Managerial Finance: Analysis and Recommendations for Improving Financial Performance

This report provides an analysis of the financial performance, position, and investment potential of two companies through ratio analysis. It also offers recommendations for improving the financial performance of poorly performing businesses. The report focuses on managerial finance and investment appraisal techniques.

Managerial finance
1

Table of Contents
Introduction......................................................................................................................................3
Portfolio 1........................................................................................................................................3
Ratio analysis..............................................................................................................................3
Analysis of financial performance, position and investment potential of both companies.........5
Recommendations on improving financial performance of poorly performing business.........13
Limitations of relying on financial ratios..................................................................................14
Portfolio 2......................................................................................................................................15
Investment Appraisal techniques..............................................................................................15
Limitations of using investment appraisal techniques in long term decision making..............16
Conclusion.....................................................................................................................................18
References......................................................................................................................................19
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Introduction
Financial decision making is critical for a business as finance provides backbone to sound
operations, success and growth of the business. It includes taking responsible decisions for
financial performance and position of the business (Chandra, 2017). This report is aimed at
evaluating financial decision making of two companies from investors' point of view and
investment appraisal techniques from management point of view. It is divided in two portfolios.
First portfolio is aimed at analysing financial performance, position and investment potential of
Sainsbury PLC and Tesco PLC through ratio analysis. Sainsbury PLC i Limitations of ratio
analysis in interpreting company's performance is also discussed. Further recommendations are
provided for improving financial performance of poorly performing businesses. Second portfolio
is aimed at analysing capital investment appraisal techniques and their limitations in long term
decision making for a company.
Portfolio 1
Ratio analysis
Ratio 2018 2019
Tesco Plc Sainsbury Tesco Plc Sainsbury
Current Ratio
= Current Assets/ Current
Liabilities
= 13749/
19233)
= 0.71
= 7866/
10302)
= 0.76
= 12668/
20680
= 0.61
= 7589/ 11417
= 0.66
Quick Ratio
= Quick Assets/ Current
Liabilities
Here, Quick Assets = Current
Asset- Inventories
= 9752/
19233)
= 0.51
= 6136/
10302)
= 0.60
= 9690/
20680)
= 0.47
= 6486/
11417)
= 0.56
Net Profit Margin Ratio
= Net Profit/ Revenue
= 1210/
63911
= 0.019
= 309/ 28456
= 0.01
= 1320/
57493
= 0.023
= 219/ 29007
= 0.008
Gross Profit Margin Ratio = 3352/ = 1882/ 28456 = 4144/ = 2007/ 29007
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=Gross Profit/ Revenue 63911
= 0.052
= 0.066 57493
= 0.072
= 0.069
Gearing Ratio
= Long Term Liabilities/ Capital
Employed
= 31135/
10480
= 2.97
= 4288/ 7411
= 0.58
= 36379/
14834
= 2.45
= 3668/ 8456
= 0.44
P/E Ratio
= Market Value Per Share/
Earning Per Share
= 229/9.35
=24.49
= 238.80/0.22
=10.85
=213.6/13.65
=16.97
= 213.40/46
=4.64
Earning Per Share
= Net Profit after Preference Share
Dividend/ No. of Outstanding
Shares
= 1210/
10480
= 0.12
= 309/ 7411
= 0.042
= 1320/
14834
= 0.089
= 219/ 8456
= 0.026
Return on Capital Employed
= Earning before Interest and Tax/
Capital Employed
= 1300/
10480
= 0.12
= 409/ 7411
= 0.055
= 1674/
14834
= 0.11
= 239/ 8456
= 0.028
Average Inventory Turnover
Period
= Net Sales or COGS/ Average
Inventory
Here, Average Inventory
= (Opening Inventory + Closing
Inventory)/ 2
= 57493/
2958.4
= 19.43
= 28456/
1598.7
= 17.80
= 63911/
2440.5
= 26.19
= 29007/
1869.5
= 15.52
Dividend Payout Ratio
= Dividend Paid/ Net Income
= 82/ 1210
= 0.068
= 212/ 309
= 0.69
= 357/ 1320
= 0.27
= 224/ 219
= 1.02
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Analysis of financial performance, position and investment potential of both companies
Current Ratio
It is a liquidity ratio used to measure the firm's ability to pay off its short term liabilities.
The ideal current ratio is 2:1. The current ratio of Tesco has reduced to 0.61 in the year 2019, it
was due to increase in current liabilities of the organisation in that year. Also the ratio of
Sainsbury has also reduced from the previous year and is 0.66 in 2019. It is due to reduction in
the total current assets of the company. While comparing both the companies it can be concluded
that Tesco has a better current ratio them that of Sainsbury as it is more close to the ideal ratio.
Quick Ratio
5
2018 2019
0
0.1
0.2
0.3
0.4
0.5
0.6
0.7
0.8
Current Ratio
Tesco Plc
Sainsbury Plc

