Understanding and interpreting financial statements - Coursework Example

? work one: Understanding and interpreting financial ments Inserts His/Her Inserts Grade Inserts Tutor’s Name 3 April 2011 ABSTRACT Financial Statement Analysis involves the careful selection of data from the financial statements in order to assess and evaluate the firm’s historical financial performance (Bernstein, 1993). The study focuses on the performance of Morrison’s and Tesco companies for 2008 and 2009. Morrison’s is one of the top Grocery Chains in the United KingdoThe financial statement analysis centers on the four groups of ratios. The four groups are Turnover, Solvency, Profitability, and Liquidity. Tesco performed financially better than Morrison’s. INTRODUCTION Financial Statement Analysis involves the careful selection of data from the financial statements in order to assess and evaluate the firm’s historical financial performance (Bernstein, 1993). The study focuses on the performance of Morrison’s and Tesco companies for 2008 and 2009. The financial statement analysis is based on the financial statements of both Morrison’s and Tesco companies. The four groups are Turnover, Solvency, Profitability, and Liquidity (Chapman, 2007). Reasons for using ratio analysis. The financial statement ratio analysis is conducted to compare the financial performance of Morrison’s and Tesco over time (2008 and 2009). Both companies are competitors in the United Kingdom Grocery Chain market segment. The financial statement analysis is used to aid management or any interested party to make more informed decisions. Ratio analysis is a better alternative when compared to using pure hindsight, gut feeling, or plain guesswork in terms of making decisions. According to Gibson (2008), financial statement analysis is useful in improving all decision making activities. Since, the financial statement ratios are taken from both company’s audited financial reports, the analysis is based on actual economic (buy and sell, etc.) conditions occurring in the United Kingdom during 2008 and 2009. Economic conditions include supply, demand, equilibrium, scarcity, opportunity cost, and government (tax and other legal interventions) conditions (Baumol, 2009). Brief description and justification of the ratios The financial statement ratios used in the Morrison’s research are divided into four sections. Liquidity ratios provide information about the firm’s ability to pay its current obligations and continue operations; In terms of justification, the ratios will indicate whether the company has to find other sources of cash inflows to pay for the company’s maturing obligations. The leverage ratios measure the company’s use of debt to finance assets and operations; in terms of justification, the ratios would help determine the feasibility of increasing, decreasing, or retaining the company’s current debt structure. The cost management ratios measure how well a company controls cash; in terms of justification, the ratios will be used as a basis for improving current cash management policies. The profitability ratios measure earnings in relation to some base, such as assets, sales, or capital. The profitability ratios will justify if the company passed (reach benchmark in generating profits) or failed (generated loss) in the prior accounting period. Financial statement analysis is profitable complement to other decision making tools (Besley, 2008). Critical evaluation of the Limitations of the Analysis with regards to both the available information and the generic limitations of Ratio Analysis There are limitations on the comparison of the financial statements of the two companies with regards to both the available information and the generic limitations of ratio analysis. The preparation of financial statement ratios would be a failure. First, the financial statement data of both Morrison’s and Tesco may be erroneous Second, both companies may be using different accounting principles. To remedy the situation, the industry ratio trends can help to alleviate the variance. However, each accountant is biased in terms of compliance with accounting standards. Accounting scandals that include Enron WorldCom prove that financial