Introduction to Accounting Coursework

Ratio Analysis of Tesco and Sainsbury

Introduction

This report details the results of a ratio analysis of two of the largest retailers in the UK: Sainsbury and Tesco based on their audited financial statements for the financial years ending 2011, 2012, and 2013. The two companies are compared with each other based on their profitability and liquidity ratios. This report then critically interprets the results of the ratio analysis calculations and then discusses the weaknesses of ratio analysis. Finally, this report concludes with some recommendations for how ratio analysis can be improved in the future.

Ratio Analysis

An Excel spreadsheet which accompanies this report has been created and contains the calculations which were used to derive the ratios from the annual reports of both Tesco and Sainsbury. The ratios are reproduced in Table 1 below. The methodology used to calculate each of these ratios is described further in Appendix 1 of this report. The income statement and balance sheets from which the numbers calculated in Table 1 are derived are reproduced in Appendix 2.

Sainsbury

2011

2012

2013

Tesco

2011

2012

2013

Profitability

Profitability

Gross profit margin

5.5%

5.4%

5.5%

Gross profit margin

8.5%

8.4%

6.3%

Operating profit margin

4.0%

3.9%

3.8%

Operating profit margin

6.5%

6.5%

3.4%

Net profit margin

3.0%

2.7%

2.6%

Net profit margin

4.6%

5.0%

2.1%

Return on assets

2.9%

2.5%

2.5%

Return on assets

3.0%

3.2%

1.4%

Return on equity

8.3%

7.3%

7.2%

Return on equity

12.1%

12.4%

5.3%

Liquidity

Liquidity

Current ratio

0.6

0.6

0.6

Current ratio

0.7

0.7

0.7

Quick ratio

0.3

0.3

0.3

Quick ratio

0.3

0.3

0.3

Cash ratio

0.2

0.2

0.2

Cash ratio

0.2

0.2

0.2

DIO

13.9

15.1

15.9

DIO

17.8

19.3

20.7

DSO

4.8

5.1

4.6

DSO

12.7

14.2

14.6

DPO

46.3

46.2

45.3

DPO

65.7

67.7

67.1

CCC

(27.7)

(25.9)

(24.7)

CCC

(35.2)

(34.2)

(31.8)

Table 1. Profitability and liquidity ratios for Sainsbury and Tesco for financial years ending 2011-2013. All figures obtained from annual reports for Sainsbury and Tesco.

Based on the profitability figures, we can say that Tesco has consistently had a higher gross profit margin when compared with Sainsbury. Given that Tesco’s revenues are approximately three times those of Sainsbury, this could possibly be due to economies of scale; Tesco may be able to purchase its merchandise at a slightly lower cost when compared with Sainsbury potentially because it is a much bigger purchaser of raw materials and therefore can have better negotiating power with its suppliers. Further down the income statement, Tesco has had better operating profit and net profit margins than Sainsbury in 2011 and 2012 but this has reversed in 2013 when Sainsbury outperformed Tesco. This has also been reflected in the ROA and ROE figures in which Tesco’s ROA and ROE are higher than Sainsbury’s in 2011 and 2012 but was lower than Sainsbury in 2013. In general, Sainsbury showed a more stable trend in profitability throughout the period.

Both companies showed adequate liquidity in terms of the current ratio although Tesco’s current ratio was higher than Sainsbury’s at 0.7 and 0.6 respectively. When the liquidity ratios are measured on a more restrictive basis using the quick and the cash ratios, there are very few differences between Sainsbury and Tesco across time and between each other.

The analysis of the cash conversion cycles (CCC) of both companies shows that Tesco consistently has a better CCC than Sainsbury at -31.8 days for Tesco in 2013 and -24.7 days for Sainsbury in the same year. The CCC describes how quickly these companies are able to convert their current assets; specifically, inventory and accounts receivable into cash while holding off paying on their current liabilities...