Financial Analysis of Retail Companies

The assignment presents a comparative financial analysis of two prominent sports retail companies, JD Sports and Sports Direct. It utilizes financial ratios to evaluate their liquidity, profitability, efficiency, and market performance. Furthermore, the analysis includes a capital investment appraisal for two projects (A and B) within a local manufacturing company, recommending Project A based on its Net Present Value (NPV). The assignment emphasizes NPV as the superior capital budgeting method compared to ARR and payback.

1
Financial Analysis of the Portfolio

2
Contents
Introduction......................................................................................................................................3
Portfolio 1........................................................................................................................................3
Calculation of Financial Ratio of both the companies (2015 and 2016) and Analyzing the
Performance, Financial Position and Investment Potential of both Companies..............................4
Different Ratios and their graphs.....................................................................................................5
Further Research on the performance of both companies.............................................................13
Recommendations..........................................................................................................................14
Limitations of Relying on Financial Ratios to Interpret Firm Performance..................................14
Portfolio 2: Capital investment appraisal......................................................................................15
Part A: Payback, Account rate of return and NPV........................................................................15
Payback Period..............................................................................................................................15
Accounting Rate of Return............................................................................................................16
Net Present Value..........................................................................................................................17
Part B: Limitations of using investment appraisal techniques to aid long-term decision-making 18
Conclusion.....................................................................................................................................19
References......................................................................................................................................20

3
Introduction
The present report is developed for providing an understanding of the accounting and
finance techniques that can be used by the investors for analyzing the financial performance of a
company. In this context, the report aims to construct two portfolios for the investors to aid their
decision-making processes by analyzing the financial performance of the companies. The first
portfolio is developed to present an analysis of the financial information of the two companies,
that are, Sports Direct International PLC and JD Sports Fashion PLC on the perspective of the
financial manger of Madhouse Retail Ltd. The analysis is aimed to assist the financial director of
the company for buying shares of the two companies. The evaluations of the financial position of
both the companies are carried out through the use of ratio analysis technique. The second
portfolio is developed for analyzing the potential worth of the two capital investment projects in
order to recommend the best option for capital investment for a local manufacturing company.
The investment appraisal techniques used to analyze the potential worth of both the projects are
NPV, ARR and payback.
Portfolio 1
The portfolio is developed for analyzing the investment worth of the following two
companies:
Sports Direct International PLC
The company is a recognized retailing group of the UK established in the year 1982. It is
attributed to be the largest sports-goods retailer company of the UK operating about 670 stores
across the world. The company carried out its operations through the four segments that are, UK

4
Sports Retail, International Sports Retail, Brands and Premium Lifestyle. In addition to this, the
company is also involved in wholesale distribution and sale of sports, leisure, clothing, footwear
and equipment under its brand name (Sports Direct International PLC, 2016).
JD Sports Fashion PLC
The company is the recognized retailer of the UK involved in retailing and distribution of
branded sports and fashion wear products. The company since its establishment in 1982 is
involved in retailing of branded sports fashion wear, clothing, leisure, footwear and sports
products. The company has about 800 stores across the world involved in providing branded
products in the category of sports and clothing. The company has also acquired First Sport in the
year 2002 that further supported its plans of geographical expansion (JD Sports Fashion PLC,
2016).
Calculation of Financial Ratio of both the companies (2015 and 2016) and Analyzing the
Performance, Financial Position and Investment Potential of both Companies
In this section financial ratios of the Sports Direct International PLC and JD Sports
Fashion PLC have been calculated for years 2015 and 2016. In all about 10 financial have been
calculated. All the detailed calculation is presented below. Financial Data used to interpret the
financial Ratio of both the companies (Kaplan and Atkinson, 2015).
Particulars Sports Direct International PLC
2015 2016
Current Assets £ 878,297.00 £ 1,311,437.00
Current Liabilities £ 382,621.00 £ 540,608.00
Inventories £ 517,054.00 £ 702,158.00

