MBA PART TIME 2010/2011 COURSE CODE 2055

Managing Accounting and Finance

J Sainsbury Plc and Morrisons Plc 2009-2010

Table of Contents
Table of Contents....................................................................................................... 2 Introduction................................................................................................................ 3 Usefulness of information provided in the annual report............................................3 Current shareholders...............................................................................................3 Potential shareholders.............................................................................................4 Lenders and suppliers.............................................................................................4 Employees............................................................................................................... 4 The usefulness of the information in the annual reports and the accounting conventions................................................................................................................5 Financial performance analysis of J Sainsbury Plc......................................................6 Liquidity analysis.....................................................................................................6 Long-term solvency analysis...................................................................................7 Profitability analysis................................................................................................ 8 P/E .......................................................................................................................... 9 Conclusion............................................................................................................... 9 References................................................................................................................10 Appendix.................................................................................................................. 12

Introduction
The objective of this report is to present an in-depth analysis of the information contained in Morrisons Plc and J Sainsbury Plc annual reports. It also takes into account a financial performance analysis of Sainsbury Plc for financial years (FY) 2009 and 2010. The analysis is supported by employing ratios as an analytical tool to illustrate the companys financial performance and position.

Usefulness of information provided in the annual report

Annual reports present a variety of information that can fulfill the information requirements of various stakeholders such as; investors, creditors, customers, suppliers, employees, and governments. In this exercise the information requirements of four main stakeholders, namely current and potential shareholders, lenders and suppliers, and employees are discussed as follows:

Current shareholders
The main readers of annual reports are current shareholders. The annual reports of Morrisons and Sainsbury present information for shareholders in the form of not only financial statements, but also top managements strategic plans, operating and financial reviews of the performance during a specific year. They clearly indicate the reason behind the performance of major financial performance indicators. Current Shareholders assess the financial performance of a company so that they can assess the future earnings capability of a company, which in turn could help them decide their investment strategy; in other words, their analysis remains concerned with risk and return trade-off by making an investment in a companys shares (Laidler & Donaghy, 1998, p. 2). The chosen companies annual reports clearly mention their key performance indicators by mainly focusing on shareholders related indicators like Return on Capital Employed, Operating Margin, Pre-tax Margin etc; all of which help make the companies emphasis on shareholders concern evident.

Potential shareholders
Potential shareholders are interested in the companys future earnings capability, which mainly depends upon the risk associated with its capital structure in the shape of high financial leverage, profitability and the companys future plans (Laidler & Donaghy, 1998, p. 2). In other words, they assess a companys annual report in order to assess if the companys shares are a good buy, which will help them provide high returns by keeping the risk at the lowest possible levels. In this regard, annual reports of both the chosen companies not only provide a complete record and review of their current financial performance but also highlight their future long-term and short term goals in order to make their companies more profitable in the future. Both companies have also mentioned their business models and respective strategies which could help them achieve their future goals, so as to lure potential investors.

Lenders and suppliers

Both these parties are generally interested in a companys ability to make payments in a timely manner; suppliers are concerned with short term liquidity and lenders with long-term solvency position (Laidler & Donaghy, 1998, p. 2). Morrisons and Sainsburys annual reports have clearly highlighted the state of their liquidity in their management reviews and substantiated their claims by providing complete information about the level of their current assets and liabilities in their financials, so that their suppliers can be sure that they are able to meet their respective claims. Lenders also want to make sure that the companies will be able to repay their funds in a timely manner; therefore both the companies annual reports not only mention their state of net debt and their interest covering ability, but also mention the risk and uncertainties which could affect their business, so that lenders can be sure of external factors which have a potential to affect their operating performance and in turn their ability to repay their loans.

Employees
Generally employees take interest in annual reports, so that they can identify a companys ability to continue provide employment at satisfactory remuneration packages. Annual reports also highlight the concern for employees in the shape of their safety, health, retirement and fringe benefits; all of which make a company at attractive employer for both, the existing as well as potential employees (Laidler & Donaghy, 1998, p. 3). The annual reports of Morrisons and
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Sainsbury provide similar information as described which highlights their concern for their employees by stating their employees as a pivotal feature in generating higher revenues because it is their employees who help in the execution of their plans and keep customers satisfied. Thus, it is their people who make them what they are; indeed are highly valued assets (Morrisons, A: 2010, p. 16).

The usefulness of the information in the annual reports and the accounting conventions
There is always a high probability that the information presented in the annual report of a company is managed to present in a way which can help hide the problem areas in its financial performance. A serious issue which analysts find with annual report analysis is the fact that these simply mention the performance of a company because of specific sets of strategies devised by the management or certain decisions taken by it; however it does not help evaluate if the management had better options to pick. In other words, analysts believe that if shareholders would have access to not only the decision but the options available too, it would have brought out the true nature of analysis to guide the investors (Bergevin, 2001, p. 110). Therefore, the cost of opportunity often goes unreported. However, it is not possible because management makes sure that its annual report appears as a public relations document which portrays the company in bright-lights even if the performance has been disappointing. Many believe that accounting principles and conventions limit the ability of a company to manage its performance, but it is in fact a measure to make comparability easy between/amongst the companies (Bergevin, 2001, p. 110). Nevertheless, I believe that information presented in the annual reports of Morrisons and Sainsbury meet the requirements of their users, primarily because their managements have intelligently planned the annual reports to provide complete account of their financial and operational performance, which could provide information regarding their profitability, liquidity, capital structure and long-term solvency, so as to reassure their shareholders, lenders and suppliers about their satisfactory performances during the past as well as in the future.

