Financial Ratio Analysis Of Sainsburys Economics Essay

A sustainable company needs effective planning and financial management. Ratio analysis is a useful tool to get the financial results and the company’s development tendency. It can be divided into four parts. They are profitability, liquidity, efficiency and gearing. This report discusses the analysis of two companies, one is Sainsbury, and the other is Tesco. It is necessary to compare these companies from the data and information in 2011 and 2012, so that demonstrates the use of an appropriate range of ratios.

Sainsbury is engaged in grocery and related retailing. It is separated three segments: Retailing (Supermarkets and Convenience); Financial services (Sainsbury’s Bank joint venture), and Property investments (The British Land Company PLC joint venture and Land Securities PLC joint venture). In 2012, this company has operated over 1000 stores comprising 572 supermarkets and 440 convenience stores (Sainsbury company information, 2013). In the current competitive food retail market Sainsbury has focused on its clear strength: providing shoppers with an easy alternative to the larger out-of-town supermarkets whilst maintaining a commitment to fresh quality foods (Sainsbury, 2012).

Tesco has the biggest supermarket chain in the UK. It has over 280, 000 employees working with them (Tesco, 2012). It can maintain their market share and profit in the UK, they also use social network to maintain the relationship with the customer. It is the biggest and most profitable supermarket chain in Britain; it has 30 per cent of grocery market. Tesco has over 2200 stores in the whole United Kingdom (Tesco, 2012). It is a superb development of Tesco, it is from a smaller store to be a superstores. Sales of non-food is one of the key parts of their strategy, it contributes to the growth picture in the UK. Tesco is launching a low price strategy; they offer the lower price for the similar product compare to others competitors.

By comparing Sainsbury and Tesco, it is easy to use financial ratio analysis to pinpoint the strengths and weaknesses. This report provides an analysis based on ratio calculation and then compares these companies’ data to help grasp the current performance of the companies and thus showing a financial snapshot of the companies’ position.

Financial Analysis

The following part will analysis the two companies’ performance in the criteria of profitability, efficiency, liquidity and gearing ratios. Ratios are important when companies need to compare the financial health of various businesses in order to understand the performance and position in the industry. Although some companies are relatively larger than the others such as comparing Tesco with Sainsbury’s, different scale of operations can be eliminated using the ratios for the same market (Atrill & McLaney, 2008).

Profitability

Sainsbury’s 2011

Sainsbury’s 2012

Changes (%)

Tesco 2012

Gross Profit Margin

5.50%

5.43%

– 1%

8.15%

Operating Profit Margin

4.03%

3.92%

– 2%

6.17%

ROCE

10.06%

9.50%

– 6%

12.64%

The purpose of profitability ratio is to measure the degree of success towards business objectives in terms of profit (Atrill & McLaney, 2008). It express the generated profit such as expenses, labour cost and sales revenue in relation to a company’s business resource. Gross profit margin measures differences between cost of sales and sales revenue, in other words a measure of profitability in purchasing and selling before any other expenses are taken into account. The data shows that gross profit margin had a slight decrease from 5.50% (2011) to 5.43% (2012), although both gross profit and Revenue increased, it could mean that sales prices were lower or an increased on purchasing. Operating profit margin is the comparison of both outputs of businesses: operating profit and sales revenue. It is used to measure the profit from trading operations before interest payable expenses are calculated. The operating profit margin has also decreased from 4.03% (2011) to 3.92% (2012) indicating a change in – 2 %. ROCE describes the relationship between operating profit and non-current liability. It has decreased from 10.06% (2011) to 9.50% (2012) by – 6%. The results indicate that Sainsburys’ profitability has decreased by a small amount.

