Basics Of Ratio Analysis On Tescos And Sainsbury Finance Essay

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Profitability Ratios:- Profitable Ratios are used to accesses a business ability to generate earnings compared to its expenses and other relevant costs over a specified period of time. The first ratio through which the profitability can be analyzed is the Return n Equity (ROE), Return on Equity measures the profitability by revealing how much profit a company generates with the money shareholders have invested. Roe is expressed in percentage and calculated as Return on Equity= Net Income/ Shareholder's Equity in the given table the ROE of TESCO and SAINSBURY is given:-

Return on Equity

Tesco

15.9427%

16.6005%

Sainsbury

11.78%

6.6042%

The return on equity for Tesco for the year 2010 is 15.94% which is less as compared to the last year, for the year 2009 it was 16.60 which was higher as compared to the current year, though the returns have decreased but Tesco still holds a better position than Sainsbury as Sainsbury current year i.e. 2010's ROE is 11.78 almost double than 2009's ROE 6.6042. though Sainsbury has shown huge growth and is showing positive signs for the investors but still share holders would prefer to invest in Tesco because the returns of Tesco is Still higher than that of Sainsbury.

The second profitability ratio used is Operating Margin Ratio which is used to measure the companies pricing strategy and operating efficiency. This ratio is derived by dividing operating income by net sales i.e. Operating Margin Ratio=Operating Income/ Net Sales. Operating Margin is a measurement of the proportion of a company's revenue i.e. left over after incurring the variable cost such as wages, raw materials etc. A healthy operating margin ratio is required to pay of the fixed costs such as interest and debts etc. The following table shows the Operating Margin of both the companies.

Operating Margin

2010

2009

Tesco

5.4121%

5.4418%

Sainsbury

3.5564%

3.5588%

The above table shows the operating margins of Companies Tesco and Sainsbury, which states that there is slight reduction in the operating margin of both the companies, but still Tesco remains the contender with the highest returns, though the operating margin ratio is decreased a bit but it is still higher than the margin of Sainsbury.

The Third Profitability ratio used for the study is Return on Total Assets Ratio (ROTA), this ratio is used to measure the Earning Before Interest and Tax against the total net assets. This ratio is a indicator which shows how effectively the assists of the organization is used to generating earnings before paying the interest and Tax, which is derived by dividing the EBIT by total net assets where EBIT =Net Income+ Interest Expenses + Taxes.. The Return on Total Assets of both the companies is being tabularized below.

Return on Total Assets

2010

2009

Tesco

5.0815%

5.6333%

Sainsbury

5.6013%

2.8688%

In this ROTA for both the companies is more than 5% for the year 2010, for Tesco the returns are declined 0.59% as compared to last year, but Salisbury has showed greater signs of Improvement in the year 2010 with more than 3% increase on the return on fixed assets and was able to make use of the assets.

The key objective of every organization is to earn profit large enough to justify its investments that have been made. The profitability ratio of Tesco remains better than that of Sainsbury which shows the financial success and growth of Tesco. The Return on Equity for Tesco is very high which makes it stand in a better position than Sainsbury and Tesco has good control on its operating expenses by which it is able to make more operating margin then Sainsbury.

Liquidity Ratio:-

In order to examine Groups Liquidity position the following ratios are being taken. Liquidity Ratio shows the liquidity position of the company i.e. companies ability to pay off its short term debts obligation. The first one is the Current Ratio, Current Ratio is a financial ratio which is being used to know the current position of the company, whether the company will be in a position to pay of its debt in the next 12 month. It is being evaluated by comparing the Current Assists with Current Liabilities. I.e. Current Ratio= Current Assets/ Current Liabilities. The Current Ratio of both the groups being listed below.

Current Ratio

2010

2009

Tesco

0.7113

0.7434

Sainsbury

0.6634

0.545

In the given Current Ratio's, it is been seen that the Current Ratio of Tesco has been reduced from 0.7434 to 0.7113, whereas there is slight increase in the current ratio of Sainsbury. I.e. from 0.545 to 0.6634. Though Sainsbury has shown improvement in the current ratio but both the groups are facing the problem that their current assets are not sufficient to meet up their current liabilities. As compared to Sainsbury Though Tesco's current position has gone down then the last year but still Tesco is in a better position to pay of its short term liability as

Compared to the Sainsbury.

Acid Test Ratio:-

(Table4)

Acid test Ratio

2010

2009

Tesco

0.5409

0.5918

Sainsbury

0.4121

0.309

.

Quick ratio or acid test ratio is used to measure the capacity of a company to utilise its quick assets or near cash to settle the current liabilities immediately. When calculating this ratio, the Current assets which can be quickly converted to cash to retire its current liabilities. When the quick ratio of the company is less than 1 it means the company cannot currently pay its current liability. From the above table we can see and measure the ability of Tesco to cover the current liabilities by the act of liquidating its current assets has decreased in 2010 when compared with that of 2009. Moreover since the Acid test ratio of Tesco is less than 1 Tesco is not having the ''real ability'' to pay off its current liabilities immediately. Sainsbury has increased the quick ratio considerably as compared to the last year but even Sainsbury's current ratio is less than 1 which means Sainsbury is not in a position to pay its liabilities immediately. However both the company is not in a better position in terms of paying back the short term debts. But when comparing Tesco and Sainsbury, Tesco is in a better position.

