finance

The finance essay below has been submitted to us by a student in order to help you with your studies.

Study On Understanding And Interpreting Financial Statements Finance Essay

Morrisons is an organisation which has group of companies including 382 stores countrywide with 10 million customers visited every week and served by 124,000 employees. The chain is the fourth largest food retailer in UK by sales with an annual turnover in excess of £14 billion. Annual turnover itself doesn’t indicate the financial strength or their performances of any company. Annual report, the set of documents which publishes in an end of each business year, states a summary of all the financial operations took place in the company in a business year and it can be used to compare it’s performances against its’ competitors and analyse it’s financial performances

Sainsbury’s, a similar kind of organisation which does the same sort of businesses is the best organisation to compare the financial activities of Morrisons. According to Individual annual reports, Sainsbury’s which has a turnover of £18.5 billion contributes 16% to the retail market share comparing to Morrisons 12.3% and Tesco and ASDA contributes 30.9% and 16.8% respectively. Therefore it can be defined as the supermarket industry in UK to be an oligopoly structure because the market share has divided among few groups.

To compare financial performances, a generally accepted method is to use the ratios of each organisation. According to Atrill, P. and McLaney, E. (2008), financial ratios can be used to examine various aspects of financial positions and performances and they are widely used for planning and control purposes. Laidler, J. And Donaghy, P. (1998) States that the relationship between two items from financial statements can be expressed either in ratio form or as a percentage. In general, ratios can be defined as a yardstick which enable us to judge whether, in particular circumstances, results are good or bad or have improved or worsened.

RATIO

FORMULA

2008

2009

Return on capital employed

Net profit before interest and tax ×100 Share capita+ reserves +long term loans

612 × 100 = 11.8% 269+4109 +774

655+60 × 100 =12.84%

263 +4257+1049

Operating profit margin

Operating profit × 100

Sales revenue

612 ×100 = 4.72%

12969

671 × 100 = 4.62%

1452

Gross profit margin

Gross profit × 100

Sales revenue

818 × 100 = 6.30%

12969

913 × 100 = 6.28%

14528

Average inventories turnover period

Average inventory held × 365

Cost of sales

442 ×365 =13.28 Days

12151

685 × 365 = 12.54 Days

13615

Av. settlement period for trade receivables

Trade receivables × 365

Credit sales

94 × 365 = 2.64 Days

12969

105 × 365 = 2.63 Days

14528

Av. settlement period for trade payables

Trade payables × 365

Credit purchases

1152 ×365=34.6 Days

12151

1443 × 365= 38.68 Days

13615

Acid test ratio

Current assets - Inventories

Current liabilities

906 - 442 = 0.25

1853

1066 - 494 = 0.28

2024

Gearing ratio

Long term liabilities

Share capital + reserves + long term liabilities

1405 × 100 = 24.29%

269+4109+1405

1682 × 100 = 27.12%

263+4257+1682

Interest cover ratio

Profit before interest and taxation

Interest payable

612+60 = 11.2 times

60

655+44 = 14.56 times

48

The dividend payout ratio

Dividends announced for the year

Earning for the year available for dividends

108 × 100 = 19.49%

554

131 × 100 = 28.48%

460

MORRISONS

RATIO

FORMULA

2008

2009

Return on capital employed

Net profit before interest and tax ×100 Share capita+ reserves +long term loans

530 × 100 = 7.6% 499+4436 +2037

466 + 148×100 =9.41%

501 +3845+2177

Operating profit margin

Operating profit × 100

Sales revenue

530 ×100 = 2.97%

17837

673 × 100 = 3.56%

18911

Gross profit margin

Gross profit × 100

Sales revenue

1002 × 100 = 5.62%

17837

1036 × 100 = 5.48%

18911

Average inventories turnover period

Average inventory held × 365

Cost of sales

681 ×365 =14.76 Days

16835

685 × 365 = 14 Days

17875

Av. settlement period for trade receivables

Trade receivables × 365

Credit sales

32× 365 = 0.65 Days

17837

49 × 365 = 0.95 Days

18911

Av. settlement period for trade payables

Trade payables × 365

Credit purchases

1703×365=36.92 Days 16835

1728 × 365 = 35.2Days

17875

Acid test ratio

Current assets - Inventories

Current liabilities

1722 - 681 = 0.65

2652

1591 - 689 = 0.31

2919

Gearing ratio

Long term liabilities

Share capital + reserves + long term liabilities

2528 ×100 = 33.87%

499+4436+2528

2738 × 100 = 38.65%

501+3845+2738

Interest cover ratio

Profit before interest and taxation

Interest payable

479+132= 4.63 times

132

466+6+146 = 3.65 times

6+146+3+15

The dividend payout ratio

Dividends announced for the year

Earning for the year available for dividends

178 × 100 = 54.1%

329

218 × 100 = 75.43%

289

SAINSBURY’S

Ratio calculations comparison

Atrill, P. And McLaney, E. (2008) considers Return on capital employed (ROCE) to be the primary measure of profitability. It compares the capital invested with the operating profits. According to them this is a vital comparison in assessing the effectiveness with which funds have been deployed. ROCE should always be higher than the rate at which the company borrows; otherwise any increase in borrowings will reduce shareholder earnings. According to calculations both companies have improved in efficiency of capital investment over the year. However it’s evident that Morrisons, which has 11.8% and 12.84% respectively in both years compared to Sainsbury’s 7.6% and 9.41% has been more efficient in utilising funds to generate profits in both years.