statement information should be taken as biased (Feldman, 2007). Consequently, the financial statement ratios should serve as a starting point or complement to other more reliable tools in the decision making process, not as a sole basis for one’s decision making activities. Calculation of the Ratios and Findings of Analysis with Appropriate Conclusions Gross Profit Ratio The gross profit ratio measures the relationship between gross profit and the net revenues. Based on the above computation, the gross profit ratio of Tesco remained fixed at 8 percent for the years 2008 and 2009. Likewise, the above computation shows Morrison’s generated gross profit ratios of 6 percent for the same two years. The above computation shows that Tesco did financially better than Morrison’s (Warren, 2009). Operating Margin Ratio The operating profit ratio measures the relationship between net profit and the net revenues. Based on the above computation, the net profit ratio of Tesco declined from its 6 percent figure to only 5 percent in 2009. Likewise, the above computation shows Morrison’s generated net profit ratios of 5 percent for the same two years. The above computation shows that Tesco did financially better than Morrison’s (Feldman, 2006). Profit After Tax Ratio The profit after tax ratio measures the relationship between the net incomes of both companies after deducting taxes incurred to the net revenues. Based on the above computation, the profit after tax of Tesco declined from its 5 percent figure to only 4 percent in 2009. Likewise, the above computation shows Morrison’s generated net profit after tax ratio of 4 percent for 2008 had declined to only 3 percent in 2009. The above computation shows that Tesco did financially better than Morrison’s (Maguire, 2007). Fixed Asset Turnover Ratio The fixed assets turnover ratio measures how much sales was generated by the use of the fixed assets. Based on the above computation, fixed asset turnover ratio of Tesco declined from its 2.39 figure to only 2.35 in 2009. The above computation shows Morrison’s generated fixed assets turnover ratio of 2.09 for 2008. The figure increased to a higher 2.21 figure in 2009. The above computation shows that Tesco did financially better than Morrison’s (Hilton, 2007). Current Asset Turnover The current assets turnover ratio measures how much sales was generated by the use of the current assets. Based on the above computation, current assets turnover ratio of Tesco declined from its 7.89 figure to only 3.98 in 2009. The above computation shows Morrison’s current assets turnover ratio of 14.25 for 2008. The figure decreased to only 13.63 figure in 2009. The above computation shows that Morrison’s did financially better than Tesco (Khan, 2006). Working Capital Turnover The working capital ratio measures if there are enough current assets available to pay for the maturing current liabilities (Hansen, 2006). Based on the above computation, working capital turnover ratio of Tesco increased from its 11.93 figure to the higher 13.60 in 2009. The above computation shows Morrison’s generated negative working capital turnover ratio ratios for the years 2008 and 2009. The 2008 figure decreased during 2009. The above computation shows that Tesco did financially better than Morrison’s. Capital Turnover The fixed assets turnover ratio measures how much sales was generated by the use of capital investments (Helfert, 2007). Based on the above computation, the capital turnover ratio of Tesco declined from its 2008 figure of 2.79 to only 2.67 in 2009. The above computation shows Morrison’s generated capital turnover ratio of 2.36 for 2008. The figure increased to a higher 2.54 figure in 2009. The above computation shows that Tesco did financially better than Morrison’s (Maguire, 2007). Inventory Turnover The Inventory turnover ratio measures how much inventory was turnover over to generate the revenues. Based on the above computation, inventory turnover ratio of Tesco increased from its 17.97 figure to the higher 18.77 in 2009. The above computation shows Morrison’s generated inventory turnover ratio of 27.49 for 2008. The figure increased to a higher 27.56 figure in 2009. The above computation shows that Morrison’s did