The document analyzes and compares the financial performance and ratios of Tesco PLC and J Sainsbury PLC over a five year period. It examines ratios related to profitability, efficiency, liquidity, gearing, and investments. While Tesco generally performed better, factors like increased borrowing negatively impacted some of its ratios in certain years. The analysis provides insights into how each company's strategies and financial decisions influenced their ratio results.
5. EXECUTIVE SUMMARY
The following report is on Financial Accounting and is divided into two sub sects.
The first part analysis the various ratios used to determine the financial performance of a
company. The same ratios are studied through the financial reports of two of the largest retailers in
UK. The primary company used for the report in Tesco plc and J Sainsbury plc its closest rival’s
performance is used to get a comparison. The report looks at both the companies over a period of
five years to analyse the trends and the fluctuations. The analysis of ratios is divided into four
parts:
Definition of the indicator
Comparative view of results between the two companies
Analysis of differences identified in point two
Conclusion
The performance of both the companies are analysed through the analysis of their ratios of
profitability, liquidity, efficiency, gearing and investment. While Tesco looks like performing well
despite of the recession, when the same is compared with its fiercest rival, J Sainsbury plc, the
picture seems quite different.
The report in the second half goes on to analyse the users of the annual financial reports, the most
common accounting conventions and the advantages and disadvantages of the annual financial
documents.
5
6. 1 Section 1
1.1 Performance Ratios
The following analysis does a study of the ratios commonly used in gauging the performance and
to provide a clear picture of the level of efficiency that the management of the company has in
wealth creation for the share holders.
1.1.1 Return on Capital Employed (ROCE)
The ROCE establishes the correlation between the profits (PBIT) and the capital employed via the
equity and/or the long-term borrowings. It indicates the percentage of return on the capital
employed. It is also used as a tool to set up future profitability targets.
Tesco plc displays higher ROCE results over the five years compared with J Sainsbury plc.
Figure 1: Comparative analysis - Tesco plc & J Sainsbury plc
However, significant changes were identified:
Tesco PLC experienced a decrease of its ROCE in 2009 (-21%) and this is mainly due to a steep
increase in the long-term borrowings (+107%). Refer to Appendix 5. Tesco PLC decided to obtain
6 new loans totalling around 4 Billion £ with an average interest of 5.55%
Figure 2: Tesco PLC - Negative impact of Long-Term Borrowings in ROCE
6
7. In contrast, J Sainsbury plc's ROCE increased by 28% in 2010. This change is linked to the
increase of profits before taxes (+43%) that is mainly contributed by of profits of £138m from joint
ventures.
Figure 3: J Sainsbury plc - Positive Impact of PBIT upon ROCE
1.1.2 Return On Shareholders' Funds (ROSF)
The RSOF indicates the level of effectiveness that the company has to generates profits with the
money invested by shareholders.
Tesco PLC and J Sainsbury plc experienced opposite ROSF results between 2007 and 2010.
Whilst Tesco PLC decreased slightly (~3% in average) over the years, J Sainsbury plc increased
(~17% in average).
Figure 4: Comparative Return On Shareholders' Funds
J Sainsbury plc displayed a significant improvement in 2010 (+78%), which was due to a rise of
net profit after taxes (+102%) during the same year. This rise in the net profits has been boosted
by the profits from joint ventures (+180%).
7
8. Figure 5: J Sainsbury plc - Positive Impact of Net Profit after taxes on ROSF
It can also be noticed that the management of equity differs between the companies. Tesco PLC's
utilises more the long-term borrowings than equity to generate profits. As a result, the finance
costs increase and the net profit decreases. On the other hand, J Sainsbury plc uses more equity
than borrowings..
Figure 6: Comparative analysis - Equity and Long-Term Borrowings
8
9. 1.1.3 Net Profit Percentage (NPP)
The net profit percentage is considered as one of the best measures of overall results of companies. It
indicates the remaining profit after production and operation costs. (Accounting Tools , n.d.).
Tesco PLC displayed a higher and stable NPP whereas J Sainsbury plc's results were lower and
unstable.
