Financial Analysis of Sainsbury’s – An Example of Financial Analysis

Introduction

Sainsbury is incorporated in the United Kingdom and is listed on the London Stock exchange. It is a public limited Company having financial year 52 weeks to 16 March 2013.  The consolidated financial statements are prepared at the year end to represent the group accounts with the subsidiary figures. The company’s principal activities are retail of grocery and non-food items. The operations are divided in to three segments: Retailing (with the help of super markets, online stores and Convenience stores), Financial Services (Sainsbury’s Bank joint venture) and the property or estate investments (represented by the British land company private limited jointly venture with Land Securities Joint venture). The major earning of the business is based on the Retailing operations.

The presentation currency of the financial statements is sterling. These are prepared on the basis of going concern assumption and historical cost convention except for selected heads which are required to be recognized on fair value as per required IFRS.

 

Critically discuss the objective of general purpose financial statements

The General purpose Financial Statements are prepared to furnish the financial information to its users. The purpose for making general purpose financial statements is to help the creditors, investors and lenders in their decision-making process (Barth & Landsman, 2010, pp. 399-423). Such financial statements mainly include Balance sheet, Income Statements, Statement of changes in equity and the statement of cash flows. The combined version of these statements is known as “General Purpose”. These Financial statements provide basic information to the stakeholders. However, there are the different other requirements which provide supplementary information to the readers of the financial statements, which are not part of the general purpose financial statements. Therefore the information with respect to economic conditions, market analyses, political events and climate, and production process cannot be extracted from the “General Purpose” financial statements. This Set of financials can be used by the creditors and investors to analyze the future performance of the company however if they would be provided with more set of information or reports such as management’s discussions or shareholders’ minutes, that would ease them in making a healthy decision (Van et al , 2011). The “General purpose financial reports” are not intended to illustrate the value of an entity; they just help the potential investors, lenders and creditors in providing primary information. Consequently, they become primary users of the financial information.

 

Explanation of main external users and their information needs

The users of the financial statements are present and impending investors, the employees, bankers, trade creditors and suppliers, consumers, governments and related institutions and the general public (Gray et al, 2011, pp. 659-684). All these refer to the financial statements in making their respective decisions. The information needs of these users are given as under:

  • Potential Investor: The investors look for the inherent risk and the possible return on their money invested. The detailed information helps them in making a stable decision.
  • Employees: Including labour unions always want to know the steadiness and productivity of their company and employers.
  • They are interested in knowing the strength of pay back by its debtors, they are interested in liquidity and available funds to the company.
  • Trade creditors and suppliers: They are interested in knowing the payment capacity of the company.
  • Guests: they are concerned with the “Going Concern Assumption” of the company.
  • Government and related agencies.They are interested in the allocation of resources, shaping fiscal policies, records, databases and similar national income information.

Evaluation of financial statement

Statement of comprehensive income

The statement of comprehensive income represents the financial performance of the company during the year. It clearly shows whether the company has operations profitable or the business is going towards the loss. The statement is also called the Score Card as it represents the Revenue and Cost figures to compute the net score of the company (Rees & Shane, 2012, pp. 789-815).

Interpretation of Revenue

The revenue is earned thru the retail business of the company. The net sales represent the sales less returns, the cost of sales, discounts to the various classes, and sales made as the sample or on promotion basis. The sales figures have been increased during the current year from 22,294 to 23,303 making a difference of 1,009 (Sainsbury’s, 2014). While analysing the revenue over last 5 years, it has been noted that the company has the modest level of revenue growth. The following table shows the critical analyses of the revenue figures over last 5 years:

Table – Revenue Growth of Sainsbury over the years 2009-2013

SAINSBURY (in £ million)20092010201120122013
Sales (Including VAT)20,38321,42122,94324,51125,632
Sales (Excluding VAT)18,91119,96421,10222,29423,303
Sales area (000s sq ft)1670317750191082034721256
Trading Intensity per Sq ft20.0120.4220.0419.4719.27
Growth in Sales (incl VAT)5.7%5.1%7.1%6.8%4.6%
Growth in Sales (Excluding VAT)6.0%5.6%5.7%5.6%4.5%
Like for Like Sales growth (incl. VAT)5.5%3.0%4.7%4.5%4.3%

The table above shows that sales excluding VAT were much higher in the year 2009 than the current figure that is 4.5%. Similarly, the sales including VAT have also a reducing trend. The company has LFL sales growth since the year 2010 and before it, the revenue was down in the year 2010 due to strict economic constraints and lower demand for the fuel. The decrease in year 2013 is again noticed on the basis of challenging market conditions for the company.

Revenue from the operating segments is recognized on the basis consistent with income statement. All the segments are involved in the sales of goods and services of the industry.

