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Sainsburys Plc Ratio Analysis And Abc Costing System Accounting Essay

The J Sainsbury plc, commonly called as Sainsburys is founded in London on 1869. Sainsburys is a supermarket giant in the United Kingdom which holds as the third largest supermarket chain in the United Kingdom. Sainsbury’s is also one of the oldest retailers in London which first and foremost is involved in groceries as well as marginally invests in properties and banking.

Being one of United Kingdom’s superpowers in terms of supermarket business in London, the company is just enticing for prospective investors to endow their financial assets. This paper shall present and discuss a financial analysis of Sainsbury’s whether it would be worth investing.

This paper is composed of two parts: the first part shall focus on Sainsbury’s profitability ratios, efficiency ratios, liquidity ratios, investment ratios and ratios which are based on share price; the second part is a critique of the increasing fame of the integration of ABC costing system in various firms as well as its imminent benefits to Sainsbury’s.

The financial statements and Annual Reports of Sainsbury’s are the primary sources for the creation of this paper.

Introduction

In order to quantify a firm’s financial conditions as well as analyze its financial strength and sustainability, most prospective investors analyze its financial statement which is commonly consisting of certain analytical tools. According to John Bajkowski: “Financial ratio analysis uses historical financial statements to quantify data that will help give investors a feel for a firm’s attractiveness based on factors such as its competitive position, financial strength and profitability.” Thus, it is imperative to employ accounting ratios in order to prove that Sainsbury’s is a company that is appealing for investments and shall generate needed profit, elements in which an investor eye for.

The company was founded by the couple John James Sainsbury and Mary Ann Sainsbury in London. The first store sold eggs, milk and butter. As Sainsbury’s continue to increase in size, the couple hired boys and young men. (Introduction to History Pack: Sainsbury’s)

Sainsbury’s have truly amplified its size and its market as it operates over 1,000 stores around United Kingdom and employs around 150,000 people. (J Sainsbury.UK.Co)

Part 1. Financial Analysis

Analysis

This section shall analyze the financial performance of Sainsbury’s based primarily on performance ratios as well as ratios based on the company’s profit. Once the ratios present satisfaction for the investors, then the business is good. The decision whether to invest on Sainsbury’s or not shall be based on the ratio analysis.

The sources for this analysis are the income statements, annual reports, balance sheets and cash flow statements from Sainsbury’s. The primary steps in every financial ratio are followed; such ratios are calculated based on the figures reported on income statements, annual reports, and balance sheets derived from various sources primarily taken from Sainsbury’s reports. Such ratios aids in interpretation and conclusion to the goal of this paper. The analysis on the ratios shall be on profitability ratios, efficiency ratios, liquidity ratios and investment ratios. The formulas used to derive such ratios are to be found on the Appendix.

Most importantly, in order to limit errors in calculations and assumptions the author made use of existing ratios presented in the annual report and financial statements of Sainsbury’s.

Efficiency Ratios

Table 1: Efficiency Ratios of Sainsbury’s 2011-2012

Sainsbury’s

2011

2012

Asset Turnover

1.90

1.88

Return per employee (£)

212,51

225,26

In order to determine whether a company is at growth, it is important to calculate its asset turnover ratio in which it gauges the efficiency of the firm in employing its assets in order to generate sales, thus, the higher the number of the ratio means the more a company is on its way to increase in growth, however, it must be noted that companies with high profit margins generally have low asset turnovers while those companies bearing low profit margins are more likely to bear high asset turnover – such cases are due to the fact that asset turnover ratio indicates notable pricing strategy. (Investopedia, 2013) Anent to this, it is evident by the numbers shown in Table 1 that Sainsbury’s asset turnover ratios for 2011 and 2012 are both relatively low, which shows that Sainsbury’s actually make high profit on its goods and products.

Sainsbury’s like other companies try to find the utmost possible profits from every employee involved into the company. Sainsbury consistently post high revenues per employee as stated in Table 1 above. These figures indicate that Sainsbury’s have solid management with consistent production operations. Such figures also show how Sainsbury’s generally possess higher revenues than the labor cost of the employees which allows the company to advance its business. As an investor the high return rate per employee ratio indicates a good investing opportunity. The figures show how Sainsbury is becoming more efficient in its business dealings.

Moreover, Sainsbury’s have continuously expanded it business and hires more and more employees which make the company’s customer service performance elevate each year.

