Sainsbury and NHS - Assignment Example

?Table of Contents Introduction 2 Analysis 3 Sainsbury Key Financials 3 NHS Key Financials 4 Ratio Analysis 5 1 Short-term liquidity Analysis 5 1.1 Current Ratio 5 1.1.2 Liquidity Ratio 7 1.2 Capital Structure and Solvency 8 1.2.1 Capital Gearing Ratio 8 1.2.2 Solvency ratio 9 1.3 Profitability 10 Performance Analysis 13 Part 2 13 References 17 Introduction The paper analyzes Sainsbury and NHS based of their financial and accounting performances. First paper of the paper analyzes the financial performance of the two companies whereas the second part comments upon the accounting profit as a measure to the organization. This includes critical discussion on the relevance of accounting profit as a performance measure in an organization. The financial analysis of two companies would be based on the CORE framework. Sainsbury Plc is a company listed in London Stock Exchange and is engaged in primarily the retailing business. The other businesses of the company include financial services and retail investment businesses within UK (Sainsbury Annual Report 2010). With the help of e-commerce technologies, the company provides home-delivery shopping services to its customers through internet. With a market capitalization of 1.59 billion, the company currently operates in over 900 stores in and around UK. The company was incorporated in 1869 with headquarters in London (Sainsbury Annual Report 2010). National Health Service (NHS) was incorporated in 1948 in United Kingdom and is now the world’s largest publicly funded health service. The services of national health services are free of cost for anyone residing in UK.  It covers everything from antenatal screening to open heart surgery, accident and emergency treatment and end-of-life care (NHS Choices 2011). NHS is also certified with The Information Standard. NHS also has a fully functional website, which helps patients to provide online information and online services. A patient can have access to the medical advice through the website of NHS (NHS Choices 2011). It also has a symptom checker that can assist patients in determine their disease, by checking for the symptoms and matching it with their own level of comfort. Analysis Sainsbury Key Financials     31/03/2010   31/03/2009   31/03/2008   31/03/2007   31/03/2006   mil GBP mil GBP mil GBP mil GBP mil GBP             Turnover 19,964 18,911 17,837 17,151 16,061 Profit (Loss) before Taxation 733 466 479 477 104 Net Tangible Assets (Liab.) 7,918 6,954 6,850 6,680 7,746 Shareholders’ Funds 4,966 4,376 4,935 4,349 3,886 Profit Margin (%) 3.67 2.46 2.69 2.78 0.65 Return on Shareholders’ Funds (%) 14.76 10.65 9.71 10.97 2.68 Return on Capital Employed (%) 9.09 6.55 6.83 6.96 1.31 Liquidity Ratio (x) 0.41 0.30 0.40 0.50 0.68 Gearing (%) 63.81 66.09 44.54 65.97 169.92 Number of Employees 97,300 97,300 98,600 95,500 96,200 Top Grocery Stores Companies by Market Cap Company Symbol Price Change Market Cap P/E Tesco PLC TSCO.L 407.25  0.27% 10.87B 437.90 J Sainsbury PLC SBRY.L 341.90  0.06% 1.59B 236.77 Greggs PLC GRG.L 513.00  0.59% 1.53B 4,130.14 Wm Morrison Supermarkets PLC MRW.L 288.30  0.70% 1.53B 246.41 Ocado Group PLC OCDO.L 234.80  3.25% 1.22B N/A Wesfarmers Limited WESN.AX 33.31  0.42% 77.08B 41.40 Source: < http://in.finance.yahoo.com/q?s=SBRY.L> NHS Key Financials PROFILE 31-01-10 31-01-09 31-01-08 31-01-07 31-01-06 Turnover 214,300 248,000 236,100 241,300 246,300 Profit (Loss) before Taxation -8,700 -17,400 3,100 4,000 15,700 Net Tangible Assets (Liab.) 70,700 102,600 104,900 107,300 114,800 Shareholders’ Funds 71,100 102,200 117,000 119,700 125,900 Profit Margin (%) -4.06 -7.02 1.31 1.66 6.37 Return on Shareholders’ Funds (%) -12.24 -17.03 2.65 3.34 12.47 Return on Capital Employed (%) -11.90 -16.59 2.61 3.29 12.28 Liquidity Ratio 1.21 1.33 1.62 1.52 1.51 Gearing Ratio (%) 2.81 3.23 3.93 7.60 4.77 Number of Employees 3,173 3,407 3,247 3,183 3,082 Ratio Analysis For analyzing the financial performance of Sainsbury and NHS, ratios would be an effective tool of control. In the ratio analysis of 2 companies we would measure liquidity, profitability, and solvency as well efficiency of the companies thereby analyzing the measures and deriving conclusions. It would also analyze the trend of performance shown by the companies in past few years. This becomes a tool for forecasting the growth and looking for investment avenues as far as the 2 companies are concerned. 