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Analyzing The Financial Ratio Add in library

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Question:

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?

 

Answer:

Introduction

The performance analysis of a company can be adjudged by analyzing the financial ratio of a company with the past data gathered from its past performance. The ratio analysis provides the short but insights of various departments in the business segment. Therefore, this type of analysis is based on the past financial and operational performance of the company. Further, from ratio analysis, the important measures like debt and equity can be estimated that can be useful in making the decision for the business. The application of ratio analysis is wide in the sense of finding the loopholes in business. Thereby, the decision of doing business can be changed due to different findings from the ratio analysis. Ratio analysis is suitable in finding the comparison between ratios of different years in the same domain. Therefore, it is a prima facie of comparative trend analysis of financial performance to indicate the health of a business in terms of financial as well as an operational perspective. The input data for conducting ratio analysis come from the accounting and financial report of the companies where financial and accounting information is present normally.  The base of ratio analysis is to indicate on the situational changes due to changing in operation or decision in business and the way to improve the condition.

In this report, the main emphasis will be given on analyzing the financial ratio of two UK based companies – Tesco Plc and Sainsbury Plc. Both the companies are in a retail business that allows an analyst to analyze and compare their financial performance using ratio analysis for the last three years. Further, this report will be based on the trend of the two companies and the difference between their performances in different segments. The management of the two companies will be able to make a better decision to improve the situation after observing the compared analyzed report here. The report will also present a structure and recommended decision for the management to improve the condition for future that may be helpful in making a decision in business.

Profitability ratio

Profitability ratio of the company produces the information of profit in terms of revenue for a particular year.

Gross profit margin

As stated by Ahmed (n.d.), gross margin helps to get information on profit made by a company in terms of revenue. It means the profit margin on sales made on the basis of the cost of goods sold. It is useful to consider the competitive analysis of the companies within a sector of business. Thereby measuring the profitability of the companies, the first way is to measure the profit margin it has considered making sales competing with others. However, Brealey, Myers and Allen (2014) observed that it is meaningless to measure the profit margin of sales price using gross profit margin. The reason is the cost of goods sold is not adjusted with the inflation carried from the past inventory while some opening inventory is possible in every business from past year. The gross margin of Tesco has tenacity towards downwards during the period from 2012 to 2014. The margin has a downward slope for the company while for Sainsbury the margin has increased so far. From the table in Appendix I, it can be seen that the gross margin for Tesco is 5.16, 5.19 and 6.14 in 2014, 2013 and 2012 respectively. The same figure for Sainsbury is 5.79, 5.48 and 5.43 in the same period. The competitiveness of the two companies in their business sector can be found from the data measured. It is true that two companies have some different view in doing business as the profit margin from the cost of goods sold has fallen differ in the same period despite they have sold almost the same branded products.

 

Net profit margin

Net profit margin of the company is the measurement of the part of the profit can be made from revenue after meeting all types of expenses in the business. From the viewpoint of D'Mello and Farhat (2008), it can be said that net profit margin expresses the information on the margin that can be recognized by the company after assessing the expenses of the companies. From the Appendix II, it can be observed net profit margin of Tesco is 1.51, .03 and 4.36 respectively for the duration of the last three years. Therefore, it can be seen that company has recovered from the disaster situation of the financial dilemma of 2013. Further, it also can be seen that company is still recovering from the bad phase of business while it made a good net margin in 2012. Sainsbury has made the profit for the period almost overall same. The net margin of the company is 2.99, 2.58 and 2.68 respectively in the period of 2012 to 2014. The trend of the margin of profit is almost upwards for the company during the period that states the situation of business is under the grip of the company.

Operating margin

Operating margin provides the operational benefit from the business of a company (Fridson and Alvarez, 2002). It can be said from the observation of Fried (2013), that operational margin is very important in evaluating the business performance as the cost associated with a business can be analyzed in this process. Therefore, the operational margin of the two companies are compared during the period and can be observed in Appendix III. The operating margin of Tesco is 4.1, 3.7 and 6.48 in the respective three years of the analysis period. The same margin for Sainsbury is 4.21, 3.78 and 3.92 during the period. From operating margin of the two companies, it can be observed that the margin is upward for Sainsbury while the same has gone through amid volatility for Tesco during the period. The operating profit for Sainsbury shows that company has affected least due to in the case in sourcing of materials and salary of the employees. Tesco has tried to make over the margin of 2012 in a recent performance but has failed to reach the last threshold level of profit margin due to high-interest cost and repayment of the loan in capital expenditure segment.