Financial performance analysis of J Sainsbury Plc

The financial performance analysis is carried out by analysing the companys liquidity, longterm solvency, profitability, and P/E if Sainsbury is a worthwhile investment. To carry out the analysis a set of ratios have been employed to compare it with the industry averages; for readers assistance graphical representations have been included in the analysis.

Liquidity analysis
It helps assess the ability of a company to meet its current obligations employing assets 187). (Atrill by current &

McLaney, 2006, p. Sainsburys liquidity position has improved dramatically in

Figure 1

FY2010 and 2009, as expressed by its current and quick ratios. The companys current ratio increased by 22% to become 0.66 in FY10, which was primarily due to a 14% increase in current assets because of 44% increase in receivables. Its quick ratio increased by 37% to become 0.40 in FY10, which means that Sainsbury has 0.40 of current assets to retire 1 of current liabilities; which seems to be not a very satisfactory position, particularly for its suppliers. However, compared to the industry average of 0.4 (Moneycentral.com, 2011), Sainsbury is on the track with the industry. The industry average for current ratio of 1.1 (Moneycentral.com, 2011) also shows that the industry carries more inventory than Sainsbury; however a more comprehensive opinion could be established after analysing the inventory management of the company. Sainsburys inventory turnover in days has remained uniform at 14days during FY09-10, which means that its takes 14days for Sainsbury to sell its inventory and restock it. Compared to the industry average of 32 days (Moneycentral.com, 2011), it seems that Sainsbury carries too little

inventory which might result in its inability to meet its customer demand should there be an unexpected increase in demand. However, Sainsburys management claims that it has invested large amounts in adapting to highly sophisticated technology which makes their inventory management not only efficient but effective as well; therefore increased their order flexibility (Sainsbury, A: 2010, p. 6). In other words, even if they carry low levels of inventory, they will not fall short of costumer expectations.

Long-term solvency analysis

It helps assess the capital structure of a company to its the is debt, the identify higher higher

financial risk; the

financial leverage and thus the risk (Brigham 94). & Houston, 2007, p. Sainsburys
Figure 2

gearing ratio has declined by 4.5% to become 47.4% in FY10, which was driven by a 13.8% increase in shareholders funds when its long-term loan rose by 8%. The increase in funds can be attributed to the companys expansion plans with regard to both space and product offering (Sainsbury, A: 2010, p. 3). However, the companys financial risk can be interpreted by its interest cover which increased by 26% to become 4.8 times in FY10. Despite the increase in long-term funds, increase in interest cover implies improvement in operational efficiency and decrease in interest expense. Compared to the industry average of 10 times (Moneycentral.com, 2011), it seems that there is room for improvement; however, the gearing of 80% as the industry average (Moneycentral.com, 2011), shows that Sainsbury is showing quite satisfactory performance with regard to interest coverage. But it must be said that Sainsbury has adopted a conservative approach with its capital structure, which although is keeping its financial risk low, is at the same time letting go an option of inflating its ROE further. Furthermore, having higher
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debt could also enable it to save more by means of tax deductible interest payments, provided that the company can keep its cost of debt lower than its ROI.

Profitability analysis
Profitability about the analysis returns is and

margins generated by the company. It shows the return on each invested in the companys capital, equity, and assets, as well as the amount of revenue which finds its way to the pretax profit, in the form of ROCE, ROE, ROA, and PTPM respectively.
Figure 3

Sainsburys ROA drastically increased by 87% to become 5.42% in FY10. The increase can be attributed to a much higher increase in assets than the increase in net income. Compared to the industry average of 1.44% (Digitallook.com, 2011), Sainsburys ROA shows over-investment in total assets which signals a potentially not very profitable use of funds. Therefore, the company should utilise the assets at their full capacity before making further investments in it. The companys ROE has increased by 78% to become 11.78% in FY10, whereas the industry average was 19.8% (Moneycentral.com, 2011), it seems that Sainsbury is not doing a very satisfactory job in relation to its competitors with respect to ROE. Not only this, its ROCE at 9.69% in FY2010 was also less than the industry average of 12.45% (Digitallook.com, 2011). With regards to returns, it is apparent that Sainsbury could increase its revenue base in order to improve its return, at the same time, it should also utilise its assets to full capacity before making further investment in it. Furthermore, with regard to margins, the company has had almost a stagnant gross profit margin and EBIT margin at 5.4% and 3.5% during FY10-09 respectively. The difference in both the
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margins makes it evident that the company loses quite a bit of its EBIT because of high operating expenses; however due to a 16% decrease in interest expense, Sainsburys profit before tax margin (PBTM) improved by 49% to become 3.67%. Although Sainsbury is more operationally efficient than the industry which showed an EBIT margin of 3.23% (Moneycentral.com, 2011); but an alarming signal is that despite a 5% increase in the companys revenue, its margins did not show improvement. This implies that the company must reduce its operational cost and increase its sources of finance income so that its EBIT can improve further. Moreover, compared to the industry average of 42.6% PBTM; it becomes evident that Sainsbury should increase its revenue along with decreasing its cost so that its margins can improve.