financially better than Tesco (Brigham & Houston, 2002). Return on Assets The return on assets ratio measures how much sales was generated by the use of the tangible assets. Based on the above computation, the return on asset ratio of Tesco declined from its .12 figure to only .05 in 2009. The above computation shows Morrison’s return on assets ratio of .07 for 2008. The figure declined to only .06 in 2009. The above computation shows that Tesco did financially better than Morrison’s. Return on Capital Employed The return on assets ratio measures how much sales was generated by the use of the tangible assets. Based on the above computation, the return on asset ratio of Tesco declined from its .12 figure to only .05 in 2009. The above computation shows Morrison’s return on assets ratio of .07 for 2008. The figure declined to only .06 in 2009. The above computation shows that Tesco did financially better than Morrison’s. Return on Net Worth The return on net worth ratio measures if the company has enough cash inflows to give its stockholders in the form of dividends. Based on the above computation, the return on net worth of Tesco declined from its .18 figure during 2008 to only .17 in 2009. The above computation shows Morrison’s generated a return on net worth of .13 for 2008. The figure declined to only .10 figure in 2009. The above computation shows that Tesco did financially better than Morrison’s. Interest Cover Ratio The interest cover ratio measures the interest effect on the lenders. Based on the above computation, the interest cover ratio of Tesco declined from its .12 figure during 2008 to only 7.18 in 2009. The above computation shows Morrison’s interest cover ratio of 7.47 for 2008. The figure increased to 11.92 figure in 2009. The above computation shows that Morrison’s did financially better than Tesco. Current Ratio The current ratio determines if there are enough current assets to pay for current maturing liabilities. Based on the above computation, the current ratio of Tesco increased from its .49 figure during 2008 to higher .53 in 2009. The above computation shows Morrison’s current ratio for 2008 of .95 has decreased to only .76. The above computation shows that Morrison’s did financially better than Tesco. Debt to Equity Ratio The debt to equity ratio measures the relationship of percentage of lenders and investors in the company. Based on the above computation, the debt to equity ratio of Tesco increased from its .95 figure during 2008 to higher .95 in 2009. The above computation shows Morrison’s debt to equity ratio for the two years cannot be computed. Morrison’s did not borrow long term funds during the years 2008 and 2008. The best ratio would be a 1 to 1 relationship. The above computation shows that Tesco did financially better than Morrison’s. Based on the above discussion, Tesco performed financially better than Morrison’s. Dividend Payout Ratio The dividend payout ratio determines the relationship between the company’s earnings per share figure and the dividends issued to the outstanding stockholders on record. Based on the above computation, the dividend payout ratio of Tesco increased from its .29 figure to only .31 in 2009. The above computation shows Morrison’s generated a dividend payout ratio of .23 in 2008. The company increased its dividend payout ratio to .34 in 2009. The above computation shows that Morrison’s did financially better than Tesco. Conclusions Based on the above discussion, Tesco performed financially better than Morrison’s. There are more financial statement ratios indicating Tesco did better than Morrison’s. However, some financial statement ratios indicate Morrison’s performed financially better than Tesco. Indeed, Tesco performed better than Morrison’s. Recommendations for Future Action It is highly recommended that surveys will be used to confirm the financial statement ratios. It is also highly recommended that the decision maker should not fully rely on the financial statement ratios as the sole basis for making decisions. The reader of the financial statement reports of both companies must perform other tests and surveys. The financial records do not ensure 100 percent future occurrence. REFERENCES Bernstein, J. (1993) Financial