Financial Analysis of Tesco, Sainsbury and Morrison - Case Study Example

Financial Reporting of Tesco, Sainsbury and Morrison Executive Summary Financial reports preparation and presentation assumes utmost importance for abusiness organization especially for one in the public sector, whose stakeholders are more curious and concerned about the financial and profitability position of the firm. Financial Reporting is not a casual and simple process. A full-fledged financial reporting requires the observance of many aspects which are made mandatory by the accounting and other government bodies. The stakeholders are always looking forward to get informed with the information that are arranged and presented in conformity with many legal and other ethical aspects. The observance of accounting standards in reporting is mandatory in all countries as per the direction of Accounting Standard Board (ASB). All countries have developed their own accounting standards and in the absence of a standard in any occasion, Generally Accepted Accounting Standards (GAAP) can be followed. This report has four sections, namely A, B, C, and D. Section 'A' deals with the specific accounting policies adopted by Tesco, Sainsbury and Morrison, followed by the comparison of the same between one another. It also throws light on whether there are any differences in the accounting policies followed by these companies and if any, what are they. Section B is meant to present the financial analysis of all the three companies' financial statements for a 5 year period using profitability ratios, liquidity ratios, debt ratios, activity ratios, gearing. Section C is for detailing the major limitations of ratio analysis in the light of given companies. Section D provides a report on the performance of a company of Morrison Plc. Based on the ratios calculated in Section B. Section A Examination of Accounting Policies followed by Tesco, Sainsbury and Morrison This section deals with the important accounting policies followed by firms in the preparation and presentation of financial statements: Tesco Plc. Basis of Financial Statements The company prepares and presents it financial statements comprising of income statement, balance sheet and cash flow statement in accordance with applicable accounting standards, under the historical cost convention, and are in accordance with the Companies Act 1985 (Accounting Policies). Basis of Consolidation The company prepares its consolidated financial statements comprising of statements of parent company and that of its subsidiaries. It has been made mandatory for the Continental European companies to prepare financial statements prior to the preparation of the same of the group so as to ensure timely preparation and reporting. As regards the excess/deficiency of purchase consideration is concerned, it shall be adjusted in reserves. It is therefore necessary for all subsidiaries to adhere to the accounting policies of the group with the aim of attaining consistency in the accounting policies. Stocks Stocks in stores are calculated at retail prices and reduced by appropriate margins to the lower of cost and net realizable value. Money market investments Money market investments are shown at cost price. All income received from these investments is included in the profit and loss account. Fixed assets and depreciation Depreciation is provided on an equal annual installment basis over the anticipated useful working lives of the assets, after they have been brought into use, at the following rates: Leasing items such as plant, equipment and fixtures and fittings are shown in the financial statements as tangible assets. These assets are subject to depreciation as per the depreciation policy of the firm. Sainsbury Plc. International Financial Reporting Standards (IFRS) Sainsbury will follow IFRS for financial reporting though it will have a small adverse impact on reported profit after tax. This impact excludes the effect of IAS 32 and IAS 39 - the Group has elected to take a one-year exemption in implementing these standards as allowed under IFRS. Morrison Plc. Basis of preparation Financial statements are prepared and presented on the basis of International Financial Reporting Standards (IFRS). The important accounting policies are detailed below: Turnover Turnover represents sales to customers. It does not include any tax such as VAT paid on sales. The sales/transfer of goods from parent to subsidiary or one subsidiary to another or subsidiary to parents etc are excluded from sales. Supplier income Any incentives, rebates and discounts received from suppliers are recognized on an accruals basis. Property, plant and equipment Land and buildings are shown at cost reduced by accumulated depreciation. Similarly, properties