International Accounting Journal of Economics

Questions: Analyse the financial performance of the two companies based on your calculations, identifying and discussing the purposes of calculating those ratios and the weaknesses of ratios analysis.? Your analysis must contain an introduction, a recommendation of how these areas can be improved in the future, and a conclusion detailing the results of your analysis.? Answers: Introduction The study of the report will enable the reader to understand the differences between the businesses status of Sainsbury and Tesco. Moreover, the report also consists of a certain part that has shown the calculation of the various financial ratios of both the firms. This evaluation of the financial ratios has enabled the learner to understand the current financial position of both the firms. The understanding has been elaborated within the report and the leading company among these two has been highlighted as well. Since 1869, Sainsbury has been expanded to 523 convenience stores and 583 supermarkets in the UK; more importantly, Sainsburys has employed around 157,000 employees (Sainsburys.co.uk, 2015). Sainsburys is one of the leading retail stores in the UK dealing with general goods and groceries (Sainsburys.co.uk, 2015). The retail sector in United Kingdom is essential for the country economy, which has profound impacts on the country as a whole. ESRC recorded that in 2013, 20% of United Kingdoms GDP is accounted by the retail sector. Particularly, Sainsburys and ASDA are the two of renowned companies in the retail sector. Three important people who are Mr. David Tyler, the chairperson, Mr. Justin King, the CEO, and Mr. John Roger, the CFO, run the management team of Sainsburys. Besides Sainsburys, Tesco is a famous British multinational retailer which also deals with general merchandise and groceries (Tesco.com, 2015). Analysing the financial performance of Sainsbury and Tesco based on the calculations The analyzing and calculating of the financial ratios of the firm will show the exact sections of both the firm that are having various loopholes (Tamari, 2011). Moreover, the calculation of the financial ratios of Sainsbury and Tesco has been compared below along with graphs, which will extract the status of both these companies. Meanwhile, the profit margins as well as the revenue generation of these firms can also be evaluated by evaluating the calculated rations of the firm. The calculation will also determine that which firm is in a better position on the current time. This report deals with the assessment of both companies performances in the last three years based on ratio analysis. Regarding employment, Tesco has recruited almost 530,000 employees who are committed to the provision of best shopping experience for their consumer and community as a whole (Tesco.com, 2015). Tesco has been operating for almost 100 years, and it has expanded more branches domestically and internat ionally (Tesco.com, 2015). The analysing of the financial performance of Sainsbury and Tesco based on the calculations are stated below: Profitability Ratios (Operating Profit margin) Refer to appendix 1 The profitability of all the firm within the industry have been affected due to the massive amount of increased competition in the recent era. This increase in competition has also affected well renowned firms like Sainsbury and Tesco. The analysis of the operating profit margin of the firms has been stated below: Operating Profit margin TESCO Sainsbury's 2012 14.55% 12.66% 2013 16.22% 11.03% 2014 0.69% 9.22% Table 1: Operating Profit margin (%) (Source: Created by author) Graph1: Operating Profit margin (%) (Source: Created by author) The study of the above table and graph quiet clearly shows that Tesco have been conducting business in a more effective manner than Sainsbury, which have changed drastically in the year of 2014. This can be said as the evaluation shows that the Operating Profit margin of Tesco have dropped to 0.69 % in 2014, while the Operating Profit margin of Sainsbury have gone up to 9.22%. Therefore, it can be said that the Sainsbury have increased its Operating Profit margin massive extent and have crossed Tesco by 8.53 %. On the other hand, Return on Capital Employed is used to indicate to the amount of success that the firm has made by using its long- term assets. The ROCE ratio can help the company to do well in future profitability. Therefore, this can measure the companys failure or success that depends on its target ROCE that has already been set. Return on Capital Employed= (PBIT/ Capital Employed) * 100 (Ziegel and Rudas, 2009) Due to the greater market share, Tesco had a better performance compared to Sainsburys in the last three year. Regardless the increase of Tescos ROCE in 2012, Tesco was seen not be able to stabilize its ROCE while Sainsbury has performed equally well to alleviate its profit every year. Therefore, it can be commented that Sainsburys was able to utilize its long - term reserves efficiently to produce more income than compared to Tesco. Profitability Ratios (Gross Profit margin) Refer to appendix 2 The gross profit margin shows the earnings of the organization after considering the cost incurred by the firm in producing goods and services. Gross Profit Margin (GPM) = (Gross profit/ Sale