Financial Ratio Analysis and Decision Making

This assignment focuses on analyzing various financial ratios commonly used in assessing a company's financial health and performance. Students will calculate key ratios such as gross profit ratio, operating profit ratio, net profit ratio, return on assets, return on equity, inventory turnover ratio, asset turnover ratio, receivables turnover ratio, current ratio, and quick ratio. They will also explore how these ratios can be used to evaluate investment decisions and understand the financial implications of business operations.

Accounting and Finance for Managers
Table of Contents
INTRODUCTION...........................................................................................................................1
SECTION A....................................................................................................................................1
a. Analyzing financial health and performance of Tesco, Sainsbury and Morrison’s Plc
.....................................................................................................................................................1
b. Writing a memo to managing director regarding the performance of firm along with
the recommendations.............................................................................................................12
c. Outlining the limitations of financial ratios.......................................................................13
SECTION B..................................................................................................................................14

Using net present value technique to assess whether three year contract is profitable
or not for the organization......................................................................................................14
b. Explaining approach of taxation in appraisal..................................................................18
c. Discussing the techniques that can be used for the evaluation of project.................18
d. Stating the other factors that need to consider while taking final decision................19
CONCLUSION.............................................................................................................................19
REFERENCES............................................................................................................................21

Illustration Index
Illustration 1: Gross profit ratio.......................................................................................................2
Illustration 2: Operating profit ratio................................................................................................3
Illustration 3: Net profit ratio...........................................................................................................4
Illustration 4: Return on assets........................................................................................................5
Illustration 5: Return on equity........................................................................................................6
Illustration 6: Inventory turnover ratio............................................................................................7
Illustration 7: Asset turnover ratio...................................................................................................8
Illustration 8: Receivables turnover ratio........................................................................................9
Illustration 9: Current ratio............................................................................................................10
Illustration 10: Quick ratio.............................................................................................................11

INTRODUCTION
Accounting and finance management are vital for the organizational growth and
success (Accounting and finance management, 2017). In the business organization,
manager places high-level emphasis on maintaining accounting records and
information, this in turn helps preparing suitable statements. Therefore, by making
analysis of financial statements through the means of ratio analysis both internal and
external stakeholders can take suitable decision. This report is based on three major
retail or supermarket stores such as Tesco, Sainsbury’s and Morrison Plc. These retail
stores are listed on the recognized stock exchange of UK and known for delivering high
quality products. Tesco supermarket is the multinational grocery and general
merchandise retailer organization (TESCO Plc, 2017). Sainsbury is the second largest
chain of the supermarket, which consist of 16.9% shares of UK’s super market sector
and Morrison Plc (Sainsbury Plc, 2017). Retail super market is the public limited
company, which has 498 locations, and the revenue of this is £16,317 million. The
present report will light on the extent to which financial condition of company is sound
over others. It will develop understanding regarding the investment appraisal techniques
and its significance in the decision-making aspect.
SECTION A
a. Analyzing financial health and performance of Tesco, Sainsbury and Morrison’s Plc
Profitability analysis
1

Illustration 1: Gross profit ratio
 Gross margin ratio: It has been assessed from ratio analysis that GP margin of
Tesco decreased over the years and accounts for 6.31% respectively. From
2010 to 2014 GP ratio. Due to high degree of expenses cost of the products
going to increase so that the sale revenue is going to be decreases and
Morrison’s Plc. is fluctuated. In 2014, gross profit ratio of Morrison’s Plc was
6.07%. In comparison to this, Sainsbury’s GP margin was 5.79% in 2014. Due to
the existence of more competition business units failed to generate more sales
and profit. In addition to this, high level of direct expenses such as material and
labor is another major cause due to which business units failed to generate high
margin. Hence, by considering such aspects, it can be stated that GP margin of
all such business units were not good. Thus, for making improvement in the
gross profitability aspect Sainsbury is required to make focus on offering
innovative products or services to the customers. This in turn helps firm in coping
up with the competitive situation and thereby helps in attaining high profit. Along
with this, by applying the tool of budgetary control company can exert control on
direct expenses.
2

Illustration 2: Operating profit ratio
 Operating profit ratio: Outcome of ratio analysis shows that declining trend took
place in the operating margin of Tesco Plc. In 2012, operating margin was
account for 6.54%, whereas in 2014 such ratio implies for 4.14%. From 2010 to
2013, operating profit margin of Morrison’s is between the ranges of 5.24% to
5.89%. On the contrary to this, such ratio was negative .54%, which entails that
business unit sales has been failed to manage general administration expenses.
In comparison to Tesco and Morrison’s Plc, operating ratio of Sainsbury’s Plc
accounts for 4.21%. Hence, by considering such trend or performance level it
can be stated that operating margin of Tesco and Sainsbury’s Plc was good.
3

