Company background

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.

The main objective of accounting is to provide information to the decision makers (Peterson Drake and Fabozzi, 2012).

Financial statement is an organized statement which is prepared to know the operating performance, financial position, disposal of surplus and movement of short term assets, cash position and total fund position. Financial statement analysis is the examination of historic financial data with the use of several financial tools such as Ratio analysis, Cash Flow statements, Profit & Loss Account and Balance sheet. The main purpose of analyzing financial records is to evaluate the company’s present performance and estimate the future potential and risk appetite of the company. These statements generates those information which are valuable for the organization, ensure the quality of earnings and helps in doing the SWOT analysis of a company. In this study for financial analysis of two companies namely Tesco and Sainsbury(Anon, 2015) are taken into consideration and their standard of performance are analyzed on the basis of three accounting period 2012, 2013 and 2014 (Anon, 2015).

Tesco is one of the largest retailers in the world. It was founded by Jack Cohen in the year 1919 from a small market at London. As the time passes this company grows and today it is operating across 12 countries in the world. They employ almost 530000 people and serve millions of customer every week. Their main two competitors in the world market are Wal-Mart and Carrefour.

Sainsbury is another renowned company in retail sector and older than Tesco company. It was formed in 1869 and today it operates over almost 12000 supermarket and convenience store. They have employed almost 161000 persons who served on behalf of the company. They demanded that they provide best possible service to their customers among all the retail sectors in the same category (Collis, Holt and Hussey, 2012).

As I have already mentioned that for performance analysis of a particular firm several techniques are used and ratio analysis is one of the important factors among those all. So here the analysis is mainly done on the basis of Ratios (Campilho and Kamel, 2012): (Collings, 2015).

Profitability ratios as the name suggest are those ratios which are used to measure the profitability of a company. Profitability means the return achieved by the efforts of management on the fund invested by the owners of the business. It is a net result of large number of policies and decisions. Long term profitability is vital for a company’s survival and benefits received by the shareholder. There are many ratios which can indicate the profitability but out of those some main ratios are Gross profit ratio, Net Profit Ratio and Operating profit ratio (Drury, 2012).

Financial performance analysis

Gross Profit ratio is calculated on the basis of net sales revenue. It represents the percentage of gross profit earned by a company on sales. Gross profit means the profit earned from direct trading activities.

 The gross profit ratio of Tesco for the year 2014 is 4010/63557*100=6.3%, for the year 2013 is 4154/63406*100=6.6% and for the year 2012 is 5261/64539*100=8.2%. A high Gross Profit ratio indicates a good profitability. However, in Tesco Company is balance sheet analysis it is found that, their Gross Profit ratio in 2013 and 2014 were 6% (approx) compared to 8% in 2012.

The gross profit ratio of Sainsbury for the year 2014 is 1387/23494*100=5.9%, for the year 2013 is 1277/23303*100=5.5% and for the year 2012 is 1211/22294*100=5.4%. The reduction in Gross Profit ratio may be due to the fewer amounts of sale in 2014 and higher amount of Cost of sales in 2013 whereas in case of Sainsbury Company, though their Gross Profit ratio is less than Tesco but it is in increasing trend (Robinson, 2012).

Operating Profit ratio is another tool used for profitability evaluation. Operating profit means the profit which can be derived from the Gross Profit after deducting the operating expense from the Gross profit. This approach is efficient than Gross Profit approach as the analysis is based on more accurate financials.

The operating profit ratio of Tesco for the year 2014 is 2631/63557*100=4.1%, for the year 2013 is 2382/63406*100=3.8% and for the year 2012 is 3985/64539*100=6.2%. In Tesco, the trend of the operating ratio is in a zigzag manner as in 2012 it was 6%, in 2013, it was 3% and in 2014, it was 4%. Overall, the ratio is drastically decreases by 50% (approx) in 2013 and though it has increased to some extent in 2014 still it is not much satisfactory.

The operating profit ratio of Sainsbury for the year 2014 is 1009/23494*100=4.2%, for the year 2013 is 882/23303*100=3.8% and for the year 2012 is 874/22294*100=3.9%. In Sainsbury Company, it maintains a stable growth as this ratio is not fluctuating widely.

Net Profit ratio is the most accurate technique used for profitability analysis as the net profit is derived after eliminating all indirect expenses from operating profit.