Liquidity

Sainsbury’s 2011

Sainsbury’s 2012

Changes (%)

Tesco 2012

Current Ratio

0.58

0.65

12.07 %

0.67

Acid Test Ratio

0.31

0.35

12.9 %

0.48

Liquidity ratios represent the ability of business to meet its short-term financial liabilities in one year time (Atrill & McLaney, 2008). The purpose of using current ratio is to compare the assets of the company that will be turned into cash with current liabilities. Different businesses have different rate of ratios, supermarket such as Sainsbury’s and Tesco usually have relatively lower ratio than 1:1 since the companies are to sell FMCG and all sales are converted into cash immediately. The calculation shows that current ratio of Sainsbury’s increased by 12.07% from 0.58 (2011) to 0.65 (2012). This suggests that the company is more efficient at converting its assets into cash in comparisons with current liabilities. Acid ratio is similar to current ratio but is calculated excluding inventories therefore the changes from both ratio changes should reasonably be similar. Therefore the result also shows an increase of 12.9% from 0.31 (2011) to 0.35 (2012), it suggests that the business of Sainsbury’s became more liquid throughout 2011.

Efficiency

Sainsbury’s 2011

Sainsbury’s 2012

Changes (days)

Tesco 2012

Inventory Turnover Period

14.86

16.24

1

22.15

Efficiency ratio is use for assessing the extent to how well assets are being managed (Atrill & McLaney, 2008). Inventories turnover period represents the average period of inventories are being held. Since maintaining inventories require higher cost, therefore it is advisable for businesses to have shorter inventories turnover period. The data suggests that Sainsbury’s inventory turnover period increased by about 1 day from 15 (2011) to 16 (2012), meaning it took longer for the company to sell its goods. The data may also suggest that an increased number of inventories take longer to sell. Moreover, competitor Tesco had inventory three times more than Sainsbury’s and it took them even longer to clear their goods.

Gearing

Sainsbury’s 2011

Sainsbury’s 2012

Changes

Tesco 2012

Gearing Ratio

35.86%

38.84%

8.31%

43.55%

Interest Cover

7.34 times

6.33 times

– 1 time

9.56

Gearing ratio is a measurement of contribution of long-term lenders to the company’s long-term capital structure (Atrill & McLaney, 2008). The higher gearing ratio the higher risk for businesses because a small increase in operation profit tends to increase greater amount of returns to shareholders, but small decline also result in greater decline. The gearing ratio of Sainsbury’s increased by 8.31% from 35.86 (2011) to 38.84 (2012). It indicates a higher risk than the previous year. Interest cover ratio measures the quantity of available operating profit to cover interest payable (Atrill & McLaney, 2008). Calculation shows a decrease on interest cover of -1 time from 7.34 (2011) to 6.33 (2012). It indicates greater risk for lenders where interest payments might not be met. However, Tesco has a higher rate of interest cover; the reason may be due to their higher operating profit with less interest payable comparing with Sainsbury’s.

Comparative Financial Analysis

In the context of financial report, it is essential to compare ratios internally and externally. In terms of internal, the objective is to criticise whether Sainsbury’s performance has an improvement or deterioration and it is usually being measured over time such as one, five or ten years. Such comparison helps the company to detect trends for example the ways of how Sainsbury’s should control the flow of its stock or the amount of dividends which affect its stakeholders’ action. Comparing financial performance with other competitors within the same industry is also essential, because having comparable levels of performance is one of the major ways to survive in the market (Atrill & McLaney, 2008).

Analysing from both annual report of Sainsbury’s and Tesco, the profitability section indicates that Sainsbury’s had a decrease on both gross profit and operating profit margin while Tesco had an increase performance on profitability for gross profit margin by 4.05% ((8.48 – 8.15) / 8.15) and operating profit margin by 5.02% ((6.48 – 6.17) / 6.17). In other words it means Tesco is more capable at generating profit in 2011 / 2012, the reason is probably due to Tesco is a larger company than Sainsbury’s in terms of the number of stores at about 6 times more than Sainsbury’s and higher market share at 26.9% while Sainsbury’s had 14% during 2011 (Mintel, 2012).