Illustration 3: Net profit ratio
Net profit ratio: The graph clearly shows that net margin of Tesco Plc increased
from 4.09% to 4.94% from 2010 to 2012. Hence, after such period, net
profitability aspect of firm after the fulfillment of obligations was 2.42% and 3.01%
in the year of 2013 and 2014. On the other side, NP margin of Morrison Plc
moved from positive to negative trends. In 2014, NP ratio of Morrison Plc was -
1.35%, which in turn presents that profitability of company was worst. On the
other side, net profit margin of Sainsbury’s Plc was within the range of 2 to 3%.
Sainsbury’s net profit was 2.99% at the end of 15 March 2014. Thus, overall
financial evaluation it can be stated that Tesco had generated higher margin by
making effectual control on expense level. Thus, other retail business units are
required to employ the system of budgeting which in turn helps in attaining higher
margin by making control over indirect and interest expense.
4

Management Effectiveness
Illustration 4: Return on assets
 Return on assets (ROA): The ROA of Tesco was 6.46%, 3.03% and 3.81%
from 2012 to 2014. As compared to Tesco, Morrison’s ROA reduced significantly
from 7.04% to -2.24%. It presents that Morrison failed to generate more funds or
returns through assets. In against to other rival firms returns generated by
Sainsbury’s Plc was within 4 to 6%. Such trend or competitor analysis shows that
Sainsbury’s Plc performance of was better in the year of 2014 compared to the
others.
5

Illustration 5: Return on equity Return on equity (ROE): The ROE of Tesco was 18.40% in 2012, which in turn
indicates that company had made effective use of equity to some extent. In
contrast to this, return on equity measure of the company was 12.22%, which
shows that performance level decreased significantly. Morrison’s ROE was
negative such as -4.80%, which demonstrates that strategic framework of
company was not highly sound. Ratio analysis results show that ROE of
Sainsbury’s Plc increased from 10.42% to 12.09% 2014. Comparative analysis
shows that Tesco and Sainsbury Plc had made their best efforts for generating
higher revenue through the means of shareholders fund. It can be depicted that
performance aspect of Tesco and Sainsbury is good over others.
6

Efficiency ratio analysis
Illustration 6: Inventory turnover ratio
 Inventory turnover ratio: Financial statement analysis presents that inventory
turnover ratio declined from 19.38 to 16.27 times. On the other side, such ratio of
Morrison’s Plc also shows declining trend in the performance level. Stock
turnover ratio of Morrison’s was 26.79, 25.24 & 23.54 respectively. On the
contrary, such ratio of concerned business organization accounts for 21.96 &
20.34 times. In addition to this, Sainsbury’s turnover ratio also shows decreasing
trend from 27.15 times to 22.65. The above mentioned trend shows that all these
three companies are facing difficulties in relation to generate more money
through sales due to the rise in competition and changes in the needs, wants as
well as expectation level of customers (Collier, 2015). Hence, outcome of ratio
analysis clearly presents that Sainsbury’s stock turnover ratio was good over
Tesco and Sainsbury’s Plc.
7

Illustration 7: Asset turnover ratio
 Asset turnover ratio: By applying the tools of ratio analysis, it has been
assessed that asset turnover ratio was 1.30 times in both 2011 & 2012. On the
other side, assets turnover ratio of Morrison’s Plc declined from 1.81 to 1.66
times. Along with this, declining trend or in the Sainsbury’s Plc performance level
pattern was seen. Hence, by considering the outcome of ratio it can be stated
that all such supermarkets failed to generate enough sales by making use of
assets. In comparison to all the firms, Tesco Plc had generated more sales from
both fixed and current assets.
8

Illustration 8: Receivables turnover ratio Receivable turnover ratio: Outcome of ratio analysis entails that Tesco
generated money from debtors within the less period in 2014 as compared to the
past years. Whereas, receivable turnover ratio of Morrison’s Plc was 87.31 in
2014. In contrast, debtor’s turnover ratio of Sainsbury’s Plc significantly declined
from 129.22 to 25.04 days. Out of the considered supermarkets, Tesco received
money from debtors within fewer time frames. However, working capital aspects
of Sainsbury’s and Morrison’s Plc was fluctuated negatively due to inappropriate
credit policy.
Liquidity ratios
9