5
Gross Profit £ 1,240,812.00 £ 1,284,644.00
Net Revenue/Sales £ 2,832,560.00 £ 2,904,325.00
Operating Profit Margin £ 295,581.00 £ 223,178.00
Net Profit Margin £ 241,353.00 £ 278,981.00
Debts (ALL) £ 138,053.00 £ 333,832.00
Shareholders’ Equity £ 1,161,551.00 £ 1,384,728.00
Total Assets £ 1,773,683.00 £ 2,359,856.00
Capital Employed £ 1,391,062.00 £ 1,819,248.00
Average Inventory £ 517,054.00 £ 609,606.00
Dividend Payments £ - £ -
EPS £ 0.40 £ 0.46
Particulars JD Sports Fashion PLC
2015 2016
Current Assets £ 400,259.00 £ 510,695.00
Current Liabilities £ 326,748.00 £ 348,154.00
Inventories £ 225,020.00 £ 238,324.00
Gross Profit £ 739,550.00 £ 884,221.00
Net Revenue/Sales £ 1,522,253.00 £ 1,821,652.00
Operating Profit Margin £ 92,646.00 £ 133,406.00
Net Profit Margin £ 53,971.00 £ 100,630.00
Debts (ALL) £ 78,820.00 £ 47,409.00
Shareholders’ Equity £ 309,991.00 £ 400,825.00

6
Total Assets £ 681,670.00 £ 791,296.00
Capital Employed £ 354,922.00 £ 443,142.00
Average Inventory £ 225,020.00 £ 231,672.00
Dividend Payments £ 0.07 £ 0.07
EPS £ 0.35 £ 0.50
Different Ratios and their graphs
Current Ratio: The current ratio measures the ability of a company to meet its short and long-
term obligations with its current asset resources. The formula used for calculating the current
ratio is depicted as:
Current Ratio=Current Assets/Current Liabilities
Particulars Sports Direct International PLC
Liquidity Ratios 2015 2016
Current Ratio 2.30 2.43
JD Sports Fashion PLC
Current Ratio 2015 2016
1.22 1.47

7
2015 2016
0.00
0.50
1.00
1.50
2.00
2.50
3.00
Current Ratio
Times
On the basis of the above graph it can be analyzed that Sports Direct International Plc
maintain more current assets as compare to JD Sports Fashion PLC that indicates that liquidity
performance of Sports Direct International Plc is much better than JD Sports Fashion PLC in
year 2015 as well as in year 2016 (Horngren, 2009).
Quick Ratio: The quick ratio measures the ability of the companies to meet the financial
obligations from the current assets that can be quickly converted into cash resources. The
formula for its calculation is as follows:
Quick Ratio= (Cash+ Marketable Securities+ Accounts Receivable)/Current Liabilities
Particulars Sports Direct International PLC
Liquidity Ratios 2015 2016
Quick Ratio 0.94 1.13
JD Sports Fashion PLC
2015 2016
Quick Ratio 0.54 0.78

8
Quick ratio tells liquidity performance of the company in more precise way as it does not
take inventory into accounts while making calculation of current assets. The quick ratio of Sports
Direct International Plc was 0.94 times in year 2015 while it was 0.54 times in case of JD Sports
Fashion. In year 2016, quick ratio was 1.13 times for Sports Direct while it was 0.78 times for JD
Sports Fashion PLC. So, on the basis of analysis it can be said that Sports Direct International
Plc keeps more liquid assets as compare to JD Sports Fashion.
2015 2016
0.00
0.20
0.40
0.60
0.80
1.00
1.20
Quick Ratio
Times
Particulars Sports Direct International PLC
Profitability Ratio 2015 2016
Gross Profit 43.81% 44.23%
JD Sports Fashion PLC
2015 2016
Gross Profit 48.58% 48.54%

9
Gross Profit: It is the profitability ratio that depicts the relation between gross profit and the
total sales realized depicting the operational performance of a company. It can be calculated as
follows:
Gross Profit Ratio=Gross Profit/Net Sales
2015 2016
41.00%
42.00%
43.00%
44.00%
45.00%
46.00%
47.00%
48.00%
49.00%
Gross Profit Ratio
Percentage
Gross profit means revenue left after deducting the cost of goods sold. So every company
wants to keep higher gross profit in order to cover the operating expenses and earn very good net
profits. There were no major fluctuations in gross profits of both the company in last two years
but JD Sports Fashion has able to earn more gross profits as compare to Sports Direct
International PL C (Higgins, 2012).
Operating Profit: The ratio depicts the profit realized by a company after meeting all its
variable expenses. The ratio can be calculated as follows:
Operating Profit=Operating Profit/Sales
Particulars Sports Direct International PLC

10
Profitability Ratio 2015 2016
Operating Profit Ratio 10.44% 7.68%
JD Sports Fashion PLC
2015 2016
Operating Profit Ratio 6.09% 7.32%
2015 2016
0.00%
2.00%
4.00%
6.00%
8.00%
10.00%
12.00%
Operating Profit Ratio
Percentage
As discussed operating profit refers to the profits left after deducting cost of goods sold
and all the operating expenses from the revenue of the company. It must be such that it can cover
the interest expenses and tax expenses so that there will be enough net profit left for the
company. Operating profit ratio of the Sports Direct International PLC was greater than the JD
Sports Fashion PLC that shows that profitability position of Sports Direct International PLC was
good subject to other expenses (Glajnaric, 2016).