under construction are also expressed in terms of cost price. Land is not depreciated and land under a lease is classified as an operating lease. Other assets such as plant, equipment and vehicles are depreciated over their estimated useful lives. Borrowing costs Finance costs which can be straight away identifies with the construction of a property are capitalized. Inventories Inventories are valued either at cost price or market price whichever is lower. Cost is calculated using the weighted average cost. Inventories form part of those goods for resale. Section B Tesco Plc Profitability Ratios: Return on Capital Employed Year Profit Before tax Interest Profit before interest and Tax Shareholders' Fund Long term loans Total of Shareholders fund and long term loan Return on Capital Employed 2004 238.3 76 162.3 2,894.10 899.00 3,793.10 4.27882 2005 255 64.3 190.7 2,257.50 786.00 3,043.50 6.26581 2006 312 72.56 239.44 2,112 678 2,790.00 8.58208 2007 317 65 252 2001.9 575 2,576.90 9.77919 2008 386 55 331 2101 687 2,788.00 11.8723 Gross Profit Ratio Year Gross Profit Turnover Ratio 2004 988 11,609 8.5111 2005 1,011 12,005 8.41954 2006 905 11,709 7.7291 2007 1403 12087 11.6075 2008 1550 14503.99 10.6867 Net Profit Ratio Year Net Profit Before tax Turnover Ratio 2004 238.3 11,609 2.0527 2005 255 12,005 2.12404 2006 312 11,709 2.66462 2007 317 12087 2.62265 2008 386 14503.99 2.66134 Liquidity Ratios Current Ratio Year Current Assets Current Liabilities Ratio 2004 2,987 3,655 0.81724 2005 2,456 3,070 0.80013 2006 3,101 3,521 0.88072 2007 2,983 2,879 1.03612 2008 2,430 2,450 0.99184 Acid Test Ratio Year Current Assets Stock Quick assets Current Liabilities 2004 2,987 402 2,585 3,655 0.70727 2005 2,456 467 1,989 3,070 0.64801 2006 3,101 531 2,570 3,521 0.72991 2007 2,983 507 2,476 2,879 0.86002 2008 2,430 498 1,932 2,450 0.78857 Efficiency Ratios Stock Turnover Ratio Year Cost of sales Stock Ratio 2004 7,821 402 19.4552 2005 6,987 467 14.9615 2006 6,831 531 12.8644 2007 7,012 507 13.8304 2008 7,327 498 14.7129 Stock Days Year Cost of sales Stock Ratio 2004 7,821 402 18.761 2005 6,987 467 24.396 2006 6,831 531 28.3729 2007 7,012 507 26.3912 2008 7,327 498 24.8082 Morrison Plc Profitability Ratios: Return on Capital Employed Year Profit Before tax Interest Profit before interest and Tax Shareholders' Fund Long term loans Total of Shareholders fund and long term loan Return on Capital Employed 2004 312.9 73.2 386.1 3,648.60 1,988.70 5,637.30 6.84902 2005 369 74.9 443.9 3,927.00 1,589.00 5,516.00 8.0475 2006 612 60 672 4,378 1,405 5,783.00 11.6203 2007 632 61 571 4485 1400 5885 9.702634 2008 621 58 563 4950 1380 6330 8.894155 Gross Profit Ratio Year Gross Profit Turnover Ratio 2004 2,977.80 12,114.80 24.5799 2005 636 12,461.50 5.10372 2006 818 12,969 6.30735 2007 950 13014.85 7.299354 2008 998.5 13099.04 7.622696 Net Profit Ratio Year Profit Before tax Turnover Ratio 2004 312.9 12,114.80 3 2005 369 12,461.50 3 2006 612 12,969 5 2007 450 13014.85 3.4575888 2008 444.3 13099.04 3.3918516 Liquidity Ratios Current Ratio Year Current Assets Current Liabilities Ratio 2004 692.1 1,806.80 0.383053 2005 749.6 1,854.90 0.404119 2006 906 1,853 0.488937 2007 986.45 1654.02 0.5963954 2008 1005.2 1750.3 0.5743015 Acid Test Ratio Year Current Assets Stock Quick assets Current Liabilities Ratio 2004 692.1 399.4 293 1,806.80 0.162 2005 749.6 367.9 382 1,854.90 0.20578 2006 906 442 464 1,853 0.25041 2007 986.45 456 530.45 1654.02 0.320703 2008 1005.2 388.06 617.14 1750.3 0.352591 Efficiency Ratios Stock Turnover Ratio Year Cost of Sales Stock Ratio 2004 9,155.50 399.4 22.92313 2005 11,825.50 367.9 32.14325 2006 12,151 442 27.49095 2007 13055.4 456 28.630263 2008 13545 388.06 34.904396 Stock Days Year Stock Cost of Sales Ratio 2004 399.4 9,155.50 15.92278 2005 367.9 11,825.50 11.35542 2006 442 12,151 13.2771 2007 456 13055.4 12.7487476 2008 388.06 13545 10.4571355 Sansburry Plc. Return on Capital Employed Year Profit Before tax Interest Profit before interest and Tax Shareholders' Fund Long term loans Total of Shareholders fund and long term loan Return on Capital Employed 2004 104 155 259 3,965 3,972 7,937.00 3.2632 2005 477 107 584 4,349 2,506 6,855.00 8.51933 2006 479 132 611 4,935 2,575 7,510.00 8.13582 2007 488 128 360 4695.4 2386 7081.4 8.628237 2008 489.5 126 363.5 4968.31 2968 7936.31 4.536113 Gross Profit Ratio Year Gross Profit Turnover Ratio 2004 1,067 16,061 6.64342 2005 1,172 17,151 6.83342 2006 1,002 17,837 5.61754 2007 1245 16894 7.36948 2008 1095 17365 6.305788 Net Profit Ratio Year Net Profit Before tax Turnover Ratio 2004 104 16,061 0.64753 2005 477 17,151 2.78118 2006 479 17,837 2.68543 2007 488 16894 2.8886 2008 489.5 17365 2.818889 Liquidity Ratios Current Ratio Year Current Assets Current Liabilities