Interest Coverage Ratio;-

ICR

2010

2009

Tesco

4.4898

5.3134

Sainsbury

2.076

1.7256

Interest cover ratio is utilised in determining how easily the company can pay the interest on the outstanding debt. It is calculated by dividing the earning of the company in the particular year divided by the expenses paid as the interest by the company in that particular year. Interest Coverage Ratio

Company which is having a interest cover ratio of 1.5 or less, the company's ability to pay the interest is questionable. If it goes below 1 it means the company is not able to generate sufficient funds to meet the interest expenses. Tesco's interest cover ratio has decreased when compared with last year's data. But Tesco is generating sufficient revenue to meet the interest expenses. Sainsbury is showing a increase in ICR in 2010 when compared to 2009. Despite of the growth in interest cover ratio, Sainsbury's is just meeting the profit earnings to pay back the interest expenses. Comparatively though Sainsbury has shown increase in ICR it is just showing profit to pay the interests. Tesco's ICR has declined in 2010 but the ''margin of safety is high in Tesco's financials compared to Sainsbury's financials. So the need for Sainsbury to cut down the operating cost and increase the operating profit so that it can pay back the interest is high.

So when we analyse the current ratio, acid test ratio and interest coverage ratio of Tesco and Sainsbury the liquidity position of Tesco is better then Sainsbury in all the aspects. Although Tesco's 2010 financials shows a decline when compared with 2009 financials Tesco still stands better than Sainsbury, which has shown significant growth in the current year when compared to the last financial year.

The asset/equity ratio is a formula that is used to determine the overall financial stability of an organisation. It is determined by the value of the total assets of an organisation minus any portion of the asset owned by the shareholder of the organisation. The asset that is owned by the shareholders is referred as owner's equity or shareholder equity. It may not be considered as eligible for collateral when the organisation is looking to secure a business loan

Asset/equity ratio

2010

2009

Tesco

3.1531

3.5461

Sainsbury

2.1859

2.2927

There are couple of reasons why this asset/equity ratio for an organization to operate. The first reason is asset/equity ratio can speak a lot about how an organization can operate. The debt equals or when the debt is more than the total assets, will not be considered as a good investment. However an organization with low debts and high asset value is also not good sign as it indicates the company is very conservative and not into growth strategies. The second reason is when the organization is trying to secure a business loan either to improve the current operation or to expand the company joining new ventures. A high asset/equity ratio will enable the organization in getting extended credit facilities. As such there is no ideal value for the asset/equity ratio which can provide a snapshot of the company's financials. This ratio can just give basic information on calculating total worth of business. So when comparing the asset/liquidity ratio of Tesco and Sainsbury, Tesco stands better than the Sainsbury.

Turnover Ratio:-

Turnover Ratios are being used to know the turnover of the company, the turnover ratio used to access the given group is the

Inventory Turn Over Ratio (ITR):-

Every firm has to maintain a certain level of stock or finished goods to meet up its current requirement. The level of inventory should nighters neither high nor too low. This indicates how many times the inventory of a company is being replaced in a given period of time. A high Inventory turnover ratio means the company is able to sell of its goods and services very quickly. It is the relationship between cost of goods sold and cost of average inventor, which can calculated as Cost of Goods Sold by Average Inventories.

Inventory Turnover Ratio=Cost of Goods Sold/Average Inventory.

The Inventory Turnover Ratio of the groups are given below.

(ITR)

2010

2009

Tesco

21.0856

21.1406

Sainsbury

28.7045

27.6073

The Inventory turnover Ratio of Tesco remains the same for both the years, and for Sainsbury there is slight increase in the Inventory Turnover Ratio. As ITR measures the velocity of conversion of stock into sales. Usually high Inventory Turnover shows efficient management of Inventory, a low inventory turnover over investment in inventories, Inventory accumulation or low profits. In case of Sainsbury the management is efficiently managing the inventory where as Tesco is lacking in it, But due to heavy demand and sales in Tesco ,to make the goods available the management is ready to insure the heavy inventory cost which does not much effect the profit ratios of Tesco which is still better than that of Sainsbury.

The other set of ratio in Turnover Ratio is the Receivable Turnover Ratio, Receivables Turnover Ratio which is also known as Accounts Receivable Ratio(ATR), which is used to measure the companies effectiveness in extending credit and collecting debts, it shows how efficiently the company uses its assets. By holding the accounts receivables in their books the company is indirectly providing interest free loan to their customers who haven't paid for their goods yet. A high ratio implies either a company run on cash basis or that its receivable management is very efficient. This can be calculated as Receivable Turnover Ratio = Net Credit Sales/ Average Receivable.

ATR

2010

2009

Tesco

11.8637

16.3204

Sainsbury

97.3854

94.3192

In the given table Sainsbury has shown great improvement and in its receivables management last year the Accounts Turnover Ratio was 94.3192 which is increased to 97.3854, where as the receivables management of Tesco has declined, last year the ATR was 16.3204 which 11.8637.It shows either Sainsbury is cash rich or their receivables management is very good than Tesco.

Working Capital Ratio:-

Working capital represent operating liquidity available to the company and working capital turnover ratio indicates the velocity of utilization of net working capital. The ratio represents the number of times the working capital is turned over the course of year and is calculated as follows:

Working Capital Turnover Ratio= Cost of Sales/ Net Working Capital.

Working Capital Ratio

2010

2009

Tesco

-12.457

-12.157

Sainsbury

-17.6049

-16.7502

There is not much difference in the Working Capital Ratio of Tesco for both the years, as for year 2010 it is -12.457 and the year 2009 it was -12.157.and for Sainsbury for the year 2010 it is -17.6049 , for 2009 it was -16.7502, the working capital ratio of both the companies is in negative which shows that both the companies does not have sufficient funds to meet up their working capital requirement, though Tesco is in the back hand and not in position to meet up their working capital requirement by its own but still holds a better position than Tesco.

The Liquidity turnover ratio put Sainsbury in a better position as its inventory turnover ratio and the Receivables Turnover Ratio is better than that of Tesco, but in case of Working Capital Ratio of Sainsbury is very weak as compared to that of Tesco's.