Managing finance of the two companies the Tesco and the Sainsbury - Coursework Example

?Managing Finance Summary: The study here deals with the analysis and evaluation of the two companies the Tesco and the Sainsbury. The analysis in the study is carried out by the financial ratio analysis. The data used in the study of both companies was taken from the past years annual report. The study comprises the introduction, which includes the background of the two companies including the sales turnover, profits, and performance. The certain ratios like the liquidity, profitability, efficiency, gearing ratios and the investor’s ratios are calculated. The ratio calculation gives a clear picture on the company’s performance. Introduction: Financial statement analysis is one of the fundamental practices for investment and analysis of performance in order to present a fast method of evaluating the financial growth of the organization. The analysis and the evaluation of the financial ratios minimize the complications within the financial data in a simple and an arranged manner. The ratio analysis is much informative as it provides information’s, suggestions and recommendations to the shareholders. The study in this context deals with the analysis of the performance of the reputed companies namely the Tesco and Sainsbury. The study is aimed at evaluating the ratios of two firms over the past year financial data of the annual report. It gives the investment suggestions and recommendations to the investors and the shareholders by including and considering the following: Profitability, Liquidity level, Efficiency level The stage of fund dependency Earning per share. Company Background and Performance: “The Tesco brand first appeared five years later in 1924 when he bought a shipment of tea from a Mr T. E Stockwell and in 1932 Tesco became a private limited company” (Barclays Stockpiles ‘Losses’ to Soften 2012). In 1995 Tesco took up Sainsbury’s as the UK’s largest supermarket. Bearing in mind how determined and competitive the 'supermarket' concept is this is fairly a success brand. Tesco’s favored evaluation of growth is 'like for like' development – sales development on shop floor room, which rejected increase from additional shop floor space in extended or latest stores. Even by this limited measure sales grew 8.3% in every year, improving Tesco’s profits every year. In April 2009, Tesco declared profits of ?1.6bn for the fiscal year concluding on 28 February; ?4.4m profit per day which is 17.6% higher than the earlier year. As an evaluation Tesco made as much income as Sainsbury, Next and WH Smith jointly. Forecasters are at present forecasting that Tesco’s pre-tax profits for coming years will be exceeding by ?2bn mark, quadruple times that of Sainsbury. Comparisons between both the companies are much difficult as they both are good players in the supermarket trade in the state. “So, rather than doing the usual comparison of the stores by their top food deals and booze bargains (which we do every week in our Frugal Food blog), today, I'm going to take a more original look at which store offers the best financial deals. I'll also compare their loyalty schemes, so you can see where your spend at the supermarket will earn you the most bang for your buck” (Wait 2010). Financial Analysis of Tesco and Sainsbury: The intention of this paper is to financially investigate and state a report of the two firms Tesco and Sainsbury. These two firms have the same industrial background and are both leading supermarkets among whom there are a very healthy and tough competition in order to capture the giant market share. “Sainsbury's v Tesco: the rumble in the supermarket aisles” (Hall 2009). Both financial as well as non financial factors have played a very vital role in the market fluctuations which have affected both the firms. In order to present a financially investigative report, it is very important to present a report on the financial ratios of the firms. For that purpose some of the most popular ratios investigated are profitability, liquidity, efficiency, gearing and the investor’s ratio. In order to find out the ratios it is very important to conduct a numerical investigation. After the conduction of a numerical investigation with the help of appropriate communication and technology systems, the financial reports of the two companies needs to be interpreted and the results needs to be presented. Presentation of the results of the firm especially the financial results can be helpful in identifying the problems faced by the firm or the obstacles which act as a hindrance to the firm’s profit. The ratios judge the financial health of a firm because they measure profitability, efficiency, and solvency and facilitates in making a comparative analysis of the performance of the two firms. Ratio analysis is also helpful in budgeting and forecasting process. Profitability Ratios: The primary objective of every business organization is profit. Therefore profitability ratios are important to all firms because they are normally designed either in relation to sales or in relation to investment. Return on Capital Employed (ROCE): The ROCE is one of the significant Profitability ratios that can be used to evaluate corporate profitability. This ratio states the relationship among the net profit made throughout a year period and the average long-term investment provided in the business throughout that period. It is computed as follows. Return on capital employed (ROCE) = “Profit before interest and tax / capital employed” (Ramsden 1998, p. 40). Gross Profit Ratio: Gross profit shows the connection between gross profit and net sales. It is generally expressed as percentage. Gross profit is in use before tax and further indirect costs. It is computed as follows. “Sales – Cost of Goods Sold = Gross Profit Calculating gross profit figure as a percentage of sales (to obtain the gross profit percentage): Gross profit divided by sales x 100” (Worthington 2006, p. 26). Net Profit Ratio: Net profit ratio demonstrates the relationship among net profit and net sales. It is also known as net profit margin. It is calculated as follows. “Net profit margin = [net profit (before income and tax)] / sales * 100” (Bowhil 2008, p. 266). Basic Earning Power Ratio: Basic earning power ratio is also a very important profitability ratio. Basic Earning Power = (Earning Before Income and Tax / Total Assets) *100 Return on Total Assets Ratio: The return on total assets is another very important profitability ratio which is very important and is calculated as follows: Return on total assets = Net Income/ Total Assets*100 The profitability ratios that had been stated above measure the performance of the firms. While the return on capital employed in both the firms is quite close, the gross profit ratios are highly different. Return on capital employed in Tesco has decreased comparing the two years but Sainsbury’s is increasing in a constant manner. While it is Tesco who has a strong return on capital employed, gross profit and net profit ratio the basic earning ratio and the return on total assets of Sainsbury’s is quite good. “The profitability measures are strongly positive” (Chong & Lopez-de-Silanes 2005, p. 217). The GP ratio of both the firms has increased but Tesco’s has increased at a considerably higher percentage. Graphical Representation of Profitability Ratio: 1. Liquidity Ratio: Liquidity refers to the firm’s ability to assemble its current liabilities further than the current assets when they turn into to be paid. Some Liquidity Ratios used: Current Ratio: Current ratio is defined as the ratio of current assets to current liabilities, which means its current assets must be doubled its current liabilities. “A current ratio of 1: 1 is considered to be the absolute minimum level of acceptable liquidity, whereas a ratio closer to 2:1 is preferred. Formula: divide all current assets by current liabilities” (Bragg 2010). Quick Ratio: Rise and fall in current ratio has more influence than quick ratio. Quick ratio is also recognized as acid test ratio or liquidity ratio. It forms the connection between quick assets by quick liabilities. It is computed as follows. Quick ratio= Quick Assets/ Quick Liabilities. Ratio Tesco Sainsbury 2011 2010 2011 2010 Current ratio 2.02 2.76 0.28 0.28 Quick ratio 1.48 2.12 0.28 0.28 The different liquidity ratios permit us to evaluate these two company’s capacity to pay current debts, and therefore their temporary capability to survive as a business. Founded on the above outcome, we can show that Tesco has the benefit in liquidity moving forward, while Sainsbury’s liquidity position has remained the same in the two financial years. One of the valid reason for Sainsbury’ liquidity position being not changing especially the quick assets is because Sainsbury has recorded nil inventories in the two years. It shows that Sainsbury can pay off its debts and liquidity far more easily than Tesco because usually the time taken to pay off liquidity is 1 year. Graphical Representation of Liquidity Ratio: Efficiency Ratio: Efficiency ratios calculate how effectively the company uses these assets, in addition to how well it deals with its liabilities. Inventory Turnover: Inventory turnover demonstrates how well a company controls its inventory stages. If inventory turnover is too short, it proposes that a company perhaps overbuilding or overstocking its stock or that it perhaps having problems selling products to consumers. All else equivalent, high inventory turnovers are improved. “Inventory Turnover = sales/inventories” (Brigham & Houston 2012, p. 102). Accounts Receivable Turnover: The accounts receivable turnover ratio demonstrates how useful the company's credit rules are. If accounts receivable turnover is also short, it may signify the company is being too liberal yielding credit or is having complexity collecting from its clients. All else equivalent, high receivable turnovers are enhanced. “Accounts Receivable Turnover = Annualized credit sales/ Average Accounts Receivable Notes payable by customers” (Bragg 2010). Accounts Payable Turnover: The accounts payable turnover ratio utilizes a liability in the equation sooner than an asset, in addition to expenditure before revenue. Accounts payable turnover is significant because it measures how a company controls paying its own bills. High accounts payable turnover is perhaps a symbol that a firm isn't getting very positive payment terms from its own dealers. All else equivalent, lesser payable turnovers are enhanced. “Accounts Payable Turnover =Total purchases / ending accounts payable balance” (Bragg 2010). Total Asset Turnover: Total asset turnover is a total of useful ratio that emphasizes how efficient management is at utilizing both long-term and short –term assets. All else equal, the upper the total asset turnover, the recovered. “Total Asset Turnover = sales/ Total Asset” (Nelson 2008, p. 370). Gearing Ratio: The gearing ratio is the amount of a firm’s debt to its equity; anywhere a higher gearing ratio symbolizes a high quantity of debt to equity, and a small gearing ratio symbolizes a low quantity of debt to equity. The gearing ratio is close to the debt to equity ratio, excluding that there are a number of differences on the gearing ratio method that can yield slightly diverse results. “The most comprehensive form of gearing ratio is one where all forms of debt - long term, short term, and even overdrafts - are divided by shareholders' equity. The calculation is: “Fixed interest loans preference share capital/shareholders fund” (Ramsden 1998, p. 75). Investors Ratio: There are a number of ratios normally used by investors to evaluate the presentation of a business as an investment: Earnings Per Share (EPS): Earnings per share are normally measured to be the single most significant variable in formative a share's price. It is also a main part used to compute the price-to-earnings assessment ratio. “Earnings per share (EPS) Ratio = net income- dividend on preferred share/number of outstanding common shares+ common stock equivalents” (Bragg 2010). Price-Earnings Ratio (P/E Ratio): “The price to earnings ratio (P/E) is the relationship that the price of a share bears with its earnings per share (EPS), either current or potential. The formula is: “Share price/earning per share stock” (Langdon