11
Net Profit: The net profit ratio depicts the profit realized by a company after meeting all its
operating expenditure such as interest, taxes and stock dividends. The formula can be calculated
as follows:
Net Profit Ratio=Net Profit/Sales
Particulars Sports Direct International PLC
Profitability Ratio 2015 2016
Net Profit Ratio 8.52% 9.61%
JD Sports Fashion PLC
2015 2016
Net Profit Ratio 3.55% 5.52%
2015 2016
0.00%
2.00%
4.00%
6.00%
8.00%
10.00%
12.00%
Net Profit Ratio
Percentage
Profitability position of both companies are not sound but on comparison it can be said
that Sports Direct International PLC has better net profit ratio as compare to JD Sports Fashion
PLC.

12
Gearing Ratio: The ratio measures the amount of funds borrowed by a company in comparison
to the use of equity funds. The formula for its calculation as follows:
Gearing Ratio=Long-term Liabilities/Capital Employed
Particulars Sports Direct International PLC
Solvency Ratio 2015 2016
Gearing Ratio 11.89% 24.11%
JD Sports Fashion PLC
2015 2016
Gearing Ratio 25.43% 11.83%
2015 2016
0.00%
5.00%
10.00%
15.00%
20.00%
25.00%
30.00%
Gearing Ratio
Percentage
In year 2015, gearing ratio of Sports Direct International PLC was better as compare JD
Sports Fashion PLC. But in year 2016, debt amount has been increased a lot in case of Sports
Direct International PLC as compare to JD Sports PLC (Gapenski, 2008).

13
Particulars Sports Direct International PLC
Market Ratio 2015 2016
Earning per Ratio 0.40 0.46
JD Sports Fashion PLC
2015 2016
Earning per Ratio 0.35 0.50
Earnings per Share: It depicts the market performance of a company through illustrating the
profit allocated in comparison to the outstanding share of common stock. The ratio can be
calculated through the use of the following formula:
EPS=Net Income/Total no. of Outstanding Shares
2015 2016
0.00
0.10
0.20
0.30
0.40
0.50
0.60
Earning Per Share
In Pounds
Return on Capital Employed: It measures the profitability realized by a company through
effective use of its capital employed calculated as:

14
ROCE=Earnings before Interest and Tax/Capital Employed
Particulars Sports Direct International PLC
Profitability Ratio 2015 2016
Return on Capital Employed 17.35% 15.33%
JD Sports Fashion PLC
2015 2016
Return on Capital Employed 15.21% 22.71%
JD Sports Fashion has earned 22.71% of return on the capital employed in year 2016 as
compare to 15.33% return in case of Sports Direct International PLC that shows predecessor has
better profitability position as compare to successor (FIRER, 2012).
2015 2016
0.00%
5.00%
10.00%
15.00%
20.00%
25.00%
Return on Capital Employed
Percentage
Inventory Turnover Ratio: It measures the efficiency of a company to effectively manage its
inventory through measuring how many times inventory is sold during a period calculated as:
Inventory Turnover ratio=Cost of goods sold/Average Inventory

15
Particulars Sports Direct International PLC
Efficiency Ratio 2015 2016
Inventory Turnover Ratio 66.63 76.61
JD Sports Fashion PLC
2015 2016
Inventory Turnover Ratio 53.95 46.42
2015 2016
0.00
10.00
20.00
30.00
40.00
50.00
60.00
70.00
80.00
90.00
Inventory Turnover Ratio
In Days
Inventory Turnover ratio of JD Sports Fashion was far better than the Sports Direct
International PLC in both the years (Elton, Gruber, Brown and Goetzmann, 2009).
Dividend Payout Ratio: It assesses the amount of dividend paid to the shareholders in
comparison to the net income realized by a company. The ratio can be calculated as follows:
Dividend Payout Ratio=Total amount of dividend paid/Total net income
Particulars Sports Direct International PLC