Revenue) * 100 (Romagnoli, 2011) Gross Profit margin (%) TESCO Sainsbury's 2012 7.55% 4.99% 2013 7.99% 6.11% 2014 5.97% 7.02% Table 2: Gross Profit margin (%) (Source: Created by author) Graph 2: Gross Profit margin (%) (Source: Created by author) The above graph and table has been obtained by calculating the Gross Profit margin (%) of both the firms, which quiet clearly shows that Tesco have beaten Gross Profit margin (%) of Sainsbury in the years of 2012 and 2013. However, the graph also highlights the fact that Tesco have not been able to hold onto its Gross Profit margin (%) in the year of 2014. The picture of this fact gets even clear as the above graph shows that Sainsbury have a Gross Profit margin (%) of 7.02 % in the year 2014, while the Gross Profit margin (%) of Tesco is calculated at 5.97% only. Therefore, it can be commented that Sainsbury have beaten Tesco in the element of Gross Profit margin (%) by 1.05%. Profitability Ratios (Net Profit margin) Refer to appendix 2 Net profit margin calculates the amount of pound of sales a firm keeps earning, which means that a 4% profit margin of company shows that company has a net income of 0.04 pound. Net Profit Margin = (Net Income/ Sale Revenue) * 100 (Prentice, 2010) Net Profit margin (%) TESCO Sainsbury's 2012 5.55% 2.97% 2013 5.11% 3.07% 2014 1.02% 1.78% Table 3: Net Profit margin (%) (Source: Created by author) Graph 2: Gross Profit margin (%) (Source: Created by author) The net profit margins of firms enable us to understand the exact financial position of the firm within the market. The calculation of the Net profit margin of Tesco and Sainsbury quiet clearly shows that the amount of profit earned by Tesco in the year of 2012 and 2013 is much higher than that earned by Sainsbury. However, Sainsbury has shown a major come back in the year of 2014 as they beat Tesco in the section of Net profit margin by 0.76 %. Liquidity Ratios (Current ratio) Refer to appendix 3 The current ratio signifies the capabilities of the company to transform its assets into cash. Current Ratio = Current Assets/ Current liabilities (Muro, 2012) Current ratio TESCO Sainsbury's 2012 65.17% 57.98% 2013 63.98% 69.12% 2014 66.10% 67.97% Table 4: Current ratio (%) (Source: Created by author) Graph 4: Current ratio (%) (Source: Created by author) The study of the above graph quiet clearly shows that the Tesco in the year of 2012 had an increased current ratio of 65.17 %,, which was much more than Sainsbury who had 57.98 %. Moreover, the year of 2013 was the turning year for the Sainsbury as they increased the current ratio of the firm to 69.12 %, which was more than Tescos 63.98%. The year of 2014 was even better for Sainsbury as they again beat Tesco by a margin of 1.87 %. Liquidity Ratios (Acid - test ratio) Refer to appendix 4 Acid - test ratio or quick ratio is an indicator that defines whether a company has sufficient short-term assets to cover its immediate liabilities without selling inventory. Acid - test ratio = (Current assets Inventories) / Current liabilities (Ketz et al. 2010) TESCO Sainsbury's 2012 49.03% 31.14% 2013 44.97% 35.01% 2014 46.04% 30.02% Table 5: Acid - test ratio (%) (Source: Created by author) Graph 5: Acid - test ratio (%) (Source: Created by author) However, Sainsbury have been able to beat Tesco in many sections over the last two years, which have been a massive achievement for the firm. However, situations are different when the Acid - test ratio of the firms are calculated, which is highlighted in the graphs. The calculations show that the Acid - test ratio of Tesco is recorded at 46.04. % in the year of 2014, while the Acid - test ratio of Sainsbury has been recorded at 30.02% in the same year. However, it should also be noticed that not only in the year of 2014 but also in 2012 and 2013, the Acid - test ratio of Sainsbury has been quiet low than Tesco. Efficiency Ratio (Asset turnover) Refer to appendix 4 The assets turnover ratio is used to define how well the company deploys its assets. The amount of sales or revenues generated per pound of assets. Generally, the higher the ratio, the better it is, since it denotes that company is making more revenues per pound of asset (Heilbron, 2011). The given figure describes that Sainsburys ability to utilize its assets was more effective than Tescos. Both companies assets turnover ratios were consistent for the last three years, which was good for the two companies, but Sainsburys was the exceptional one. Asset Turnover = Sale revenue / Total assets Efficiency Ratio (Receivables collection period) The collection period is the calculation of the period of how long it takes customers to pay for the credit sales. The period of collection also equals the average accounts receivable divided by the credit sales (Demonstratingvalue.org, 2015). TESCO Sainsbury's 2012 44 39 2013 54 38 2014 61 41 Table 6: Receivables collection period (%) (Source: Created by author) The study of the above table shows that Sainsbury is more advanced in this section than Tesco. The calculation in the year of 2014 shows that Tesco has a average collection period of 61, which is 41 in case of Sainsbury. Therefore, it can be said that Sainsbury is far ahead of Tesco in this section. Efficiency Ratio (inventory turnover period) Refer to appendix 5 The inventory turnover is