P/E
P/E indicates the price which investors are willing to pay for a companys share based upon their assessment of the companys future earnings capability; the more positive the expectation; the higher is the P/E (Brealey, Myers & Allen, 2008, p. 795). Sainsburys average P/E has declined by 50% to become 10 times in FY10; it implies that investors are willing to pay 10 times more price than the companys earnings. The decrease in P/E occurred despite a 93% increase in EPS to become 32.1 in FY10;
Figure 4

thus the decrease can be attributed to decrease in consumer confidence in stock market investment. Compared to the industry average of 9.9 times (Moneycentral.com, 2011), it seems that Sainsburys shares performed better than the majority of the companies shares in the market. However, we believe that with the expected expansion in economy, the investor confidence will improve and thus the companys P/E.

Conclusion
It can be concluded that Sainsburys performance can substantially improve if it can increase its revenues, decrease operating expenses, use total assets at full capacity, and slightly increase its financial leverage so that its ROE can improve. Nevertheless, the company is definitely a
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worthwhile investment as compared to other players in the industry, which is also evident from its higher P/E, as investors value Sainsbury more than other similar companies with lower P/Es.

References
Atrill, P., & McLaney, E. (2006) Accounting and Finance for Non-specialists. 5th ed. Essex: Financial Times Prentice Hall.
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Bergevin, P. (2001). Financial Statements Analysis: An Integrated Approach. 1st ed. New Jersey: Pearson Brealey, R., Myers, S., & Allen, F. (2008) Principles of Corporate Finance. 8th ed. New York: McGraw Hill Brigham, E., & Houston, J. (2007) Fundamentals of Financial Management. 10th ed. Mason: South-Western Digitallook.com. (2011) Food and Drug Retailers Financial Ratios. [Online] Available at:
http://www.digitallook.com/cgi-bin/dlmedia/security.cgi?csi=50085&action=constituents

Laidler, J., & Donoghy, P. (1998). Understanding UK Annual reports and Accounts: A Case Study Approach. 1st ed. London: International Thomas Business Moneycentral.com. (2011) J Sainsbury Plc Industry Ratios. [Online] Available at:
http://uk.moneycentral.msn.com/investor/invsub/results/compare.asp?Page=ProfitMargins&symbol=GB %3aSBRY [Accessed May 8 2011]

Morrisons, A: 2010 (2010) Morrisons Plc Annual Report and Financial Statements 2010. [Online] Available at: http://www.morrisons.co.uk/corporate/investors/Financial-Reports/ [Accessed May 8 2011] Sainsbury, A: 2010 (2010) J Sainsbury Plc Annual Report and Financial Statements 2010. [Online] Available at: http://www.jsainsburys.co.uk/index.asp?pageid=20 [Accessed May 8 2011]

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Appendix
Ratios Table Current ratio = current assets/ current liabilities Current assets Current liabilities Current ratio Quick ratio= (Current assets - inventory) / Current liabilities Current assets Inventory Current liabilities Quick ratio Gearing = long-term funds/ total equity Long-term funds Total equity Gearing Interest cover= EBIT/ interest expense EBIT Interest expense Interest cover (times) Return on equity = Net income/ Total equity Net income Total equity ROE Return on Assets = Net income/ Total assets Net income Total assets ROA Sainsbu ry 2010 Sainsbu ry 2009 Industry Average

1797 2793 0.64

1570 2919 0.54 1.1

1797 702 2793 0.40

1570 689 2919 0.30

0.4

2357 4966 47.46%

2177 4376 49.75%

80%

710 148 4.80

673 177 3.80

10

585 4966 11.78%

289 4376 6.60%

19.80%

585 10799 5.42%

289 10012 2.89%

1.44%

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Return on capital employed = Net income/ (Total assets - current liabilities) Net income Total assets Current liabilities ROCE Gross profit margin = Gross Profit / Revenue Gross Profit Revenue GPM EBIT Margin = EBIT/ Revenue EBIT Revenue EBIT Margin Profit Before Tax Margin = Pretax profit/ revenue Pretax profit Revenue PBTM P/E = Average market price/ EPS Average market price per share EPS P/E (times)

585 10799 2793 7.31%

289 10012 2919 4.07%

12.45%

1082 19964 5.42%

1036 18911 5.48%

26.90%

710 19964 3.56%

673 18911 3.56%

3.23%

733 19964 3.67%

466 18911 2.46%

42.6%

321.46 32.1 10.01

336.56 16.6 20.27

9.9

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