Profitability Ratios

Table 2: Profitability Ratios of Sainsbury’s 2011-2012

Sainsbury’s

2011

2012

Operating Profit Margin

4.03

4.14

Gross Profit Margin

5.50

5.74

ROCE

11.1

11.1

The operating profit margin and gross profit margin are basically driven by sales. It is common that food retailers such as Sainsbury’s which basically retails basic food commodities and other food-related products operate on low prices in order for consumers to afford the products and also in accordance with government laws and procedures, thus, the profit margins of Sainsbury’s are relatively low. It is evident that there is a significant increase in the operating profit margin and gross profit margin of Sainsbury’s for the year 2011 and 2012. It is apparent that the gross profit margin ratio, which is actually a gauge of profitability in the production and selling of products before taking into account any other outside expenses, thus, the cost of sales signifies a key expense for Sainsbury’s as a retailer company. With the figures shown above it can be noted that the increase of operating profit margin and gross profit margin of Sainsbury’s for the past two years show an increase on its profit in which these margins have higher relation to sales revenue, thus, it can be noted that Sainsbury’s have reduced slightly on its cost of goods which is favorable to the consumers.

On the other hand, the ROCE which stands for “return on capital employed” virtually calculates the effectiveness of the new invested monetary assets as well as the scheme in which the existing monetary capital conveys income. The ROCE for Sainsbury’s remained stagnant within the past two years and this is explained by Sainsbury’s official statement in their Annual Report which states that:

“ROCE growth was held back by the cumulative effect of Sainsbury’s accelerated investment in space growth since June 2009. This has an initially dilutive impact on profits as the stores mature, while increasing the value of capital employed.” (J Sainsbury plc Annual Report and Financial Statement 2012)

The ROCE ratios being the same for the past two years show sustainability of Sainsbury’s, as a savvy investor the reflection of the ROCE ratios allowed clear insight on growth forecasts as well as measure the corporate performance of Sainsbury’s.

Investment Ratios

Table 3: Investment Ratios of Sainsbury’s 2011-2012

Sainsbury’s

2011

2012

Earnings per Share

34.4

32.0

Dividend per Share

6.62

5.52

Dividend cover

1.94

1.76

In order to analyze deeply whether Sainsbury’s is a good company to invest in, it is valuable to compare the investment ratios of the company for the past two years. Such investment ratios allow a prospective investor to examine the overall health of Sainsbury’s, thus, these investment ratios are crucial for a prospective investor. Such ratios shall allow direct comparison of investments and allow the creation of trading strategies and basically remove inventories that are not selling well.

As described by the figures above Sainsbury’s posted higher investment ratios in 2011 than in 2012 this is basically because of the food inflation in 2011 around United Kingdom which have reached at least 6%. Consumers have to struggle with the fact that at least 10% to 25% of their monthly bills are tendered to groceries. (Shah, 2011) Although this has resulted to price wars in certain supermarket companies, but, Sainsbury’s have remained sturdy. The earnings per share in 2011 reached a peak of 33.8% which reflects improving operating profit although this has declined in 2012 because of “lower non-underlying profits”. The Sainsbury Plc Annual Report explained:

“Underlying basic earnings per share increased by 6.0 per cent to 28.1 pence (2010/11: 26.5 pence), reflecting the improvement in underlying profit, partially offset by the effect of the additional shares issued during the year. The weighted average number of shares in issue was 1,870.3 million (2010/11: 1,858.7 million), an increase of 11.6 million shares or less than one per cent. Basic earnings per share decreased to 32.0 pence (2010/11: 34.4 pence) due to lower non-underlying profits.” (J Sainsbury plc Annual Report and Financial Statement 2012)

In terms of dividend cover Sainsbury’s need to be sustainable since it posted low dividend over, thus its shows that Sainsbury’s have chances of not being able to pay the investors. Thus, Sainsbury’s have applied several strategies to attract investors such as the DRIP program which stands for the Dividend Reinvestment Plan which “allows shareholders to reinvest their cash dividends in more J Sainsbury plc shares bought in the market through a specially arranged share dealing service.” (J Sainsbury plc Annual Report and Financial Statement 2012) Moreover, according to Atrill (2009), giant food and goods retailers such as Sainsbury’s literally posts higher dividend cover which reaches an average of 2.6 a year. Thus, Sainsbury’s dividend policy is actually justified by this fact.

“In 2012, Sainsbury’s trade payables equated to 47.4 payable days…This reduction will provide Sainsbury with greater financial flexibility as market growth staggers and trading conditions remain tough. This policy, if maintained, with help promote long-term flexibility and growth. ” (Cates, 2012)

Dividend policy has always been an important matter to shareholders. Thus, Sainsbury’s need to maintain its dividend constant or make it increase even more - a situation that did not took place in 2012 which posted low investment ratios.

Liquidity Ratios

Table 4. Liquidity Ratios of Sainsbury’s 2011-2012

Sainsbury’s

2011

2012

Current Ratio

0.58

0.65

Quick Ratio

0.31

0.35

The liquidity ratios are one of the most important accounting ratios that need to be considered in deciding whether to invest in a company or not, thus, taking into account the computations of the liquidity ratios of Sainsbury’s shall allow prospective investors to assess whether the company has the ability to quickly generate monetary assets to pay outstanding debts. The ability of a company to meet short-term debts is primarily a concern for investors.