Figure 7: Comparative Net Profit Ratio
It can be noticed that policies related to operating expenses have changed with Tesco PLC increased
the operating expenses and J Sainsbury plc reduced them.
In 2007 Tesco PLC reached its highest NPP
result for two reasons, the operating
expenses were low and exceptional incomes
such as Pensions adjustment - Finance Act
2006 (£258m) were recorded.
Nevertheless, in 2009 the NPP failed
drastically due to a significant increase of
operating expenses (+37%) mainly
administrative expenditures.
Figure 8: Tesco plc - NPP & Operating
Expenses
By contrast, J Sainsbury plc reduced the
operation expenses from 2007 to 2011 by 63%.
Due to this reduction of costs, the NPP
reached its highest level by 2011 with
4.47%.
Figure 9: J Sainsbury plc - NPP & Operating
Expenses
9
10. 1.1.4 Gross Profit Percentage (GPP)
The GPP reflects the margin of profit that companies are able to earn on their trading and
manufacturing activity after deducting the cost of sales. The higher the percentage the better it is for
the company as it provides more financial resources to pay costs associated with growing the
business (e.g. R&D). (Newcorn, n.d.)
Tesco PLC displays a higher trade effectiveness compared with J Sainsbury plc.
Figure 10: Comparative analysis of Gross Profit Ratio
Tesco PLC's GPP increased from 2009 to 2011 by 7%. It is explained by the decrease of selling
costs. This was propelled by the modernisation of IT systems that allowed the reduction of selling
costs (e.g. the improvement of Tesco direct website to sell online more non-food products and reduce
costs - less stores resulting in fewer employees)
Figure 11: Tesco PLC - GPP and proportion of selling cost
10
11. J Sainsbury plc's GPP decreased by 18% between 2007 and 2008 due to an increase of cost of
sales by 2.11%.
Figure 12: J Sainsbury plc - GPP & Changing % of costs
11
12. 1.2 Efficiency Ratios
These ratios provide a clear picture of how well the two companies use their assets and liabilities
internally (Investopedia, n.d.)
1.2.1 Inventory Turnover in days
This ratio calculates the number of days taken by the company to sell a piece of stock (Ciancanelli
et al., 2009: 20). The optimal inventory turnover is the shortest one because the shorter is the
stock turnover period, the quicker the good is converted into cash.
Based on figure 13, it can be stated that J Sainsbury's plc gets the cash back quicker (14 days on
average) than Tesco PLC (19 days on average).
As the chart below shows a substantially higher inventory period for Tesco PLC and this can be
explained from the fact that Tesco PLC also has operations in other countries (e.g. Japan) which
results in a higher inventory turnover cycle, whereas J Sainsbury plc has market exclusively in UK.
A possible recommendation to Tesco PLC is to keep improving the internet channel to reduce
geographical distances and better manage stocks.
Figure 13: Inventory (stock) holding period - (days)
1.2.2 Accounts receivables turnover
This ratio indicates how long, on average, credit consumers take to pay the amounts that they owe
to the company (Atrill and McLaney, 2011: 201). It has a direct impact on the cash flow of the
company. It is the efficiency of the company to collect debts at the shortest time possible.
12
13. Figure 14: Receivables (debtor) payment period (days)
Based on figure 14, J Sainsbury's plc’s management of credit from debtors is more effective than
Tesco PLC. In some cases, the company collects three times faster than Tesco PLC. It could be
suggested that Tesco PLC should improve its credit control policies to ensure better work capital.
1.2.3 Accounts payable turnover
This ratio allows quantifying the rate at which a company pays off its suppliers.
Figure 15: Comparative analysis of accounts payable turnover
Figure 15 illustrates the different trends of accounts payable turnover for both companies over the
last 5 years. Tesco PLC has increased this period by 13% from 2007 to 2011.Two aspects shall
be underlined as the main reason:
The company has the opportunity to use the cash allocated in the short-term liabilities and
make more money through better rotation of the same.
As the company is well established in the retailer market, suppliers trust it and are ready to
wait longer.