It is also known as acid test ratio. It helps in measuring the firms ability as to how well it
can pay its current liabilities without the use of inventory and taking additional finance. The
higher the ratio is the better it is for the company's liquidity. The quick ratio of Tesco was better
in the year 2018, i.e. 0.51 an comparison with 0.46 in 2019. It was better for Sainsbury in the
year 2018 as compared to the year 2019, which was due to increase in current liabilities. By
comparing both the companies it can be summarised that Sainsbury has a better performance in
context of Quick ratio in comparison with Tesco.
Net Profit Margin Ratio
6
2018 2019
0
0.1
0.2
0.3
0.4
0.5
0.6
0.7
Quick Ratio
Tesco Plc
Sainsbury Plc

It is the percentage of net profit or income generated to Revenue earned by the company.
Higher the net profit margin ratio the better it is for the company. The net profit margin for
Tesco has increased to 0.023 in the year 2019 due to higher revenues generated in that year.
Whereas the net profit margin for Sainsbury is higher in the year 2018. It was a result of
decreased net profit due to increased cost of operations. By comparing both the companies it is
concluded that Tesco has a better performance index then Sainsbury for the year 2019 due to its
increased revenues.
Gross Profit Margin
7
2018 2019
0
0.005
0.01
0.015
0.02
0.025
Net Profit Margin Ratio
Tesco Plc
Sainsbury Plc

It is a profitability ratio that compares the gross margin of the company with the revenue
earned . It shows the profit making capability of the organisation after paying for the cost of
goods sold. Higher the Gross profit margin better is the performance of the company. Tesco has
improved its GP margin in the year 2019 with 0.072 in comparison with the previous year 2018.
Also in case of Sainsbury there is an increment in the ratio for the year 2019 in comparison with
that of the year 2018. Sainsbury has a better gross profit margin in context with that of Tesco for
bout the years. This was due to low cost of goods sold of Sainsbury.
Gearing Ratio
8
2018 2019
0
0.01
0.02
0.03
0.04
0.05
0.06
0.07
0.08
Gross Profit Margin Ratio
Tesco Plc
Sainsbury Plc

It measures the financial leverage demonstrating the degree at which the company funds
its operations by equity capital or by use of debt. It is also known as debt to equity ratio, and
considered optimum for a well established company between 25% to 50%. The capital gearing
ratio for Tesco was better in the year 2019 with 24.5 which is very close to the optimum ratio. In
case of Sainsbury the company is not in a good position in this context but while comparing in
the year 2018 and 2019, the ratio was better in 2019, due to the reduction in the debt taken by the
company. While analysing both the companies in this term it is concluded the Tesco has a very
good capital gearing ratio in comparison with Sainsbury due to less use of debt for funding the
operations.
Price to Earning Ratio
9
2018 2019
0
0.5
1
1.5
2
2.5
3
3.5
Gearing Ratio
Tesco Plc
Sainsbury Plc

