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Sainsbury’s Ratio Analysis

Accounting and Finance Assignment – Sainsbury’s Ratio Analysis Nowadays, it is important for organizations to know how to survive in the competitive market in which they are involved, markets that require managers who understand and are aware of the internal and external factors that concerns to the company. Therefore, it is vital to know the existence of different techniques of measurement such as financial tools, which can give an idea on how the company’s financial situation is going to affect its performance in the marketplace.
One of these tools can be the used of financial ratios, which gives to managers the information to set up strategies in order to make decisions in the future. However, it is important to highlight that this ratios provide an overview of the business’s financial condition, but an analysis in depth is needed to know the reasons why certain changes have occurred (Maclaney and Atrill, 2002). Nevertheless, there are some limitations in the used of financial ratios, for instance, the information is out of date so it does not reflect the real situation of the company, hence it can lead to wrong decisions, also, the analysis made from the financial statements gives symptoms of such situations but not the causes of it (Berry and Jarvis, 1997).
The purpose of this report is to analyze Sainsbury’s financial performance using the analysis of ratios as a financial tool. This information will be taken from the annual reports of 2003 and 2004. In addition, it will include external and relevant information of the company which adds value to the analysis and thus to the financial performance in the already mentioned period of time. This will also help to compare Sainsbury’s with its competitor Tesco, in order to identify and evaluate the performance of both companies. Finally, this report will give conclusions and recommendations to those investors who want to make an investment in a secure company.
RATIO ANALYSIS Profitability Ratios
According to Maclaney and Atrill (2002, p. 197), Profitability ratios provide an insight to the degree of success in achieving this purpose. For instance, the profitability ratios of Sainsbury plc are:
Profitabiliy Ratios
2004
2003
Return on Capital Employed
8.53%
9.29%
Return on Equity
7.64%
8.95%
Gross Profit Margin
8.65%
8.14%
Net Profit Margin
3.91%
4.25%
Table 1. Profitability Ratios (Base on data contained in Appendix A)
Regarding on this table, Sainsbury’s profitability ratios show a moderately deterioration in profit from 2003 to 2004 in a margin of 6%. This downward trend is due to several changes the company had such as, (1) the sell of JS Development and Shaw’s supermarket, this has an impact on the company’s current assets (cash) and profit, in one hand it brings in cash for the sell but on the other hand it stops the daily cash input, consequently there were a decline in profit in 2.6%; (2) the purchase of Swan Infrastructure Holdings Limited, which consist of a whole modern IT system and it is part of a Business Transformation Programme, therefore, there was a rise in 6% of the capital employed (fixed assets and net debt), and also a significantly fall in cash in 27%. Because of all these reasons, there was a drop in profit, but as it is a long-term investment it is estimated to be an income generation in the future.
Efficiency and Effectiveness Ratios
These ratios are used to try and identify the strengths and weaknesses of a business using a variety of different ratios (Giles et al., 1994, p. 371). The following table illustrates the efficiency ratios used in Sainsbury’s case.
Efficiency and Effectiveness
2004
2003
Fixed Asset Turnover
2 times
2.17 times
Debtor Collection Period
1.51 days
2.48 days
Creditor Payment Period
28.83 days
28.78 days
Stock Holding Period
17.61 days
18.67 days
Table 2. Efficiency and Effectiveness (Base on data contained in Appendix A)
The fixed asset turnover has slightly decreased due to the acquisition of Swan Infrastructure Holdings Limited, which caused a rise of 7.73% on Sainsbury’s fixed assets in comparison with the year 2003. Moreover, sales have remained constant which have risen in 0.3%. The purchase of the IT systems will give opportunities to enhanced operational effectiveness, a stronger platform, low costs and an increased in sales.
In what a debtor collection period concerns, although this ratio shows a very little period to collect debts from customers, it is logic for this kind of business to be like that owing to the fact that being a supermarket, sales are in cash, only a 8% of the current assets are related to debtors, which had a fall in almost 40% comparing with 2003. On the other hand, the creditor payment period has stayed constant and it shows good rates. The cycle of both debtor collection period and creditor payment period demonstrates that the company receive the money from their debtors before paying to their suppliers, which is good since they do not need to finance themselves but pay with the cash they get in from debtors.
