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Financial Statement Analysis PBL assignment part A BSB6300 Corporate Finance G Grroouupp M Meem mbbeerrss:: - Fadhel AlMastoor (201100180) - Wadeea Mohamed (201100817) - Bayan Riyadh (201101148) - Alaa Rajab (201000791) Table of contents: Question 1: Question 2: Question 3: Question 4: Question 5: Question 6: Question 7: Question 8: Question 9: (A) Accounting methods (B) Economic sector (1) Annual growth in sales (2) Annual growth in net income Cash flow statements analysis Profitability ratios (1) ROE (2) ROA (3) Gross profit margin (4) Operating profit margin (5) Net profit margin (6) Cash flow to sales Liquidity ratios (1) Current ratio (2) Quick ratio (3) Cash ratio (4) Cash flow ratio Efficiency ratios (1) Inventory turnover (2) Days inventory in hand (DOH) (3) Receivable turnover (4) Days of sales outstanding (DSO) (5) Total asset turnover Solvency ratios Total Debt-to-Capital Total Debt-to-Equity Interest coverage DuPont analysis Recommendations 2|Page Page 3 Page 3 Page 3 Page 3 Page 4 Page 4 Page 4 Page 4 Page 5 Page 5 Page 6 Page 6 Page 7 Page 7 Page 7 Page 8 Page 8 Page 8 Page 9 Page 9 Page 9 _____Page 10 _____Page 10 _____Page 11 _____Page 11 _____Page 12 _____Page 12 _____Page 13 _____Page 13 Question 1 A) Accounting methods: In order for the comparison to be consistent, both of the companies should use the same accounting standards, in this case through reviewing the annual reports for TESCO and Sainsbury's it had been found out that the two companies follow the international financial reporting standards (IFRS) which was established by the International accounting standards board and currently over 120 countries report their financial statements using IFRS which includes: Australia, Canada, The European union and New Zealand . B) Economic sector: By reviewing the annual reports for Sainsbury and TESCO, it has been identified that both of the companies main activities are grocery and related retailing. In addition, TESCO and Sainsbury's are two main competitors in the United Kingdom, TESCO has 50% of the grocery market while Sainsbury's market share is only 22%. Therefore, the common economic activities between the two companies and the usage of the same accounting standards leads us to a conclusion that the comparison between the two companies is consistent and valid. Question 2 Annual growth in sales: For the 4 year period that is in between 2005-2008, the sales growth for Sainsbury's has been around 4% and 6.8%, the average is 5.61%, while on the other hand the sales growth for the TESCO has been around 8.1% and 16.5% and the average is 12.59%. It can be clearly recognized that TESCO is way ahead of Sainsbury's in terms of Sales growth. Annual growth in net income: The average net income growth for Sainsbury's for the period between 2005-2008 is 96.76%. It may seem as a high rate; but however, in 2005 and 2008 the net income growth rate had been in minus which meant that it had been decreasing. In 2006 it Sainsbury's has had a massive jump in net income growth as it has increased by 407.8% which is about 4 times increase over one year. The average net income growth for TESCO in the period between 2005-2008 is 12.82% however, the net income growth has had a sharp fall in 2008 as it was 13.34% in 2007 and dropped down to 1.74% in 2008. Question 3 Cash flow statements analysis After analyzing the net cash flow figures for both Sainsbury and TESCO for the last 5 years, it can 3|Page be concluded that TESCO's financing net cash flow is annually increasing although it was negative in 2005 until 2007 and they had to pay for a loan but later on in 2008 it increased and the company witnessed a jump in 2009 as it went up from $412 to $3,615. Their operating activities net cash flow has also observed a boost in 2008 and 2009 after increasing gradually in the first three years whilst their investing are vastly negative and it keeps getting wider. On the other hand, Sainsbury’s operating activities cash flow went slightly down in 2006 but it rise again in 2007 and it is increasing ever since. However, their financing and investing cash flows are falling down annually