Understanding and interpreting financial statements - Dissertation Example

?Introduction There are thousands of companies doing business around the globe. A lot of these multinational corporations are public enterprises. A pubic company is a firm whose stocks are traded in financial marketplaces such as the London Stock Exchange (Investorwords, 2011). Public companies are required by regulatory agencies to release financial statements at least once a year. Most companies release their financial statements on a trimester basis. The four major financial statements are the income statement, balance sheet, statement of retained earnings, and statement of cash flow. The information contained in the financial statements can be used by financial analysts to perform ratio analysis. The purpose of this paper is to analyze the financial performance of Morrisons Inc. Company Profile: Morrisons Morrisons was founded in 1899 by William Morrison. The first supermarket chain was opened in 1961. Today the company has become the 4th largest supermarket retailer in the United Kingdom (Morrisons, 2011). The initial public offering of the company occurred in 1967. The company serves over 10 million customers each week across its network of 382 stores. Morrisons helps the United Kingdom’s economy by providing the community with 124,000 jobs. One of the aspects of the Morrisons operation that makes this company different is that the firm owns its supply chain logistics. The company has its own packing facilities, baking capabilities, distribution centers, and fleet of trucks to deliver fresh goods to its stores (Annual Report: Morrisons, 2009). Ratio Selection The use of ratio analysis can help a person evaluate the financial performance of a company. To perform ratio analysis one must retrieve the financial statements of the company. The two financial statements that are mostly used when performing ratio analysis are the income statement and the balance sheet. There are different categories of ratios that an analyst can utilize. The five categories of ratios are profitability, solvency, efficiency, liquidity, financial gearing, and investment. To evaluate Morrisons this paper uses a variety of financial ratios from the different categories mentioned. A profitability ratio that will be used in the paper is net margin. Net margin is calculated dividing net income by sales (Besley & Brigham, 2000). It is preferable to have a high net margin because higher net margins imply that the company is more profitable. Another profitability ratio of importance is the gross profit. The gross profit is calculated with the following formula. (Sales – CGS) / Sales (Weygandt & Kieso & Kimmel, 2002). High profit margins are preferable. Two additional metrics that will be used to evaluate Morrisons is return on assets and return on equity. Return on assets is calculated dividing net income by total assets, while return on equity is calculated dividing net income by total equity (Dictionary, 2011). An efficiency ratio that will be used to evaluate Morrisons is sales revenue per employee. Obtaining high sales revenue per employee is preferable because it implies that each employee of the company is helping the firm generate more money. Another efficiency ratio that will be used in the analysis of Morrisons is sales revenue to capital employed. The ratio is calculated dividing revenues by capital. A liquidity ratio that was selected for the Morrisons ratio analysis was the current ratio. The current ratio determines the capabilities of the company to pay off its short term debt (Investopedia, 2011). The formula to calculate current ratio is current assets divided by current liability. Two gearing ratios that will be used in the analysis of Morrisons are the debt ratio and the debt to equity ratio. The debt ratio is calculated by dividing total assets by total liabilities. The debt ratio measures the ability of the company to pay off its long term debt (Garrison & Noreen, 2003). The debt to equity ratio is calculated dividing total assets by total equity. The investment ratios chosen to perform the ratio analysis on Morrisons were earnings per share (EPS) and price earnings ratio. Trend analysis Morrisons in fiscal year 2009 generated sales of ?14,528 million. This sales figure represents a 12% increase in comparison with 2008. The net income of the company in 2009 was ?460 million dollar. The net income of the company in 2008 was ?554 million. This implies that the net income of the company decreased by ?94 million or 16.97%. The reason the company had a lower net income despite having higher sales is because the operating costs of the company went up. The cost of goods sold and administrative expenses of the firm went up in 2009 in comparison with the previous year. The cost of goods sold went up by 12.05%. Rising operating costs is a negative sign in a company. The total assets of the company in 2009 were ?8226 million. The firm’s asset account increased by ?590 million in comparison with 2008. An important asset account is the cash balance of the company. Cash is so important because without access to cash a company becomes insolvent. The cash balance of the company in 2009 was ?327 million. Morrisons cash balance increased by 71.2% in comparison with the previous year. The total debt of the company in 2009 was ?3,706 million. The total debt of the company rose by ?448 pounds in comparison with 2008. The total equity balance of the company in 2009 was ?4520. The company experienced an increase in equity in comparison with 2008 of 3.24%. Ratio Analysis A ratio analysis of Morrisons is provided in this section of the report. In order to