Medicine and business: a practitioner’s guide Essay

The retail sector is one of the major contributors in the economy of the United Kingdom. The sector constitutes a major percentage of the country’s GDP. Sainsbury’s and Tesco companies are among the major contributors of the country’s GDP in the retail industry (Lewis 1990, p.386). This paper seeks to examine in a detailed analysis the performance, efficiency and ability of the two companies to meet the immediate obligations when due over the last three financial periods. The report shows a comparison of the two companies in 2012, 2013 and 2014. The analysis is based on the use of financial ratios where profitability, liquidity, working capital and investment ratios. Profitability ratios will be used to compare the performance of the two companies, in the light of return on equity (ROE), return on capital employed (ROCE), net profit margin and gross profit margin. The liquidity ratios that will be utilized include; acid test and the current ratio. The ratio will be geared at examining the ease at which the companies effectively convert assets into cash while the working capital ratios will assess the rate at which the current assets such as stock circulate in the companies (Richards 1980, p. 35). Objectives             This paper targets to present a detailed analysis over the performance of the two companies and routine operations; therefore the main objectives of this paper are: To compare the performance of the two companies over the last three years To detail recommendations for both companies on the basis of the ratios computed and their implications to the companies and the economy as a whole. Research methodology             The paper will explore the performances of both companies by utilizing ratio analysis. In order to be in a position to undertake this examination, financial statements of both companies over the last three years will be extracted and ratios computed using the information. The results of this report will be expressed in terms of pounds. Financial extracts Tesco Company Income statement For the years 2014, 2013 & 2012 (pounds) 22/02/2014 23/02/2013 25/02/2012 (Millions) (Millions) (Millions) Revenue: 63,557.00 63,406.00 63,916.00 Operating Profit / (Loss): 2,631.00 2,382.00 4,182.00 Net Interest: (432.00) (397.00) (235.00) PBT: 2,259.00 2,057.00 4,038.00 PAT from continuing operations: 1,912.00 1,528.00 3,164.00 Discontinued Operations: PAT from discontinuing operations: (942.00) (1,504.00) (350.00) Profit for the period: 970.00 24.00 2,814.00 Attributable to: Equity holders of parent company: 974.00 28.00 2,806.00 Minority Interests / Other Equity: (4.00) (4.00) 8.00 Total Dividend Paid: c 14.76 c 14.76 c 14.76 Tesco Company Statement of financial position As at 2014, 2013 & 2012 (pounds) 22/02/2014 23/02/2013 25/02/2012 (Millions) (Millions) (Millions) Assets Non-Current Assets Property, Plant & Equipment: 24,490.00 24,870.00 25,710.00 Intangible Assets: 3,795.00 4,362.00 4,618.00 Investment Properties: 227.00 2,001.00 1,991.00 Investments: 1,301.00 1,312.00 1,949.00 Other Financial Assets: 4,706.00 4,430.00 3,627.00 Other Non-Current Assets: 73.00 58.00 23.00 Current Assets Inventories: 3,576.00 3,744.00 3,598.00 Trade and Other Receivables: 2,190.00 2,525.00 2,657.00 Cash at Bank & In Hand: 2,506.00 2,512.00 2,305.00 Current Asset Investments: 1,016.00 522.00 1,243.00 Other Current Assets: 3,797.00 3,162.00 2,550.00 Other Assets: 2,487.00 631.00 510.00 Total Assets: 50,164.00 50,129.00 50,781.00 Liabilities Current Liabilities Borrowings: 1,910.00 766.00 1,838.00 Other Current Liabilities: 18,296.00 17,937.00 17,342.00 Non-Current Liabilities Borrowings: 9,303.00 10,068.00 9,911.00 Provisions: 777.00 1,278.00 1,260.00 Other Non-Current Liabilities: 3,963.00 3,137.00 2,560.00 Other Liabilities: 1,193.00 282.00 69.00 Total Liabilities: 35,442.00 33,468.00 32,980.00 Net Assets: 14,722.00 16,661.00 17,801.00 Capital & reserves Share Capital: 405.00 403.00 402.00 Share Premium Account: 5,080.00 5,020.00 4,964.00 Other Reserves: (498.00) 685.00 245.00 Retained Earnings: 9,728.00 10,535.00 12,164.00 Shareholders’ Funds: 14,715.00 16,643.00 17,775.00 Minority Interests / Other Equity: 7.00 18.00 26.00 Total Equity: 14,722.00 16,661.00 17,801.00 Retrieved from; Hargreaves Lansdown. ‘Tesco Plc | Financial Statements & Reports’. N.P., 2014. Web. 31 Dec. 2014. Sainsbury’s plc.Income statement For the years ended 2014, 2013 & 2012 15/03/2014 16/03/2013 17/03/2012 (Millions) (Millions) (Millions) Revenue: 23,949.00 23,303.00 22,294.00 Operating Profit / (Loss): 1,009.00 882.00 874.00 Net Interest: (139.00) (134.00) (103.00) PBT: 898.00 772.00 799.00 PAT from continuing operations: 716.00 602.00 598.00 Profit for the period: 716.00 602.00 598.00 Attributable to: Equity holders of parent company: 716.00 602.00 59.00 Total Dividend Paid: c 17.30 c 16.70 c 16.00 Sainsbury’s plc.Statement of financial position As at 2014, 2013 & 2012 15/03/2014 16/03/2013 17/03/2012 (Millions) (Millions) (Millions) Assets Non-Current Assets Property, Plant & Equipment: 9,880.00 9,804.00 9,329.00 Intangible Assets: 286.00 171.00 160.00 Investments: 404.00 532.00 566.00 Other Financial Assets: 283.00 236.00 215.00 Other Non-Current Assets: 1,318.00 38.00 38.00 12,171.00 10,781.00 10,308.00 Current Assets