Experiential Introduction of Auditing & Journal of Accounting

Question: Analyse the financial performance of the two companies based on your calculations, identifying and discussing the purposes of calculating those ratios and the weaknesses of ratios analysis.? Answer: Introduction In modern business times, there exists an intense competition among the business firms. It is important for the organizations to perform a competitive analysis to sustain in the competitive environment. Financial statement analysis assists the business organizations to perform such kind of internal and external assessments of their respective financial positions. The given report will shed light on the business firms Sainsbury and Tesco. This will be evaluated through the analysis of financial statements of both the organizations for the last two years. Both these two organizations are retail giants of United Kingdom and market share of both the organizations are on the higher side (Ongore and Kusa, 2013). Financial status of both the organizations The financial status of both the organizations can be analyzed with the assist of financial ratios. There are various types of financial ratios. These are liquidity, profitability, efficiency and gearing ratios. All these ratios help to interpret the financial position of the firm with respect to its close competitors. With the help of financial ratios, the organization can control their strategies and forecast them for the future. On the contrary, there are several disadvantages of these ratios. One of the biggest limitations or weakness of financial ratios is that it is based on historical data analysis and it does not include all the elements of a financial statement of an organization. However, the below financial analysis will reflect the analysis of both the organizations in terms of their financial statements. The stakeholders and investors of a business organization can take different investment decisions based on the interpretation of financial ratios (Hall, 2013) Liquidity ratios Liquidity ratios reflect the liquidity status of a business firm. This further interprets that capability of a firm to meet their short-term debt obligations. Jiang and Lee (2012) interprets that liquidity ratio has a direct correlation with the working capital cycle of a firm. If the business organizations like Sainsbury and Tesco are capable to manage their working capital cycle, then, they can easily improve their liquidity status on the eyes of the stakeholders. Current ratio and quick ratio are the two main types liquidity ratios that assist the firm to interpret the liquidity status of both the organizations (Mawani, 2012) Current ratio and Quick ratio of Sainsbury Sainsbury Current Ratio= Current Assets- Current liabilities Quick Ratio= Current Assets-Stock-Prepaid expenses/Current Liabilities 2013 0.610272873 0.293419 2014 0.644789357 0.496231 2015 0.638595984 0.494583 Table 1: Liquidity ratio of Sainsbury Current ratio and Quick ratio of Tesco Tesco Current ratio Quick Ratio 2015 0.603635 0.475298 2014 0.727698 0.595435 2013 0.689808 0.490261 Table 2: Liquidity ratio of Tesco The calculations of liquidity ratios have been presented in appendices of the report (Refer to Appendix 1). The above analysis reflects that the both the organizations have performed considerably well to maintain their liquidity status in accordance to their investors. However, the liquidity ratios of Sainsbury are better than the organization Tesco. This reflects that Sainsbury is maintaining its working capital cycle better than its closest competitor Tesco. The liquidity of the firm Tesco has declined than previous years. On the contrary, Sainsbury is successful in maintaining a higher liquidity ratio from the last three financial years. Current ratio reflects about the working capital management of the business organizations. In terms of current ratio, Sainsbury has performed slightly better than Tesco. In addition to this, Quick ratio interprets about the liquidity status of the organization by excluding inventory and prepaid expenditure. Sainsbury has a better quick ratio than Tesco. This reflects that the organization is utilizing its working capital expenses by managing their inven tory and prepaid expenditure. In terms of liquidity, the investors will opt for Sainsbury rather than Tesco. Profitability ratios The financial ratios also help to interpret the profit position of a business organization. These can be done through effective implementation of profitability ratios. These are in the form of Gross profit, net profit and operating profit margin. All the profitability ratios will assist an investor of an organization to interpret how well the organizations are managing their profits in terms of their sales revenue (Bekaert and Hodrick, 2012). The below analysis will reflect the profit status of both the firms. Gross profit, net profit and operating profit margin of Tesco and Sainsbury Sainsbury Gross profit ratio Net profit margin Operating profit margin 2015 0.047613039 -0.00698 0.003197 2014 0.018539396 0.029897 0.039334 2013 0.019611209 0.026349 0.035189 Table 3: Profit margin ratios of Sainsbury Tesco Gross profit ratio Net profit margin Operating profit margin 2015 -0.03391 -0.09217 -0.0962 2014 0.063093 0.015325 0.041396 2013 0.063077 0.001913 0.033752 Table 4: Profit margin ratios of Tesco Table 2 reflects about the reflection of profitability margin of Sainsbury from three consecutive financial years that is from 2013-2015. Gross profit