Since Sainsbury’s is mainly a supermarket chain in which the only those goods and products that are being sold quickly to the consumers are being held and because all of these goods and products are paid in cash, hence, the liquidity ratios are normally low.

With the figures presented in Table 4 it is apparent that Sainsbury’s have increased its current ratios for the past two years which means that the business is becoming more and more liquid, an element vital for business to attract more and more investors. The quick ratio because of its much in-depth technique of test because it takes into account the fact that some inventories cannot be converted into actual sales or cash rapidly, thus, these inventories should be excluded whilst measuring the liquidity of the company. Sainsbury’s show a similar trend in its quick ratio as posted on its current ratio which means that excluding inventories that do not rapidly convert into cash sales makes the company more liquid.

Gearing Ratios

Table 5. Gearing Ratios of Sainsbury’s 2011-2012

Sainsbury’s

2011

2012

Gearing Ratio

44.49

49.16

Interest Cover

0.58

0.65

Similar to liquidity ratios, gearing ratios allow prospective investors to examine the health of Sainsbury’s company through its capital structure. Such ratios allow comparison of the company’s equity in relation to borrowed funds. Moreover, the gearing ratios presented in Table 5 above presents a measure of the financial leverage of Sainsbury’s for the past two years.

In 2012, Sainsbury’s posted increase gearing ratio and interest cover than in 2011; this is combined with the fact that Sainsbury’s have posted stable figures in its gearing for the past years. Thus, it is evident that considering Sainsbury’s gearing ratio, the company need no counteractive measures or action required.

Sainsbury’s increase in gearing ratios can be related to the fact that Sainsbury’s integration of new objectives of financing new profit-producing assets such as new stores.

Limitations of Ratios

Financial ratio analysis always vary in terms of the type of company as well as its market structures and regulations, thus, this paper has only made use of ratios that can be applied to Sainsbury’s as a supermarket chain giant.

Moreover, the figures interpreted in this paper have been extracted or calculated through the use of the figures and numbers reported in the annual report and financial statements provided by Sainsbury’s PLC over the Internet. The data and the figures may have been altered due to progress or decline during the present time or by the time this paper has been analyzed.

In addition, financial ratio analysis is always subject to estimates and assumptions, thus, might not reflect the actual status or figures of the company. Most importantly, the financial ratio analysis presented on this paper dealt with Sainsbury’s performance for the past two years, although prospective investors may want to look at its present condition.

Part 2. ABC Costing and Its Implications to Sainsbury’s

In the recent years, there is a flourishing desire among numerous organizations to have a clear understanding of their costs and the factors that influence these costs. Despite this growing desire, however, there is still confusion on how to go about understanding costs and differentiating competing cost measurement methodologies such as standard costing, project accounting, target costing, throughput accounting and activity-based costing. With all these unclear information, managers and employees alike find it confusing to pinpoint exactly which costs are accurate and correct. However, if we are going to look at it closely, we will realize that all these different costing methodologies do not, in fact, contend with one another. If used properly, they can coexist and blend for the benefit of the organization.

Now that the business environment has been becoming increasingly competitive with all the technologies available, various companies try to find a way to maintain or improve their competitive need cost information. Back in the years, organizations would plan and control their operations making use of accounting information that is assumed to accurately measure the costs of their products and services as well as their channels and customers. However, these methods do not usually yield accurate and relevant results. The costing systems of numerous organizations, with their extensive averaging allocation of indirect costs, hiding behind the delusion of accuracy, were actually giving them nothing but misleading information which could maim the decision-making of managers.

The need was to overcome the over-generalization of traditional costing systems. Since the previous methods only paved way for extremely simplified cost allocation and consequently lack of visibility for indirect costs, the ABC or activity-based costing systems have been adopted by many organizations. Activity-based costing systems are based on cost modeling that tracks an organization’s expenses both indirect and direct, to the services, products, channels and customers that bring about those expenses to be acquired. (Implementing Activity-Based Costing, 2006)

For us to understand ABC costing even more, let us have a look at, for instance, two products that are manufactured by the same company. Product A is a low-volume item that needs certain activities such as special engineering, additional testing and many other machine setups to be made since it is ordered in small. On the other hand, Product B, which is akin to Product A, is a high volume product. Being so, it runs without end and needs very little attention and no special activities. If the company that manufactures Products A and B will utilize the traditional type of costing, it could allot most of its overhead to products based on the number of machine hours it took to make them. In our example, Product A will be allotted little overhead cost because it did not require many machine hours. However, its other demands such as tons of engineering, testing and setup activities might be overlooked. On the contrary, Product B will be allotted a huge amount of overhead because of all the machine hours it took while demanding very little overhead activity. This erroneous and inefficient type of costing will cause miscalculation of the true manufacturing overhead cost of a product. Activity-based costing will eliminate this error by assigning overhead on more than just one activity which is running the machine.

