BAAF Accounting & Finance/ ACCA Professional Accountancy Course

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BAAF Accounting & Finance/ ACCA Professional Accountancy Course

Financial Management and Control

Year 2 Semester 2

Contents Page

Strategic and major features review        

    6.2 Ratios………………………………………………………………………………...

    6.3 Company Accounts/ Annual Reports.……………………………………………….


1. Introduction

1.1 Chosen company of focus and comparison company within the same sector

The company I have chosen to focus our report on is Tesco Plc; the largest chain of supermarkets in the company, we will be comparing and contrasting the business operations of Tesco Plc with it’s close rival Sainsbury’s Plc.

1.2 Reasons for choice of the main company

As we have chosen to report on Tesco Plc as our main company to research and advise after comparison with competition. We will compare Tesco with one of it’s closest market rivals; Sainsbury’s, to provide a analysis of what they are doing better and can learn from in order to compete as well as learn from the others mistakes, and also to consider the direction the company is heading as well as highlight the characteristics Tesco has as a company which makes it the UK’s number one retailer. Tesco is a very large company in a very competitive sector

1.3 Aims and objectives of this report

The aim of this report is to advise a shareholder on the performance of the chosen company; Tesco Plc, in order to inform them of the health of the company and advise what action they should take in relation to the company’s shares. Many issues will be considered that are internal issues of the company such as its own activities as well as external issues such as competition (Sainsbury’s) in the market as this will obviously affect share value.

We will provide in our report a portfolio of various relevant financial ratios that will help us to analyse the profit and loss accounts, and balance sheets of both companies to understand better which companies shares would be a better investment.

We will use the current annual reports of both companies to make comparisons of the performance of both companies, given that the latest annual reports are already out of date by the time they are printed we will also look at other up to date sources of information on the performance of both companies such as news reports,  press releases and expert analysis already in existence in order to explain our view of the present position of the company and future trading environment it will operate in.

In this report we are aiming to explain why there is such a major difference between these two companies even though they operate in the same industry; using this information in the report we will present our findings and recommendations.

 We will also include in the appendices of the report additional information such as minutes of our team meetings and financial data. We will also provide with the report the latest annual reports of both companies as they will help the reader to further understand our findings that we base our advise upon.

1.4 Background information on Tesco Plc

Tesco was founded in 1924 by Sir Jack Cohen. Using his gratuity from his Army service in the ‘Great War’ he started selling groceries in the markets of London’s East End markets in 1919. The brand name of Tesco made its first appearance on tea packets in the 1920s. The name was based on the initials of T.E.Stockwell who was a partner in the firm of tea suppliers, and the first two letters of Cohen. They opened the first Tesco store in 1929 in Burnt Oak, Edgware.

Tesco Stores (Holdings) Ltd was floated on the Stock Exchange in 1947, with a share price of 25p. The price at the beginning of February 2002 was around 2.42p.modify!

By the early 1960s, Tesco had become a household name. Along with groceries they also sold fresh food, household goods and clothing in their stores. Tesco stores were located in the high streets of towns and cities up and down the country. In 1961 Tesco opened the largest store in Europe at the time at 16,500 square feet of shop floor.

Given the size of Tesco during the 1960s they should have been able to use their economies of scale such as bulk buying power to reduce costs in order to be able to sell goods at lower prices in order to be more competitive than their competition (especially independent stores) as they do now, but they were restricted up until 1964 when laws that allowed suppliers to insist stores sell their goods at a price set by them (Resale price maintenance) were removed. These laws made it difficult for Tesco to reduce price as the whole purpose of these laws were to protect small stores from being heavily undercut by large chains such as Tesco.

A earlier version of the current reward card systems in place at all major chains of supermarkets were trading stamps introduced by Tesco to build a reward system for customers in order to build customer loyalty and entice customers through the ability to make savings. Customers received stamps when they made purchases. Once they had collected enough stamps to complete a book, they had the choice to exchange the book for cash or other gifts. The reward system was later taken up by other companies and still exists now in a more sophisticated form.

As well as expanding its chain by opening new stores; Tesco also bought existing chains of stores. In 1960 it bought out a chain of 212 stores in the north of England, then another 144 stores in 1964 and 1965. In 1968 it took over the Victor Value chain of stores.

Tesco was first to introduce the concept of a superstore in 1967 by opening a 90,000 square feet store in Westbury, Wiltshire. In retailing the superstore was a new concept; a very large unit on the outskirts of a town, which is designed to provide easy access to customers coming by car or public transport. The term “superstore” was first used in relation to the Tesco store opened in Crawley, West Sussex, in 1968.

