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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 Nevertheless, there are some limitations in the used of financial ratios, for instance, the information is out of date so it does not reflect the real situation of the company, hence it can lead to wrong decisions, also, the analysis made from the financial statements gives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&subsection=&Year=2004&NewsID=384), there are some opinions that contrast with the statement already mentioned, which states that this acquisition of sophisticated technology was too ambition and did the approach too quick, now Sainsbury's is in a worst position than it was before (Smiddy cited O'Brian, 2004). In addition, after have used the new IT system, Sainsbury's realized that the supply chain system have failed and it did not work as they have expected, it did not increased productivity and the costs were higher than they were years ago (http://www.computerweekly.com).

SAINSBURY'S vs. TESCO

The supermarket industry is very competitive nowadays, and even more when it comes to the customers satisfaction which is more and more demanding, so it is important for companies in this business to be focus in valued than in profitability, since the former leads them to the latter.

Sainsbury's and Tesco are two of the principles supermarket chains in UK. Both chains have similar things to offer, such as own label goods; have concern about consumers needs for example healthy and organic food; launched loyalty cards; expand their products such as clothing, electro domestics, etc. and others. On the other hand, they have some differences that make one stand out from the other. While Tesco have a good supply chains and a good strategy, which is having low prices and improving customer satisfaction by having the right products in shelf, Sainsbury's is facing some problems in what a supply chain relates to the implementation of the IT system (http://proquest.umi.com), which causes the lack of products in the shops and also the customers find it more expensive than its competitors, where they can have equal quality products with lower price (http://proquest.umi.com).

There are other differences between Sainsbury's and Tesco, but there is an important question which is where to invest?. It is important to draw attention to the fact that Sainsbury's financial situation does not attract investors, due to the decrease in the profit and sales. In addition, the company has being going through its first loss in 135 years of history (www.accountancyage.com). This reduction was mainly caused by the 554 million acquisition of IT system, and by the drop in profits for the financial year. Thus, it can be said that Tesco might be a better choice to invest in, but this is open to discussion.

CONCLUSION

Taking into consideration the ratio analysis applied to Sainsbury's, it can be said that the company had some variation between 2003 and 2004. Whereas, most of the profitability, efficiency and effectiveness, liquidity and investor ratios demonstrate decline, the gearing ratios demonstrate a rise due to the growth in the long-term debts and the capital employed.

Understanding the ratio analysis and the relevant information gathered looks like Sainsbury's has gone through some difficulties in their supply chain and their financial and marketing management. Although they have invested in a long-term project and are positive in a potential growth in the coming years, to reach their aim they have to work hard and play in the same field its competitors (Tesco and Asda) are doing, by having low prices and good quality food always available in their shelf for all kind of consumers.

Sainsbury's still have a strong position in the retail sector in the UK. For this reason it is good for investors to wait and see its performance for the next years, currently is not a good moment to invest in.

REFERENCES

BERRY, A. and JARVIS, R., 1997. Accounting in a Business Context. 3rd Edition. London: International Thomson Business Press.

GILES, R. and CAPEL, J., 1994. Finance and accounting. 3rd Edition. London: MacMillan.

HARDING, D., 2005. Supermarket sweep-up for Sainsbury's. Accountancy Age. Available from: [http://www.accountancyage.com/news/1139885] Accessed 22/Apr/2005.

MARKETING WEEK, 2004. Reinvention is the only option left for Sainsbury's. Marketing Week, pg. 30. Available from: [http://proquest.umi.com/pqdweb?did=727035691&sid=8&Fmt=3&clientId=15517&RQT=309&VName=PQD] Accessed 20/Apr/2005.

MARKETING WEEK, 2005. Sainsbury's promises must mean business. Marketing Week, pg.22. Available from: [http://proquest.umi.com/pqdweb?did=792773011&sid=9&Fmt=3&clientId=15517&RQT=309&VName=PQD] Accessed 20/Apr/2005.

MCLANEY, E. and ATRILL, P., 2002. Accounting An Introduction. Second edition. London: Prentice Hall.

O'BRIEN, L., 2004. Sainsbury's blames profit warning on supply failures. Supply Management, 9 (22). Available from: [http://proquest.umi.com/pqdweb?did=749826531&sid=8&Fmt=4&clientId=15517&RQT=309&VName=PQD] Accessed 20/Apr/2005.

SAINSBURY'S WEBSITE, 2005. Annual Report and Financial Statements 2004. Available from: [http://www.j-sainsbury.co.uk/index.asp?pageid=20] Accessed 15/Apr/2005.

SAINSBURY'S WEBSITE, 2005. Sainsbury's simplifies financing of IT contract with Accenture. Investor News. Available from: [http://www.j-sainsbury.co.uk/index.asp?PageID=19&subsection=&Year=2004&NewsID=384] Accessed 20/Apr/2005.

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