Activity based costing will take into consideration all activities that cause costs such as engineering, special testing and additional machine setups which obviously makes the company use its resources. When a company uses ABC, it will compute the costs of the resources utilized in each of these activities. After which, the cost of each of these activities will be given only to those items that needed these activities. Under ABC, in our example, Product A will be allotted a portion of the company’s costs for engineering, testing and machine setup. Other items that also need these activities to manufacture will also be assigned some of their costs. On the other hand, Product B will not be allotted any cost for special needs. It will be given only a small amount for machine hours.

Because of its efficiency and accuracy, ABC has been used by more and more organizations in recent years. Today, ABC is one of the most popular methods of costing by utilizing activities to allocate indirect costs like overhead. It has grown in importance mainly because of these four reasons: first, manufacturing overhead costs have relatively skyrocketed; second, manufacturing overhead costs do not parallel anymore with hours of productive machine or direct-labor; third, the diversity of products and the diversity of the demands of the customers have grown tremendously; and lastly, some goods are produced massively while others require small production. (Activity Based Costing, 2013)

A supermarket giant such as Sainsbury’s will definitely benefit from activity based costing. The analysis of supermarket profitability requires a different set of demands from other businesses. In this industry, margins are very thin and concern negotiation with suppliers mostly. As price is vital to negotiations, terms and conditions of delivery, payment and promotion costs are also as crucial. A supermarket business, such as Sainsbury’s, definitely needs a tool to understand which items are credited for the bulk of supermarket profit and the method to analyze suppliers in order to know which suppliers are profitable for the company.

The retail industry’s best tool to help understand its economics is definitely Activity Based Costing or ABC. Not only does it give information in terms of profitability analysis by supplier, product groupings (such as family and category) and by channels (stores, delivery, online, etc.), it also provides process information and activity that can pilot best practices, supply chains and other endeavors. With activity based costing, all activities and costs that are related to each item and service will be pinpointed and so real profitability of each product, category or service can be established. In the retail industry, sales revenue alone will not suffice as a reliable indicator of profitability. Averaging each item or service costs over the whole product line paves way for difficulty in seeing which products sell well and which do not.

While activity based costing gives information regarding product and supplier profitability, it also assists with internal cost control. When activity and process are analyzed properly, there will be improvement in terms of efficiency and cost reduction opportunities. When a value / non value analysis has been conducted, activities that need to done and at what frequency will be determined. When activities are analyzed from a process view, then we will know where activities such as attending customer complaints, cleaning the area, customer serving, inventory management, temperature control, training, should be performed in the value chain, independent of the area they are actually being done.

Sainsbury’s can also use activity based costing in knowing best practices between stores. Of course a store layout is determined based on product groups. By using ABC, activities needed to support each product group will be established. After which, best practice analysis between stores to find out optimal layout, cost structure and costs can be executed. It is important to take into account product mix and consumer habits by geographical area. If this is done, it is possible to gauge the operating standards and pinpoint learning’s from one store and apply it to all other stores.

Sainsbury’s can definitely use ABC to its advantage because first it is one of the best tools to manage supplier relationship which subsist between store and producer. Second, it is a method to determine which store layout works best. Third, ABC can be used to lessen costs while increasing profitability; and lastly ABC can surely improve the management of the organization.

Sources:

Atrill, P. (2009) Financial Management for Decision Makers, 5th ed. Harlow: Financial Times Prentice Hall.

Cates, J. (2012) Financial Strategy Analysis of Sainsbury plc.’s. Slideshare.net <web> Retrieved from: http://www.slideshare.net/AdrJasonCates/analysis-of-sainsburys-financial-strategy

Directors’ Report and Financial Statements for the year ended 31 December 2010. Sainsbury’s Bank plc. <web> Retrieved from: http://www.j-sainsbury.co.uk/media/171816/bank_ar2011.pdf

Financial performance. J Sainsbury plc. j-sainsbury.co.uk <web> Retrieved from: http://www.j-sainsbury.co.uk/investor-centre/financial-performance/5-year-summary/

Report by the Board of Directors to the Shareholders and Financial Statements for the year ended 31 December 2011. Sainsbury’s Bank plc. <web> Retrieved from: http://www.j-sainsbury.co.uk/media/649399/sainsburys_bank_plc_0106.pdf

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Shah, D. (2011) How a supermarket price war will affect investors. Moneywise. <web> Retrieved from: http://www.moneywise.co.uk/investing/stocks-and-shares/how-supermarket-price-war-will-affect-investors

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