It is also known as price or earnings multiple. It reflects the comparison current market
price of share of the company with earnings per share of the company shareholders. It is very
important ratio for the investors. In the above-mentioned ratio analysis, Tesco has provided
better values to its shareholders in comparison to the shareholders of the Sainsbury. Both the
companies have negative performance in 2019 as compared to their respective 2018
performance.
Earning Per share
10
2018 2019
0
5
10
15
20
25
30
P/E Ratio
Tesco Plc
Sainsbury Plc

It is reflection of the profitability of the investors. Higher the EPS, higher the profitability
of the investors. In the above-mentioned ratio analysis, it can be seen that EPS of Tesco is better
than Sainsbury. Both the companies have negative performance in 2019 as compared to their
respective 2018 performance.
Return on Capital Employed
11
2018 2019
0
0.02
0.04
0.06
0.08
0.1
0.12
0.14
Earning Per Share
Tesco Plc
Sainsbury Plc

It is a reflection on the efficiency of usage of the capital of the company in relation with
the profitability. It is one of the most important tool for analysis for both management and
investors. In the above-mentioned ratio analysis, it can be determined that Tesco is able to utilise
its capital more efficiently than Sainsbury. Both the companies have negative performance in
2019 as compared to their respective 2018 performance.
Average Inventory Turnover period
12
2018 2019
0
0.02
0.04
0.06
0.08
0.1
0.12
0.14
Return on Capital Employed
Tesco Plc
Sainsbury Plc

This ratio refers to that period in which inventory of a company rotates and is sell off.
Therefore, shorter this period is, better it is for company. In the above-mentioned ratio, it can be
seen that Sainsbury is better at rotating its inventory which can be attributed to its high sales.
Tesco has negative performance in 2019 as compared to 2018 while Sainsbury has improved its
performance.
Dividend Payout Ratio
13
2018 2019
0
5
10
15
20
25
30
Average Inventory Turnover Period
Tesco Plc
Sainsbury Plc

This ratio compares the dividend paid to the shareholders with the net income available
for them. The amount left in net income post dividend payout is retained earnings of the
company and is either reinvested in the business or reserved as provision. In the above-
mentioned analysis, it can be observed that Sainsbury is better at paying out dividends to its
shareholders in comparison to Tesco. Also, its yearly improvement is better than Tesco in
dividend payout ratio.
Recommendations on improving financial performance of poorly performing business
Below mentioned are the recommendations on the basis of above-mentioned ratio
analysis:
 Companies shall vigilantly check their inventory management processes to improvise the
effectiveness of their quick ratio (Templar, Hofmann and Findlay, 2020). They must
change their marketing strategies and run new promotions and discounts to decrease
inventory turnover time and improvise their liquidity ratios.
 Companies must engage in renewed market research such as competitors analysis,
demand analysis, etc. with an aim to identify factors that reduces demand and eliminating
which can increase their revenues so that their dependencies over the debt reduces. This
will indirectly improve their interest coverage ratio as well.
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2018 2019
0
0.2
0.4
0.6
0.8
1
1.2
Dividend Payout Ratio
Tesco Plc
Sainsbury Plc