1.1 Short-term liquidity Analysis Liquidity refers to short term position of the company and short term liquidity analyzes whether the companies would be able to meet their short term liabilities or not. The primary measures of liquidity ratios are current ratio and quick ratio. These are analyzed as follows: 1.1.1 Current Ratio This indicates the ratio of current assets to current liabilities within the company. It exhibits the margin of safety that a firm has while it has to repay its short term liabilities. The current ratio of NHS and for Sainsbury over the 5 years was as follows: Comparing the current ratios of a public and private company it can be see that current ratio of the public company is certainly outperforming that of a private company. This could be primarily due to aggressive approach of private company compared to conservative approach of public companies. It could be seen that current ratio of NHS is well above the comfortable mark floating within the range of 2.21 to 1.93 in past 5 years. This is certainly a comfortable position for the company wherein it can payback it shot term creditors without defaulting. Compared to NHS, position of Sainsbury endangers short term liquidity crises for the firm. The current ratio of Sainsbury in past one year has never crossed one which indicates that the firm is not having enough current assets to pay for its current liabilities. It may well be the case that the company is financing its Working Capital through a long term loan which is a very pessimistic approach by Sainsbury. 1.1.2 Liquidity Ratio Along with the current ratio quick ratio gives an additional assurance regarding the short term position of a company by judging the quality of current assets that the companies are holding. Even though current assets are deemed to liquidate easily, inventory sometimes is not considered as a very liquid asset due to its reselling capacity. So while calculating quick ratio we deduct inventories from current assets to see if the company’s most liquid assets could payback short term liabilities or not. The liquidity ratios of NHS and Sainsbury for the past 5 years are as follows: The liquidity ratio of both the companies shows the mirror reflection of their position as in case of current ratios. The NHS is still at a very comfortable position with the ratio of 1.21 in 2010. But Sainsbury after the reduction of inventories had dipped its quick ratio to 0.41 endangering the company’s liquidity position. This is not a good sign for the company. Short term default could be very serious in nature if waivers are not obtained and in such case a firm may have to file reorganization through bankruptcy. 1.2 Capital Structure and Solvency Capital structure of a company measures the components of capital in its business. It is generally through debt and equity. Capital structure of a company has various implications with high debt increases the risk of bankruptcy or default whereas lower debt and higher equity increases the cost of capital for a firm. The right mix of capital structuring is very essential for a firm depending on its business, industry and target cost of capital. In capital structure and solvency analysis of 2 companies, we would analyze capital gearing ratio and solvency ratio of both Sainsbury and NHS. This is done as follows. 1.2.1 Capital Gearing Ratio This ratio measures the capital structure of the company by quantifying the equity with fixed return bearing debt of the company. It analyzes the relationship of long term sources of finance bearing fixed costs to equity. The Capital gearing ratio for the NHS and Sainsbury over the past 5 years is as follows: The capital gearing analysis of both the companies show high gearing impact on Sainsbury. The company had a capital gearing ratio of 63.81 in 2010 compared to 2.81 of that of NHS. The above figure shows the capital gearing ratio of the company for past 5 years. Though the pertinent mark for this ratio is considered to be 1 but both the companies have maintained above average ratio wherein Sainsbury having a very high ratio. This means that Sainsbury has a very low amount of fixed income bearing funds compared to equity sourcing in the company. 1.2.2 Solvency ratio Solvency ratio measures the nature and sources of finances for the company. It helps investors and prospective investors measure the performance of the company along with it ability to meet its long term commitments and obligations. The solvency ratios for Sainsbury and NHS over the past 5 years are as follows: This describes the solvency rations of NHS and Sainsbury to show the trend in past 5 years. 