and the figures do not show any improvement or revenue as they are decreasing. Thus, the cash flow statements suggests that TESCO is a better investment in-terms of net cash flow figures. Question 4 Profitability ratios In order to measure the ability to generate earnings with the relationship of expenses and costs for a company, calculating profitability ratios is essential. There are many profitability ratios, however the two most commonly used are: Return on assets, and Return on equity. Each represent different measurements, but both determine the ability of a company to generate earnings from their investment. Added to that, profitability ratios also include profit margin, which is the amount of profit that a company earns through sales. Profit margin consists of, gross profit margin, operating profit margin and net profit margin. 1) ROE: Return on equity (ROE) is calculated to measure the profit generated from the investment that the shareholders invested their money in. The calculations of the profitability ratios show that TESCO has the following ROE: 17.16% 16.79% 15.79% 14.95% And Sainsbury’s ROE is as the following: 7.07% 6.99% 1.55% 1.79% In comparison, TESCO is generating profits more efficiently and have less dept than Sainsbury’s, because the more dept a company has, the less equity it has, which results in a higher return on equity. 4|Page 2) ROA: Return on assets (ROA) is calculated to measure the efficiency of the usage of the firm’s assets in order to generate operating profits; it is also significant to measure the return to the capital providers in total. TESCO's ROA is as the following: 4.90% 5.48% 5.52% 5.41% And Sainsbury’s ROA is as the following: 3.18% 3.05% 0.90% 1.35% This makes it clear that Tesco’s assets are better managed and more productive that Sainsbury's. 3) Gross profit margin: Gross profit margin evaluates how a company controls their costs which means that the sales are increasing way faster than the costs. This comes out as an optimal situation for the company. Gross profit margin for TESCO: 9.95% 9.74% 9.66% 9.79% 9.95% 9.88% 10.22% Gross profit margin for Sainsbury’s: 7.95% 8.31% 9.33% This shows that in the first three years TESCO has had a higher gross profit margin which obviously indicates that TESCO plan their revenue well enough for paying additional expenses and future savings, meanwhile, in the last two years Sainsbury had a gross profit margin higher than Tesco. 4) Operating profit margin: Operating profit margin for Tesco: 4.78% 5.50% 5.02% 5.13% 5.27% Operating profit margin for Sainsbury’s: 2.90% 2.98% 3.07% 2.22% 2.18% 5|Page For the last five years, TESCO has had a larger operating profit margin than Sainsbury's. In other words, Tesco’s core business is more profitable than Sainsbury’s. 5) Net profit margin: Net profit margin is a percentage to express the revenue and how much the company keeps as net income. Net profit margin for TESCO: 3.98% 4.49% 4.39% 3.98% 3.97% 0.40% 0.47% Net profit margin for Sainsbury’s: 1.53% 1.84% 1.89% The difference is very clear in the net profit margin between TESCO and Sainsbury’s as TESCO is in the lead; this indicates that TESCO has a healthier net income that it keeps from their revenue. 6) Cash flow to sales: Cash flow to sales ratio is calculated to compare between the sales and the cash flow of a company. Cash flow to sales for TESCO: 7.58% 7.52% 6.61% 7.09% 7.07% Cash flow to sales for Sainsbury’s: 4.94% 4.69% 4.41% 3.90% 5.16% TESCO 's cash flow to sales ratio is higher that Sainsbury's during the 5 years, which obviously means that TESCO have a better management than Sainsbury’s when it comes to transforming the revenue into cash. 6|Page Question 5 Liquidity ratios: In order to verify the ability of paying the debt obligations for a company, liquidity ratios needs to be calculated. There are few different types of liquidity ratios: current ratio, quick ratio, cash ratio, and cash flow ratio. 