However, there is also a risk of undermining commercial relationships with suppliers.
13
14. As for J Sainsbury's plc, the number of accounts payable has been reduced by 4%. It could be
perceived as an effective management of short-term debts and a source of motivation to do
business with the company.
1.2.4 Working Capital Cycle
The working capital allows measuring both, the company's liquid assets and its short-term financial
health. The working capital can be positive or negative; it will depend on the sector of the company
and the level of inventory, receivable and payable that the company is carrying.
For retailers companies such as Tesco PLC and J Sainsbury plc, the inventory turns on a cash
basis very fast. Given that, their need to have an important working capital available is very low.
(Kennon, n.d.)
Figure 16: Comparative analysis of Working Capital
As shown in figure 16, both companies display a negative working capital. It means that their
current liabilities (Account payables) are higher than their turnover receivable. This result does not
represent a risk for the company because the time to get the money from the customer after
buying a piece of stock is lesser than the time available to pay to creditors.
1.3 Liquidity Ratios
The liquidity ratios indicate the availability of the company to meet short-terms financial obligations
(Atrill and McLaney, 2011: 207). The higher the value of the ratio, the bigger is the margin of
safety that the company has to pay current debts. (Investopedia, n.d.)
1.3.1 Current Ratio
This ratio specifies if the company is able to pay back its debts and payables with its current
assets such as inventory, trade and other receivables.
Based on figure 17, on average, both companies have the same current ratio average. However,
their value is lesser than one which indicates that the companies would be unable to pay back its
14
15. debts if they come due at that point (Investopedia, n.d.). Nevertheless, given that retailers have
the possibility to convert products into cash quickly; it would not represent a signification risk to
payables.
Figure 17: Comparative analysis of current ratio
In 2009, Tesco plc increased by 27% its
current ratio. It could be mainly due to an
increase of its current assets (+118%)
coming from loans that Tesco PLC has to
banks (£2,100) and customers (£1918) and
an increase of current liabilities by 71%.
Figure 18: Tesco PLC - Impact of Current Assets &
Loans upon Current ratio In the
contrary, J Sainsbury plc decreased its current ratio
during the same year. It could be due to an increase of
current liabilities (+12%) and a reduction of the current
assets (-8%). The later was due to a -90% decrease of
the loans to banks and other financial assets.
Figure 19: J Sainsbury's plc - Impact of Current
Assets & and Loans upon Current ratio
15
16. 1.3.2 Quick Asset Ratio
This ratio is similar to the current ratio except that it does not include the inventories in the
calculation.
Figure 20: Comparative analysis of Quick Ratio
In 2009 Tesco plc recorded a large surge in its current assets, due to loans and advances to other
banks (£1541 m) and increase on cash and cash equivalent (£3,509 m).
16
17. 1.4 Financial Gearing Ratios
These ratios indicate the extent to which a company is under debt and the burden of the financial
obligation thereof. The ratios are analysed in relation to the investment of shareholders through
equity and the outside financing used in the company operations. Moreover, gearing ratios are an
effective indicator of the level of risk associated with the business. The higher a company's degree
of leverage, the more the company is considered risky. (Investopedia, n.d.)
1.4.1 Gearing ratio
The ratio measures the long-term borrowings the firm uses to finance the business in relation to
the total capital structure (all borrowings + total equity + preferred equity).
Figure 21: Comparative Gearing Ratios
J Sainsbury plc experienced a lower level of gearing ratio than Tesco PLC. While this might
project a risky scenario for Tesco, it is also important to understand that low interest on long term
debt also encourages a company to seek funds through this mode.
Besides, in 2009 Tesco plc reached the highest gearing ratio level over the five years. This
behaviour is due to an important rise of long-term borrowings (+107%). Due to that, the firm
reached 48.98% gearing ratio (47% higher than the previous year). An additional consequence of
the increase of long-term borrowings is that the ROCE has decreased.
Figure 22: Tesco plc - Long-term borrowing and gearings
17
18. 1.4.2 Interest Cover
It is a ratio utilised to calculate how safe a company is on its financial cost obligation payments.