The net profit ratio of Tesco for the year 2014 is 970/63557*100=1.53%, for the year 2013 is 24/63406*100=0.04% and for the year 2012 is 2814/64539*100=4.36%.The Net Profit ratio of Tesco shows a drastic fall in the year 2013 from 4.36% to 0.04%. In this year the company had to adjust a huge amount of loss from its discontinued operations which may be one of the reasons of this fall. In 2014, they showed an increasing trend compare to previous year.

The net profit ratio of Tesco for the year 2014 is 970/63557*100=1.53%, for the year 2013 is 24/63406*100=0.04% and for the year 2012 is 2814/64539*100=4.36%.Sainsbury also did not perform very well but its condition is better than Tesco.

Liquidity ratios show the liquidity position of a company. Liquidity means the amount of cash and cash equivalents the firm has on hand and the amount of cash it can arrange in a short period of time. Liquidity is essential for smoothly conducting of business activities. If the firm has a poor liquidity position it may not able to make timely payments to the creditors and, in effect will not be in a position to buy goods and service further on credit. High liquidity can help to grasp different market opportunities. The most two important liquidity ratio is current ratio and quick ratio (Alan Russell, R. Langemeier and C. Briggeman, 2013); (Collis, Holt and Hussey, 2012).

Current ratio is also known as the working capital position ratio. It shows whether a company’s short term debt is capable of paying off its short term liabilities. Higher the ratio better will be the company’s position. The ideal ratio is always 2:1 i.e. for 1-rupee debt there should be rupees two as current asset.

The current ratio of Tesco for the year 2014 is 13085/20206=0.65, for the year 2013 is 12465/18703=0.67 and for the year 2012 is 12353/19180=0.64. In Tesco Company, the current ratio is not at all in a good position as in all the 3consequtive years the ratio is below 1 i.e. there are not enough current assets to pay of the current liabilities. The current ratio of Sainsbury for the year 2014 is 1612/4847=0.33, for the year 2013 is 1677/4667=0.36 and for the year 2012 is 1572/4651=0.34. In Sainsbury Company also the ratio is too bad rather it is in diminishing trend.

Quick ratio is also known as the Acid Test Ratio. This ratio further redefines the liquidity by measuring the quick assets and quick liabilities. These ratios exclude those items which are difficult to turn into cash like inventory, prepaid expense. The reason for the omission of stock from the current asset may be that stock can be valued in different ways by different firms. Quick ratio is often compared with current ratio. If the quick ratio is comparatively higher it indicates the dependency on the inventory.

The quick ratio of Tesco for the year 2014 is 9509/20206=0.47, for the year 2013 is 8721/18703=0.47 and for the year 2012 is 8755/19180=0.46. In case of this ratio also the Tesco Company shows an unsatisfactory image as this is also below 1 it implies the company does not have enough cash and cash equivalent to pay off its liabilities. The quick ratio of Sainsbury for the year 2014 is 1612/4847=0.33, for the year 2013 is 1677/4667=0.36 and for the year 2012 is 1572/4651=0.34. One interesting thing happened in case of Sainsbury because in Balance sheet the company does not have any inventory balance so the quick ratio is same as its current ratio.

Profitability ratios

Each performance has some standard and when the performance goes beyond the standard it is known to be an efficient performance. The efficiency ratios are the indicator of measuring the efficiencies. Receivable collection period, inventory turnover, interest coverage ratio etc are the commonly used efficiency indicators (Foroughi, 2012).

Asset turnover ratio is indicating the availability of total assets on the basis of sales revenue earned. It also reveals the extent of utilization of the total asset into the business. The ratio proves the efficiency of the management in operational activities. Higher the ratio better will be the position.

The asset turnover ratio of Tesco for the year 2014 is 50164/63557=1.27, for the year 2013 is 50129/63406=1.26 and for the year 2012 is 50781/64539=1.27. Tesco Company have almost stagnant turnover ratio among the three periods. The ratio above 1 indicates that the company is able to earn more than rupee 1 by its sales revenue after utilizing rupee 1 as asset.

The asset turnover ratio of Sainsbury for the year 2014 is 10485/23949=2.28, for the year 2013 is 10441/23303=2.23 and for the year 2012 is 10342/22294=2.16.The Asset Turnover Ratio of Sainsbury is too good as it is more than 2 in three years representing that their revenue is almost double of their assets.