1) Current ratio: Current ratio that measures the ability to pay off the short-term debt commitments. Current ratios for TESCO: 0.75 0.58 0.52 0.49 0.53 0.80 0.58 Current ratio for Sainsbury’s: 0.54 0.66 0.72 The Calculations illustrates that TESCO had a higher current ratios for only last year. Meanwhile, Sainsbury’s ratio was higher for the other four years, which indicates that Sainsbury’s have a larger margin of safety that the company own in order to cover their short term debts. 2) Quick ratio: Quick ratio measures the ability to meet the short-term obligations with the company’s most liquid assets. Quick ratio for TESCO: 0.56 0.29 0.22 0.26 0.30 0.64 0.43 Quick ratio for Sainsbury’s: 0.28 0.32 0.45 TESCO had a higher quick ratio’s value than Sainsbury’s at the last year, but for the previous four years, Sainsbury’s ratio’s values got higher, which defiantly means that Sainsbury’s ability to cover their debt is higher than TESCO's. 7|Page 3) Cash ratio: Cash ratio is the ratio of cash equivalents to the company’s current liabilities, which indicates how fast can a company repay its debt obligations. Cash ratio for TESCO: 0.28 0.22 0.14 0.19 0.20 0.23 0.16 Cash ratio for Sainsbury’s: 0.24 0.28 0.42 TESCO had a higher cash ratio for the last year but for the previous three years Sainsbury’s ratio’s value got higher than Tesco. And in 2005, TESCO's cash ratio’s value increased. This ratio is used by creditors to measure the debt, and the higher the value is, the larger the amount of cash owned by the company to pay off the short-term liabilities. The mean for TESCO's cash ratio is 0.21, and the mean Sainsbury’s cash ratio is 0.26. Therefore, it is safe to say that Sainsbury’s has a greater amount of cash that is dedicated to cover short term depts. 4) Cash flow ratio: Cash flow ratio compares between cash and cash equivalents, marketable securities, and cash flow from operations to the total current liabilities of a company. Cash flow ratio for TESCO: 0.23 0.35 0.35 0.37 0.42 Cash flow ratio for Sainsbury’s: 0.32 0.32 0.28 0.13 0.16 Only for the last year, Sainsbury’s had a cash flow ratio which is higher than TESCO's, for the past 4 years, Tesco’s cash flow ratio’s values increased and a huge difference between the two companies can be noticeable. Which points out that TESCO is more successful in handling its short term dept with its current liquid assets. Question 6 Efficiency ratios Efficiency ratios are used to analyze the company’s performance in using their assets and liabilities. There are different types of efficiency ratios calculations such as: the turnover of receivables, the 8|Page repayment of liabilities, the quantity and usage of equity and the general use of inventory and machinery. 1) Inventory turnover: A ratio to illustrate how many times the company's inventory has changed during a specific time period. Inventory turnover for TESCO: 18.55 19.56 23.24 24.43 Inventory turnover for Sainsbury’s: 26.04 26.99 27.55 26.79 TESCO had lower inventory turnover for the whole 4 years, this indicates that Sainsbury’s sells and replaces its inventory faster than Tesco; therefore, Sainsbury’s is more efficient in turning its inventory into sales. 2) Days inventory on hand (DOH): A ratio that is used to determine the number of days needed for a company to vend their balance of inventory and its’ sufficient. DOH for TESCO: 19.67 18.66 15.70 14.94 DOH for Sainsbury’s: 14.02 13.52 13.25 13.63 It is clear from the ratios values that Sainsbury’s keeps the inventory for less days than TESCO because it relates to the inventory turnover ratio, it is conducted that Sainsbury’s has a healthier inventory and stronger sales. 3) Receivables turnover: An accounting evaluation for the measure of firm’s extending credit efficiency and collecting debts. It is an activity ratio used to measure a firm’s assets usage. Receivable turnover for TESCO: 16.94 63.64 65.21 62.08 9|Page Receivable turnover for Sainsbury’s: 141.56 163.34 15.52 9.05 TESCO has been in a bad shape in the last two years in comparison with Sainsbury’s in the matter of receivable turnover. The mean of the values for Sainsbury’s is 82.37 while the mean of the values for TESCO is 51.97, which strongly implies that Sainsbury’s operates on a cash basis and it has an efficient collection of accounts receivable. 