Liquidity

Liquidity of a company is very important to run the business as it is the measure of cash present in hand and company can spend money during emergency requirements. According to Hubbard, (2008), liquidity of a company provides the manager to make a strong decision as well as it also helps to recover from any financial disaster during an adverse situation in the economy. Two types of the liquidity ratio are popular in the market – current and quick ratio. The difference between the two is simple – the first one is assessed accumulating inventory as liquid assets while the second one does not consider inventory as a liquid.

 

The current ratio of a company also provides information on how much company can meet the current obligation through its current assets in the adverse situation (Trent, 2008). The current ratio of Tesco has grown during the period as can be seen from Appendix III. The reason for this increase is mainly increase of inventory and credit from the suppliers in current liabilities section while the company has also increased some cash on hand during the period. The same ratio of Sainsbury is almost an at stable position during the period as the company has not changed its policy of holding minimum inventory at the end of the year. Further, company does not idle its cash in hand.

A quick ratio of business shows that apart from inventory, how far the company can be able to meet the current obligation from its position cash and cashable securities in current assets. Therefore, some analysts think that measuring quick ratio provides a correct measurement of the meeting the current obligation (Huffman, 2008). The quick ratio of Tesco has growth in the current period due to increase in cash in hand from increasing the short-term loan. However, Sainsbury has a volatile figure during the period in quick ratio because it has low cash at the end period. The wide expansion in business infrastructure has made the cash moving in capital expenses mainly.

Efficiency ratio

Efficiency ratio of a company is the simple measurement of assessing the efficiency of the companies in doing business. According to Islam (n.d.), business efficiency is the measurement of the managements' efficiency to run the business during a period.  In that case, the decision of running the business can be estimated through the decision made for improving the working capital cycle of the business.

Asset turnover ratio

The turnover of asset or utilization assets in generating the sales for a year is the measurement in this case that allows the analysts to understand the how many times the assets of the company are being used in a particular year (Sheela, n.d.). From the Appendix V, it can be seen that assets turnover for Tesco has deteriorated during the given period while for Sainsbury the figure is much better. It depicts that in terms of assets, Sainsbury was able to make generate more revenue compare to Tesco in the period of 2012 to 2014.

 

Receivable collection period

Receivable collection period provides the efficiency of the management in clearing the bad debt as well as the debtors of the company in a period (Magiera, 2010). This is an important measurement for the business as it shows the days taken for bring back the collection from the debtors for a company as well as the company is counting the interest for giving advances to the buyers. Lower the figure of the collection period, better is the test result for any period. For Tesco, the figure is too high while Sainsbury has maintained a steady 5 to 6 days in collecting the credits from the debtors. It depicts that second company has better debtor management as the management was able to collect the money from the market. It also indicates that decision of providing a loan to specific customers by Sainsbury has a great impact on financial performance.

Payable collection period

The payment period for the creditors is known as the management of suppliers that can be done by the management of the company. The higher the value of paying the creditors' makes the sensible approach of making more profit for the company (Wimmer and Rada, 2013). From Appendix VI, it can be seen that Tesco take more time to pay its creditors compare to Sainsbury. It might be efficient management, but it also increases the risk of losing the suppliers in the long run.

Gearing ratio

Gearing ratio is the measurement of risk for a business has considered by borrowing funds from the outside. As stated by Nelson (2011), the gearing ratio is the measurement of running business with borrowed funds to promoters' fund. Therefore, the risk taking the ability of the company as well as the risk owned for borrowed fund can be measured by this ratio.

Interest coverage ratio

The time of interest can be paid for the borrowed fund from the income from the business is measured in this ratio analysis. The higher ratio indicates the conservative nature of running the business while the low ratio indicates risky decision made by the management (Pankratyeva, 2013). From Appendix VI, it can be seen that situation of Tesco has been worsened during the period while Sainsbury has maintained almost the same figure. It indicates that Sainsbury can take any risky decision while Tesco needs to control its borrowing or increase its income.

