Financial Analysis Essay

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Comparative Financial Analysis-Tesco and Sainsbury

Introduction

The evaluation of financial statements of organisations is critically important for the assessment of the entire performance of the firm and finally evaluation of better investment decisions. There are different financial tools that are accessible for establishing relevant analysis of the financial statements of organisations (Fernie & Ebooks Corporation, 2005). One of the financial tools that are widely used in evaluating the financial statement is ratio analysis, which not only assists in the evaluation of the company’s performance but also gives room for effective comparison of the performance of one firm to that another (Baker, 2011). In this report, the main goal is to make comparison of two UK based firms; Tesco and J Sainsbury Supermarkets through the determination of ratio analysis for both of these firms over a time period of three years.

Overview of Tesco

Tesco is among the top food retailers in Ireland and United Kingdom with about 2715 retail stores located countrywide.  Tesco was found by Jack Cohen in the year 1919 and its headquarters are located in East London. The management of the company has shifted forward by two major individuals inclusive of Sir Terry Leahy as the CEO and David Reid as the Chairman (Yahoo Finance, 2013). The company has a definitive product range such as Groceries, financial services, telecoms and consumer goods. The total revenue of the firm by March 2013 was about £ 43.6 billion with operating income of about £ 2.272 billion. Tesco’s net income is currently about 2.8 billion as of financial year 2013. In 2012, these figures were £63916 million, £3803 million and £2806 million respectively. The company distributes its profits among the investors in the form of dividends. Generally it distribute dividend twice a year (Yahoo Finance, 2013).

Overview of Sainsbury Plc

Sainsbury is the third biggest supermarket chain in the UK. The company has a market share of 16.5% in the UK Supermarkets chains. J Sainsbury was found in 1860 and currently it is one of the major players in the supermarkets with about 537 chains of supermarkets and 335 convenience retail stores (Yahoo Finance, 2013). The firm has expanded its business to include shares in Lloyds Banking Group and in real estate industry by two joint investments with British Land Company and Land Securities Company. In 2013, the firm’s revenue was £23303 million; a bit higher from last year’s which was £22294 million.sme trend was seen in the operating and net profit which were £882m and £614m in 2013 and £891m and £598m in 2012 respectively. Sainsbury understands the need of distributing dividends and in this regard, it distributes interim dividends in December/January and annual dividends in July.  

Financial Analysis

As mentioned there different types of ratios that will be determined for Tesco and Sainsbury. These comprise of profitability ratios, liquidity ratios, efficiency ratios as well as gearing ratios.

Profitability Analysis

Return on Assets

The profitability of Tesco is on the rise, which is evidenced by the increasing profitability trend over the firm (Warren, 2013). Compared to Sainsbury, their trend in profitability is gradually rising. Tesco rise in profitability is owed to the ability of the company to attract good and efficient investors with the objective sustaining this strong financial strategy for the earning in future to be in the constructive trend. As ROA is going upward, the trend over the three years had a particular fall in 2013 to a figure less than 6%. Even though the firm’s sales are rising there are potential that the firm may not be getting their receivable in a timely manner and most of the sales might be acquired on credit.

The graph below is an indication of the trend in the flow in return on assets. Tesco had the highest peak in 2012 compared to Sainsbury. However, Sainsbury demonstrated a high record in 2011 and 2013, which might be attributed to timely collection of sales revenues by the company and effective strategies used by the management in the promotions of its inventories.  

Return on Assets

Source: (Own Determination from the data given)

Return on Equity

 

Source: (Own Determination from the data given)

The above diagram shows a graphical presentation of return on equity for Sainsbury and Tesco supermarkets. From the diagram, there is an indication that Tesco has higher returns on equity within the three-year period. This is owed to its diversified investments in other sectors such as financial sector, real estate investments.  Moreover, the higher return on equity can be owed to the long history of effective management of shareholder’s equity in the company’s operations. Ultimately, effective investment decisions by Tesco doubled by the huge proceeds from the investments have increased the level of returns within the company.

The net margin

Source: (Own Determination from the data given)

From the graph above Tesco still shows great ambience in its performance in terms of its profitability compared to Sainsbury. Notably this increase in the profit margin is attributed to the efficient management of expenses and good strategies of marketing of its products to maximise on the sales. Sainsbury has been recording low volumes of sales revenue compared to Tesco with numerous retail outlets in the United Kingdom to boost the sales revenue. In addition, Sainsbury low sales revenue can be linked to poor methods of products promotion, which lead to minimal sales revenues. Tesco has effective methods of collective trade receivables, which boosts the collection of debts owed by customers to the company. Furthermore, it is definite that Tesco has done well in areas of risk management especially with the diversification of its businesses, which improves its ability to invest and expand the market outlets of its products. Apparently, as noted from the introduction, it is also evident that the retail outlets by Tesco exceed by a bigger margin those of Sainsbury.