4) Days of sales outstanding (DSO): This ratio is used for calculating the average number of days for a company to collect their profits after a sale. If it turned to be low then it means that it takes the company less days to collect its accounts receivables. However, if it was high it means that the company is selling the product on credit and it will take them longer to get their money. DSO for TESCO: 21.55 5.74 5.60 5.88 DSO for Sainsbury’s: 2.58 2.23 23.52 40.32 TESCO had a higher DSO values for the last two years, while Sainsbury had a higher DSO in 2006 and 2007. The mean for the values of TESCO is 9.69 and the mean for the values of Sainsbury’s is 17.16. Therefore, it is noticeable that TESCO manages credits very well and uses receivables efficiently which will facilitate to grow their business, on the other hand, Sainsbury’s is taking longer time to collect its receivables. 5) Total asset turnover: Total asset turnover measures the sales or revenue that is generated from assets per dollar, the ratio indicates how well a company manages and organizes its assets. Total asset turnover for TESCO: 1.24 1.56 1.67 1.59 Total asset turnover for Sainsbury’s: 1.77 1.74 1.44 1.25 10 | P a g e For the last two years, Sainsbury’s had slightly higher asset turnover values than TESCO, but the opposite happened in the first two years. The mean for the values of TESCO is 1.51, and the mean for the values of Sainsbury’s is 1.55, which shows a very small difference between the two companies, Sainsbury’s has a higher asset turnover value which represents how well its gathering the revenue of assets per dollar. Question 7: Solvency ratios 1) Total Debt-to-Capital: A measurement of a company's financial leverage, calculated by dividing the company's debt by its total capital. Debt includes all short-term and long-term obligations. Total capital includes the company's debt and shareholders' equity. Total debt to capital for TESCO: 0.56 0.41 0.35 0.36 0.37 Total debt to capital for Sainsbury’s: 0.35 0.31 0.36 0.38 0.35 It s been clarified that Sainsbury has a lower Debt-to-Capital ratio than TESCO as the average for Sainsbury is 0.35 while the average for TESCO is 0.41 . 2) Total Debt-to-Equity: A measure of a company's financial leverage calculated by dividing its total liabilities by its stockholders' equity. It gives us the proportion of equity and debt that the company is using to finance its assets. Therefore, the lower debt-to-equity the better for the company. Total debt to equity for TESCO: 1.27 0.68 0.54 0.57 0.59 Total debt to equity for Sainsbury’s: 0.53 0.45 0.56 0.62 0.53 The calculation clearly shows that the Debt-to-Equity ratio in Sainsbury Company is lower than Tesco Company as the average for Sainsbury is 0.54 and for TESCO 0.73. However, in 2009 TESCO's debt- 11 | P a g e to-equity ratio has increased to 1.27 while Sainsbury's ratio was 0.53 in the same year. Overall, Sainsbury uses less debt to finance their assets than TESCO. 3) Total Assets-to-Total Equity: A ratio that is used to help determine how much would the shareholders receive in the event of the company's wide liquidation. Total assets to total equity for TESCO: 0.28 0.39 0.42 0.42 0.43 Total assets to total equity for Sainsbury’s: 0.44 0.49 0.46 0.31 0.35 Sainsbury's average total-assets-to total equity ratio is slightly higher than TESCO's which means that in case if the company went through liquidation, Sainsbury's investors will receive higher amounts of money than TESCO's. However, the gap in between the companies was not that big from2005 an until 2008, but in 2009 TESCO's total assets-to-total equity dropped down to 0.28 while Sainsbury's was 0.44. 4) Interest coverage: A ratio used to determine how easily a company can pay interest on outstanding debt. Interest coverage for Tesco: 4.71 7.37 7.39 6.77 5.99 Interest coverage for Sainsbury’s: 3.52 3.91 4.50 3.12 2.42 The mean average for the interest coverage ratio for TESCO is 3.49 while Sainsbury's 6.44. As a result Sainsbury have more ability to pay interest on outstanding debts than TESCO. 