 Other than improving their revenue, they must focus on cost optimisation which will
improve their profit margin. This will also help them in setting up renewed and better
price structure (Warren and Farmer, 2020).
Limitations of relying on financial ratios
Ratios are useful for highlighting relationships between items of a financial statement. It
facilitates gaining of general information of financial position and cash flows of the business. It
is often used for comparing company's performance with different organisation's performance for
a period of time. It is used to compare profitability, efficiency and liquidity of similar businesses.
But there are few limitations of ratio analysis, which are listed as:
 Inflationary effect- Many of the ratios are calculated on historical cost. The price level
change over a period of time is totally ignored. Historical cost based financial statements
don't reflect the current value of financial statements and ignores the impact of inflation,
especially when assets are purchased by different organisations at different time. There is
no adjustment made of the inflation. The real prices are not reflected in the financial
statements due to inflation. Therefore it does not reflect the true and fair financial
situation of an organisation.
 Change in Accounting Policies- Different organisations use different policies and
procedures for a similar transaction (Ehrhardt and Brigham, 2016). It makes the
comparison between two companies difficult and may lead to misleading results. Also if
a firm changes its accounting policies, may have a significant impact on financial
reporting. In such cases, the financial criteria used for ratio analysis may be altered and
can not be compared with the results recorded prior to these changes. The changes are
normally found in notes of the financial statements and sometimes there are chances of
being ignored.
 Historical Information- the information used for computing ratios are derived from real
time past results released by the company. So it is not certain that the organisation may
perform in the similar trends in future as well due to the unpredictable business
environment. Also the information in the income statement is based on the historical cost
and some of the components of Balance Sheet are recorded on historical cost. This results
in unusual ratio calculation.
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 Operational Change- An organisation may notably change its operational composition
to an extent that ratios calculated few years prior and compared with similar ratio
computed currently may yield misleading results and conclusions with respect to
company's performance and future aspects (Florou and Kosi, 2015). It can be illustrated
as implementation of a constraint analysis leads to reduced investments in the fixed assets
of the company and the ratio may summarise that the organisation is granting its fixed
assets base becoming too old.
Portfolio 2
Investment Appraisal techniques
Capital investments involve heavy expenditures and therefore, require estimated pre-
investment appraisal to assess financial viability of the proposed investments (Kumar,
Colombage and Rao, 2017). Companies use various techniques such as internal rate of return,
discounted payback period, profitability index, net present value etc. for taking capital budgeting
decisions. In the provided situation with the present information in the hand, most appropriate
investment appraisal is net present value (NPV). Below mentioned are calculations of NPV for
project A and project B:
Project A
Net Profit Discounted rate Present Value
45000 0.86 38970
45000 0.74 33435
45000 0.64 28845
35000 0.55 19320
35000 0.48 16660
25000 0.41 10250
Total 147300
Less: Initial investment -110000
Net Present Value 37300
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Project B
Net Profit Discounted rate Present Value
10000 0.86 8620
15000 0.74 11145
25000 0.64 16025
55000 0.55 30360
65000 0.48 30940
58000 0.41 23780
Total 120870
Less: Initial investment -110000
Net Present Value 10870
Interpretation
Net present value refers to the sum of the discounted future cash flows of the proposed
project net of initial investment. Cost of capital is taken as discounting rate. This method says
that project with higher net present value must be selected by the management. In the above-
mentioned two projects, Project A has higher Net Present Value and therefore, more appropriate
for selection by management.
Limitations of using investment appraisal techniques in long term decision making
Investment appraisal techniques are necessary to assess the financial viability of a
proposed project (Нугуманова, 2016). There are various methods that can be used by
management to appraise capital investment techniques. Below mentioned are the limitations of
various investment appraisal techniques:
 Difficulty in selecting appropriate discounting rate – One of the biggest challenges in
assessing various investment proposals are determining appropriate discounting rate.
Discounting rate is that rate which is used to ascertain converted present value of future
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cash flows. This rate is dependent upon many factors such as risk involved, calculative
accuracy, etc. which are easily subjected to faults. Also, factors such as risks are dynamic
over the period of the investment and choosing incorrect rate of return may cost heavily