Tesco has grown at great speed in size, value and profit since its formation. In 1979, its annual turnover reached £1. It went on to in 1987 to announce a £500 million program to build another 29 stores. By 1991, the popularity of Tesco petrol stations at its superstores had made Tesco Britain’s largest independent petrol retailer. In September of 2002 Tesco launched its own exclusive clothing brand “Cherokee” in many of its UK stores. The Cherokee brand, along with Florence & Fred and Tesco own brand clothing went on to see sales increase by 6 times the market rate.

The stores have a diverse range of goods beyond just food and household goods such as clothing, electronics, financial services and petrol to name a few. It has tried to target important niche markets such as organic food that are growing in size.

1.5 Background information on Sainsbury’s Plc

John James and Mary Ann Sainsbury founded Sainsbury's in1869. They first opened a  small dairy shop at 173 Drury Lane, London. Drury Lane was in one of London's poorest areas and the Sainsburys' shop became quickly very popular for offering high-quality products at very low prices. It was so successful that more branches were opened in other market streets in Stepney, Islington and Kentish Town.

By 1882 John James Sainsbury already had four shops and had further plans to expand his business. He later opened a depot in north-west London, to supply this growing chain as well as on the same site he built bacon kilns that produced the first Sainsbury branded product. In 1882 he also opened his first branch in the prosperous suburb of Croydon. This shop stocked a wide range of 'high-class' products and was more elaborately decorated than the earlier shops to target higher class customers.

During war time there was great depression and hardship for many, even then it was a period of rapid expansion for Sainsbury's. New stores were opened in London's expanding suburbs as well as in new trading areas outside of london such as Luton, Cambridge and St Albans. By 1936 they had expanded into the Midlands, through the acquisition of the Thoroughgood chain of stores. There were 244 Sainsbury's shops by 1939, all of which received daily deliveries of fresh foods from the headquarters in Blackfriars.

Refinements were made to the design of the shops and new products, particularly fresh meat and packaged own-brand groceries, were added to the range. By the 1920s a typical new Sainsbury's branch had six departments, offering a much larger product range than its competitors. Each shop offered home delivery throughout the surrounding district, an important service in the days before most people had motor cars.

Sainsbury's entered its second century still wholly owned by its founding family. By the early 1970s, however, it had reached a scale and stature that warranted public status. The company's public flotation in 1973 was at the time the largest ever flotation on the Stock Exchange, with a 45-fold oversubscription for shares. Preference was given to small shareholders in the allocation of shares.

In the decade to 1994, the choice of products offered by Sainsbury's more than doubled. These continued to reflect the company's historic strength in fresh foods: exotic fruits, ready meals, speciality breads and reduced-fat milks were introduced in response to customers' increasingly sophisticated tastes. Other innovative products reflected consumers' wider social and environmental concerns: Sainsbury's led the way in offering own-brand phosphate-free detergents and recycled paper products and was the first British supermarket to sell Fairtrade marked products.

The new millennium has seen a shift in customers' requirements, with organic food, genetically modified ingredients, farming for biodiversity, healthier options and convenience foods all being topical. We have responded to customers' needs and are proud of the initiatives we have in place. All Sainsbury's own-brand products have been GM free since 1999; in April 2004 Sainsbury's won the Soil Association’s Organic Supermarket of the Year for the third successive year; and we have had a farming biodiversity action plan since 1997.

Sainsbury's Bank opened in 1997; it now provides a range of affordable services including life and health cover, personal loans, savings accounts, travel insurance and ISAs. In 2003 Sainsbury's Bank was named the ‘Best Overall Provider’ in the Your Money Direct Awards.

J Sainsbury plc employs around 150,000 people


2. Analysis

Now we can analyse the data and information held in both of the companies annual financial report, this will aid us in calculating the Profitability, Solvency & Liquidity, Activity and Financial ratios for both companies for the investors benefit. Furthermore, a SWOT analysis will be conducted in order to aid us in seeking out the strengths and weaknesses of the two selected companies and the available opportunities and any threats that may be faced by them.  

2.1 Analysis of Information

Profitability Ratios

Return on Shareholders Funds (ROSF)

The owners of a business will purchase assets with the funds that have been invested; these assets will then in turn be used to generate returns. In case of a limited liability company, it will be the owners’ equity (i.e. Ordinary share capital plus All reserves). This investment potential will be appraised by comparing the expected gains to the investment costs. This approach, however, is a refinement of the ROCE (Return on Capital Employed) as the ROSF measures the return on funds provided by the owners.