1.3 Profitability Profitability means excess of revenues after deducting the cost of revenues. Profitability ratios focus on sufficiency and sustainability of an entity’s earnings. Profitability ratios forms an important part of any business as it measures the capacity of firm to earn profit along with analyzing profit trends in past few years. There are three profitability ratios of a company namely gross profit ratio, operating profit ratio and net profit ratio. These are explained as follows: The primary measure of profitability is Gross profit ratio which analyzes the simple gross profit margin of the company. As revenues from product and services are the primary source of income for any company therefore it is highly necessary to measure the percentage margin between revenues and cost of goods sold. This decides on what surplus amount the company has in current fiscal for meeting other expenses like operating, interest and tax. The Gross income for NHS and Sainsbury are as follows: As we can see in the gross profit ratios illustrated above that there is significant different in the ratios of two companies and Sainsbury is certainly under pressure as far as these ratios are concerned. However NHS has maintained a very good gross profit ratio with consistency over the past 5 years. This shows complete monopoly of NHS in hospital chains in UK. In case of Sainsbury lower gross profit ratio could be seen as a result of high competition in retail segment because of giants like Tesco operating within the country. It could also be the case that the company is trying to play on volumes rather than margins. But still the company has to maintain a steady gross profit to meet other expenses. Other than gross profit ratio, the profitability of a company could also be analyzed through operating profit and net profit ratios. The operating profit analyzes the margin between the revenues and operating profit of the company whereas Net profit margin analyzes the net income of the company with respect to its revenues. These two ratios are very important to determine the quality of earnings of the company and is very influential from the point of view of an investor investing in the company. If a company is not making enough profit, it would hurt investor sentiment as it won’t be able to reward its shareholders by dividend neither by wealth appreciation. The net profit margin for Sainsbury as well as NHS Group for the period of 5 years is as follows: The net profit margin shows a bit surprising trend compared to that of growth profit margins. As seen above the growth profit ratio of NHS was well above 50% and that of Sainsbury is in the range of 5%-6%. But seeing at net profit it can be said that Sainsbury has maintained profitability in past 5 years whereas NHS has maintained positive net profits only 3 out of 5 years. NHS has displayed volatility in earning its net profits and has shown a decreasing trend with the net profit ratio of -4.06% in 2010. However in case of Sainsbury, net profit ratio has shown a constantly uptrend with 0.65% in 2006 to 3.76% in 2010. This shows high quality earnings of Sainsbury whereas high operating and non-operating expenses and volatility in earnings of NHS. NHS even being a market leader has been under pressure in terms of earnings whereas Sainsbury operating in high competitive environment wherein giants like Tesco and Wal-Mart eat through the market share has performed well. Performance Analysis NHS seems to be performing really well within all its operating segments with around 19-week of maximum waiting time within a year for meeting tough and challenging targets. The company has undergone a remarkable turnaround in the past couple of years from which it had overcome poor performance showing high accuracy of its systems. The doctors with NHS are highly qualified and probably one of the best in the medical industry in UK. Being directly under the department of health UK, the hospital has abundant resources which are provided to its customers at very lower costs as compared to most of the multi-specialty private hospitals. This is a major boom to the performance if NHS. The performance of Sainsbury is driven by quality of its operations. The company is second largest retail chain n UK after Tesco. It faces high competition from Tesco and Morrison which leads to squeezing of margin in the race to acquire customers. The company has been maintaining a low profitability through the last 5 years due to the on-going competition. Part 2 Accounting profit is the final profit of the company in accordance with GAP taking explicit costs of doing business, interest, depreciation and taxes. Some researchers and experts have always argued that accounting profit is the simple and most comparable measure for evaluating the performance of a company. As discussed above that accounting profit takes explicitly the charges for doing business therefore it shows the quality of earning a company is making. This figure could be rightly considered as the most comparable figure within the industry of within 2 companies analyzing their profit making capacity. It also highlights the performance of the company over the years based on these parameters. If a company is not making enough profit, it would hurt investor sentiment as it won’t be able to reward its shareholders by dividend neither by wealth appreciation. Andrade (1998) argues that accounting profit cannot be taken as a sole measure of performance of a film. It is