Managerial Finance: Ratio Analysis and Investment Appraisal Techniques

This study explores the concepts of ratio analysis and investment appraisal techniques in managerial finance. It analyzes the financial performance, position, and investment potential of two companies, Sainsbury PLC and Tesco PLC. The study provides recommendations for improving the financial performance of underperforming businesses and discusses the limitations of relying solely on financial ratios and investment appraisal techniques.

Managerial Finance

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.........11
Limitations of relying on financial ratios..................................................................................11
PORTFOLIO 2..............................................................................................................................13
Investment Appraisal techniques...............................................................................................13
Limitations of using investment appraisal techniques in long term decision making...............14
CONCLUSION..............................................................................................................................16
REFERENCES..............................................................................................................................17

INTRODUCTION
Finance is the backbone of solid management, profitability, and development in a firm,
therefore business decision is important. It entails making prudent judgments about the capital
structure and condition. This study examines two firms' business decision from the perspective
of investors, as well as investing assessment methodologies from the perspective of management.
It's split into two halves (Salehi, Daemi and Akbari, 2020). The first portfolio uses ratio analysis
to examine Sainsbury PLC and Tesco PLC's profitability, positioning, and future value. Ratio
analysis' shortcomings in assessing a company's success are also highlighted. There are also
suggestions for enhancing the competitiveness of underperforming firms. The second portfolio
examines capital investment assessment methodologies and their limits in establishing long -
term business decisions.
PORTFOLIO 1
Ratio analysis
One of the earliest components of data reporting information is ratio analysis. It was
created by commercial lenders to assist them in deciding between rival firms requesting loans. It
might be tough to distinguish 2 pairs of financial statements. The effects of time, being in various
sectors, and creating separate ways of conducting things may make it nearly hard to determine
whether firm a superior asset.
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
= 9752/
19233)
= 0.51
= 6136/
10302)
= 0.60
= 9690/
20680)
= 0.47
= 6486/
11417)
= 0.56

Here, Quick Assets = Current
Asset- Inventories
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
=Gross Profit/ Revenue
= 3352/
63911
= 0.052
= 1882/ 28456
= 0.066
= 4144/
57493
= 0.072
= 2007/ 29007
= 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 = 82/ 1210 = 212/ 309 = 357/ 1320 = 224/ 219

= Dividend Paid/ Net Income = 0.068 = 0.69
= 0.27
= 1.02
Analysis of financial performance, position and investment potential of both companies
Current Ratio
Tesco Plc Sainsbury Tesco Plc Sainsbury
2018 2019
0
5000
10000
15000
20000
25000
13749
7866
12668
7589
19233
10302
20680
11417
0.71 0.76 0.61 0.66
Current Assets
Current liabilities
Current ratio
It's a liquidity ratio that assesses a company's capacity to pay down quick obligations. A 2:1
current ratio is good. Tesco's liquidity amount decreased to 0.61 in 2019, owing to a rise in the
company's current liabilities during that year. Sainsbury's ratio has similarly decreased from
either the past season, now standing at 0.66 in 2019. It is related to a decrease in the business's
total current assets. When evaluating the present ratios of the two firms, it can be stated that
Tesco's is superior to Sainsbury's since it is closer to the ideal ratio.
Quick ratio: It's also referred to as the acid test ratio. It aids in determining a company's capacity
to pay existing commitments while relying on inventories or putting on further debt. The greater
the ratio, the greater the firm’s capital structure will be. Tesco's quick ratio was stronger in 2018,
at 0.51, compared to 0.46 in 2019. Sainsbury's performance in 2018 was stronger than in 2019,
which was attributable to a rise in current liabilities. When compare these two firms, it can be

concluded that Sainsbury has an improved performance in terms of Quick ratio than Tesco
(Arnold and Bauch, 2020).
Tesco Plc Sainsbury Tesco Plc Sainsbury
2018
2019
0
5000
10000
15000
20000
25000
9752
6136
9690
6486
19233
10302
20680
11417
0.51 0.6 0.47 0.56
Quick assets
Current liabilities
Quick ratio
Net profit ratio: It is the ratio of a firm's earnings or profit to the money it earns. The greater the
business's net profit margin ratio, the healthier. Tesco's net profit margin grew to 0.023 in 2019
as a result of increasing revenues. In 2018, Sainsbury's net profit margin was greater than in
2017. It was owing to a drop in net profit as a result of higher operating costs. When using these
firms, it is clear that Tesco has a larger capacity rating than Sainsbury's for the year 2019, owing
to higher earnings.
Tesco Plc Sainsbury Tesco Plc Sainsbury
2018 2019
0
10000
20000
30000
40000
50000
60000
70000
1210 309 1320 219
63911
28456
57493
29007
0.019 0.01 0.023 0.008
Net profit
sales
Net profit margin ratio