Regarding to the stock holding period, even though it has fallen in 1 day, it still is high for a business like supermarket in which the stock plays an important role because the rotation has to be in short periods of time to keep the food fresh. However, it is good to consider that Sainsbury also have a stock of electro domestics, entertainment, house-wares, etc., that the rotation is meant to be in long periods of time.
Liquidity Ratios
As Maclaney and Atrill (2002, p. 197) said, Certain ratios may be calculated that examine the relationship between liquid resources held and creditors due for payment in the near future. These ratios in Sainsbury’s company are as follow.
Liquidity Ratios
2004
2003
Current Ratio
0.83:1
0.87:1
Acid Test (Quick Ratio)
0.67:1
0.70:1
Table 3. Liquidity Ratios (Base on data contained in Appendix B)
The current ratio has a slightly fall, due to the current liabilities rising faster than the current assets. Looking at the current liabilities it can be seen that the company is using bank loans to finance the acquisition of the IT systems by the group, which increased in 63%. The current assets have also been affected by a decreased in 27% of cash account since a 10% of the purchase was made in cash. Similar situation happened with the acid test ratio with a slight fall in the rate.
These ratios show a low rate, due to the fast stock rotation which produces cash sales. Although, it seems like the current assets do not cover the current liabilities, the liquid assets are used as productively by the growing of the business to make it more effective, thus profitable.
Capital Gearing Ratios
This is the relationship between the amount financed by the owners of the business and the amount contributed by outsiders (Maclaney and Atrill 2002, p. 197). For instance, Sainsbury’s capital gearing ratios are:
Capital Gearing Ratios
2004
2003
Gearing Ratio
28.54%
25.97%
Times Interest Covered
5.91 times
5.31 times
Table 4. Capital Gearing Ratios (Base on data contained in Appendix B)
The gearing ratio has increased by 9% due to the long-term debts rising faster than the capital employed during the period from 2003 to 2004. The long term debts went up by 14%, which is because the purchase of IT fixed assets and also the company resort to operations in the capital market and by operating subsidiaries to deal with the interest rate and current risk these finance involves. On the other hand, the times interest covered stayed constant and even though is a low rate, the company still can cover its interest with their profit.
Investor Ratios
Certain ratios are concerned with assessing the returns and performance of shares held in a particular business (McLaney et al., 2002, p. 197). In this case, the investor ratios for Sainsbury’s are the followings:
Investor Ratios
2004
2003
Earnings per Share
0.20
0.23
Price Earnings Ratio
12.63 times
9.54 times
Dividend Yield
6
6.89
Dividend Cover
1.32
1.52
Table 5. Investor Ratios (Base on data contained in Appendix B)
The earning per share has fall by 13% mainly caused by the higher profits on business disposals that the company went through last year, so the return to shareholders was a lower rate per share. In contrast, the price earning per share growth by 24%, due to the increase in the market share price in 14%, this is a good new for Sainsbury’s since it reflects that the market confidence grew from 2003 to 2004. The dividend yield had a slightly decreased since the dividend per share only increased by 0.7% from last year. This was a decision from the company and it reflects the reduction in the earning per share already mentioned and the fall in the dividend cover by 13%.
RECOMMENDATION TO POTENTIAL INVESTORS
According to the information given by the ratios analysis in the last section, it can be said that even though the company’s ratios showed a decreased rates from 2003 to 2004, the expectations of the business performance looks profitable. This is due to the Business Transformation Programme, which consists on the acquisition of IT systems and the sell of Shaw’s Supermarket and JS Development. The former will be a positive impact in the financial performance of the company in a long-term by increasing sales and reducing costs; and the latter will be used to develop and make more effective the financial and management resources, hence it will enlarge Sainsbury’s core UK business and strengthen its market position.
Therefore, from the ratios analysis, it can be stated that Sainsbury’s is not a good company to, at present time invest in, since the company has not showed a significant growth in profit during the last financial year. To conclude, if Sainsbury’s finances start to grow, there is no doubt that investors should consider this company to invest in as it plans a better performance in the long-term.
In the next part, it will be given some additional information about Sainsbury’s and also a comparison with Tesco.