Sainsbury earned a year-over-year increase of sales (excluding VAT) up to 4.5% in the year 2013. Sainsbury’s revenue strategy of increasing the proportion of higher priced items with the taste of difference in the product has improved the revenue. In the current year the sales increased with nominal percentage due to economic conditions, however, the in year 2012 the revenue increased due to 20% increase in the online sales. The super markets, additional stores and sales from the new stores were main sources of the growth in revenue (Sainsbury’s, 2014).

 Analyses of Customer Base

The company has developed an aggressive strategy for the expansion of new super stores and convenience stores in the country to increase selling space during last 5 years. The company has invested in retail sales for the years as compared to its competitors

According to this plan, the company has increased total sales area by 5,074,000 sq. ft, which increased the sales to 21.3 million during the year 2013. Further, as per this plan, the registered transactions per week were 23 million. The online system of Sainsbury can record approx 190,000 online sales per week. The management accomplished a good customer base due to this rapid expansion plan and attracted and retained its customers in this way.

 

Interpretation of Cost of Sales

The cost of sales represents the total cost incurred such as transportation costs, warehouse costs, the cost of operating retail outlets and the costs incurred till point of sales stores (Mistry & Singh, 2012). The rebates, incentives and discounts allowed by the suppliers are also recognised within the cost. The cost of sales since last year has been increased by 943 million during the current year; this represents the increase in operations and changes in prices of the primary goods.

Interpretations of Profits

Table – Profitability of Sainsbury over the years 2009-2013

SAINSBURY 20092010201120122013
Gross Profit5.48%5.42%5.5%5.43%5.48%
Net Profit1.5%2.9%3.0%2.7%2.6%
Return on Equity6.6%11.8%11.6%10.6%10.7%
Total assets turnover Ratio1.881.841.851.811.84
 Equity Multiplier2.292.192.072.192.21
ROCE10.1%11.0%11.1%11.1%11.2%

 

The profit figures are based on the three segments of the business operated by the company. The significant operations and the assets are located in the UK. The Company’s business is not related to the seasonal fluctuations except for the increase in operations and trading during the period leading up to events like Christmas.

The gross profit for the five year period has been noticed consistent and the slight increase is observed in year 2011. The companies involved in the food retaining offer various discount offers to the customers and experience fluctuations in revenue on the basis of change of these offers. The profit in year 2013 was higher due to increased revenue from the Fuel in this year. The net profit of the company has been reduced in the current year due to increased operation cost of the additional space. The growth in revenue approximately up to 6-7% are not represented by the profit, which indicated that the company has increased marketing and admin cost during the year. The objective behind such usage may be to attain increased market share or maintaining its existing market share on the cost of profitability.

There is another component of other income which has increased revenue of the company as well. However, in the current year, there is a negative effect of this income as compared to the last year.

Taxation

The final expense deducted out of the profit of the company is tax expense. The amount of tax calculated by the accounting treatment is different from the tax figures calculated by the tax authorities (Jones & Rhoades-Catanach, 2011). The tax expense during the current year is 22% over the net profit before tax and the same was 25% in last year. The changes are due to the various tax announcements by the UK government. The corporate tax rate has been reduced by 1% on the deferred tax balance during the year. The effect is partially reduced by the increased tax on retirement plans of the company.The profit after tax in year 2013 is higher than the last year, due to the impact of reduced tax rates

 Evaluation of Consolidated Balance Sheet

The consolidated balance sheet represents the performance of a company after incorporating all the factors of profits and losses of the subsidiary and associated companies of the parent company (Hsu et al, 2012, pp. 198-225). This helps in measuring the financial stability and strength of the company’s available assets and liabilities. The Consolidated balance sheet of Sainsbury is evaluated on the basis of significant differences of the balance sheet items, which are explained hereunder;

 Total Assets

Property Plant and Equipment

The property plant and equipment has been increased by 475 million during the current year (Sainsbury’s, 2014).  The company has warehouses in as part of property, plant and equipment, which has been continuously increased over last five years in order to meet the area and capacity requirements as per expansion plan of the management.

Movement in property plant and equipment

   In millions
Opening NBV 9,329
Addition (cost) 1,099
Acquisition of Subsidiary21
Disposal (cost) (392)
Transfer (13)
Depreciation  (240)
Closing NBV 9,804

 

The table above shows that the company has expanded the super markets as the cost shown in financial statements is 50 million in last year and in the current year, the cost is 62 millions in case of land and buildings. Further the company has invested in new subsidiary as well. As per financial statements note no. 11 the company has acquired 100% Property Company from BL Sainsbury superstores limited joint venture which cost 21 million and this is also a reason for the overall increase in the assets of the company.