The lower the ratio, the more the company is under risk in their payment on long term debt.
Figure 23: Comparative Interest Cover
For Tesco PLC, Interest Cover Ratio decreased drastically from 2008 to 2009 (-42%). It was due
to an increase of interest expenses (+91%) during the same period (Tesco plc, 2009: 70).
18
19. 1.5 Investment ratios
These ratios are considered separately from those that are used to interpret financial statements.
In fact, qualities of the company are not directly linked with company's management (Ciancanelli et
al., 2009: 37)
1.5.1 Earnings Per Share (EPS)
EPS is the most frequent ratio used to determine the share's price. It relates the earnings
generated by the business, and available to shareholders, during a period, to the number of
shares in issue. (Atrill and McLaney, 2011: 218).
The EPS ratio shows the strength of a company to make money in relation to the shares. The
chart below shows a spurt in the J Sainsbury plc EPS as against Tesco PLC mainly due to a faster
growth of net profits.
Figure 24: Comparative Analysis of Earnings Per Share
1.5.2 Price Earnings Ratio (P/E)
The P/E ratio is a measure of investor's expectations as future earnings (Ciancanelli et al., 2009).
It takes into account the market price of an ordinary share with the earnings per ordinary share.
There are proponents and opponents of a higher P/E ratio. Tesco PLC ratio which has remained
stable can also be defined as the returns on a lower investment, whereas a higher ratio of J
Sainsbury plc suggests better future prospects.
19
20. Figure 25: Comparative analysis of P/E
1.5.3 Dividend Yield ratio
The ratio gives a scenario in context to the dividend and the market price of the shares. This can
fluctuate as per the fluctuation of the market price. The growth of Tesco PLC in 2009 is mainly
driven due to the share price being the lowest in the mentioned period. This ratio allows
shareholders to assess the cash return on their investment in the business.
Figure 26: Comparative Analysis Dividend Yield Ratio
20
21. 1.5.4 Dividend Payout Ratio
The ratio gives a synopsis of the ratio of cash payout to the total available earnings for the
shareholders. The effect on J Sainsbury plc’s payout ratio is highlighted in the figure below.
Figure 27: Comparative Analysis of Dividend Payout Ratio
1.5.5 Dividend Cover Ratio
The ratio gives a picture of the comfort with which a company is able to dole out dividends. As the
figure below points out, Tesco PLC has historically had a much higher cover ratio. J Sainsbury plc
meanwhile showed a ratio of around one in the year 2009. This was due to the really high dividend
payout ratio as discussed in Figure 27.
Figure 28: Comparative Analysis of Dividend Cover Ratio
21
22. 1.6 Conclusion
While historically Tesco has been performing better and delivering better results in financial terms,
the last two years has seen a reversal of fortunes through better P/E ratio and higher EPS for J
Sainsbury plc. While both the companies have been showing a healthy trend even during the
worst period of recession, J Sainsbury plc seems to have recovered faster and projecting better
figures post recession.
22
23. 2 Section 2
2.1 Annual Report and Informational Needs from Users
The annual report (AR) is the company's most important strategic communication document,
setting forth the firm's vision, values and operating philosophy, as well as its communication
strategy (Goldstein, 2001). The different interested parties are illustrated and described below:
Figure 29: Main users of financial information
Adapted from: (Atrill and McLaney, 2011: 5)
23
24. 2.2 Accounting conventions
The accounting conventions that are commonly used by the users listed above are:
24
25. 2.3 Applicability
The relevance of any financial data is subjective to the need of the user. In the current age of
creative accounting the information provided also might not be in the required form by the user.
Advantages
Being the primary source of information about a company’s performance and health, the annual
reports are a valued document for any investor. For an ordinary common investor and analyst,
these reports still constitute the main source of information about the health of their investment.
The reports are also used by other users mentioned earlier for their objectives.
These reports are also used to derive the ratios which give the required information to a user for
all types of decisions.