margin interprets the capability of the firm in utilizing its sales margin to earn higher profitability status by minimizing the direct expenses. The gross profit margin of Sainsbury has increased by a higher percentage. On the contrary, table 4 reflects about the profit position of the retail firm Tesco. Tesco has a lower profit margin and it is on the declining stage. In the last financial year that is 2014-2015, all the profit margin of Tesco is on the negative side. This further interprets that Tesco has failed to develop a higher margin or percentage of sales revenue. The firm has also failed to cut down their respective direct and indirect expenses. In addition to this, the organization has also lagging far behind than its closest competitor Sainsbury. However, Table 1 interprets that the net profit margin of Sainsbury is negativ e, still the gross profit margin and operating margin is on positive. Since, the net profit margin of the firm is negative, it interprets that the organization has a higher indirect and operating expenses. This is not a good sign for the organizations as they are failed to control the operating expenses by a large percent. Therefore, it is of great essence for both firms Tesco and Sainsbury to cut down their expenses to increase their profit margin in terms of their sales revenue. All the calculations of the profitability ratios are shown in the list of Appendices. Financial Ratios (Gearing) Gearing ratios interpret the total amount of percentage of financial risks present within the business firms. The primary types of financial ratios are debt-equity ratio, interest coverage ratio and equity financing. Debt equity ratio of the organization reflects about the percentage of debt in terms of its total equity. Higher debt equity ratio interprets that that the particular firm is exposed to financial risk and a higher chance to liquidate and become bankrupt. On the contrary, interest coverage ratio of a business firm the manner in which the firm is capable to meet up with the debt expenditure by covering up the interest expenses. If the given interest coverage ratio is lower, then, it reflects that the firm is not at all capable in meeting up its debt expenses by covering up the total amount of interest expenses. Therefore, it is necessary for the firm to keep a higher amount of interest coverage ratio. A higher ratio will reflect the capability of a firm to meet the respect ive interest expenses (Gifford and Howe, 2012). Gearing ratios of Tesco and Sainsbury Sainsbury Financial Gearing Ratio Equity gearing Interest Coverage ratio 2015 0.736276 2.028652 5.121951 2014 0.850256 1.882784 12.06107 2013 0.874716 1.91757 11.19531 Table 5: Gearing ratio of the organization Sainsbury Tesco Financial Gearing Ratio Equity gearing Interest Coverage ratio 2015 0.280081 0.954808 -8.66733 2014 0.289274 0.871193 11.12081 2013 0.267246 0.763488 10.71685 Table 6: Gearing ratio of the organization Tesco The table 5 interprets about the gearing ratio of the firm Sainsbury in the previous three financial years from 2013-2015. The organization Sainsbury has a higher interest coverage ratio than the firm Tesco. However, this ratio of the firm has declined by a certain percentage from the previous year. This cannot be considered as a positive sign for Sainsbury internally, as there are lagging to meet their interest expenses of their respective debt expenditure. On the contrary, interest coverage ratio of Tesco is lower and on the negative side. Therefore, the management of the organization Tesco is extremely suffering to match up with their interest expenses of their debt expenditure. From an investor point of view, this is a negative sign for the retail firm Tesco as they are not capable to cover their debt expenses. In case of equity gearing ratio, Sainsbury has a higher equity-gearing ratio and is on the higher side in the current financial year. This means that the retail firm is de pended on the debt source of financing for their respective source of funds. On the contrary, Tesco also has an equity-gearing ratio of 0.95 which is also on the higher side. However, by comparing both equity gearing and interest coverage ratio, Sainsbury has a higher percentage of interest coverage ratio and also a higher equity gearing ratio. Therefore, it reflects that the firm is capable of meeting their debt requirements even if there is a higher amount of debt. On the contrary, Tesco has a higher equity gearing ratio and a lower interest coverage ratio. Therefore, they are not at all capable to fulfill their debt obligations. In terms of financial gearing ratio, Sainsbury is ahead in comparison with Tesco. It reflects that the organization has a higher financial risk than Tesco. From the eyes of investors and shareholders, Tesco is more exposed to financial risk than Sainsbury. This is mainly because of the fact that Sainsbury has an efficient working capital cycle and interest coverage period (Epstein and Lee, 2014). Therefore, Sainsbury can be recomme nded in terms of its gearing ratio in accordance to their financial statements. Financial Ratios (Efficiency) The efficiency ratios of the organization reflect the manner in which the firm manages their inventories, assets, debtors and creditors. In case of asset turnover ratios, the firm will be able to judge their respective utilization of assets in terms of their sales revenue. If this ratio is higher, then, it will be favor the business firm. In addition to this, stock turnover ratio highlights the