 

Intangible Assets

The intangible assets have been increased from 160 million to 171 million during the current period.

Movement in property Intangible Assets

   In millions
Opening NBV 11
Addition (cost) 08
Disposal (cost) (10)
Amortization  5
Closing NBV 14

 

The table above represents the movement in intangible assets of the company. The company has goodwill as an intangible, which is recognised on the full basis. The test of impairment of goodwill i conducted on regular basis by means of comparing the recoverable amount with the carrying value of each cash generating unit of the business. Therefore based on operating performance of all the cash generating units no impairment loss has been recognised.

 

Liabilities and Capital

Liabilities

The liabilities of the company have been increased during the current year by 250 million (Sainsbury’s, 2014). The major increase is represented by the increase in retirement benefit obligations of the company, borrowings and other payables of the company. The retirements benefits obligations have been verified by the Actuarial valuation, the figure has been increased due to increase rate of interest cost and increase in the actuarial losses. The effect of increase in future salaries and pension rates has also been taken more than the last year expected figures.

 

Capital

Further, after the analyses of the capital and reserves figures, it is noticed that the company has accumulated more reserves in the current year than the last year, which has boosted the figure of overall capital of the company. The company has transferred its profit to the retained earnings more than the last year, due to increase profit levels in year 2013.

 

Critical examination of Statement of cash flow

Objectives of Cash Flow Statement

The cash flow statement shows the inflow and outflow of the cash available to the company. The cash flow statement is prepared in two ways that are direct and indirect method. The main objective of the cash flow is to determine the impact of accrual based accounting; it concerts the accrued transactions in to cash and then interprets the total liquid cash position of the company (Goldwater & Fogarty, 2011, pp. 16-29).

 

Link between the Cash Flow and Profitability

As highlighted above, there is difference between the actual profit and the cash position of the company due to the accrual based accounting system. Following are the main points highlighted in this respect:

  • The figures of cash flows during the year are not equal to the sales and cost of sales amounts represented in the statement of comprehensive income
  • Depreciation expense, amortization expenses, unusual losses and write downs are not the cash items however these are considered in calculation of the profit of the business {Acharya et al, 2013, pp. 2059-2116)

The factors that raise the cash flow are decrease in debtors and the inventory and increase in creditors and accruals of the company.

 

Sainsbury Cash Flow Statement

The investors are always interested in the free cash generated by the company. The method of calculating the free cash flow is:

Free Cash Flow= Net Income + Amortization/ Depreciation-Changes in working capital- Capital Expenditures

As per calculations the free cash flow in year 2013 available to Sainsbury is 604 millions. This indicates that the company has cash position to meet its short term liabilities to some extent. The company should prepare an investment strategy to keep the funds in readily convertible instruments

 

Calculation of some important ratios

Return on capital employed

 

Return on capital employed =             Earning before income and Tax/Capital Employed

The purpose of calculating this ratio is to interpret the percentage of earnings of the company with respect to the capital invested by the shareholders of the company.  The ratio indicates that the company earned 9.26% income over the capital employed in year 2013, while the same was 9.5% in the year 2012. The slight decrease is due to increased current assets during the year 2013, which affects the denominator here hence the ratio is in significantly lower than the year 2012 (Sainsbury’s, 2014). The increase in the amount of capital has left dilutive effect on the income till the next stores mature.

 

Gross Profit Margin

The Gross profit looks at the earning of the company only after deducting the direct cost incurred on the production,

Gross Profit Margin =                         Gross Profit/ Revenue

The ratio shows the profitability of the company with respect to the revenue during the year.  The company has turned 5.5% of its revenue in to the operating profit during both the years. The companies involved in the food industry attract and retain the consumers by offering various promotion schemes, during the last 5 years, initially the company faced a down turn in GP ratio, then its offered coupon sales and offered festive discount to result growth in GP ratio.

Current ratio

The Current ratio shows the liquidity of the company and measures the financial position of the company.  The ratio is calculated to determine the percentage of current liabilities which could be paid off after using the current assets available to company.

 

Current Ratio =                       Current Assets

Current Liabilities

In this case, the company can pay 60% of its short term debts out of its current assets in year 2013; same was the position in last year approximately. In retail business, the companies have low current ratio. The increase in current ratio has been noticed since last 5 years. However, the company should strengthen its liquid position to make the available assets twice to its current liabilities.

 

Debt equity ratio

This ratio is calculated to avoid the bankruptcy and other financial losses to the company.

 

Debt to Equity Ratio =                       Total Debt

Total Equity

The ratio in year 2013 is 88% and the same was 83% in the last year. The reason behind increased ratio is that the company has been involved in more liabilities than the last year due to increased retirement obligations in year 2013.