Disadvantages
Historic cost convention is based on a figure in the past which don’t have any relevance in the
current times. Properties and land should be periodically revalue for the statement to show the
real picture.
The prudence convention can lead to a misinformation of financial placement of the organization
which can result in resulting in users making poor decisions.
Money measurement concept quantifies all factors in terms of money including goodwill and
brands value which can make the statements very subjective.
Realisation and the accruals concepts show revenues and expenses in the books prior to
receiving or deducting them thus paving way for a potential over or understatement of figures.
The financial accounting by nature does not represent the current financial state of a firm because
it only analysis historical data (Anonymous, n.d.). As a result, managers cannot completely base
their decisions on the AR.
External factors such as the inflation, political or economical issues are not included in the annual
report. As a result, decisions made by users can not only be based on the financial information.
Accounting conventions do not measure key resources of the business such as the level of
workforce or leadership. As a result, the information provided does not allow users to estimate the
potential value of the firm.
Potential income or expenses are not considered in the financial statement since the financial
information is recorded based on the accrual basis accounting.
25
26. 2.4 Conclusion
The annual reports are a very important part of the financial markets as well as reporting method
for a company. This is really depended on by majority of the investors for their evaluation of a
company and their investments. But it is also important to ensure that all aspects of the reports are
looked at and judgements are not passed after analysing a single years performance.
While studying the ratios also it is equally important to analyse all, profitability, liquidity, financial,
efficiency and investment before arriving at a conclusion about a portfolio.
26
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28
29. Appendix 1. Brief Presentation of the Companies
The financial ratios have been calculated for the principal company Tesco plc and then compared
with J Sainsbury plc.
Tesco plc is a public limited company incorporated and domiciled in the
United Kingdom (Tesco plc, 2011: 103) and one of the most successful
British companies of recent years (Wearden, 2010). Its principal activity
is retailing and associated activities. Moreover, it provides banking and
insurance services through its subsidiaries.
J Sainsbury plc is a public limited company incorporated in the United Kingdom (J Sainsbury's plc,
2011). It is the third-largest food retailer in the United
Kingdom and the largest public equity pure play in
the U.K. food retail sector (Morningstar, n.d.). The main
activities of the group are grocery and related retailing. (J Sainsbury's plc, 2011).
29
30. Appendix 2. Formulas
RATIO FORMULA
PROFITABILITY
Return On Capital Employed
Return on Shareholders' Funds x 100
Net Profit Percentage x 100
Gross Profit Percentage
LIQUIDITY RATIO
Current Ratio
Quick Ratio (Acid Test)
EFFICIENCY RATIOS
Inventory (stock) holding period
(days)
Receivables (debtor) payment
period (days)
Payables (creditor) payment
period (days)
FINANCIAL STRUCTURE
Leverage (gearing)
Interest cost
INVESTMENT RATIOS
Earnings per share
P/E ratio
Dividend yield
Dividend ratio payout
Dividend cover ratio
30
31. Appendix 3. Working Ratios for Tesco plc
TESCO plc
2007 2008 2009 2010 2011