measured by days that explain the duration that needed to transform the companys inventories into sales. In this regards, the less number of the days, the better performance of the firm is. Inventory Turnover (days) = (Inventory / Cost of sales) * 365 (Chaudhuri, 2011) TESCO Sainsbury's 2012 20 14 2013 21 15 2014 23 15 Table 7: Inventory turnover period (%) (Source: Created by author) Graph 7: Inventory turnover period (%) (Source: Created by author) The calculation of the inventory turnover period of both the firms has been represented above in the graph, which quiet clearly shows that Tesco is having higher inventory period in all the three years consistently than Sainsbury. Gearing Ratio Refer to appendix 6 Gearing ratio is a financial ratio that measures the financial leverage, signifying the degree to which a firm's activities are funded by owner's funds versus creditor's funds. Gearing Ratio = Long - term Debt + Preference Shares / Equity * 100 (Bourke, 2009) TESCO Sainsbury's 2012 59% 51% 2013 56% 53% 2014 63% 52% Table 8: Gearing Ratio (%) (Source: Created by author) Graph 8: Gearing Ratio (%) (Source: Created by author) The gearing ratio of both the firms has been calculated at a stable position but the gearing ratio of Tesco has been greater than the grading ratio of Sainsbury consistently from 2012 to 2014. The lowest difference between the gearing ratios of these two firms was in 2013, which was only 3%. Interest cover The interest cover measures the amount of availability of operating profit for covering interest payable. In addition, stated that the lower level of operating profit coverage, the higher the risk to lender and shareholder. Interest Cover = Operating profit / Interest Expense TESCO Sainsbury's 2012 7.15 7.29 2013 9.33 7.11 2014 6.88 6.81 Table 9: Interest Cover (Source: Created by author) Graph 9: Interest Cover (Source: Created by author) The study of the above table and graphs quiet clearly shows that both the firms is quiet capable of covering their interest payable with the operating profit. The highest interest cover of Tesco has been recorded at 9.33. Meanwhile, the highest interest cover of Sainsbury has been recovered at 7.29 %. Discussing and identifying the purposes of calculating the ratios of Sainsbury and Tesco The financial ratios, which are also known as the Key Performance Indicators (KPIs) of the firm plays a massive role in extracting the actual financial condition of the firm within the market. These ratios will also enable the management of Tesco and Sainsbury to understand the areas that the firm is lagging behind and needs improvement within the minimum possible time (Bonett and Price, 2015). Moreover, these will also enable the management of Tesco and Sainsbury to draw and plan a certain action that will be taken by them in the next financial year to cover up all the identified loopholes. Therefore, it can be commented that the KPIs of a firm has the capability to highlight the exact current financial condition of the firm, which will also help the management to draw up certain financial strategies. Weaknesses of ratios analysis The weaknesses of the ratio analysis are stated below: Many large firms operate various divisions in different industries. For these companies it is difficult to find a meaningful set of industry-average ratios (Alzubaidi, 2014). The analysis of ratio of the financial statements do not always provide the exact amount, which makes the firm to assume the approximate value of that particular section, Inflation may have badly distorted a company's balance sheet. In this case, profits will also be affected. Therefore, a ratio analysis of one company over time or a comparative analysis of companies of different ages must be interpreted with judgment (Baur and Leuenberger, 2011). Conclusion The study of the entire report quiet clearly states that Tesco have outperformed Sainsbury in the year of 2012. The scenario have changed drastically form the year of 2013 as the study highlights that Sainsbury has various sections that are superior than Tesco in the year of 2013 and 2014 as well. Therefore, it can be said that the study has educated the learner regarding the various financial ratios of Tesco and Sainsbury along with its importance in evaluating the financial conditions of the firms. Recommendation The first and foremost recommendation to the management of Sainsbury is to operate their business in a strategic manner, which will enable them to beat Tesco in other areas as well. The management of Sainsbury needs to implement various strategies that will enable the firm to achieve a competitive advantage over Tesco. Meanwhile, Tesco has outperformed Sainsbury in the past, nut have failed to do the same in the recent years. Therefore, the management of Tesco needs to find out the loopholes that have created this problem in the recent time. Reference List Alzubaidi, R. (2014). Spreadsheets-based modelling for financial analysis ratios. International Journal of Economics and Accounting, 5(3), p.216 Baur, H. and Leuenberger, C. (2011). Analysis of Ratios, 60(6), pp.813-825 Bonett, D. and Price, R. (2015). Analysis Methods for Odds Ratios and Risk Ratios. Psychological Methods Bourke, A. (2009). Comparative Analysis of Investment Ratios. 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