Liquidity Ratios

Liquidity ratios demonstrate the ability of the company to meet its short-term obligations with the available short-term assets. This is exhibited by two main ratios; the current ration and the quick acid ratio (Gibson, 2012).

The current ratio

The current ratio shows the ability of the company to meet its short-term liabilities with the available liquid or current assets. The ratio is found by the formula; current assets divided by the current liabilities.


From the diagram above it is evident that none of the companies was able to achieve a current ratio of 1 for the last three years. This is a risky observation for the company. Notably it is recommended that a company should have a current ratio of more than one but not more than two.  Even though none of the two companies was able to achieve a current ratio of one in the food retail industry, Tesco showed a greater prowess in its results by having slightly better current ratio compared to Sainsbury. The two companies’ shows signs of risk in its operation given that the managements of the two firms are not in a position to meet short term liabilities with the available current assets hence the creditors might it hard to supply their commodities to the firms. Eventually the customers might lose trust in the supermarkets if products cannot be supplied in time.   There are possible reasons that might have contributed to this observation in the trend of current ratio for the last three years. It is possible that both companies are having excessive orders of inventory, which is held by the company against the diminishing demand for the products. Besides, it is also possible that the low current ratio is owed to increase in payables for the company which increases the amount of current liabilities to be payable. Excessive inventory, poor methods of marketing or product promotion, which leads to low movement of goods and services, has a greater impact on the flow of inventory. Furthermore, Tesco and Sainsbury might be experiencing a slow pace in the collection of accounts receivables, which lead to, held up of funds in the company.Source: (Own Determination from the data given)

Quick Ratio

Similar to the Current ratio, the quick ratio, which shows the ability of the firm to meet its short-term debts by use of liquid cash without cash, the results from the calculations, does not show much to be desired from the two large scale supermarkets. Tesco has a better edge over its competitor Sainsbury in terms of the quick ratio (Warren,Reeve & Duchac,and 2012). Sainsbury has a declining trend in the quick ratio. This is not a good sign for the company. This is an indication that the liquid cash at the disposal for the company is limited which might be attributed to the low level of collection of receivables. As a result, the company has much to do in terms of establishing the best ways of collecting its trade receivables such as use of discounts. Tesco on its hand, even though it has a better edge over Sainsbury, it has much to act on in connection to the management of its liquid assets.  

Leverage Ratio

Interest coverage ratio

            Interest coverage ratio shows the ability of a business to repay or service its loans with the net income from the operations. It is notable interest coverage ratio has the ability to demonstrate to the management how well its interest expense can be covered and the period to which this can be done (Kaas, Goovaerts & Dhaene, 2010).  The diagram below shows the interest coverage ratio for the two large chain supermarkets.   

Source: (Own Determination from the data given)

Tesco demonstrates a high ability to repay its interest expense with the acquired operating income. The line graph shows that Sainsbury’s interest coverage ratio is on the negative side of the graph. It should be noted that a ratio under a figure of one implies that the firm is experiencing challenges in generating adequate cash flows to meet the interest expenses hence the recommended ratio must be more than 1.5. In this case, Sainsbury is highly at risk of going under solvency owing to the observed trend in the interest expense ratio for the last three years. This is because the firm can barely manage to cover or meet the costs on interest rates, which might easily lead into bankruptcy of the company. Besides, it is an indication that its earnings or revenues are at risk given that it can be used to repay the full loan in case of default (Ulwick,2007).

Debt to asset ratio

This is a metric used to determine the financial risk of a company by calculation the quantity of the assets by the company that has been utilised to finance debt (Beyer, 2010). This is determined by adding a long term and short-term debt and finally dividing the results by the total assets of the company. In the event the ratio falls below one most assets by the company are financed though equity and if it is more than one it is an implication that the assets of the company are financed through debt financing.

 

From the above diagram, it is evident that both companies have low level of leverage hence they are financed through equity finance. This is because their trend in the debt to asset ratio falls below one. This is an implication that the companies have low risk in terms of leverage hence creditors to the company have less chances of demanding for their debt (Pachamanova & Fabozzi,2010). The companies can safely carry out their normal operations without concerns over the creditors. Sainsbury is safer compared to Tesco which indicates that Tesco has a higher leverage over Sainsbury (Bradford, 2008).