Inventories: 1,005.00 987.00 938.00 Trade and Other Receivables: 433.00 306.00 286.00 Cash at Bank & In Hand: 1,592.00 517.00 739.00 Other Current Assets: 1,332.00 91.00 69.00 Other Assets: 7.00 13.00 N/A Total Assets: 16,540.00 12,695.00 12,340.00 Liabilities Current Liabilities Borrowings: 534.00 165.00 150.00 Other Current Liabilities: 6,231.00 2,950.00 2,986.00 Non-Current Liabilities Borrowings: 2,250.00 2,617.00 2,617.00 Provisions: 256.00 316.00 349.00 Other Non-Current Liabilities: 1,264.00 809.00 609.00 Total Liabilities: 10,535.00 6,857.00 6,711.00 Net Assets: 6,005.00 5,838.00 5,629.00 Capital & reserves Share Capital: 545.00 541.00 538.00 Share Premium Account: 1,091.00 1,075.00 1,061.00 Other Reserves: 807.00 820.00 315.00 Retained Earnings: 3,560.00 3,401.00 3,715.00 Shareholders’ Funds: 6,003.00 5,837.00 5,629.00 Minority Interests / Other Equity:2.00 1.00 N/A Total Equity: 6,005.00 5,838.00 5,629.0 Retrieved from; Hargreaves Lansdown. ‘Sainsbury (J) Plc | Financial Statements & Reports’. N.P., 2014. Web. 31 Dec. 2014. Ratio Analysis Profitability ratios             These ratios indicate company’s profitability status. They determine the capacity of a company to generate returns to compensate the providers of capital. Using the data extracted, return on capital employed, gross profit margin and net profit margin are computed below; Return on equity This ratio is an indicator of the returns that a company generates out of the owners’ equity. Return on equity (ROE) = (Net income/equity capital) * 100 (ALBRECHT 2007, p. 234) Return on capital employed             Return on capital employed is used to indicate how a company is able to generate income to service the providers of capital employed. The ratio can be used to compare profitability of a firm within successive periods to evaluate profitability and predict future failure.The ratio is computed as follows; Return on capital employed = (profit before interest and tax/ capital employed) * 100 (COLES 1997, p. 32) Net profit margin This ratio measures the return per pound of sales a company earns. It is computed through the following formula; Net profit margin = (Net income / sales revenue)* 100 (GITMAN 2008, p. 492) Where, net income is obtained by Lessing total operating expenses from the sales revenue. Gross profit margin This ratio indicates the returns of the company after taking into consideration the costs of production incurred. It is calculated as follows; Gross profit margin = (Gross profit/ sales revenue) * 100(KHAN 2007, p.10) Below is a summary of the ratios; Ratio TESCO SAINSBURY’S 2012 2013 2014 2012 2013 2014 ROE 23.5% 14.3% 17.9% 15.5% 15.1% 16.8% ROCE 12.8% 6.5% 7.5% 8.7% 8.1% 9.2% Net profit margin 6.5% 3.8% 4.1% 3.9% 3.8% 4.2% GP margin 8.4% 6.6% 6.3% 5.4% 5.5% 5.8% Liquidity ratios These are ratios that measure the speed at which a company is able to convert its assets into cash or its equivalents (BUCCI 2014, p.71). They explain how fast a company can turn its current assets into cash so as to meet the current obligations. There are two types of liquidity ratios namely; current ratio and acid test ratio. Current ratio It indicates the ability of the company to convert its assets into cash or cash equivalents. The ratio is computed as follows; Current ratio = current assets/ current liabilities (times) Acid test ratio Acid test ratio also known as quick ratio is a measure that examines the capacity of a company to settle its immediate obligations from own current assets without selling stock. It is computed through the following formula; Acid test ratio = (current assets- inventories)/ current liabilities (TRACY 2011, p.287) The table below is a summary of the ratios computed using the financial data extracted; Ratio TESCO SAINSBURY’ Liquidity ratio 2012 2013 2014 2012 2013 2014 Current ratio 0.64 0.67 0.65 0.65 0.58 0.64 Acid test ratio 0.46 0.47 0.47 0.35 0.26 0.50 Working capital ratios             These are ratios that indicate the efficiency of a company to utilize its assets. They are also referred to as asset management ratios or asset turn over ratios. The commonly used ratios are; receivables turnover, payables turn over and inventory turnover (TALEKAR 2005, p.85). Receivables turnover This is a measure of how fast a company collects its funds from the debtors. It is calculated on the basis of the following formula; Receivables turnover = annual credit sales/accounts receivables It is reported in terms of number of days that sales made on credit remain with debtors before collection. Therefore; Average collection period = (accounts receivables/annual credit sales) * 365 days The ratio can also be expressed as; average collection period = 365 days / Receivables turnover (BOOKER 2006, p. 4). Inventory turnover             This is a ratio of the cost of goods sold to the average inventory. Cost of goods sold comprises of opening stock add purchases less closing stock while average inventory is the mean of opening and closing inventory. It is expressed in terms of days. Inventory turnover= cost of goods sold (COS) / Average inventory Therefore; Inventory period = 365/ inventory turnover Payables turnover This ratio indicates the period that the company takes to pay its creditors. It is defined by; Payables turnover = annual credit purchases/ accounts