Illustration 9: Current ratio
 Current ratio: Graphical presentation shows that current ratio of Tesco Plc was
declined from .71 to 0.61 times at the end of 2014. Hence, during the period of 5
years company’s capability in relation to fulfilling obligations decreased
significantly. On the other side, in 2010 current ratio of Morrison’s Plc was .51,
whereas it reached on .50 times in 2014. During the same time, current ratio of
Sainsbury’s Plc also decreased from .66 to .64 times. Hence, in 2014, all these
companies were failed to maintain enough current assets. Thus, it can be stated
that liquidity position of all three supermarket was not good because ideal ratio
implies for 2:1 (Francis and et.al. 2015). However, as compared to other firms
liquidation position of Sainsbury Plc was good.
10

Illustration 10: Quick ratio Quick ratio: From ratio analysis, it has been assessed that quick ratio of Tesco,
Morrison’s and Sainsbury’s Plc was fluctuated from the period of 2010 to 2014. In
2014, quick ratio of Tesco, Morrison and Sainsbury accounts for .42, .16 and .48
times respectively. In this year, quick ratio of Tesco and Sainsbury’s Plc was
near to the ideal ratio such as .5:1. By considering this, it can be stated that both
the organizations maintained enough current assets other than inventory and
prepaid expenses that can easily be converted into cash (Nielsen, Mitchell and
Nørreklit, 2015). However, quick ratio performance of Sainsbury shows that it
was not highly capable in relation to meeting immediate payments.
Investment ratios:
 EPS: By doing ratio analysis, it has been identified that earnings per share of
Tesco decreased from .88 to .36. On the other side, Sainsbury’s EPS showed
increasing trend from .32 to .36 at the end of 2014. The main reasons behind
such decreasing tend in earnings is that, in 2013, firm failed to generate higher
income which in turn placed direct impact on shareholders earnings per share.
 DPS: Outcome of ratio analysis exhibits that dividend per share of Tesco inclined
from .37 to .42 respectively. In contrast to this, DPS of Sainsbury lies within the
11

range of .14 to .17. By considering the overall trend, it can be stated that Tesco is
offering high dividend to the shareholders who in turn helps company in attracting
more investors. As compared to Tesco, Sainsbury offered less return to their
shareholders. Hence, during the period of 2010 to 2014, Tesco distributed high
net income among the shareholders in the form of dividend. In the year of 2014,
net income of Tesco and Sainsbury accounts for £974 & £716 respectively. Thsu,
overall trend presents that in comparison to Tesco, Sainsbury provided
shareholders with higher returns.
Non-financial ratios
 Revenue/Employee: In the accounting year 2014, employee revenue of Tesco,
Morrison’s and Sainsbury’s Plc was £124513, £337953 & £484798 respectively. By
making evaluation of performance, it has been identified that workforce of Sainsbury’s
Plc is highly efficient and made significant contribution in the revenue level. From
research, it has been identified that Sainsbury has highly skilled personnel who are able
to deliver quality services to the customers. This in turn help firm in building and
sustaining competitive edge over others.
 Operating Income/Employee: From the assessment of company’s annual
report, it has been identified that operating income generated by Morrison’s
personnel are highly lower as compared to Tesco & Sainsbury’s Plc. Thus,
Morrison is required to frame competent HR policies and strategies to enhance
employee performance (Ferrell and Fraedrich, 2015). Moreover, without having
highly skilled and competent personnel firm would not become able to attain
success in the competitive environment.
b. Writing a memo to managing director regarding the performance of firm along with the
recommendations
To,
Managing Director of Morrison’s Plc
12

Date: 21st March, 2017
Subject: Financial performance results
From financial statement analysis, it has been assessed that profitability aspect of the
company was worst in the year of 2014. During such period, both operating and net
profit margin of firm was negative which in turn closely influence the future monetary
aspects of firm. Further, it has been identified that liquidity position of the company was
insignificant. Moreover, as compared to ideal ratio business unit was maintained only
25% of current assets. This in turn entails that company was not highly capable during
the period of 2014 to meet its current liabilities. Company also failed to incorporate high
return from assets such as, debtors, inventory etc. Thus, it is suggested to the firm to
follow below mentioned aspects which will help it in enhancing financial performance:
Business organization should focus on advertisement campaign and sale promotion
13