Gross profit ratio: It is a profit measure that determines a corporation's gross margin to its
profits generated. It demonstrates the organization's capacity to make a profit after covering the
cost of items sold. The higher this ratio presents the greater corporation's success. Tesco's gross
profit margin increased by 0.072 percent in 2019 compared to the prior year. In the case of
Sainsbury, there's an increase in the total per year 2019 as compared to the previous year. For
several years, Sainsbury's has had a higher gross profit margin than Tesco. This was attributed to
Sainsbury's lower price of merchandise supplied.
Tesco Plc Sainsbury Tesco Plc Sainsbury
2018 2019
0
200
400
600
800
1000
1200
1400
82
212
357
224
1210
309
1320
219
0.068 0.69 0.27 1.02
Dividend Paid
Net income
Dividend payout ratio
Gearing ratio: It calculates the capital structure, that shows how much of the operating
performance are funded by equity financing or borrowing. It's also referred as the debt-to-equity
ratios, and it should be around 25% and 50% for that well business. Tesco's capital gearing ratio
improved in 2019, reaching 24.5 percent, which would be incredibly close to the optimal level.
In the instance of Sainsbury, the firm is not in a favourable situation in this regard, although
when compared the years 2018 and 2019, the ratio was higher in 2019, owing to the
corporation's decrease in indebtedness. When comparing the capital gearing ratios of both firms
in this regard, it is determined that Tesco has a far improved capital gearing ratio than Sainsbury
since it uses fewer borrowing to support its activities.

Tesco Plc Sainsbury Tesco Plc Sainsbury
2018 2019
0
5000
10000
15000
20000
25000
30000
35000
40000
31135
4288
36379
3668
10480
7411
14834
8456
Long term liabilities
Capital em[ployed
Gearing ratio
Price to earnings ratio: It's also referred as a going great or a pricing multiplier. It presents a
comparison of the market value of shares of an entity with the business's investors' earnings
growth. To marketers, this is a critical ratio. Tesco has delivered higher value for the company in
compared to Sainsbury's stockholders with the above ratio study. In comparison to their relative
2018 results, both firms have had a poor year in 2019.
Tesco Plc Sainsbury Tesco Plc Sainsbury
2018 2019
0
200
400
600
800
1000
1200
1400
82
212
357
224
1210
309
1320
219
0.068 0.69 0.27 1.02
Dividend Paid
Net income
Dividend payout ratio
Earnings per share: It is a representation of the shareholders' profits. The greater the earnings
per share (EPS) are better for stockholders. As per the above calculation of this ratio study shows

that Tesco's EPS is higher than Sainsbury's. In comparison to their relative 2018 results, both
firms have had a poor year in 2019.
Tesco Plc Sainsbury Tesco Plc Sainsbury
2018 2019
0
200
400
600
800
1000
1200
1400
82
212
357
224
1210
309
1320
219
0.068 0.69 0.27 1.02
Dividend Paid
Net income
Dividend payout ratio
Return on capital employed: It is a commentary on the firm’s capital use effectiveness in
connection to revenue. It is one of the most essential tools for both managers and customers in
terms of method. Company is able to use its resources more effectively than Sainsbury,
according to the previous section accounting ratios. In comparison to their individual 2018
results, both firms have had a poor year in 2019.
Tesco Plc Sainsbury Tesco Plc Sainsbury
2018 2019
0
200
400
600
800
1000
1200
1400
82
212
357
224
1210
309
1320
219
0.068 0.69 0.27 1.02
Dividend Paid
Net income
Dividend payout ratio

Average inventory turnover period: This ratio covers the period when a periodic inventory
rotations and is sold off. As a result, the smaller this term is, the healthier for the firm. Sainsbury
is better at cycling inventories, as seen by the earlier in this thread ratio, which may be ascribed
to its massive sales. In comparison to 2018, Tesco's productivity has deteriorated in 2019, whilst
Sainsbury's has increased.
Tesco Plc Sainsbury Tesco Plc Sainsbury
2018 2019
0
200
400
600
800
1000
1200
1400
82
212
357
224
1210
309
1320
219
0.068 0.69 0.27 1.02
Dividend Paid
Net income
Dividend payout ratio
Dividend payout ratio: The dividends distributed to investors are compared to the net earnings
accessible to them in the ratio. The remaining operating earnings after dividend distribution is
called maintained profits, and it is usually re-invested in the firm or set aside as a reserves. In
compared to Tesco, Sainsbury is superior at handing out tax to the government, as seen in the
above-mentioned data. In terms of dividend policy, it also outperforms Tesco on an annual basis.