The diagram below shows the movement of Tesco share prices, which shows a falling in value in the share value an indication the shareholder’s wealth is at its reducing trend. This is not the same for Sainsbury as its shares has been shown to show a slight improvement.

Source: (Yahoo Finance, 2013:1)

As far as Return on Investment is concerned, Tesco has improved their level of investment because the profit acquired in the last few years have been on the rise (Penner, 2013: 9). Hence increasing the level or quantity of profits is an indication of increased efficiency for the capital employed. This in comparison with the Sainsbury, there is a huge disparity in their way of management owing to the fact that Tesco has its own independent financial services compared to Sainsbury, which has opted to invest in Lloyd bank (Zelman, McCue & Glick,and 2009).

EPS Ratio

            For the year 2013, the EPS Ratio of Tesco is coming out to be 4.71 while for Sainsbury it is coming out to be 31. EPS indicates the profitability of the company, higher the EPS ratio, better is the performance of the company. Therefore, on the basis of EPS ratio it can be said that Sainsbury is more profitable than Tesco.

P/E Ratio

            This ratio is indicator of valuation of firm’s existing share price with its EPS. Generally, company with higher PE ratio is expected to generate better results. In 2013, PE ratio for Tesco was 75.615 and for Sainsbury were 13.37. On this basis, it can be said that Tesco is expected to generate higher earnings.

Turnover Ratio

Inventory Turnover Ratio

            It tells about the company’s efficiency regarding generation of sales, that is, how quickly the company can generate is sales. For Tesco, this figure is coming out to be almost same for the last three year, whereas, Sainsbury has significantly improved in generation of sales. This is because of its aggressive marketing campaign and promotional strategies.

 

Receivable Turnover Ratio

This ratio tells about the company’s credit management. Lower the ratio, better is the credit policy of the company, higher the ratio, company may experience scarcity of funds. In comparison to Sainsbury, receivable turnover ratio for Tesco is much better as it is able to collect cash from its debtors in much less time (Zelman, McCue and Glick, 2009). Further, its ratio is near about same in all the years, while for Sainsbury, it varies significantly. This shows credit management of Tesco is better than Sainsbury.

Recommendation

According to the observation, it is apparent that Sainsbury currently trades on 12.3 times the current year’s forecasted income, which implies that this is a yield of 4.5% (Young & Aitkin, 2007). Even though one might look at this figure to back investment in Sainsbury, it might be too early to judge the performance of the company given its good shape in the current fiscal year.  I would rather recommend investment in the company given its slight premium to Tesco supermarket regardless of its size and magnitude (Asia Pacific Economic Cooperation, 2001). Comparing the two businesses, the shares of the two companies have a fair value with a good and strong yield. There is however, no strong rationality to come out even though there is a good reason to buy in shares from this company while shares in Tesco can be held as opposed to selling the shares.

Conclusion

From this discussion, it is evident that Tesco has a more competitive advantage compared to Sainsbury based on its scope of operation, revenues acquired and good ratio outcome. Tesco is well diversified with strong financial records as well as management insight as noted from the results of the ratio analysis. Moreover, the financial services offered by the company have had a strong influence on the profitability of the company in the food retail industry. Investing funds in Tesco now is risky based on its diminishing trend in the financial ratios however; investors would be advised to hold their shares in the company to prevent selling the shares at a loss.

References

Asia Pacific Economic Cooperation. (2001). The new economy and APEC. Singapore: APEC Secretariat.

Baker, H. K., and English, P. (2011). Capital budgeting valuation: Financial analysis for today's investment projects. Hoboken, N.J: Wiley.

Beyer, S. ( 2010). International Corporate Finance - Impact of financial ratios on long term credit ratings: Using the automotive examples of BMW Group, Daimler Group and Ford Motor Company. München: GRIN Verlag GmbH.

Bradford, A. (2008). The investment industry for IT practitioners: An introductory guide. Chichester, England: John Wiley & Sons.

Fernie, J., and Ebooks Corporation. (2005). International retailing. Bradford: Emerald Group Publishing.

Gibson, C. H. (2012). Financial Reporting and Analysis . Ontario: South-Western Pub.

Kaas, R., Goovaerts, M., and Dhaene, J. (2010). Modern Actuarial Risk Theory. S.l.: Springer Berlin Heidelberg.

Pachamanova, D. A., and Fabozzi, F. J. (2010). Simulation and optimization in finance: Modeling with MATLAB, @Risk, or VBA. Hoboken, N.J: Wiley.

Penner, S. J. (2013). Economics and financial management for nurses and nurse leaders. . New York: Cengage.

Ulwick, A. W. (2007). Business Strategy Formulation: Theory,Process and the Intellectual Revolution. Zurich: IAP.