 

Financial gearing

The financial gearing ratio is the measurement of the ratio of equity is engaged in business compare to interest paid for loans. It depicts the fund used in running a business from the owners' fund compare to borrowed funds (RIEDL and SRINIVASAN, 2010). In this case, the fund used for Tesco has a low concentration from owners compare to Sainsbury as seen from Appendix VII. Therefore, it can be said that Sainsbury has a better return for the equity holders.

Equity gearing

Equity gearing provides the information of a portion of funds allocated to business from loans to equity holders. Therefore, it measures the right of the shareholders in gross income from business compare to lenders (Ross, Westerfield and Jordan, 2014). From the appendix IX, it can be seen that the proportion of borrowed fund to run the business for Tesco has increased during the period that has also decreased the right of the shareholders. However, Sainsbury has decreased its borrowing during the period to increased the right of the shareholders. It also said that Sainsbury could increase its borrowings for any aggressive decision of expanding in future.

Conclusion

From the above analysis, it has observed that Tesco is going through a difficult phase recently. The company has tried to recover its financial performance in this period but still it has not seen much progress in this matter. Further, it is also true that Sainsbury has made improvement in reducing its loan as well as the cost of interest that has made the company to provide a better return to the shareholders. The efficiency of the management for Tesco has not improved much as it is still looking a suitable strategy to collect from the debtors. The supplier management of the company is better than the Sainsbury as it holds the payment to suppliers for more time.

Recommendations

It is recommended that both the companies need to overcome the challenge of competition in increasing the revenue in future. Generating more revenue is the only solution for the companies for increasing the return for the shareholders as well as increase the asset usage in business. Further, it is also recommended that Tesco must find to reduce the borrowed funds to gear the business.  Sainsbury must improve its supplier management that may help to pay the suppliers lesser frequent compared to now.

 

References

Ahmed, A. (n.d.). Financial Ratio Analysis of Square Pharmaceuticals Limited. SSRN Electronic Journal.

Brealey, R., Myers, S. and Allen, F. (2014). Principles of corporate finance. New York: McGraw-Hill Irwin.

D'Mello, R. and Farhat, J. (2008). A comparative analysis of proxies for an optimal leverage ratio.Review of Financial Economics, 17(3), pp.213-227.

Fridson, M. and Alvarez, F. (2002). Financial statement analysis. New York: John Wiley & Sons.

Fried, A. (2013). An Event Study Analysis of Statement of Financial Accounting Standards No. 158.AFR, 2(2).

Hubbard, J. (2008). Financial Statement Analysis. CFA Digest, 38(1), pp.59-61.

Huffman, S. (2008). Financial Statement Analysis. CFA Digest, 38(4), pp.41-43.

Islam, M. (n.d.). An Analysis of the Financial Performance of National Bank Limited Using Financial Ratio. SSRN Electronic Journal.

Magiera, F. (2010). Financial Statement Analysis. CFA Digest, 40(1), pp.85-86.

Nelson, S. (2011). Quickbooks 2011 all-in-one for dummies. Hoboken, NJ: Wiley Pub.

Pankratyeva, E. (2013). Provision of information management and analysis to recording and assessment of business entities’ financial position. International Journal of Academic Research, 5(6), pp.110-117.

RIEDL, E. and SRINIVASAN, S. (2010). Signaling Firm Performance Through Financial Statement Presentation: An Analysis Using Special Items*. Contemporary Accounting Research, 27(1), pp.289-332.

Ross, S., Westerfield, R. and Jordan, B. (2014). Essentials of corporate finance. New York, NY: McGraw-Hill Irwin.

Schoon, N. (2010). Financial Statement Analysis. CFA Digest, 40(2), pp.33-34.

Sheela, S. (n.d.). Financial Position Analysis of Barakath Engineering Industries (P) Limited. SSRN Electronic Journal.

Trent, W. (2008). Financial Statement Analysis. CFA Digest, 38(4), pp.39-40.

Velez-Pareja, I. (n.d.). Financial Analysis and Control - Financial Ratio Analysis (Slides in Spanish).SSRN Electronic Journal.

Wimmer, H. and Rada, R. (2013). Applying Information Technology to Financial Statement Analysis for Market Capitalization Prediction. Open Journal of Accounting, 02(01), pp.1-3.

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