activities. Hence, by providing suitable information to the large number of customer
regarding the quality and price of product sales revenue and thereby profitability can be
maximized. Along with this, for making control over cost level Morrison Plc should
undertake budgeting technique.
In addition to this, Morrison should lay more emphasis on maintaining current assets
such as cash etc., by reducing the level of expenses. This can be achieved by the firm
through the means of continuous monitoring. By this, firm can maintain high liquidity and
thereby would become able to meet obligations on time.
Further, by encouraging personnel to give their best efforts Morrison’s Plc can make
optimum utilization of assets and thereby would become able to generate high profit
margin. Hence, by following all such measure's Morrison Plc can make significant
improvement in the profitability and liquidity aspects. All these aspects will help
company in gaining competitive edge over others.
Recommendation: It can be recommended that the Morrison’s Plc is the worst
performing entity, whose sale revenue goes down continuously and they fluctuate
regularly. Moreover, through the reduction of cost the sale revenue will be expected to
increase. For this the Morrison’s Plc must try to reduce their expenses so that they able
to reduce the cost. Furthermore, due to this, the profit margin as well as profit
potentiality will be increases and the performance of this retail market is increases.
Sincerely
Financial analysts
c. Outlining the limitations of financial ratios
Limitations
 Different rules and regulations: Accounting policies that are undertaken by
different organizations highly differ. Moreover, some organization considers UK
14

GAAP, whereas other considers IAS and IFRS for both recording and reporting
(Reckers and Samuelson, 2016). These different rules and ratios are essential
part of the organization but it need proper efficient staff as well as proper facts
and figure so determination of the ratio is appropriate and if the facts figures are
not sufficient than the organization did not get proper ratio. This is one of the
biggest drawbacks of the different rules and regulations. For instance: One
business unit undertakes straight line method for the calculation of depreciation,
whereas other or rival firm uses written down value method. In this, such
changing rules closely influence the profitability aspect of firm and thereby
outcome of ratio analysis.
 Inflation: Rate of inflation changes over the years or time frame which in turn
closely influences the financial health and performance (Anderson and et.al.
2015). Hence, rate of inflation highly varied from one year to another. In this, it is
not possible to evaluate company’s performance over the years. Company’s
balance sheet has been badly distorted due to inflation. Company must interpret
with judgment so that it is not necessary that the judgment is good. The major
drawback of this ratio is the organization must require some experience and also
the facts and figures of previous years.
 Historical evaluation: Financial statement analysis presents information
regarding the past performance. However, it does not reflect trend in relation to
future performance and aspects (Bebbington, Unerman and O'Dwyer, 2014). Due
to this evaluation organization does not takes its major decisions. Hence, by
considering this it can be stated ratio analysis tool does not help in making
suitable decision regarding investment. For investment purpose this ratio must
need to be more appropriate and excellent so that the investor can take
decisions on the basis of this. Investment just like in gold, bonds, foreign
exchange and derivatives etc.
15

SECTION B
Using net present value technique to assess whether three year contract is profitable or not for the
organization.
To
John Green
Financial director, Sound Equipments Ltd
Date: 21st March, 2017
Subject: Investment appraisal analysis
Introduction: This report based on net present value technique of capital appraisal
which is aimed at helping the organization to make the best decisions about the projects
in the organization. The net present value denotes that the perfect outcome of the
project after using the present values of the initial investment. This method is one of the
best methods of capital appraisal.
From evaluation, it has been assessed that business unit will get positive returns of
£51842.2 by making contracts for three years. Stakeholders Invests in the particular
projects by applying these ratios. Outcome of investment appraisal analysis is based on
the aspect that firm will make payment of tax in the next year. By considering 18% cost
of capital it has been identified that Sounds Equipment's Ltd will generate positive
returns from such proposal.
Comment: It is to be concluded that the organization must take major steps and
achieving the higher amount of profit with satisfy the needs and wants of the customers
by applying the facts and figures of the financial and non-financial ratio analysis.
Sincerely
Financial analysts
16

Calculation of cash inflow
Particulars Year 1 Year 2 year 3
Sales revenue /
turnover
18000
0
21600
0
25920
0
Material 60000 63000 66150
Labor 40000 42000 44100
Depreciation 11250 11250 11250
total outflow 11125
0
11625
0
12150
0
EBIT 68750 99750 13770
0
Taxation 0 22687.
5
32917.
5
EAT 68750 77062.
5
10478
3
Add: Depreciation 11250 11250 11250
Cash inflow 80000 88312. 11603
17

5 3
Working note: Depreciation
Initial investment 15000
0
Scrap value (25% of initial
investment)
37500
Cost – scrap 11250
0
Depreciation (Cost – scrap value)
/ life of machinery
11250
0/10 =
11250
Net present value: net present value (NPV) denotes the difference between the
cash inflow and initial investment (What is NPV?, 2017). It is the best method of capital
budgeting for taking the best project decision. It is very common and easy method,
mostly every organization whether it is small or big uses this method’s facts and figure
before getting the project.
Calculation of NPV
Year Cash
inflow
PV
factor
@
18%
Discount
ed cash
inflow
1 80000 0.847 67796.6
2 88312. 0.718 63424.7
18