ROSF = Net profit after Interest & Taxation x 100

Owners’ Equity

Return on Shareholders Funds (ROSF) analysis is one of a few methods to measure the profitability of a company. Investments in particular are only proceeded with and are solely decided upon the results of using ROSF.  The process by which a company sets its ROSF figure is very important, as some companies undergo extensive mathematical approaches to conclude this figure.  Other companies will rather just base their decisions and such based on previous decisions. However, while the company decides upon a suitable ROSF, there are certain issues that must be considered.  The investment must be financed by the company itself.  This source of finance can be equity. Having equity as a source of finance may provide cost implications for the future as well as in the past.  Also, retained profit as a source of finance is not free.  The shareholders are the ‘owners’ of the company as they maintain a fair holding of the company’s shareholdings, have also the complete ownership of the retained profit.  So, the company will have to consider and evaluate the level of risk it can endure and help decide itself if the investment is worth following if it is not within the level of tolerance. The managers will have to ascertain that this is the best use of the available funds rather than alternatives such as debt reduction.  Finally, a company will have to check and make sure that its profitability is on a safe and secure base if it is to reach any future goals.

As the ROSF is a profitability ratio it is very important to compare the performance of the company over a period of at least five years in order to help to analyse any developing trends in the company.

Sainsbury’s, in the last five years have seen their ROSF decrease up by 23.44% in 2005, whereby being its year of lowest return on shareholders funds. This is not a good sign, as there is a further slump in the year 2006 of 3.17% with a ROSF figure of 1.49%. The years 2005 and 2006 can be explained as Sainsbury’s results reflect the recent reorganization of the company with a drop in sales, slicing prices in order to realign the product offering with other rivals and the cost of sorting out supply-chain problems. However, for the company to improve, it is the detailed cost savings and margin improvements that the City is focused on. The City is where all the improvements are coming through. Many institutional investors, financial analysts and consumers alike all acknowledge that the new management efforts are having some effect.

Figure 1 – Return of Shareholder funds for the past 5 years

Tesco’s ROSF has been considerably higher than Sainsbury’s during the course of the five years. Although the 2004 figures show that it has suffered a decrease in its ROSF, since then the figures have increased dramatically.  Although their ROSF had dropped in the 2004, year after year Tesco’s have increased their profit and are the market leaders with 29% of the market share. It is possible to say that the ROSF has reduced due to an increase in the shareholders’ funds. However, analysts suggest that Tesco’s reign will not be at the top for much long.

Figure 2 – ROSF figures for the past 5 years

 


Return On Capital Employed ( ROCE)

To assess the profits or the growth of profit correctly without directly attributing them to the capital employed initially is proven to be quite difficult. Like ROSF, ROCE is also a very important profitability ratio in assessing the return on the capital that was invested. Potential investors will calculate the ROCE when deciding whether to invest or not and will compare the rate of return that will be generated to the initial capital that was injected rather than the return that can be earned on other investments. This ratio, otherwise known as the Primary ratio measures how effectively the managers of the company are using its capital employed in the business.

ROCE= Net Profit before Interest and Tax x 100

Capital Employed

The ROCE ratio seems generally to be a high figure. This is due to the fact that it includes investments by the company at a given year. However, income earned through investments, the company’s share of profits from other associated companies and trade profits are all inclusive in the total ROCE.

Figure 3 – ROCE figures for the past 5 years for J Sainsbury Plc

Figure 4 – ROCE figures for the past 5 years for Tesco Plc

As the above in figure 3 and 4 results show that up until 2004 Sainsbury’s shareholders gained good returns. However, since 2004 it has declined by 10.5%, this could be due to a loss of sales to competitors, such as Tesco’s. Also, due to the company’s’ reorganization as it had to cut prices and its drop in sales, has been the cause of the reduced profits.

In the last 5 years, as the above results show, that Tesco has been operating quite stable. However, there has been an opportunity cost arisen for Tesco during the period. As the ROCE has declined and inclined evenly every year, the company’s actual profit has increased, especially in 2005 and 2006 – the only British retail company, as Tesco announced in 2005 that it had made 2bn annual profit and had resulted in 220m worth of windfall bonuses to all its staff members and directors throughout the business – thus providing shareholders a larger return.

When the two companies are compared with one another, in terms of its profitability, it seems that Tesco’s a more profitable company.


Asset Turnover

This ratio is used to measure the company’s performance in generating sales from disposal of company assets. It provides an insight in the rate of asset turnover, for the company to reach its end sales.

Sales that are ongoing and consistently increasing imply a higher turnover. The result for this can be due to two reasons that are linked together; either there has been a drop in price or the company has undergone an expansion. A prosperous company is signified by its expansion, which is always the case with successful companies. This expansion would then lead to larger volume of purchases, which would further result in discounts being received. This would then allow a company to lower prices, whereby sales can be increased.

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Figure 5 – Asset Turnover ratio figures for the past 5 years for both companies

Sainsbury’s have seen the number of times their assets have been used to produce revenue over the past 5 years with an average of 3.7 times asset turnover. This rate has steadily increased over the years since 2002. There has been a rise of 0.4 times since 2005. The figure of 2006 may be the result of the new management of Sainsbury’s and may bring further success in the coming years.

Furthermore, Tesco’s asset turnover had been on average 4.3 times ...

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