Operating profit of a company is what the percentage of sales contributing towards the profits. Bragg, S. M. (2007) states that percentage reveals the extent to which a company is earning a profit from standard operations, as opposed to resorting to asset sales or unique transactions to post a profit. Morrisons maintained a higher rate than Sainsbury’s in both years but comparing to 2008, Morrisons operating profit margin has decreased by 0.10% in 2009. This may be due to lack of control of costs and fluctuations in prices while Sainsbury’s has increased their operating profit margin by 0.59% in 2009 comparing to the previous year.

Gross profit represents the difference between sales revenue and the rest of sales. Comparing in ratios, Atkinson, A. A., Kaplan, R, S. And Young, S, M. (2004), states that the gross profit margin measures the portion of each sale that is consumed by manufacturing cost. Both the companies have maintained stable gross profits over the both years though there’s a slight decline in both companies. This may be due to restricted margins on products during the recession. A higher closing stock can indicate a higher gross profit and vice versa can reduce the gross profit margin and indicated that Morrisons overtakes Sainsbury’s in terms of profitability in past two years.

According to Brealey, R.A., Myers, S.C. and Marcus, A.J (1999) managers use inventory turnover ratio to monitor the rate at which the company is turning over its inventories and it’s measured by how the management has used the stocks and other assets in the company. Average stock turnover of Morrisons is 13.28 days in 2008 while Sainsbury’s takes extra 1.5 days. Morrisons has reduced the rate to 12.55 in 2009 which is a good performance though Sainsbury’s decreased their rate to 14 days by just less than one day. These figures illustrate the higher efficiency of Morrisons.

Average collection period, commonly known as settlement period for trade receivables is used to measure the swiftness with which customers pay for the purchases for products or services. According to Atrill, P. (2009), this ratio calculates how long, on average, credit customers take to pay the amounts that they owe to the business. For both years, it has remained a similar figure to Morrisons which is less than 3 days but considerably higher when compare to Sainsbury’s as they kept it for less than 1 day. It indicates that Morrisons has less control over debtor days which is not healthy and this may indicate that Morrisons has less controllability of financial institutions. This can be happed due to customers’ use of their credit cards.

Any organisations would like to receive the debts from their customers as quickly as possible but they prefer to have a longer period to settle the trade payables such as debts for their suppliers and it’s important to obtain a longer credit settlement period. According to Griffiths, A. and Wall, S. (2007) trade payable ratio indicates the size and period of credit a company receives from its suppliers, by comparing its sales with the total amount the company owes to its trade creditors. over the last year Morrisons has manage to extend the credit terms with their creditors compared to previous years but Sainsbury’s has taken extra 3 days from 35 to 38. Both ratios indicate that management has tried to keep a good cash flow within the business. Extended settlement period for trade payables is important to maintain a sound level of working capital of the company but breaching the terms of contracts with suppliers by extending the days than agreed will be resulted in bad relationship and eventually it will effects the working capital cycle.

Liquidity refers to the ability of a firm to meet its short term financial obligations when and as they fall due, states Brealey, R.A., Myers, S.C. and Marcus, A.J (1999) and Gowthorpe, C. (2003), states that liquidity ratios are used to assess the extent which a business can comfortably cover its liabilities. It’s the lenders to the company who keep a close eye on the Liquidity ratios.

Acid test ratio works on the assumption that it takes longer to turn stock into cash. Garrison, R.H and Noreen, E.W (2003), states that the acid test ratio is designed to measure how well a company can meet its obligations without having to liquidate or depend too heavily on its inventories. In a period of recession, liquidity is a key element in measuring the performance of Morrisons. A glance at the figures indicates that acid test ratio has increased compared to 2008 but still it has a weaker ratio against rival Sainsbury’s which performs marginally well in 2009 compared to its 0.65 in 2008. As a rule of thumb, acid test ratio should be at least 1:1 but it with the effect of global recession Morrisons ratios can be justified compared to over 50% decrease in Sainsbury’s.

Atrill, P. And McLaney, E. (2008), describe that gearing ratios tend to highlight the extent to which the business uses borrowings. The level of gearing has an important effect on the degree of risk associated with a business. This ratio measures the financial leverage of the company that demonstrate degree to which firm activities are funded by owners and creditors. Calculations figure out that capital funded by creditors in Morrisons and Sainsbury’s have increased in 2009 but directors of Morrisons have taken less risk compared to their competitor by investing only 27.12% of the capital from creditors compared to 38.65% of Sainsbury’s.