RELEVANT INFORMATION ABOUT SAINSBURY’S
The acquisition of IT system was an important contribution to lead Sainsbury’s strength its position in the high competitive marketplace. Whereas the group chief executive of Sainsbury’s said: The net reduction in costs will provide Sainsbury’s with additional resources to develop our customer proposition, by investing in quality and innovation and improving further our competitive offer, as we move towards trading our business harder from summer 2004 (http://www.j-sainsbury.co.uk/index.asp?PageID=19

Absorption and Marginal Costing Methods

Absorption costing treats the costs of all manufacturing components (direct material, direct labour, variable overhead and fixed overhead) as inventoriable or product costs in accordance with generally accepted accounting principles (GAAP), (BARFIELD et al., 2001).
1.2 Marginal Costing Variable costing is a cost accumulation method that includes only variable production costs (direct material, direct labour, and variable overhead) as product or inventoriable costs. (BARFIELD et al., 2001)
1.3 Similarities between Both Methods Marginal costing Absorption costing
Closing inventories are valued at marginal production cost.
Closing inventories are valued at full production cost.
Fixed costs are period costs. Fixed costs are absorbed into unit costs.
Cost of sales does not include a share of fixed overheads.
Cost of sales does include a share of fixed overheads
1.4 Influences of Marginal and Absorption costing on the pricing policy Pricing decisions: Since marginal cost per unit is constant from period to period within a short span of time, firm decisions on pricing policy can be taken, If fixed cost is included, the unit cost will change from day to day depending upon the volume of output.
Overhead Variances: Overheads are recovered in costing on the pre-determined rates. This creates the problem of treatment of under or over-recovery of overhead, if fixed overhead were included Marginal costing avoids such under or over recovery of overheads.
True profit: It is argued that under the marginal costing technique, the stock of finished goods and work-in-progress are carried on marginal cost basis and the fixed expenses are written off to profit and loss account as period cost. This shows the true profit of the period.
Break-even analysis: Marginal costing helps in the preparation of break-even analysis, which shows the effect of increasing or decreasing production activity on the profitability of the company.
Control over expenditure: Segregation of expenses as fixed and variable helps the management to exercise control over expenditure. The management can compare the actual variable expenses with the budgeted variable expenses and take corrective action through, variance analysis.
Business decision-making: Marginal costing helps the management in taking a number of business decisions like make or buy, discontinuance of a particular product, replacement of machines etc.) (BRAGG, STEVEN M., 2007)
1.4.1 Influences of Marginal Costing It recognizes the importance of fixed costs in production;
This method is accepted by Inland Revenue as stock is not undervalued;
This method is always used to prepare financial accounts;
When production remains constant but sales fluctuate absorption costing will show less fluctuation in net profit and
Unlike marginal costing where fixed costs are agreed to change into variable cost, it is cost into the stock value hence distorting stock valuation. (Accounting for management) (BRAGG, STEVEN M., 2007)
1.4.2 Influences of Absorption Costing (It is simple to operate.
There are no apportionments, which are frequently done on an arbitrary basis, of fixedcosts. Many costs, such as the marketing director’s salary, are indivisible by nature.
Fixed costs will be the same regardless of the volume of output, because they are period costs. It makes sense, therefore, to charge them in full as a cost to the period.
The cost to produce an extra unit is the variable production cost. It is realistic to value closing inventory items at this directly attributable cost.
Under or over absorption of overheads is avoided.
Marginal costing provides the best information for decision making.) (KAPLAN, 2008)
Classifications of cost systems in terms of object: function, product (services) and behaviour, analysing probable causes of cost variances and offer directors the needed advice to improve performance.
2. Cost by Object 2.1.1 Direct Cost Direct costs are costs which can be directly identified with a specific cost unit or cost centre. There are three main types of direct cost:
Direct materials for-example, cloth for making shirts
Direct labour for-example, the wages of the workers stitching the cloth to make the shirts
Direct expenses for-example, the cost of maintaining the sewing machine used to make the shirts.
2.1.2 Indirect Cost Indirect costs are costs which cannot be directly identified with a specific cost unit or cost centre. Examples of indirect costs include the following:
The total of indirect costs is known as overheads.
indirect materials these include materials that cannot be traced to an individual shirt, for example, cotton
indirect labour for example, the cost of a supervisor who supervises the shirt makers
Indirect expenses for example, the cost of renting the factory where the shirts are manufactured.