Statement Analysis. London: Irwin Press Besley, S. (2008) Essentials of Managerial Finance. Sydney: Cengage Press. Brigham, E. and Houston, J. (2002) Fundamentals of Financial Management. London: Thomson Baumol, W. (2009) Economics: Principles and Policy. London, Cengage Press. Chapman, C. (2007) Handbook of Management Accounting Research. London: Elsevier Press. Czinkota, S. (2006) International Marketing. London: Wiley & Sons. Feldman, M. (2007) Crash Course in Accounting and Financial Analysis. London: J. Wiley& Sons. Gibson, C. (2010). Financial Statement Analysis. LondonSydney: Cengage Press. Hansen, D. (2006) Management Accounting. London: Thomson Press. Helfert, E. (1997) Techniques of Financial Analysis. London: Irwin Press. Khan, M. (2006) Management Accounting. London: McGraw Hill Press Maguire, M. (2007) Financial Statement Analysis. London: Grin Press. Mayo, H. (2007) Investments: An Introduction. London: Cengage Press. Moyer, R. (2009). Contemporary Financial Management. London: Cengage Press. Warren, C. (2008). Financial and Managerial Accounting. London: Cengage Press. . APPENDIX Gross Profit Ratio       Tesc0   Tesc0   Morrison’s Morrison’s       2009 2008 2009 2008       Gross Profit = 4218 3630 913 818   Revenues 54327 47298 14528 12969           0.08   0.08   0.06   0.06 Operating Margin Ratio       Tesc0   Tesc0   Morrison’s Morrison’s       2009 2008 2009 2008         Net Profit = 2954 2803 655 612     Revenues 54327 47298 14528 12969           = 0.05 = 0.06 = 0.05 = 0.05   Profit After Tax Ratio     Tesc0   Tesc0   Morrison’s Morrison’s         2009 2008 2009 2008           Profit after Tax = 2166 2130 460 554   Net Sales 54327 47298 14528 12969         = 0.04 = 0.05 = 0.03 = 0.04   Fixed Asset Turnover Ratio       Tesc0   Tesc0   Morrison’s Morrison’s         2009 2008 2009 2008         Net sales = 54327 47298 14528 12969     Fixed Assets 23152 19787 6587 6205           = 2.35 = 2.39 = 2.21 = 2.09   Current Asset Turnover     2009   2008   2009   2008     Net Sales = 54327 47298 14528 12969 Current Assets 13647 5992 1066 910       = 3.98   7.89   13.63   14.25 Working Capital Turnover     2009   2008   2009   2008     Net Sales = 54327 47298 14528 12969 Working Capital 3995 3963 -958 -943       = 13.60   11.93   (15.16)   (13.75) Capital Turnover     Tesc0   Tesc0   Morrison’s Morrison’s       2009 2008 2009 2008       Net Sales = 54327 47298 14528 12969   Capital Employed 20360 16933 5710 5497         = 2.67   2.79   2.54   2.36   Inventory Turnover     Tesc0   Tesc0   Morrison’s Morrison’s       2009 2008 2009 2008       Net Sales = 54327 47298 14528 12969   Capital Employed 20360 16933 5710 5497         = 2.67   2.79   2.54   2.36   Return on Assets       Tesc0   Tesc0   Morrison’s Morrison’s         2009 2008 2009 2008         NPAT = 2166 2130 460 554     Tangible Assets 46053 17565 8226 7636         = 0.05 = 0.12 = 0.06 = 0.07                         Return on Capital Employed       Tesc0   Tesc0   Morrison’s Morrison’s         2009 2008 2009 2008         NPAT + Interest = 2644 2380 520 614     Capital Employed 12995 11902 4520 4378         = 0.20 = 0.20 = 0.12 = 0.14                         Return on Net Worth     Tesc0   Tesc0   Morrison’s Morrison’s         2009 2008 2009 2008       NPAT = 2166 2130 460 554   Total Shareholder Funds 12995 11902 4520 4378         = 0.17   0.18   0.10   0.13   Interest Cover Ratio       Tesc0   Tesc0   Morrison’s Morrison’s         2009 2008 2009 2008         PBIT = 3432 3053 715 672     Interest 478 250 60 90           = 7.18 = 12.21 = 11.92 = 7.47   Current Ratio       Tesc0   Tesc0   Morrison’s Morrison’s         2009 2008 2009 2008         Current Assets = 1066 906 13647 5992     Current Liabilities 2024 1853 18040 6300           = 0.53 = 0.49 = 0.76 = 0.95   Debt to Equity Ratio       Tesc0   Tesc0   Morrison’s Morrison’s         2009 2008 2009 2008     Long Term Debt = 12391 5872 0 0     Shareholders' Funds 12995 11902 4520 4378           = 0.95   0.49   -   -   Dividene Payout Ratio       Tesc0   Tesc0   Morrison’s Morrison’s       2009 2008 2009 2008       Dividends per share = 0.084 0.077 0.058 0.048   Earnings Per share 0.275 0.27 0.17 0.21         = 0.31 = 0.29 = 0.34 = 0.23 Read More