determine if the ratios of the company are good or not it is good to compare the ratios of the firm with another competitor in the same industry. The company that was selected to compare the ratio results of Morrisons was Tesco. Tesco is the third largest food retailer in the world (Annual Report: Tesco, 2009). The net margin of Morrisons in 2009 was 3.16%. Tesco had a net margin of 3.98%. The performance of Morrisons was inferior in comparison with Tesco. The profit margin of Morrisons in 2009 was 6.28%. Tesco had a profit margin in the same period of 7.77%. The profit margin of Morrisons is inferior to Tesco by 1.48%. The return on assets of Morrisons for 2009 was 5.59%. The return on assets of Tesco for 2009 was 4.70%. Morrisons performed better than Tesco in terms of ROA by 0.89%. The return of equity of Morrisons in 2009 was 10.17%. Tesco had a return on equity of 16.66%. The return on equity of Tesco was better than Morrisons by 6.49%. The revenue per employee of Morrisons in 2009 was $1,171,161. The revenue per employee metric of Tesco in 2009 was $1,155,589. The revenue per employee metric of Morrisons was better by $15,572. This implies that Morrisons is generating more revenue for each employee it hires than Tesco. The sales revenue to capital employed of Morrisons was 3.21. The sales revenue to capital employed metric of Tesco was 4.18. The sales revenue to capital metric of Tesco is superior by 0.97. The current ratio of Morrisons in 2009 was 0.53. The metric is a little low since is below the desired 1.0 threshold. The current ratio of Tesco in that same period was 0.78. Tesco is in a better position to pay off its short term debt. The debt ratio of Morrisons in 2009 was 2.22. Due to the fact that the metric is well above the 1.0 threshold the firm is in a good position to pay off its long term debt. The debt ratio of Tesco in 2009 was 1.39. The debt ratio of Morrisons is better that Tesco’s by 0.83. The debt to equity ratio of Morrisons in 2009 was 0.82. Tesco had a debt to equity ratio in 2009 of 2.54. Morrison financed its operation more with equity than Tesco. The diluted earnings per share of Morrisons in 2009 was ?17.16. The EPS of Tesco in that same period was ?27.31. Tesco had a better EPS metric by ?10.15. Investors prefer to invest in companies that have higher earnings per share. The price to earnings ratio of Morrisons in 2009 was ?16.09. The price to earnings ratio of Tesco in 2009 was ?14.24. Morrisons had a better price to earnings ratio by ?1.85. Discussion Limitation Ratio Analysis The use of ratio analysis can help investors and users of financial information analyze the financial condition of a company. Despite the benefits associated with ratio analysis there are also limitations. One of the limitations of ratio analysis is that the ratios cannot be used to predict the future performance of a company. Another limitation of ratio analysis is that it is based solely on quantitative analysis. Information that might influence the financial performance of a company such as a pending lawsuit against the firm is not considered in ratio analysis. A third limitation of ratio analysis is the quality and reliability of financial information. A fourth factor that can affect ratio analysis is the presence of inflation. Inflation can distort a ratio analysis. Ratio analysis can only provide a limited picture of the financial performance of a firm. A fifth limitation of ratio analysis deals with information problems. Sometimes outdated information is presented in the financial statements of a company (Blurit). Conclusion Morrisons is a company that was able to generate a positive net income in 2009 despite the recessionary forces in the marketplace. The ratio analysis realized on the company revealed that the firm had an inferior financial performance than Tesco in most aspects. The profitability ratios of Tesco were better except in the return on assets. The only metric that I identified as being very poor was the current ratio of Morrisons. The reason this metric is so important is because it determines the ability of the company to pay off its short term debt. Ironically the firm had an excellent debt ratio. Morrisons was getting more production out of its employees than Tesco. Overall despite the fact that Morrison performed worst than Tesco in the ratio analysis I would consider the Morrisons a good buy based on the trend analysis and the fact that company did not lose money in 2009. Appendix A: Ratio analysis comparison: Morrisons vs. Tesco Morrisons Tesco Net margin 0.03 0.04 Profit margin 0.06 0.08 ROA 0.06 0.05 ROE 0.10 0.17 Sales to capital 3.21 4.18 Current ratio 0.53 0.78 Debt ratio 2.22 1.39 Debt to Equity 0.82 2.54 Price to earnings 16.09 14.24 EPS 17.16 27.31 Revenue per employee 1171161 1155589 References Annual Report: Morrisons (2009). Investors. Available from [Accessed 24 March 2011] Annual Report: Tesco (2009). Investor Centre. Available from [Accessed 24 March 2011] Besley, S., Brigham, E. (2000). Essentials of Managerial Finance (12th ed.). Forth Worth: The Dryden Press. Blurit.com. What is Ratio Analysis? What are Its Limitations? Available from [Accessed 24 March 2011] Dictionary.com (2011). ROA. Available from [Accessed 24 March 2011] Garrison, R., Noreen, E. (2003). Managerial Accounting (10th ed.). Boston: McGraw-Hill Irwin. Investopedia.com (2011). Current Ratio. Available from Investorwords.com (2011). Public Company. Available from [Accessed 24 March 2011] Morrisons.com (2011). Company History. Available from [Accessed 24 March 2011] Weygandt, J., Kieso, D., Kimmel, P. (2002). Accounting Principles (6th ed.). New York: John Wiley & Sons. Read More