Receivables collection period show the time allowed to debtors. It is the lag of time interval for collecting the dues from the debtors. It can also be termed as debtor’s collection period. A high turnover ratio indicates that the company cannot be able to collect the amount from their customers as a result cash is being blocked into it and its liquidity position is affected. Here in the ratio calculation it is found that their receivable collection period is low it indicates that the company is having a good receivable management policy as low the collection period means higher frequency of collection and lower the risk of bad debt.

The receivable turnover ratio of Tesco for the year 2014 is 2190/63557=29.02, for the year 2013 is 2525/63406=25.11 and for the year 2012 is 2657/64539=24.29. Thus, the collection period for Tesco is in 2014 is 12.58, in 2013 is 14.53 and in 2012 is 15.03. The receivable turnover ratio of Sainsbury for the year 2014 is 1428/23949=16.77, for the year 2013 is 1254/23303=18.58 and for the year 2012 is 1099/22294=20.29. Thus, the collection period for Sainsbury is in 2014 is 21.76, in 2013 is 19.64 and in 2012 is 17.99. In case of Sainsbury, also the collection period is low though the frequency is less then Tesco.

Liquidity ratios

Payable turnover period is just opposite like the receivable collection period. It indicates the credit period allowed by the suppliers for making payment to them. A high turnover period indicates high obligation.

The payable turnover ratio of Tesco for the year 2014 is 10595/59547=5.62, for the year 2013 is 11094/59252=5.34 and for the year 2012 is 11234/59278=5.28. Thus, the payable period for Tesco is in 2014 is 64.94, in 2013 is 68.34 and in 2012 is 69.17. The payable turnover ratio of Sainsbury for the year 2014 is 4457/22562=5.06, for the year 2013 is 4571/22026=4.82 and for the year 2012 is 4494/21083=4.69. Thus, the payable period for Sainsbury is in 2014 is 72.10, in 2013 is 75.75 and in 2012 is 77.80.

Both Tesco and Sainsbury had too high payment period of 69 days and 77days respectively in 2012 and after that it has reduced its period to 64 days and 72 days in 2014.

Inventory turnover period is the time lag which represents how many times inventory is ordered in a particular year. On the other terms, it shows the frequency in which inventory is cleared and new order can be made. A low inventory turnover indicates a good inventory management policy. The inventory turnover ratio of Tesco for the year 2014 is 3576/59547=16.65, for the year 2013 is 37445/9252=15.83 and for the year 2012 is 3598/59278=16.48. Thus, the inventory turnover period for Tesco is in 2014 is 21.92, in 2013 is 23.06 and in 2012 is 22.15.

For the three consecutive years, Tesco have a good inventory turnover, which indicates that it has a well-organized inventory management policy and there is less chance of inventory pileup. The inventory turnover ratio of Sainsbury is not possible as it has no inventory given in its balance sheets. There is no balance available in the B/S of Sainsbury regarding the inventory so it is not possible to calculate the Inventory Turnover.

Interest coverage ratio is used for calculating the financial stability of the company. It shows the number of time a company is able to pay its interest obligation based on earned profit. It is calculated by dividing the EBIT by interest. A high interest coverage period indicates a high financial leverage.

The interest coverage ratio of Tesco for the year 2014 is 2337/78=29.96, for the year 2013 is 2134/82=26.02 and for the year 2012 is 3949/114=34.64. The interest coverage ratio of Sainsbury for the year 2014 is 924/26=35.54, for the year 2013 is 804/32=25.13 and for the year 2012 is 823/35=23.51.

Tesco’s ratio analysis calculation shows that it had a very good interest coverage ratio in 2012 but all on a sudden it reduced by almost 50% in 2013 and then again it started increasing in 2014 whereas Sainsbury has 23.51 as  interest coverage in 2012 which increase to 35.53 in 2015 indicating an upward movement of interest paying capability.

Different group of investors provides long-term capital of a business. Gearing is a method of comparing how much the long-term capital of a business is financed by equity and how much is provided by fixed charged capital investors who are entitled to get interest before the payment of dividend to the shareholders.

Financial gearing ratio can also be termed as Debt Equity ratio. It is showing the proportion of external debt of a company on which the company has to pay fixed interest obligation to the internal debt, which is known as the owner’s equity. The ideal ratio is 1:1.

