not the case. Profit growth is much higher than the sales growth.
Sainsbury has a negative asset growth of 15% in 2011. This may due to disposal of some fixed assets or reduction of accounts payables or reduction of stock at the year end. Asset growth should be proportional to sales and profit growth. Firm’s asset growth has an explanatory power for the firm’s future returns. A firm with higher asset growth is associated with higher future returns. Sainsbury competitor, Tesco has an asset growth rate of 2.6% in2011 compared to its growth rate of 0.07% in 2010. Tesco is thus in a better position to have higher returns in future than Sainsbury.
In conclusion, Sainsbury is performing better in terms of asset utilization than its counterpart Tesco Company. In terms of profitability, the management of Sainsbury should put in place policies to increase profitability level. In terms of liquidity, Tesco is more liquid than Sainsbury thus has an ability to cater for its short term financial liabilities as they fall due. Sainsbury is under financial risk and management should also take effective measures on their current assets and current liabilities.
A critical analysis of Sainsbury’s financial statement populates that the company has sound liquidity and profitability positions as indicated by its quick ratio and gearing respectively. In addition, the company has a relatively stable, though slightly declining leverage. However, the company’s P/E ratio is fast declining.
In terms of investment opportunities, Tesco Company needs to work to improve its P/E ratio. This can be done by taking necessary steps to either improve the market price of its shares or reduce its EPS. Also, the company needs to minimize debt financing, and seek for alternative financing such as asset finance. In order to maintain its liquidity, the company needs to, properly, identify and mitigate liquidity risks. To improve its profitability, the company needs to carefully work on matters of quality, and adopt effective cost minimizations strategies.
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