 

Dividend cover ratio

The dividend cover ratio measures whether the dividend payout ratio is sustainable in future or not.

 

Dividend Cover Ratio = Profit after tax- dividend paid on irredeemable preference shares                                                 Dividend paid to ordinary shareholders

The dividend cover has steadily decreased slightly than the last year, the company has policy to pay dividends out of its earnings. In the current year, management has revised the medium dividend cover ratio to 2 times. Further the company has stability to pay the dividend for all past 5 years.

Importance of other reports in annual report

Statement of Directors’ Responsibilities

Every annual report contains Directors’ report addressed to shareholders of the company. This report consists of the roles and responsibilities along with the duties of the directors towards the company and shareholders. The report includes charts and graphs which contain the useful information and contains significant analytical sections which are used in the decision-making process of the companies (Thomas et al, 2011).

There is a requirement in the companies’ ordinance for the statement of directors’ report to the share holders of the company as well. The report emphases on the duties of the directors, whether executive, non- executive or independent director. In the case of Sainsbury, the report is not extended and limited as compared to other reports given by the peer group company.  The report should contain the share price and market index analyses of the company; this will help the investors in making a stable decision.

 

Additional Shareholder information

This report pertains to the information with respect to the shareholders of the company. There are various companies’ ordinance requirements which are covered in this report as well. Such as schedule of Annual General Meetings, Shareholding pattern, information with respect to external auditors, tax and legal advisors and registrar of the company. The section also provided information for the online or electronic communications to the shareholders such as availability of annual report and financial statements at website, important notifications such as interim and final distributions, company’s news and events section etc. Further the shareholders are facilitated with the online submission of their votes in the annual general meeting or extra ordinary general meetings.

The information presented in Note 125 to the financial statements attached in annual report of Sainsbury for the year ended 2013 is sufficient for the stakeholders, however, this note should have represented the information with respect to the subsidiary and associate companies of the parent company. The pattern of shareholding is prepared by following the format as provided by the Companies Ordinance.

 

Conclusion

According to the analyses of the Sainsbury, the company is worth to invest in at the current share price. The company’s revenue has steadily growing trend since past years and the market share is expanded with the help of Rapid expansion plan. Further, the growth in revenue is remarkable to increase the overall GP margin and Net profit of the company, which shows a healthy EPS as well. The management has positive vision for the increase in dividends to shareholders as well. The company has covered its Finance and taxation costs and there are no major contingent liabilities and commitments towards the company. Looking at the key performance indicators, there is the high probability that Sainsbury will grow in future. The investors of the company are advised that there is no inherent risk in buying the shares of the company at the time.

 

References

 

Acharya, V. V., Almeida, H., & Campello, M. (2013). Aggregate risk and the choice between cash and lines of credit. The Journal of Finance, 68(5), 2059-2116.

Barth, M. E., & Landsman, W. R. (2010). How did financial reporting contribute to the financial crisis?. European Accounting Review, 19(3), 399-423.

Goldwater, P. M., & Fogarty, T. J. (2011). Cash flow decision making and financial accounting presentation: A computerized experiment. Journal of Applied Business Research (JABR), 11(3), 16-29.

Gray, G. L., Turner, J. L., Coram, P. J., & Mock, T. J. (2011). Perceptions and misperceptions regarding the unqualified auditor’s report by financial statement preparers, users, and auditors. Accounting Horizons, 25(4), 659-684.

Hsu, A. W. H., Duh, R. R., & Cheng, K. (2012). Does the Control-based Approach to Consolidated Statements Better Reflect Market Value than the Ownership-based Approach?. The International Journal of Accounting, 47(2), 198-225.

Jones, S. M., & Rhoades-Catanach, S. C. (2011). Principles of Taxation for Business and Investment Planning: 2011. McGraw-Hill

Mistry, D. S., & Singh, S. K. (2012). A Study of Cost and Sales Trend of Indian Passenger Vehicle Industry as Determinants of Profitability. JIM QUEST, 8(2), 21.

Rees, L. L., & Shane, P. B. (2012). Academic research and standard-setting: The case of other comprehensive income. Accounting Horizons, 26(4), 789-815.

Sainsbury’s. 2014. Financial Statement. [online] Available at: http://www.jsainsbury.co.uk/media/1616189/sainsburys_ara.pdf [Accessed: 6 Jul 2014].

Thomas, D. O., Perkins, S. C., Childs, A. S., Mew, S. R., Morrice, S., Gulliford, A. E. G., & Lifford, V. (2011). Report of the Directors.

Van Greuning, H., Scott, D., & Terblanche, S. (2011). International financial reporting standards: a practical guide. World Bank Publications.

 

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