16
Market Ratio 2015 2016
Dividend Payout Ratio 0.00 0.00
JD Sports Fashion PLC
2015 2016
Dividend Payout Ratio 20.00% 14.80%
2015 2016
0.00
0.05
0.10
0.15
0.20
0.25
Dividend Payout Ratio
In Pound
Sports Direct International PLC has not declared any dividend to the shareholders instead
to that they invest the profits for the expansion of business. While JD Sports Fashion has
successfully provided dividend to their respective shareholders that shows market performance
of the JD Sports was better than Sports Direct International PLC (Elmuti and Kathawala, 2001).
Further Research on the performance of both companies
It can be stated from the analysis of the financial statements of both the companies that
they have good financial performance. However, the JD sports Fashion Plc has reported a higher

17
profitability with recording in dividend growth from 6.20p to 7.40p from the financial year of
2015 to 2016 (Sports Direct International PLC, 2016). On the other hand, the dividend payout
ratio of Sports Retail is not good for the respective financial period also its earnings per share
and profit before tax has shown a decreasing trend (JD Sports Fashion PLC, 2016). On the
contrary, the profit before tax for JD Sports has recorded high financial figures of £157.1 million.
Therefore, it can be stated from the financial analysis of both the companies that Madhouse
Retail Ltd should buy out the shares of JD Sports Fashion PLC.
Recommendations
On the basis of the financial analysis carried out for both the companies of JD Sports
Fashion and Sports Retail, it is recommend that the investors should invest in the JD sports as its
financial position is much better than Sports Retail. The profit before tax, earnings per share and
dividends per share of the company has decreased to a large extent indicating that the company
financial position is not stable. AS such, the company is recommended to implement effective
strategies for improving its financial performance. It needs to improve its profit before tax by
reducing its operational expenses and variable costs of production. The earnings per share and
dividend payout ratio of the company can be improved through enhancing its net sales
realization.
Limitations of Relying on Financial Ratios to Interpret Firm Performance
The major limitation of the ratio analysis is that it uses historical financial data for
analyzing the financial performance of the companies. The ratio analysis technique is not useful
for estimating the future performance of the companies as the historical data used cannot predict
the future market trends. The ratio analysis is also not regarded to be a useful technique for

18
generating consistent results as different companies uses varied accounting policies for
developing the financial statements (Dixon and Monk, 2009). Therefore, the results obtained
through the use of financial ratio analysis technique are not regarded to be accurate and reliable
for comparing the financial performance of the companies. Also, the technique cannot carry out
financial analysis of the companies having different sizes and belonging to different industries
due to large difference in the preparation of the financial statements. The ratio analysis has also a
drawback of not carrying out financial analysis of a company on stand-alone basis. It can only be
used to carry out comparative analysis of financial performance of the two companies. The
impact of inflation can also distort the financial data used for evaluating the financial
performance of the companies in the ratio analysis method. Therefore, the use of the technique
can sometimes lead to manipulates results in the event of distortion of the financial data due to
certain economic conditions (Deegan, 2013).
Portfolio 2: Capital investment appraisal
Part A: Payback, Account rate of return and NPV
Years Particulars Project A Project B
Machine 1 Machine 2
01-Jan-17 Initial Investment -£170,000.00 -£170,000.00
31-Dec-17 Cash Inflow £65,000.00 £25,000.00
31-Dec-18 Cash Inflow £65,000.00 £35,000.00
31-Dec-19 Cash Inflow £65,000.00 £45,000.00
31-Dec-20 Cash Inflow £55,000.00 £75,000.00

19
31-Dec-21 Cash Inflow £55,000.00 £85,000.00
31-Dec-22 Cash Inflow £45,000.00 £65,000.00
31-Dec-22 Residual Value £0.00 £20,000.00
Payback Period
Method 1 Payback Method
For Even cash inflows For Uneven Cash Inflows
Initial Investment A+ B/C
Cash Inflow per Period
Where:
A is the last period with a negative cumulative cash flow;
B is the absolute value of cumulative cash flow at the end of
the period A;
C is the total cash flow during the period after A
Cumulative Cash Flows of Machine 1
Years Machine 1 Cumulative
01-Jan-17 -£170,000.00 -£170,000.00
31-Dec-17 £65,000.00 -£105,000.00
31-Dec-18 £65,000.00 -£40,000.00
31-Dec-19 £65,000.00 £25,000.00
31-Dec-20 £55,000.00 £80,000.00