argued that even though accounting profit is the most simple and comparable figure within companies, but it is a high probability that firms can window dress its financials for showing high accounting profit. This practice of known as earnings management by the companies and includes revenues as well as expense manipulation. Consider the example of Enron who had manipulated its earnings thereby showing high accounting profit. Even its independent accounting firm Arthur Anderson was not able to detect these malpractices of the company. Firms can cheat its investors by using such practices, therefore accounting profit as a sole measure of performance of company cannot be deemed to be effective measure. Gitman (2007) argues that along with accounting profit earnings quality and some other comparable measures should also be used for evaluating the performance of a firm. Economic Value Added (EVA) is regarded as a very prominent measure by analysts for measuring the quality of earnings by a company. EVA is considered an initiative towards measuring the economic profit of the company. The variables that are used in measuring this are the cash flows of the company, capital employed/utilized by the firm and opportunity cost of capital. This is a perfect measuring for analyzing economic benefits reaped out of a firm. Andrade (1998) also argues that using EVA as a persistent measure gives lower long term profits for any company. But still EVA along with accounting measure can be said as a full proof measure for evaluating the performance of companies. Some of the other methods for evaluating the earnings of a company are identifying and assessing the key accounting policies used by companies, evaluating the extent of flexibility in accounting displayed by the companies, analyzing the reporting strategies of the companies and identification as well as assessment of red flags. Assessment of accounting policy is highly required to measure the quality of earning or accounting policies by the company. Some of the majorly accessed policies include revenue recognition policies, expense recognition policies, impairment polices and sale and purchase of assets policies. Internal measures like accessing the mergers and acquisitions completed by the companies are also considered in this. Similarly flexibility in accounting principles is another thing to be noted in such cases. Segregating the profits of gross profits margins, operating profit margins and net profit margins are also effective measures within accounting profits to measure a firm’s earning performance. The primary measure of profitability is Gross profit ratio which analyzes the simple gross profit margin of the company. As revenues from product and services are the primary source of income for any company therefore it is highly necessary to measure the percentage margin between revenues and cost of goods sold. This decides on what surplus amount the company has in current fiscal for meeting other expenses like operating, interest and tax. Accounting profit could only be used as a short term measure of performance for a firm or a method of enriching the investor sentiments about the profits a company is making. But as far as long term evaluation of a company is concerned in depth, due diligence and earning analysis of the company is required for evaluating the performance to avoid cases like Enron and Satyam. In the previous decade before the enactment of SOX law in US, the companies in US use to manipulate in stock compensation expenses in lieu of making profits. The stock options were given to their employees and the option date given to the SEC was such that the stock price on that date would be lowest in 2 months thereby recoding in the money call option. This malpractice gave the advantage to companies for not recording stock based compensation expense in their financials. This was a mal-practice that was refrained from the enactment of SOX law in 2002 and many companies was inquired by SEC in regards to that. So if accounting profit is used as a sole way of measuring the performance of a company will an investor or an analyst be able to measure discrepancies and manipulations like these? The answer would be certainly no. Therefore according to me accounting profit of a firm cannot be regarded as the most simple and comparable measure of the performance of a firm. References Andrade G. & Kaplan, S.N., How costly is Financial distress [Journal]. - [s.l.] : Journal of Finance, 1998. - 53. Bragg Steven M. Business Ratios and Formulas [Book]. - [s.l.] : John Wiley and Sons, 2007. - Vol. 3. Gitman Priciples of Managerial Finance [Book]. - [s.l.] : Pearson Education, 2007. - Vol. 11/E. Hussain Ashiz A text book of business finance [Book]. - Nairobi : East African Educational publishers Ltd., 2006. 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