Ratio 2004 3,820 4,810 0.79418 2005 1,915 2,721 0.70379 2006 1,610 2,605 0.61804 2007 1,709 2,020 0.846208 2008 1,891 2,046 0.924242 Acid Test Ratio Year Current Assets Stock Quick assets Current Liabilities 2004 3,820 576 3,244 4,810 0.67443 2005 1,915 590 1,325 2,721 0.48695 2006 1,610 681 929 2,605 0.35662 2007 1,709 638 1,071 2,020 0.530366 2008 1,891 653 1,238 2,046 0.605083 Efficiency Ratios Stock Turnover Ratio Year Cost of sales Stock Ratio 2004 14,994 576 26.0313 2005 15,979 590 27.0831 2006 16,835 681 24.721 2007 15,089 638 23.65047 2008 16,001 653 24.50383 Stock Days Year Cost of sales Stock Ratio 2004 14,994 576 14.0216 2005 15,979 590 13.4771 2006 16,835 681 14.7648 2007 15,089 638 15.4331 2008 16,001 653 14.89563 Section C Ratio analysis is widely accepted as a powerful tool for financial statement analysis and decision making. However, they are not completely free from limitations. Financial ratios computed from income statement and balance sheet are reliable and dependable for investors as well creditors for their decision making under certain assumptions and circumstances. What made this imperative is commonly called the limitations of ratio analysis. Following are the important points to be taken care of while decision making depend on ratios: 1. Lack of Standard Ratios 2. Window dressing 3. Variations in accounting policies from time to tome and / or firm to firm 4. Interpretation of Ratios 5. Price level changes 6. Correlation among ratios Section D Evaluation of the overall Performance of Morrison Plc This part of the course work reports the results of the comparative study of the overall performance of two retail giants. The task involves the evaluation of profitability and financial performance of two companies independently and a comparative evaluation of their performance taken together. The period for which the financial statements are analysed is five years. An attempt is also made to examine their performance in the economy in the light of growth of the economy as a whole. The report also attempts to help the investors and potential investors to understand in detail of the share price movements of the firms for the last three years. An attempt is also made to correlate the performance of the companies and the share price movements at the stock exchange. Morrison Plc Analysis of Profitability The profitability of a firm is usually evaluated in terms of the gross margin, net margin, earnings per share and payment of dividend. Over the last three years the gross profit of the company has been showing both upward and downward trend. In the first year (2004), gross profit has shown a decrease of 1.12 percent from that of the year 2003. In the next year also, the profit has shown a significant setback, which accounts for around 79 percent. However, it was corrected in the third year, where the firm could achieve an increase of around 29 percent when compared to the year 2007. This is because of the reason that in the first and second year (2004 and 2005), cost of goods sold has shown a significant increase which is not in proportion to the change in sales. However, the net profit figures over the period show a different picture. The firm could achieve a positive figure in all the three years which indicate that the firm is in a position to meet the interest of all its stakeholders, particularly that of shareholders. The profit after tax, which represents the amount available to ordinary shareholders (investors) for all the three years, shows an increasing trend. It is also quite a good signal for the investors as well as potential investors. The creditors of the firm will also be happy with such an increasing trend in the profitability of the firm. Return on Capital Employed It is given in the Task II that how good is the return on capital employed of the firm. It is evident from the table (please include table No. Here) that return on capital employed has been good for the form for the last three years. Apart from not being it stable, return on capital employed shows an increasing trend. From the year 2004 to 2005, there is an increase of about 7 percent. From the year 2005 to 2006, it is further increased by another 8 percent. It was again increased from 8 percent to 11.6 percent in the year 2007. This state of affairs is really a green signal for the investors to ensure themselves that they will be assured a happy return. Analysis of Financial Status Financial status of a firm is the financial position or condition that the firm has on a particular date as a result of business operations. Financial position of a firm is usually described the balance sheet and other analytical tools like common size balance sheet, balance sheet ratios etc. When balance sheet exhibits