12 | P a g e Question 8 DuPont Analysis Conducting the DuPont is needed in order to understand where the changes in the ROE. Thus, we have to assess the ROE through the net profit margin, in the sense how much profit gets out of its revenues, asset turnover from the aspect of how successfully the company uses its assets and the equity multiplier which is how much leveraged is the company. The calculation clearly shows that TESCO’s net profit margin and total asset turnover has been increasing over the years which reflects a positive sign for the company. As a result of the company being properly leveraged, the company might face the risk of being over leveraged. On the other hand, in comparison with TESCO, Sainsbury's is not performing that well. Furthermore, the net profit margin shows a negative sign for them and the total assets turnover figures are low. However, they are properly leveraged in the market. Question 9 (Recommendations) 18.00% 16.00% 14.00% 12.00% 10.00% 8.00% 6.00% 4.00% 2.00% 0.00% Sainsbury Tesco 2008 2007 2006 2005 Annual sales growth As it can be seen in the graph above, in terms of annual sales growth TESCO has been perfuming better than Sainsbury for the last 5 years. For the net income annual growth, even though Sainsbury's has a better overall average, it hadn't been as stable as the net income growth for TESCO; Sainsbury had a major increase in 2006 but it decreased in both 2005 and 2008. After revising the net cash flow figures for both Sainsbury's and TESCO for the past five years, it has been evident that TESCO is better than Sainsbury in terms of their net cash flow figures as it has been increasing constantly whilst Sainsbury’s cash flow is falling down and the figures does not show any sign of revenue as they are decreasing negatively. 13 | P a g e An investment in TESCO is most likely to succeed because It is generating more profit as its core business is more profitable than Sainsbury’s. TESCO also has a very good revenue management as it keeps net come from its revenue, adding to that, TESCO has enough revenue to serve it when it comes to additional expenses and future savings. Furthermore, after calculating and reviewing the liquidity ratios for both TESCO and Sainsbury’s, it is conducted that Sainsbury’s cover their short-term debts better than TESCO, because Sainsbury’s own a great margin of safety for the matter of debts as it generates higher amount of cash in order to cover the short-term debts. On the other hand, Tesco is excellent with using its current liquid assets to manage and handle its short-term debts. Moreover, it is essential to calculate and analyze efficiency ratios to be able to complete such recommendations for an investment, the ratios indicated that TESCO might has had a problem that is expectedly a shortage or insufficient inventory levels comparing to Sainsbury's as it replaces the inventory very quickly and it doesn’t take a long period of time in the storages, as they are very good in transforming the inventory into sales efficiently. Added to that, when evaluating the account receivables for both of the companies, it implied that Sainsbury’s collect its receivables more efficiently than TESCO as it operates on a cash basis, but when using the receivables and managing the credit well, TESCO does a better job than Sainsbury’s which will help the company to grow faster. And for the period of time taken when collecting the receivables, TESCO gathers it faster and more efficiently. In addition, TESCO is facing an issue with its assets, meanwhile, Sainsbury’s figures are clearly showing that its using their assets very well and its generating revenue per dollar. It can be recognized that Sainsbury's investors will receive more money in case the company went through liquidation. In addition, Sainsbury have more ability to pay interest on outstanding debts than TESCO and uses less debt to finance their assets than TESCO. Nevertheless, TESCO has a higher degree of leverage than Sainsbury's. According to the calculations in the excel sheet, the ROE figures for Tesco are much better than Sainsbury's. Therefore, TESCO is in a better financial position than Sainsbury's. After analyzing the financial statements provided, it can be concluded that an investment in TESCO is more likely to succeed and generate higher profits than an investment in Sainsbury's. 14 | P a g e