manner in which the organization utilizes and manages their inventory in terms of their sales. However, if this ratio is too much high, then it will reflect that the firm is possessing excessive inventory. On the contrary, if the firm is having an extreme lower inventory then, the firm is having shortage of stock. Therefore, it is of great essence to keep the stock turnover ratio in check. Debtors turnover ratio reflects in what course of time the debtors are able to pay their debts to the firm (Drury, 2013). On the contrary, creditors turnover ratio interprets in what time the creditors are p aying off their debts to the organization. Both these ratios need to be lower for the particular business organization. The analysis of the given two ratios of the firm is evaluated through the below tables:- Sainsbury Asset Turnover ratio Creditors turnover ratio Debtors turnover ratio Stock Turnover Ratio 2015 3.765659 62.33978 37.63384 0.04418 2014 5.006459 490.4783 246.345 0.044544 2015 5.253323 46.66525 288.1156 0.044811 Table 7: Efficiency ratio of Sainsbury Tesco Asset Turnover ratio Creditors turnover ratio Debtors turnover ratio Stock Turnover Ratio 2015 0.473945459 67.57187828 2.969648 0.045706071 2014 0.477747412 57.75654704 4.098751 0.060053403 2015 0.458892105 22.83345865 4.442051 0.061887366 Table 8: Efficiency ratio of Tesco Table 7 and Table 8 reflect about the efficiency ratios if the firm Sainsbury and Tesco in terms of asset turnover ratio, creditors turnover ratio, debtors turnover ratio and stock turnover ratio. In case of asset turnover ratio, Sainsbury has a higher asset turnover ratio more than Tesco. On the other hand, this ratio has declined from the last two financial years. In case of Tesco, this ratio has increased from last two financial years, but, not in terms of Sainsbury. In case of Creditors turnover ratio, Sainsbury has a lower rate than Tesco. This reflects that the creditors of the firm are paying off their debts in time. On the other hand, Tesco has a higher creditors turnover ratio which reflects that the organization is not successful in gaining the confidence of their creditors. This is the reason why, the creditors of the firm is not clearing off their debts in the given period. In case of debtors turnover ratio, Sainsbury has an upper debtors turnover ratio. This reflects tha t the debtors are not paying off their debt to the firm in time. In addition to this, the organization Tesco has a lower debtor turnover ratio in the given three financial years. This also reflects that the debtors of the organization have a trust over the management of the firm Tesco. In case of Stock turnover ratio, Tesco has a better stock turnover ratio than Sainsbury. Tesco is successful in managing and clearing off their debts in terms their inventory. However, Sainsbury is not that much successful in managing their inventory than Tesco in the given last three financial years. This reflects that there may be a shortage of stock for Sainsbury in accordance to their sales or demand of the customers. This can add up to the customer grievances of the firm (Hodgkinson, 2012). Recommendations to both Sainsbury and Tesco Financial ratio has several loopholes. These are in terms of lack of coverage of all the elements that requires matching up with the requirements with the various stakeholders and it is based on historical data analysis. However, the primary advantage of the financial ratios is it helps the organizations in forecasting purpose. Based on the analysis of the given ratio analysis of Sainsbury and Tesco, more than a few recommendations can be given to both the retail firms. Recommendations to Tesco The retail firm Tesco requires improving their liquidity status to rally their working capital needs and requirements in the competitive business environment. The working capital balance of Tesco is lower; therefore, the organization needs to minimize their cost of capital and other operating costs to attain a higher margin of profit. In addition to this, the organization may effective change their capital structure by minimizing their debt structure and obtaining source of fund through equity. The operating expenses of the firm Tesco is extremely high and this is the reason why the firm is earning negative profit or going into losses. These recommendations will assist the organization to succeed in the long-run. In addition to this, the organization Tesco may use their fixed assets to generate sales effectively. This will further assist the organization to increase their sales. Recommendations to Sainsbury Sainsbury needs to improve their debtors turnover ratio and stock turnover ratio. This can be done by paying off their debtors timely. The organization may clear off their excess inventory in time or may use their assets more effectively to generate sales. The firm may use several forecasting tools to forecast the demand for their products so that there is no shortage of inventory. Conclusion Financial statement analysis of Sainsbury and Tesco reflects that both the firms have several merits and demerits. Based on financial ratios, several recommendations have been given to both the organizations and this will further assist them to minimize their loopholes. References Gifford, R. and Howe, H. (2012). Rosies East End Restaurant: An experiential introduction to auditing.Journal of Accounting Education, 30(2), pp.207-219 Hall, J. (2013).Introduction to accounting information systems. 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