Warren, C. S. (2013). Financial and managerial accounting. Cincinnati: South-Western.

Warren, C. S., Reeve, J. M., and Duchac, J. (2012). Corporate financial accounting. Mason, OH: South-Western Cengage Learning.

Yahoo Finance, (2013). Tesco Corporation. Yahoo Finance.

Yahoo Finance, (2013). J. Sainsbury. Yahoo Finance.

Young, A., and Aitken, L. (2007). Profitable marketing communications: A guide to marketing return on investment. London: Kogan Page Ltd.

Zelman, W. N., McCue, M. J., and Glick, N. D. (2009). Financial management of health care organizations: An introduction to fundamental tools, concepts, and applications. San Francisco: Jossey-Bass.

 

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Financial statement analysis (or financial analysis) is the process of reviewing and analyzing a company’s financial statements to make better economic decisions. These statements include the income statement, balance sheet, statement of cash flows, and a statement of retained earnings.

Horizontal analysis (also known as trend analysis) is a financial statement analysis technique that shows changes in the amounts of corresponding financial statement items over a period of time. It is a useful tool to evaluate the trend situations.

The statements for two or more periods are used in horizontal analysis. The earliest period is usually used as the base period and the items on the statements for all later periods are compared with items on the statements of the base period. The changes are generally shown both in dollars and percentage.

Vertical analysis is the proportional analysis of a financial statement, where each line item on a financial statement is listed as a percentage of another item. Typically, this means that every line item on an income statement is stated as a percentage of gross sales, while every line item on a balance sheet is stated as a percentage of total assets.

The most common use of vertical analysis is within a financial statement for a single time period, so that you can see the relative proportions of account balances. Vertical analysis is also useful for timeline analysis, where you can see relative changes in accounts over time, such as on a comparative basis over a five-year period. For example, if the cost of goods sold has a history of being 40% of sales in each of the past four years, then a new percentage of 48% would be a cause for alarm.

Solvency Ratio is a key metric used to measure an enterprise’s ability to meet its debt and other obligations. The solvency ratio indicates whether a company’s cash flow is sufficient to meet its short-term and long-term liabilities. The lower a company’s solvency ratio, the greater the probability that it will default on its debt obligations.

Solvency and liquidity are both terms that refer to an enterprise’s state of financial health, but with some notable differences. Solvency refers to an enterprise’s capacity to meet its long-term financial commitments. Liquidity refers to an enterprise’s ability to pay short-term obligations; the term also refers to its capability to sell assets quickly to raise cash. A solvent company is one that owns more than it owes; in other words, it has a positive net worth and a manageable debt load. On the other hand, a company with adequate liquidity may have enough cash available to pay its bills, but it may be heading for financial disaster down the road.

Solvency and liquidity are equally important, and healthy companies are both solvent and possess adequate liquidity. A number of financial ratios are used to measure a company’s liquidity and solvency, the most common of which are discussed below.

Liquidity Ratios

Current ratio = Current assets / Current liabilities

The current ratio measures a company’s ability to pay off its current liabilities (payable within one year) with its current assets such as cash, accounts receivable and inventories. The higher the ratio, the better the company’s liquidity position.

Quick ratio = (Current assets – Inventories) / Current liabilities

= (Cash and equivalents + Marketable securities + Accounts receivable) / Current liabilities

The quick ratio measures a company’s ability to meet its short-term obligations with its most liquid assets, and therefore excludes inventories from its current assets. It is also known as the “acid-test ratio.”

Days sales outstanding = (Accounts receivable / Total credit sales) x
Number of days in sales

DSO refers to the average number of days it takes a company to collect payment after it makes a sale. A higher DSO means that a company is taking unduly long to collect payment and is tying up capital in receivables. DSOs are generally calculated quarterly or annually.

Solvency Ratios

Debt to equity = Total debt / Total equity

This ratio indicates the degree of financial leverage being used by the business and includes both short-term and long-term debt. A rising debt-to-equity ratio implies higher interest expenses, and beyond a certain point it may affect a company’s credit rating, making it more expensive to raise more debt.

Debt to assets = Total debt / Total assets

Another leverage measure, this ratio measures the percentage of a company’s assets that have been financed with debt (short-term and long-term). A higher ratio indicates a greater degree of leverage, and consequently, financial risk.

Interest coverage ratio = Operating income (or EBIT) / Interest expense

This ratio measures the company’s ability to meet the interest expense on its debt with its operating income, which is equivalent to its earnings before interest and taxes (EBIT). The higher the ratio, the better the company’s ability to cover its interest expense.

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