Interest cover ratio measures the amount of operating profit available to cover the interest payable. When comparing two organisations’ figures, a higher ratio indicates that the company has the financial strength to meet its interest payments. Siciliano, G. (2003) suggests that interest cover ratio attempts to measure how well a company’s cash flow will succeed in paying the interest-bearing debt. Morrisons interest cover ratio is stronger than the Sainsbury’s as they cover only 3 times of the interest from their profits and lenders have less risk of getting their interest from Morrisons than Sainsbury’s because its profit before tax is 14.5 times than the interest payable as well as it has increased its ratio from 11.2 times in 2008 to 14.5 times in 2009. These kind of figures are encouragement for the investors or the share holders of Morrisons and it gives then as understanding of how profitable for them to invest in the particular company.

Dividend payouts describe the portion which available for share holders. According to Garrison, R. H and Noreen, E. W (2003) dividend payout gauges the portion of current earnings being paid out in dividends. Morrisons pays 28.48% of their profits to share holders in 2009 while Sainsbury’s pays 75.43. Referring to calculations, it indicates that Sainsbury’s usually gives a higher portion of their profits to share holders than Morrisons. A higher dividend payout ratio is favourable to short term investors as they can have an instant return for their investment. A lower dividend payout ratio (Morrisons) is an indication for a higher share price in the market as retain profit reinvested within the company.

Earnings per share in organisations are also use to analyse organisations profitability. A high EPS ratio is considered as a good indicator by investors. Laidler, J. And Donaghy, P. (1998), states that EPS are used by an investor or potential investor in making decisions. Ordinary shares issued quantity has decreased in 2009 compared to 2008 for Morrisons. This may indicate that there has been a share buyback and also due to the lower profits for the year but It’s not a wise move to have a share buyback during a recession period. This was also pointed out in the chief executives report. Sainsbury’s profits have also dropped down and it has resulted in a lower EPS compared to 2008 which is 18.83p but Morrisons still has a higher EPS than its rival.

Limitations and Conclusion

Ratios can be calculated using income statement and the balance sheet but they are not the sole measurers to understand the financial performance of a company. Above mentioned ratios are stand on profit and loss accounts, known as P&L accounts and balance sheets, which is only a snap shot of the financial year end are subject to the boundaries of historical cost accounting. Price, increases, differing bases for valuing properties or specific price changes can misrepresent inter-company comparisons and comparisons over time. Black, G. (2003) states that ‘financial statements do not seek to meet all the information needs of users, and other sources of information will usually be needed’, and there can be other measurements such as customer satisfaction reports, research and development reports which is available for the internal management to take in to the account when make decisions. However, they may not available for public. According to Laidler, J. And Donaghy, P. (1998) the financial statements are drawn based on accounting policies and accounting standards used by each company. Therefore it can effects the results of ratio analysis.

From the overall picture given by the above indicators, it can be concluded as that Morrisons has a better profitability, efficiency and investor friendly figures than the competitor Sainsbury’s and it’s evident from the ratio calculations that Morrisons financial performances has generally increased compared to previous years’ figures but Morrisons need to concern more about the areas such as average settlement period for trade receivables which will effects on working capital cycle.

References

Atkinson, A.A., R.S. and Young, S.M. (2004). Management Accounting. New Jersey, Pearson Education Limited.

Atrill, P. and McLaney E., (2008), Accounting and Finance for Non Specialists, 6th Edition, Harlow, FT Prentice Hall.

Atrill, P. (2009), Financial Management for Decision Makers, 5th edition, Harlow, FT Prentice Hall.

Black, G. (2003), Students Guide to Accounting and Financial Reporting Standards, 9th Edition, Harlow, Pearson Education Limited.

Bragg, S.M. (2007). Business Ratios and Formulas. New Jersey, John Wiley and sons Inc.

Brealey, R. A., Myers, C. S. and Marcus, A. J. (1999). Fundamentals of corporate Finance, McGraw-Hill companies.

Garrison, R. H. and Noreen, E.W. (2003). Management Accounting, International Edition, New York, McGraw-Hill/Irwin.

Gowthorpe, C. (2003). Business Accounting and Finance for Non Specialists, Surrey, Thomson

Griffiths, A. and Wall, S. (2007), Applied economics, seventh edition, Harlow, Pearson Education Limited.

Laidler, J. and Donaghy, P. (1998). Understanding UK Annual reports and accounts, Oxford, The Alden press.

Siciliano, G. (2003), Finance for non financial managers, New York, McGraw-Hill companies.


Request Removal

If you are the original writer of this essay and no longer wish to have the essay published on the UK Essays website then please click on the link below to request removal:

Request the removal of this essay


More from UK Essays