2.2 Cost by Function 2.2.1 Production Cost Production costs are the costs which are incurred when raw materials are converted into finished goods and part finished goods (work in progress).
3.2.2 Non-Production Cost 2Nonproduction costs are costs that are not directly associated with the production processes in a manufacturing organisation.
2.3 Cost by behaviour 2.3.1 Variable Cost Variable costs are costs that tend to vary in total with the level of activity. As activity levels increase then total variable costs will also increase.
Note that as total costs increase with activity levels, the cost per unit of variable costs remains constant.
Examples of variable costs include direct costs such as raw materials and direct labour
2.3.2 Fixed Cost A fixed cost is a cost which is incurred for an accounting period, and which, within certain activity levels remains constant.
Note that the total cost remains constant over a given level of activity but the cost per unit falls as the level of activity increases. (KAPLAN, 2008)
Examples of fixed costs:
rent
business rates
Executive salaries.
2.3.3 Stepped Fix Cost This is a type of fixed cost that is only fixed within certain levels of activity.
Once the upper limit of an activity level is reached then a new higher level of fixed cost becomes relevant.
Examples of stepped fixed costs: Warehousing costs (as more space is required, more warehouses must be purchased or rented)
Supervisors’ wages (as the number of employees increases, more supervisors are required).
2.3.4 Semi Variable Cost Semi variable costs contain both fixed and variable cost elements and are therefore partly affected by fluctuations in the level of activity.
• Semi variable costs can be shown graphically as follows
Examples of semi variable costs:
– Electricity bills (fixed standing charge plus variable cost per unit of electricity consumed)
– Telephone bills (fixed line rental plus variable cost per call)
2.4 Cause of Cost Variances (Sales price variances may be caused by:
unplanned price increases (sales price variance)
unexpected fall in demand due to recession (sales volume variance)
Materials price variances may be caused by:
supplies from different sources
unexpected general price increases
Materials usage variances may be caused by:
a higher or lower incidence of scrap
an alteration to product design
Labour efficiency variances may be caused by:
changes in working conditions or working methods, for example, better supervision
consequences of the learning effect) (BPP, 2007)
Responsibility accounting as a system of planning and control of the organisation.
3. Responsibility Centres Responsibility accounting systems identify, measure, and report on the performance of people controlling the activities of responsibility centres. Responsibility centre sari classified according to their manager’s scope of authority and type of financial responsibility. Companies may define their organizational units in various ways based on management accountability for one or more income-producing factors-costs, revenues, profits, and/or asset base. (BARFIELD et al., 2001)
3.1 Cost Centres In a cost centre, the manager has the authority only to incur costs and is specifically evaluated on the basis of how well costs are controlled. Theoretically, revenues cannot exist in a cost centre because the unit does not engage in revenue producing activity. Cost centres commonly include service and administrative departments. For example, the equipment maintenance centre in a hospital may be a cost centre because it does not charge for its services, but it does incur costs. (BARFIELD et al., 2001)
3.2 Revenue Centre A revenue centre is strictly defined as an organizational unit for which a manager is accountable only for the generation of revenues and has no control over setting selling prices or budgeting costs. In many retail stores, the individual sales departments are considered independent units, and managers are evaluated based on the total revenues generated by their departments. Departmental managers, however, may not be given the authority to change selling prices to affect volume, and often they do not participate in the budgeting process. Thus, the departmental managers might have no impact on costs. (BARFIELD et al., 2001)
3.3 Profit Centre In a profit centre, the manager is responsible for generating revenues and planning and controlling expenses related to current activity. (Expenses not under a profit centre manager’s control are those related to long-term investments in plant assets; such a situation creates a definitive need for separate evaluations of the subunit anther subunit’s manager.) A profit centre manager’s goal is to maximize the centre’s net income. (BARFIELD et al., 2001)
3.4 Investment Centre An investment centre is an organizational unit in which the manager is responsible for generating revenues and planning and controlling expenses. In addition, the centre’s manager has the authority to acquire, use, and dispose of plant assets in a manner that seeks to earn the highest feasible rate of return on the centre’s asset base. (BARFIELD et al., 2001)

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