The previous annual report of 2010 / 2011 shows that the online checkout system helped increase Sainsbury’s sales by 20% (130,000 weekly orders) which was the strength of the company (Sainsbury’s, 2011a). However the sales decreased in 2012 which was also partially caused by online shopping. The financial damage was due to sales cannibalisation and charging delivery at low rate. The reason to that is because the trend towards online grocery shopping where more and more customers are shopping online (Guardian, 2013). Another weakness of Sainsbury’s causing it to lose shares to its competitor Tesco was because of lack in investment internationally, particularly in China (The Independent, 2012). Currently Tesco already has over 100 stores in China. Sainsbury’s did not fully understand the trends and operating environment comparing to its home competitors.

In addition, Current Ratios are also needed to make comparisons between two companies because the current ratios provide us with the first slight of the financial strength of a company, but the current ratio analysis of different companies can be misleading in some case so that investors must be careful while evaluating a company on the bases of its current ratio (Atrill & McLaney, 2008). The Liquidity section demonstrates that Sainsbury’s had a modest increase on current ratio by 12.07% ((0.65-0.58) / 0.58) while the current ratio of Tesco had remained intact. In spite of this, it can be seen from comparison that Tesco is the winner in the current ratio contest as it has more current ratios that is 0.67 in 2012 compared to Sainsbury where the result is 0.65. Consequently, Tesco has more money to afford the liabilities and deal with its bills better than Sainsbury. The reason of this is probably due to the number of operating profit for Tesco at about 4 times more than Sainsbury’s in 2012, which was 3,985£m and 874£m respectively.

In order to make an exact measure of financial leverage, demonstrate the degree to which a firm’s activities are funded by owner’s funds versus creditor’s funds, the gearing ratios are needed to be compared also (Atrill & McLaney, 2008). According to the annual report of Sainsbury’s and Tesco, it can be shown that in this section, Sainsbury is doing better because its lower proportion of debts. The calculations demonstrate that the liability of Tesco shows more than approximately 73% of its debt is from borrowings while the loans of Sainsbury is lower than about 73% comparing with Sainsbury.

Limitation

Ratios provide an efficient and straight forward method to analyse the performance and position of businesses, however there are limitations companies should take into account.

Firstly, all numbers are taken and are used from the financial statements; therefore the results of all ratios can only be based on the quality of the information. It indicates that intangible non-current assets such as the value of brand names and goodwill cannot be included into the balance sheet. Moreover, no businesses are identical therefore companies should be aware of differences in accounting policies, financial year ends between businesses and financing methods when carrying out ratio analysis especially during benchmarks.

Secondly, inflation can affect the values of ratio analysis. Since balance sheet is made for the previous financial year, therefore the values of assets held could change in a period of time which results little relation to current values. Inflation can also affect the measurement of profit, it may show that the current prices does not reflect to previous expense, in that case profit may be overstated leading to inaccuracy.

Thirdly, companies should only use ratios as an insight but not fully rely on it. The reason is due to the fact ratio cannot measure information such as differences in scale between businesses and capital employer, profit / sales used for measuring changes of company size over time. As ratio can only measure relative position and performance of a business.

Conclusion & Recommendations

This report reveals the financial analysis techniques used to evaluate the financial performance of Sainsbury’s, and the evaluation of the company’s position and performance. The result shows that Sainsbury’s overall performance in 2012 was similar to 2011 but with minor decrease which may affect shareholders / investors decision on whether or not to continue investing on the company.

It is advisable for Sainsbury’s to increase dividends in order to keep its investors at a satisfy level. As the company is also the initiative to the ‘Click & Collect’ service, it should focus investment on improving its quality and differentiation from the competitors.

In terms of pricing issue leading to decrease on profitability, there are two choices for Sainsbury’s. First is to keep the pricing at the same level because its market share has been increasing, or secondly to increase price to gain profit where the decision is depending on Sainsbury’s objectives.