et al. 2008). Dividend Yield Ratio: Dividend yield ratio is the association among the market value of the shares and dividends per share. Share holders are actual owners of a business and they are interested in actual sense in the earnings distributed and paid to them as dividend. Consequently, dividend yield ratio is calculated to assess the connection among dividends per share paid and the market value of the shares. Following formula is used for the computation of dividend yield ratio: “Dividend Yield Ratio = Dividend per Share / Market Value per Share” (Thompson 1993, p. 166). Note: Report is prepared on the basis of Tesco’s annual report as on February 2011 and February 2010. Note: Report is based on the Sainsbury’s annual reports on March 2011 and March 2010 respectively. Graphical Representation: Above the chart represents Total efficiency ratio, Total gearing ratio and Total investors ratio. The case of Inventory Turnover and Accounts Payable Turnover, Sainsbury supermarket shows greater performance because of the character of their industry being mostly extra food based than Tesco plc. In 2011, Sainsbury supermarket shows higher Accounts Payable Turnover that is 114.97. The efficiency ratio of both the firms has increased but Sainsbury supermarket has increased at a considerably higher percentage. Both Tesco plc and Sainsbury figures have reduced which is a good symbol; this means they are a smaller amount risky to probable investors. In 2010, the figure has better of Tesco but in 2011 it has reduced. The gearing numbers of Sainsbury are below TESCO plc. Gearing Ratio in Sainsbury has decreased comparing the two years but Tesco plc is increasing in a constant manner. Both companies indicate constant increase over the two years, for creating shareholders happy. Tesco plc has also improved but Sainsbury’s are more attractive to probable investors. The increase rate of both companies is growing; Sainsbury’s significantly, demonstrating appositive performance from each company. The Investors Ratio of both the firms has increased but Sainsbury supermarket has increased at a considerably higher percentage. Use of Communications and Information Technologies: Tesco is one of the largest companies in retailing industry and Sainsbury is one of the oldest in the same industry. The financial problems are Cash Flow:- Cash flow is the most Common financial problem as most corporate face at least a few times. The problem occurs when the revenue is high on paper and the bank balance is terrible. The top authorities should make sure that the collection agents can get the money on time Funding: The fund can rise by getting debts from banks, financial institutions or from private money lenders. The other way to raise fund is share market i.e., equity and preference shares. The both debts and equity should used for an effective capital structure. The capital structure is supposed to be best possible when it composed of maximum return and less risk. Economic Cycles:- The economic cycle have downturns some times because of the habits and choices of the consumer. The decisions of the customer will affect the demand of the products. The recession and depression in the economic cycles had been bigger challenges for the Tesco plc and Sainsbury. Asset Protection:- The financial problem includes inadequacy of fund or bank balance to close the credits. In such situation the corporate should focus to protect their assets. The protection of assets can be done by debentures and bank credits. Resource Allocation:- Resource allocation of these international corporate is most complicated as they have more branches in outside of the country. The resource allocation means the strategies for decision making by which they can allocate the investment properly. Resource allocation should be optimum to get maximum return from the business. Over-Expansion: When the firms are excited about expansion, they occasionally buy further businesses or increase into lines of industry that aren't their power. “The resulting bad investments can cause financial downturn and leave a business with significant loans to repay or investors selling off stock. Companies in this situation usually sell parts of their business; liquidate inventory and try to mitigate losses” (Feigenbaum 2012). These are the main financial problems and the Tesco plc and Sainsbury have enough financial analysts to advice them about how to tackle these problems because these problems can lead the companies to failure in achieving their goals. Conclusion: Over all, Tesco supermarket UK shows a more stable positive performance than Sainsbury supermarket UK. Investors would find Tesco supermarket more attractive to give equity in and receive a high return. Recommendation: According to the data given by the financial analysis in the earlier segment, it can be assumed that even though the industries ratios illustrated reduced rates from 2010 to 2011, the expectations of the industry performance looks profitable. This is because of the Business change Programme, which contained on the attainment of IT systems and the trade of JS Development and Shaw's Supermarket. The previous will be a positive crash in the economic performance of the company in a long-term by rising sales and falling costs; and the latter will be utilized to increase and create more efficient management and financial resources, therefore it will increase Sainsbury's core UK industry and make its market position stronger. Consequently, from the ratios analysis, it can be declared that Sainsbury's is not a good company to presently invest in, because the company has not explained an important increase in profit throughout the last financial year. Reference List Barclays Stockpiles ‘Losses’ to Soften. 2012. The Telegraph. [Online] Available at [Accessed on January 02, 2012]. Bragg, SM 2010. Business Ratios and Formulas: A Comprehensive Guide. Print. Bowhil, B 2008. Business Planning and Control: Integrating Accounting, Strategy, and People. Print. Brigham, EF & Houston, JF 2012. Fundamentals of Financial Management. P. 102. Print. Chong, A & Lopez-de-Silanes, F. 2005. 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