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One of the best idea to account for analysis is to ask the question’ should we invest our money in the company either to buy a small business Or share of existing company before we take such decision there are question we tend to ask ourselves. If the business could be profitable, has there been any growth over some period of time. The best way to answer this question is to do some analysis over the financial income statement and balance sheet for performance evaluation. A technique ratio called financial ratio can get this done.
This is a technique used to describe and interpret the relationship of certain financial data in the financial statements that would otherwise be devoid of meaning. Bendrey et al (2004).
Users of financial Statement
Users of financial statement can be found with and outside the organisation sector of an economy. Most user intend to have full information of the organisation before doing any transaction with them for instance a potential customers may request for special information like annual financial report . Therefore, the use of financial statement is categories under the respective people.
Users information Need
- Investors: This help to decide whether there is need to increase and decrease interest of ownership. For making investment risk and return.
- Managers: it helps the management to set up managerial goal. The goal like be set in term of increase in profitability.
- Customers: this is to know the firms stability and capability to delivered goods and service to be purchased.
Other users they include government in area like Tax, security trading.
Potential suppliers and creditors: They are in rest to know if a company can pay their bills.
In order for financial information to be useful it has to be interpreted.
Not only should financial statement be interpreted but to also compare it with another financial statement of an organisation in context.
Reason for ratio comparison
Skousen et al(1999) states that . “The standard of comparison used for benchmarking can be used on the performance of the company withinâ€¦.”
To determine the performance of a company there will be need for comparison of financial statement of that company either by using the past and the present or with another company financial statement. It is not good enough to compare the financial statement of a company but to also recognise comprising by benchmarking this is because there is need to deal with the inability of recognising any shortcomings and faults.
Economic performance measurement
Most big organisation are separated into divisions where there managers have aggregate responsibility for investment and profit. There is a structure comprising many sections, the relationship that division has should be run so that no division by seeking to increase its own profit can reduce the organisation profit as a whole.
We shall be concerned with the ratios that measure the economic performance, which concentrate not only on profitability, but on range other performances.
RELEVANT RATIOS IN MEASURING THE PERFORMANCE OF AN ORGANISATION
In Davies and Buckskin(2005) outlines various ratios’ of which the following shall be used to analyse the performance of Marks and Spencer, & Sainsbury
Profitability ratio: The general primary object is for the organisation to maximise the wealth of the owners of the business. To this two ratios will be discuss under this
Profit Margin: This is a ratio that helps to gain the relationship between purchasing costs and sales revenue of an organisation
Gross margin%= gross margin = Sales-Cost of sales(COS)
ROCE: This measures the return to the owners on the book value of their investment in a company.
Efficiency Ratios: The monitory of efficiency ratios by companies is important because this relate direct to the effectiveness of a business changed into cash for instant if company are not paid in accordance to trading there profit margin may be eroded by financing costs. Therefore resources that have been used will be measure with the following ratios
Stock days (turnover): The number of days that’s stock could last. This applied to either total stock or work in progress.
Total stock value
Cost of sales
Debtors Days or trade receivable: This indicates the average time taken in calendar days to receive payment from credit customers.
= Trade debtors x 365
LIQUIDITY RATIOS: This reflects the health position of the business and its liability to meet its short-term obligation. This could be compared by using the following ratios.
Current Ratio: This is an overall measure of the liquidity of the business.
= Current assets
Acid test(times): This indicate the ability of the company to pay its creditors in short-term
=Current – Stock
(D) Gearing Ratio: They are generally concerned with the relationship between debt and equity capital, the financial structure of an organisation.
These ratios are both used in describing the relative proportions of debts and equity used to finance a business.
Long term debts
Equity + long term debt
Interest covered: This ratio calculates the number of times the interest payable is covered by profits available for such payments.
= Profit before interest and tax
(E) Investment ratio: “This indicates the extent to which the business is undertaking capital expenditure to ensure survival.” Bockzko & Davies(2005).
Dividend cover: The number of times profit is attributed to equity shareholders covers the dividends payable for the period.
= earnings per share
Dividend per share
Earnings per share: This measures the return per share of earnings available to share holders. Bockzko & Davies (2005).
= profit after tax- preference share dividends
Number of ordinary shares in issue
INTERPRETATION OF THE CALCULATED FINANCIAL RATIO OF
SIANSBURY & MARKS AND SPENCER 20099/2008.
This report will be represented according to the standard set by A CIMA (1990) financial report can be presented as follows:
To: GRIGORIOUS THEODOSPOUIOS
SUBJECT: THE TWO COMPANY’S PERFORMANCE
A mere examination of accounting figures is normally insufficvient to allow for any meaningful conclusion to be reached, and ratio analysis enables enable the data available to be used on more comfortable basis. The information used toproduce this report is the extract from the |historical cost account for the year ended> of two companies. The calculated ratios are found in the appendix to the report
- LIQUIDITY RATIO
Their is very much higher liquidity figure of creditors of Marks and Spencer in 2009 compare to Sainsbury in 2009. Also applicable in 2008. It appears that Marks & Spencer is more Liquidity compare to Sainsbury in respective years. This may be that both companies are not running on same assets and liability.
- EFFICIENCY RATIO
Sainsbury is having a stock turnover of 14days compare to the previous year as 15 days. This may indicate that stock is being managed efficiently, it is taking the business longer to collect debtors, although even at 11.5days compare to previous year which was 2008. Sainsbury debtors are not finding it difficult to pay their debts .They have been able to do this within 3.8days in 2009 compared to debtors owned in 2008. This within 3.8days in 2009 compared to debtors owned in 2008. This might lead to Sainsbury discounting amount own for quick payment.
Sainsbury is having 13.1% of return on capital employed in 2009 which is higher to that of Marks and Spencer as 6.24%. This simply indicate that Sainsbury have been able to properly make use of their resources within their reach. A company should be profitable and efficient at the same time.
Marks & Spencer is having a high profit Margin of 7.8% in 2009. This might be that the company is operating at low price. Sainsbury profit Margin is very low at 2.5% in same year. This may be as a result of the company running its product at high price to bring about sales.
- GEARING RATIO
Sainsbury and Marks & Spencer would not be having problem in paying interest charged simply because they have a high profit to pay their lender in year 2009. Considering their gearing ratio, Sainsbury is having a very high gearing ratio to Marks & Spencer
- INVESTORS RATIO
In 2009 Marks and Spencer earning per share made available to its shareholder is 0.6 p compare to Sainsbury as 0.3p. It simply means that marks and Spencer is having a high return for it investors. In this case it will interest Marks and Spencer shareholder to invest more money into the business. In 2009 Marks and shows 1.4 times its profit attributes to equity shareholders covering dividends payable for the period compared to Sainsbury in 2009 for 1.3times.
Limitation of financial ratio
Gillespie et al(1997) States that, ” financial statement do not give sufficient information to draw firm conclusions.”
Therefore, in interpreting the financial statements of the two companies there is need to bear in mind that the analysis are based on profit and loss accounts and balance sheets which are subject to all the limitations of historical cost accounting. Inflation, specific price changes and differing bases of valuation are likely to distort comparisons
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