5
3 11603
3
0.609 70621
Total discounted cash
inflow
201842
Initial investment 150000
NPV (Total
discounted cash
inflow – initial
investment)
51842.5
Interpretation: Net present value is positive than the project should be accepted
otherwise rejected. Here, this project provides the positive NPV with high amount so
that the organization must need to choose this project for getting the profit in long run.
b. Explaining approach of taxation in appraisal
Under investment appraisal technique tax policy aid in effectively determining
earning which business unit will get after taxation. In this, by adding the value of
depreciation analysts can determine the value of cash inflow (Upton and et.al. 2015).
Thus, by making treatment of taxation analyst of Sounds Equipment Ltd can assess
suitable cash flow and thereby become able to fund NPV, which is associated with
proposed investment. This approach determining the actual profit of the organization
after considering the tax amount so that the organizer would identify the actual benefit
of the project so that they can take decision about the opting the project or not. NPAT
need to be considers the tax amount so that the organization gets better output so that
they get the information about the actual profits after tax amount.
19

c. Discussing the techniques that can be used for the evaluation of project
Sound Equipment Ltd can also undertake following techniques for the purpose of
project evaluation is enumerated below:
Payback period: By applying the payback period technique, business unit can
assess the time frame within which it would become able to recover initial investment
(Payback period, 2013). Hence, by employing such technique Sound Equipments Ltd
can identify the time period after which it become able to generate profit margin
(Goodman and et.al. 2013). However, in the present investigation analysts do not
undertake such method because it not renders information about the cash flows which
will be generated by the firm after payback period (Investment Appraisal, 2017). Along
with this, such method does not offer solution by taking into account the value of money
concept. Hence, such aspect closely influences the significance of such method and
thereby affects overall decision making.
Post payback period: The post payback period determine that the profitable
year, it defines the times which the organization receives the benefits (Post payback
period, 2017). By applying these tools and techniques, John Greek determines the
amount of time on which it can earn money. Moreover, the organization effectively takes
decisions about the choosing of the projects.
Profitability index: Profitability index determine the value pay off ratio, it means
this ratio determine the time period in which the amount of money recovered
(Profitability Index, 2016). It is ease to convey and presentation of it is also very good. It
can be easily under stable and measurable by the people in the organization.
Average rate of return: Company can also take decision about the selection of
proposal by making considering ARR technique. Such techniques provide deeper
insight to the firm about the average return which will be generated by it from proposed
investment proposal (Dyson and Berry, 2014). Therefore, by considering such aspect
Sound Equipments Ltd can suitable proposal which aid in the profitability aspect of firm
(Beck, Raj and Britzelmaier, 2013). Moreover, this approach offers solution for decision
by considering profit margin rather than annual cash flows. However, on the critical
20

note, it can be said that ARR also avoids time value of money concept and thereby
influences decision-making. In addition to this, it has been identified that ARR method
considers profitability aspect for evaluation rather than cash flows.
d. Stating the other factors that need to consider while taking final decision
There are several factors which business unit should consider at the times of
making decision in relation to the selection of proposal (Götze, Northcott and Schuster,
2015). These include technological advancement, life of the project and aspect of
environment sustainability. Moreover, company can grow and attain success only when
it makes focus on the adoption of latest technological aspects. Besides this, life of the
project has also significant impact on the success of business unit. In addition to this,
now business units are encouraged to take initiatives which in turn make contribution in
the aspect of environment sustainability. By considering these factors john Green
determine the best possible facts and figures through which it makes the best possible
solution (Factors that affect decision making, 2017). Hence, by considering such factors
John Green can take suitable decision regarding investment.
CONCLUSION
From the above report, it has been concluded that out of competitor’s financial
position and performance of Tesco and Sainsbury’s Plc were sound. It can be seen in
the report that Morrison’s Plc is required to take corrective measures or actions for
making improvement in the performance level. Moreover, financial condition and
position of firm has high level of impact on the decision-making aspect of investors. This
report presents that the John Greek makes its business more profitable and producible
in long term and achieves the long term goals and targets. Through these policies, the
organization can achieve more amounts of benefits by satisfying the needs and wants
of the customers. Thus, by making significant modification in the strategic and policy
framework Morrison can build its effectual image at marketplace. Besides this, it can be
revealed from the report that Sound Equipments Ltd should select investment proposal,
which will prove to be more beneficial for it.
21

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