LIQUIDITY RATIOS
Current ratio .5:1 .6:1 .7:1 .7:1 .6:1
Current Assets 4168 5992 13081 11392 11438
Current Liabilities -8152 -10263 -17595 -16015 -17731
Quick Asset Ratio (Acid Test Ratio) .3:1 .3:1 .6:1 .5:1 .5:1
Current Assets less Inventory less prepaid expenses 2237 3562 10412 8663 8276
Current Liabilites -8152 -10263 -17595 -16015 -17731
EFFICIENCY RATIOS
Inventory (stock) holding period -(days) 18 days 20 days 20 days 19 days 21 days
Inventory (stock) 1 931 2 430 2 669 2 729 3 162
Cost of Sales -39 401 -43 668 -49 713 -52 303 -55 871
Inventory turnover (times) 20.4 times 18.0 times 18.6 times 19.2 times 17.7 times
Cost of Sales -39401 -43668 -49713 -52303 -55871
Inventory (stock) 1931 2430 2669 2729 3162
Receivables(Debtor) Payment Period(-days) 9 days 10 days 12 days 12 days 14 days
Trade Receivables (debtors) 1 079 1 311 1 820 1 888 2 314
Revenue (sales) 42 641 47 298 53 898 56 910 60 931
Payables (Creditor) payment period(-days) 56 days 61 days 64 days 66 days 68 days
Trade Payables (Creditors) -6 046 -7 277 -8 665 -9 442 -10 484
Cost of Sales -39 401 -43 668 -49 713 -52 303 -55 871
Working capital cycle -29 days -30 days -32 days -35 days -34 days
FINANCIAL STRUCTURE
Laverage (gearing) 28% 33% 49% 44% 37%
Long term borrowing (debt) - 4 146 - 5 972 - 12 391 - 11 744 - 9 689
Long term borrowing plus equity 14 717 17 874 25 297 26 425 26 312
Interest cover 13.3 times 12.2 times 7.1 times 6.5 times 8.3 times
Profit before interest and tax 2 869 3 053 3 395 3 755 4 018
Interest expenses -216 -250 -478 -579 -483
INVESTMENT RATIOS
Earnings per share 23.69 26.57 26.67 29.14 33.31
P/E ratio 6.18 p 6.01 p 4.53 p 4.81 p 5.23 p
Dividend yield 4.68 4.75 6.82 6.50 5.83
Dividend ratio payout 28.54 28.40 30.96 31.29 30.40
Dividend cover ratio 3.50 3.52 3.23 3.20 3.29
31
32. Appendix 4. Working Ratios for J Sainsbury plc
J SAINSBURY's plc
2007 2008 2009 2010 2011
LIQUIDITY RATIOS
Current ratio .7:1 .7:1 .5:1 .7:1 .6:1
Current Assets 1940 1722 1591 1853 1721
Current Liabilities -2721 -2605 -2919 -2793 -2942
Quick Asset Ratio (Acid Test Ratio) .5:1 .4:1 .3:1 .4:1 .3:1
Current Assets less Inventory less prepaid expenses 1325 929 881 1095 896
Current Liabilites -2721 -2605 -2919 -2793 -2942
EFFICIENCY RATIOS
Inventory (stock) holding period -(days) 13 days 15 days 14 days 14 days 15 days
Inventory (stock) 590 681 689 702 812
Cost of Sales -15 979 -16 835 -17 875 -18 882 -19 942
Inventory turnover (times) 27.1 times 24.7 times 25.9 times 26.9 times 24.6 times
Cost of Sales -15979 -16835 -17875 -18882 -19942
Inventory (stock) 590 681 689 702 812
Receivables(Debtor) Payment Period(-days) 4 days 4 days 4 days 4 days 6 days
Trade Receivables (debtors) 197 206 195 215 343
Revenue (sales) 17 151 17 837 18 911 19 964 21 102
Payables (Creditor) payment period(-days) 52 days 49 days 51 days 48 days 48 days
Trade Payables (Creditors) -2 267 -2 280 -2 488 -2 466 -2 597
Cost of Sales -15 979 -16 835 -17 875 -18 882 -19 942
Working capital cycle -34 days -30 days -33 days -30 days -27 days
FINANCIAL STRUCTURE
Laverage (gearing) 32% 30% 33% 32% 30%
Long term borrowing (debt) - 2 090 - 2 084 - 2 177 - 2 357 - 2 339
Long term borrowing plus equity 6 439 7 019 6 553 7 323 7 763
Interest cover 5.5 times 4.6 times 4.1 times 6.0 times 8.1 times
Profit before interest and tax 584 611 614 881 943
Interest expenses -107 -132 -148 -148 -116
INVESTMENT RATIOS
Earnings per share 18.68 18.83 16.49 31.44 34.21
P/E ratio 28.65 p 17.43 p 18.86 p 11.35 p 10.60 p
Dividend yield 1.77 3.60 4.22 4.26 4.30
Dividend ratio payout 52.19 63.72 80.07 45.16 44.14
Dividend cover ratio 1.92 1.57 1.25 2.21 2.27
32