to the company. A simple looking mistake of choosing incorrect discounting rate is
capable of causing fatal blows to the finances of the company.
 Size of investment – In techniques like Net Present Value (NPV), it is said that higher
NPV represents better investment but it overlooks a basic fact that if two investments are
being compared, then the one with the higher future inflows will obviously result in
better NPV (Chittenden and Derregia, 2015). But, having higher NPV does not always
mean better project for it, ignored the individual returns rate. Therefore, it is not suitable
to assess projects having unequal size. It can be considered to evaluate projects with same
initial outlay and same discounting rate but to gain a clearer and more accurate picture of
viability of an investment option, individual project returns must be concentrated rather
than concentrating on present values of estimated future cash flows.
 Difficulty in estimating future cash flows and ascertaining cost of capital – Company
assesses financial viability of the proposed projects on the basis of estimated future cash
flows but the uncertainties lying in the future is very difficult to predict. Structured and
unstructured risks in the future, future returns on investment, etc. all are dynamic and are
capable of changing dynamically in the future. This makes it difficult not in projecting
estimates but also in managing those estimates in the future. Cost of capital refers to that
rate which the investment proposed is going to incur and assessment of which decides
whether investment is worth taking risk or not. If company over projects or under
projects cost of capital, it might not take the risk of taking up the project or might think it
not worthwhile and in both the cases, company might miss out a good investment
opportunity (Reinert, 2020).
 Difficult to build common base – There exist no standard rate or base of evaluating
investments between companies belonging to even same industry and therefore, one
investment which is good for one company need not necessary be good for another
company. But these investment appraisal techniques ignore such factors and brings out
same answers for both the organisations. This diminishes the effectiveness of these
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techniques. For example, there is no agreed standard method of calculating accounting
rate of return.
 Ignores time value of money – Some investment techniques like payback period and
accounting rate of returns ignores time value of money. Payback period also ignores all
the cash flows that the project would generate post payback period as well as timings of
the cash flows within payback period. This gives inaccurate profitability status of the
proposed project and therefore, cannot be definitive of the correctness of the financial
advise generated on the basis of it result.
 Complicated to understand – Techniques such as payback period are easy to understand
and perform but they do not identify correct viability as much as Net present Value
(Hsiao and Kelly, 2018). However, net present value is complex to understand and
requires technical knowledge on the part of managers to identify cost of capital. Other
method like Internal rate of return is also complicated to understand as it is the rate at
which NPV is equals to zero. Non-conventional cash flows can give rise to multiple IRR
and also, there is highly likely chances of contradicting advices in IRR and NPV in
mutually exclusive projects.
Conclusion
From the above report, it has been concluded that assessment of financial information of
a company is not relevant to the managerial point of view but also investors point of view. There
are various tools and techniques available for evaluation. Management evaluates financial
information to ensure optimum utilisation of funds while investors evaluates such information to
decide on their investment decision. Companies also undertake capital budgeting techniques to
assess financial viability of different investment options available to them.
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References
Books and Journal
Chandra, P., 2017. Investment analysis and portfolio management. McGraw-hill education.
Chittenden, F. and Derregia, M., 2015. Uncertainty, irreversibility and the use of ‘rules of
thumb’in capital budgeting. The British Accounting Review. 47(3). pp.225-236.
Ehrhardt, M.C. and Brigham, E.F., 2016. Corporate finance: A focused approach. Cengage
learning.
Florou, A. and Kosi, U., 2015. Does mandatory IFRS adoption facilitate debt financing?. Review
of Accounting Studies. 20(4). pp.1407-1456.
Hsiao, P.C.K. and Kelly, M., 2018. Investment considerations and impressions of integrated
reporting. Sustainability Accounting, Management and Policy Journal.
Kumar, S., Colombage, S. and Rao, P., 2017. Research on capital structure determinants: a
review and future directions. International Journal of Managerial Finance.
Reinert, J., 2020. Valuation accuracy across Europe: a mass appraisal approach. Journal of
Property Research, pp.1-23.
Templar, S., Hofmann, E. and Findlay, C., 2020. Financing the end-to-end supply chain: A
reference guide to supply chain finance. Kogan Page Publishers.
Warren, C.S. and Farmer, A., 2020. Survey of accounting. Cengage Learning.
Нугуманова, Г.А., 2016. COMPARISON OF INVESTMENT APPRAISAL TECHNIQUES. In
НАЧАЛО В НАУКЕ (pp. 134-137).
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