The debt equity ratio of Tesco for the year 2014 is 2009/14722=0.14, for the year 2013 is 887/16661=0.05 and for the year 2012 is 1966/16623=0.12. The debt equity ratio of Sainsbury for the year 2014 is 388/4369=0.09, for the year 2013 is 89/4259=0.02 and for the year 2012 is 338/4233=0.08.

Both companies are having financial gearing ratio less than 1 it implies that these companies are more dependent on their internal fund (S and Suresh Kumar, 2013).

Equity gearing ratio is the ratio between total asset and total equity. By this ratio we can say that how a company utilizes its owner’s equity for acquiring its assets. A higher ratio indicates an efficient performance.

The equity gearing ratio of Tesco for the year 2014 is 14722/50164=0.29, for the year 2013 is 16661/50129=0.33 and for the year 2012 is 16623/50781=0.33. The equity gearing ratio of Sainsbury for the year 2014 is 4369/10485=0.42, for the year 2013 is 4259/10441=0.4079 and for the year 2012 is 4233/0.409=0.08.

For the Tesco equity gearing ratio, is good as it is less than 1 and gradually decreasing. For Sainsbury it is in stagnant condition.

There are few limitations of ratios, which are as follows

Ratios are calculated based on past results, so, proper prediction for future may not always be possible.

Comparison of the ratios with the other units will be meaningless if the uniformity has not been observed in the preparation of the accounts of these units.

Financial system suffers from a number of limitations. When the ratios are constructed from those financial statements, ratios suffer from the inherent weakness of the accounting system itself.

Accounting ratios are simply clues. They do not indicate any cause of difference. Therefore they are not considered as basis for immediate conclusions.

Ratios are not free from individual bias, because accounting is manmade. Two same type of business with the same level of operation may show highly incomparable financial results.

While constructing a ratio arithmetic window dressing is possible by concealing vital facts and presenting the financial statements in such a fashion as to show the business in a better position than it actually is (Seal, Garrison and Noreen, 2012).

Following are my recommendations for the two companies

From the Tesco company’sbalance sheet it is observed that it has suffera huge loss from its discontinuing operations as a result their net profits are reducing, they should try to increase their revenue by cutting down unnecessary costs (Karelskaya and Zuga, 2012); (Kieso, Weygandt and Warfield, 2012).

For Sainsbury Company they should change their payable management policy. It requires paying their dues in less time interval as a result their current ratio may improve. The same suggestion is applicable for Tesco also.

The financial position of Sainsbury is not too bad so they can trade with more of debt capital for getting the benefit of trading on equity. Their interest coverage ratios are also quite good.

Tesco should make new investments in different financial assets and instruments, which will give a fixed return to their company, and that return can be utilized for further expansion.

The cash flow statement of Tesco shows a negative balance generated from all activities. The company should make proper investigation for revealing the reasons behind it (Kusano, 2012).

Lastly, both the companies are very reputed company so they should try to take the benefit of competitive advantage by using their core competencies so that they can able to sustain in this competitive market.

Conclusion

Conclusion means the end report of the project or the summary of the whole study in brief. This study is concerned with the financial analysis of two firms on the basis their ratios. But reaching any particular conclusion only on the basis of ratio is not too accurate because there are some other factors influencing the financial decision. But if we want to incorporate all these factors into this study then it will be too elaborative. So here the initiative is taken to conclude the report on the basis of Ratios only (Llewelyn, 2012); (Marilena and Alice, 2012).

Ratios are calculated from the various accounting data for establishing the logical relationship between them and for explanation and analysis of various accounting information. From the above discussions, relating with ratios the following conclusions can be made.

Tesco Company has a higher Gross profit margin than Sainsbury though but later its fails to maintain its position and net profit ratio become too low.

The liquidity position of Tesco is comparatively better than the other one.

From the view point of efficiency in all the cases Sainsbury shows better result than Tesco except in Payable management policy.

Sainsbury Company does not show any inventory amount though it reduces the dependency on inventory but it is not at all a good sign.

So I would like to conclude that the business of Sainsbury is more consistent than the Tesco and both companies should take some measures to overcome their liquidity and profitability crunch (Goodhart, 2013): (Jury, 2012).

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