20
31-Dec-21 £55,000.00 £135,000.00
31-Dec-22 £45,000.00 £180,000.00
Cumulative Cash Flows of Machine 2
Years Machine 2 Cumulative
01-Jan-17 -£170,000.00 -£170,000.00
31-Dec-17 £25,000.00 -£145,000.00
31-Dec-18 £35,000.00 -£110,000.00
31-Dec-19 £45,000.00 -£65,000.00
31-Dec-20 £75,000.00 £10,000.00
31-Dec-21 £85,000.00 £95,000.00
31-Dec-22 £65,000.00 £160,000.00
Machine 1 Machine 2
Payback 3.62 4.87
3.62 years 4.87 years
Decision: On the basis of above calculation, senior management should select Machine 1 as it
has lower payback period as compare to Machine 2.
(Brigham and Houston, 2012)
Accounting Rate of Return
Method 2 Accounting Rate of Return

21
Formula Average Accounting Profit
Average Investment
Particulars Machine 1 Machine 2
Annual Depreciation £28,333.33 £25,000.00
Calculation of Average Accounting Profit/Income
Machine 1
Years Year 1 Year 2 Year 3 Year 4 Year 5 Year 6
Cash Inflows
£
65,000.00
£
65,000.00
£
65,000.00
£
55,000.00
£
55,000.00
£
45,000.00
Less:
Depreciation
£
28,333.33
£
28,333.33
£
28,333.33
£
28,333.33
£
28,333.33
£
28,333.33
Accounting
Income
£
36,666.67
£
36,666.67
£
36,666.67
£
26,666.67
£
26,666.67
£
16,666.67
Average
Accounting
Income
£
30,000.00
Accounting Rate
of Return
17.647%

22
Machine 1
Machine 2
Years Year 1 Year 2 Year 3 Year 4 Year 5 Year 6
Cash Inflows
£
25,000.00
£
35,000.00
£
45,000.00
£
75,000.00
£
85,000.00
£
65,000.00
Less:
Depreciation
£
25,000.00
£
25,000.00
£
25,000.00
£
25,000.00
£
25,000.00
£
25,000.00
Accounting
Income
£
-
£
10,000.00
£
20,000.00
£
50,000.00
£
60,000.00
£
40,000.00
Average
Accounting
Income
£
30,000.00
Accounting Rate
of Return
Machine 2 17.647%
Decision: In both the projects the accounting rate of return of both machines is equal, so it is
advised to senior management to select either of projects.
(Brigham and Ehrhardt, 2013)

23
Net Present Value
Method
3 Net Present Value
Formula Present Value of Cash Inflows less Present Value of cash outflows
Particulars
PVF @
20% PV of Machine 1 @ 20% PV of Machine 2 @ 20%
31-Dec-17 0.833 £54,166.67 £20,833.33
31-Dec-18 0.694 £45,138.89 £24,305.56
31-Dec-19 0.579 £37,615.74 £26,041.67
31-Dec-20 0.482 £26,523.92 £36,168.98
31-Dec-21 0.402 £22,103.27 £34,159.59
31-Dec-22 0.335 £15,070.41 £21,768.37
Residual Value 0.335 £0.00 £6,697.96
Present Value of Cash Inflows £200,618.89 £169,975.46
Particulars Machine 1 Machine 2
Present value of cash Inflows £200,618.89 £169,975.46
Present value of cash outflows £170,000.00 £170,000.00
NPV £30,618.89 £24.54
Decision: On the basis of above calculation, senior management should select the machine 1

24
due to higher NPV as compare to machine 2.
Part B: Limitations of using investment appraisal techniques to aid long-term decision-
making
NPV
 The cost of capital assed by the method is based on estimation and therefore not reliable
 It is not a useful method for comparing the projects of two different sizes
 The results obtained from the method are also highly sensitive to the discount rates as it
incorporates the use of summation of multiple discounted cash flows for estimating the
present value of an investment
 The method is also difficult to understand and implement by the project managers
(Brealey, Myers and Marcus, 2007)
ARR
 The method does not take into account the concept of time value of money and thus not
effective method for estimating the future worth of an investment
 The method also does not include the external factors that can impact the profitability of
a project
 The method also does not determine the present value of cash flows that are more
important than the accounting profits
 It is also not an effective method to be used for calculating the worth of a project in
which investment is to be made in parts (Batra and Verma, 2014)
Payback