the list of assets a business owns and liabilities that the business owes, common size balance sheet and balance sheet ratios provide a detailed picture of the financial position of the concern. Therefore, it is better to describe the common size balance sheet and important balance sheet tools to know more about the firm's financial condition. In the common size statement all important items in the balance sheet are expressed as a percentage of shareholders' equity. The statement reports that current liabilities are regularly paid out by the firm as it shows a decrease from year to year. In the first year, current liabilities accounts for around 50 percent of the shareholders' equity. However, it was reduced to 47 percent and then to 32 percent in the second and third year respectively. On the other hand, current asset position seems to have increases from year to year. However, when current assets and current liabilities are taken together, the firm seems to face liquidity problem. Analysis of Liquidity Current Ratio Liquidity is the ability of a firm to pay off its short term obligations. Short term obligations are usually paid out of the current assets and as such a firm's current assets should always be greater than current liabilities. In case a firm is unable to pay off its current liabilities in time, the firm will not be in a position to get credit n future. It is usually agreed upon across industries that a firm should have at least assets of two times of current liabilities. Liquidity as indicated by the current ratio is not satisfactory as it comes to less than 50 percent of the current liabilities. However, it is notable that current ratio is getting improved over the years. Acid Test Ratio Acid test ratio is a more rigorous test of liquidity. It measures how able a firm is to pay off its short term obligations out of its quick assets. Quick assets are current assets reduced by inventory/stock. The liquidity of the firm as exhibited by acid test ratio is also not satisfactory. However, it goes on increasing from year to year. In the first year, the ratio comes to around 0.16 times of current liabilities. But, by third year, it was increased to 0.25 times. Efficiency Ratio Efficiency ratio implies the efficiency with which the assets of a firm are utilized. Efficiency ratios are computed for both current assets and fixed assets. Stock Turnover Ratio Stock turnover ratio indicates the number of times stock is converted into sales. Normally, higher the ratio, greater will be the efficiency. The firm's turnover ratio over the years indicates a good position as it is increasing. Initially, it was around 23 times and increased to 32 times in the second year and again reduced to 27 times. Stock Days Stock days represent the number of days the firm will take to convert the stock in to sales. It is expressed in number of days after adjusting for the number of days in a year. Here, the firm's ratio shows a decreasing trend and it is a good sign that the firm reduces the holding of inventory in the warehouse and thereby investment in inventory and holding cost. In the first year, the firm has stock days of around 16 days to convert its stock into sales. This was later reduced to 11 days in the next year and further it was increased to 13 days. Fixed Assets Turnover This shows the magnitude of firm's investment in the fixed assets. Here the ratio indicates that the number of times the investment in fixed assets is converted into sales. Normally, higher the ratio, greater will be the firm's position. As the firm needs to ensure maximum usage of fixed assets, it is always preferred to have a higher turnover ratio. It is evident from the fixed assets turnover figures that (please enter the table No. here) the firm is decreasing the investment in fixed assets and thereby effective utilization of assets. In the first year the turnover ratio was 1.382 and later it was increased to 1.92 in the third year. Total Assets Turnover It is a combination of the total of all current assets turnover and fixed assets turnover. It is not quite common that firm do not calculate the turnover ratio for all components of current assets except stock. The table (please enter the table No) exhibits that the firm's total assets turnover ratio is not satisfactory as it is decreasing year to year. The ratio of around 3.32 in the first year was reduced to 2.96 when the company passed its third year. References 1. Tesco's Financial Report http://www.tescoreports.com/downloads/tesco_report_final.pdf 2. Sainsbury's Financial Report http://www.jsainsburys.co.uk/ar08/downloads/pdf/sainsbury_ar2008_lowres.pdf 3. Morrison's Financial Report http://www.morrisons.co.uk/Documents/Morrisons_Report_2008.pdf 4. Accounting Policies, Read More