payables It is also expressed in terms of day. Therefore; Average payment period = 365 days / payables turnover. The table below is a summary of the asset ratios of the two companies; Ratio TESCO SAINSBURY’S 2012 2013 2014 2012 2013 2014 Receivables turnover 15.2 14.5 12.6 4.7 4.8 6.7 Inventory turnover 11.2 11.5 11.0 8.1 8.2 8.1 Payables turnover 10.8 11.0 11.2 5.2 4.9 10.1 Investment ratios These are ratios that help investors to evaluate the returns of their investments. Common investment ratios include; Earnings per share (EPS) Dividend payout ratio Dividend yield ratio Dividend payout ratio This ratio measures the part of earning that a company gives out to shareholders as dividends. It is computed as follows: Dividend payout ratio = (total dividends declared for the year/ earnings available for dividends) * 100 (GEDDES 2002, p. 14). Where; earning available for dividends is the profit after tax and preference dividends. Dividend yield This relates the returns from a share to its market value. It assists investors to assess the returns from their investments. It is worked out as follows: Dividend yield = (dividend per share/ market value per share) * 100 Earnings per share             EPS indicates the proportion of the company’s earnings that are attributable to the ordinary shareholders that have been generated during the period. The earnings attributable to ordinary shareholders are denoted by the profit after tax. EPS = Earnings attributable to ordinary shareholders/ Number of ordinary shareholders. It is an important indicator of company’s performance in terms of the earning power of the shares. However, comparing performance of companies based on EPS is inefficient since some companies may choose to issue more shares. Companies can also choose to increase or decrease the number of issued shares leading to an automatic alteration of the EPS. Ratio TESCO SAINSBURY’S 2012 2013 2014 2012 2013 2014 EPS 38.25 18.04 22.56 32.10 33.00 35.37 39.20 19.05 22.70 30.40 31.22 36.67 40.41 33.67 31.67 26.18 29.45 31.56 Dividend payout ratio 0.5 61.5 1.5 27.1 2.8 2.4 Uses of ratios             Various groups of individuals are interested with the analysis of financials of companies. They use ratios to work out specific financial features of a company that they are interested in. they help individuals in the following ways; To determine profitability: profitability ratios indicate the capacity of companies to generate profits. Ratios help the management to estimate the earning power of the company’s assets. To assess solvency: gearing ratios are used to assess company’s ability to service its debts. They show the relationship between assets and liabilities. A high gearing ratio is an indicator that the company is likely to land into financial problems in the future. They assist in the analysis of financials: Ratios assist stakeholders such as banks, shareholders and creditors to assess the profitability, liquidity and the capacity of companies to pay dividends. Forecasting purposes: financial ratios reflect the trend of the company. Such trends are important for forecasting the future of the company. Past years ratios are used to estimate the future therefore ratios are an important tool of preparing budgets and forecast statements. Limitations of ratio analysis             Despite the overwhelming usefulness of financial ratios, they are characterized by many drawbacks. To begin with, ratios are based on historical data. They are computed using historical financials but not pro forma statement. This poses a great challenge since the financials reflect the past financial position not the current situation. Ratios can thus lead to wrong decision making since what is true now may not be reflected by the past data. Decision making that is based on financial ratios may thus be misleading especially for material items and transactions. Ratios are also computed using financial statements that are normally prepared under accounting principles and policies. Different companies embrace varying policies and principles. The policies also vary with time within the same company. Owing to these variations, it becomes challenging to compare performance of different companies or even the performance of the same company over successive periods. Inflation and seasonal factors also threaten the validity and reliability of ratio analysis. Inflation impacts greatly on the financial statements just like seasonal factors such as economic cycles. Ratios are computed on the basis of historical financial statements which do not take into account the effects of price level changes and seasonal variations. Making decisions on the basis of financial ratios can thus be misleading. Conclusion and recommendation             Over the three years covered by this analysis, it can be seen that Tesco performed better than Sainsbury’s in terms of profitability, working capital ratios and investment ratios. The two companies are however characterized by falling liquidity ratios. To improve this trend, they should liquidate their cash efficiently through the capacity to convert current assets into cash quickly without necessarily selling their inventory. The profitability ratios of Tesco also observed to be declining over the period examined. 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