Tesco Plc Sainsbury Tesco Plc Sainsbury
2018 2019
0
200
400
600
800
1000
1200
1400
82
212
357
224
1210
309
1320
219
0.068 0.69 0.27 1.02
Dividend Paid
Net income
Dividend payout ratio
Recommendations on improving financial performance of poorly performing business
The following are the recommendations based on the earlier in this thread ratio analysis:
 Businesses must closely monitor their stock control procedures in order to improve the
efficiency of their liquidity ratio. To improve their liquidity ratios and minimise return on
assets times, they must modify their marketing approach and conduct fresh specials and
reductions.
 Organizations must do fresh market survey, such as marketing plan, material
requirements, and so on, with the goal of identifying elements that limit desire and
removing those that might enhance profits, reducing their debt dependency. Adversely,
this will increase their interest coverage ratio.
 They must focus on cost optimization, which also will enhance their profitability, in
addition to increasing sales. This will also assist them in establishing a new and improved
cost structure.
Limitations of relying on financial ratios
Ratios are important for identifying connections between financial statement components.
It makes obtaining significant knowledge about the company's financial status and working
capital easier. It's frequently used to compare a corporation's overall performance with that of

other businesses. It's being used to evaluate similar firms' earnings, productivity, and flexibility.
However, there are a few drawbacks to ratio analysis, which are as follows:
 Higher inflation effect: Several of the ratios are based on past prices. The variation in
pricing level in the long run is totally disregarded. Historical cost accounting overlooks
the effects of liquidity and does not represent the current worth of financial reports,
particularly whenever assets are bought by various groups at varying periods. Inflation is
not factored into the equation. Adjusted for inflation, actual values are not represented in
the accounting records. As a result, it's doesn't represent an organization's actual and
equitable financial position (Werning and Spinler, 2020).
 Accounting Standards Change- For a same operation, different groups employ various
processes and procedures. It complicates comparing two firms challenging and may lead
to inaccuracy findings. Moreover, whenever a company's accounting standards change, it
may have a big influence on financial statements. In such circumstances, the financial
conditions used for accounting ratios may be changed, and the findings collected before
the modifications cannot be contrasted. The adjustments are usually noted in the
accounting records' comments, and they might be overlooked at sometimes.
 Historical Data: The data used to calculate ratios is obtained from actual prior data posted
by the firm. As a result, owing to the unstable economic environment, it is not assured
that the corporation will continue to follow the same patterns in the foreseeable. In
addition, the statistics in the balance sheet and certain of the elements of the financial
statements are reported at book value. As a consequence, the ratio calculation is peculiar.
 Operational Vary- An organization's existing component may shift significantly over
time, to the point where ratios established a few years ago and contrasted to different
proportions estimated now may produce deceptive findings and inferences about the
corporation's status and overall prospects. It may be shown as the adoption of a constraint
analysis results in lower expenditures in the business's fixed assets, and the proportion
may indicate that the total interest investment portfolio is getting a bit old (Geszler,
2020).

PORTFOLIO 2
Investment Appraisal techniques
Capital investments include large outlays, necessitating an anticipated before the evaluation to
determine the financial feasibility of the planned investments. Organizations use a variety of
approaches to make financial decision, including internal rate of return, discounted payback
time, income approach, present value, and so on (Ramaswamy and Ozcan, 2020). The most
suitable investment assessment in the given scenario with the available facts is net present value
(NPV). The following are the NPV estimates 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
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: The total of the expected future cash flows of the planned project, net of upfront
outlay, is referred to as net current value. As either a discounting rate, the cost of capital is used.
According to this technique, the administration must choose the alternative with the highest net
value. Project A has a larger Net Present Value than the other various tasks, making it more
acceptable for administration to choose.
Limitations of using investment appraisal techniques in long term decision making
To determine the financial feasibility of a project proposal, investment evaluation
methodologies are required. Manager must determine capital investment approaches using a
number of different methodologies (Mandičák and et.al, 2020). The following are some of the
drawbacks of different financial evaluation methods:
 Difficulty in identifying suitable discounting rate - Establishing an acceptable
discounting rate is one of the most challenging parts of evaluating various financial ideas.
The discounting rate is often used to calculate the discounted cost of capital inflows. This
rates is influenced by a variety of variables, including the degree of responsibility
associated, the precision with which calculations are made, and so on, all of these are
susceptible to errors. Furthermore, elements such as hazards change with time, and
picking the wrong rate of interest may be very costly to a firm. A seemingly innocuous
error such as selecting the improper discounting rate can have disastrous consequences
for a company’s financial position.
 Investment size – It is commonly assumed that a larger NPV indicates a superior
investment, but this ignores the simple reality that even if two investments are examined,
the one with investment returns inflow will certainly have a positive Return. However, a
greater NPV does not just imply a better project, especially when the particular return
rate is taken into account. As a result, it is not appropriate to evaluate different tiers sizes.

Application framework yields must be emphasised rather than focussing on market prices
of projected cash inflows in order to get a better and more accurate view of feasibility of
a capital structure (Topor, 2020).
 Difficulty in predicting future cash flows and ascertaining cost of capital: The
Company evaluates the financial feasibility of preliminary results based on projected
future revenues, but transformation is difficult to forecast. Upcoming hazards, both
structured or unstructured, prospective rewards on investment and so on both are variable
and can evaluate information’s in the present. Such makes it tough not just to predict
figures in the ahead, and to manage such projections. The price of debt and the cost with
which the economic growth would spend, and its evaluation determines whether the
venture is worthwhile. If a firm over- either under its cost of debt, it may be hesitant to
work on the challenge or believe it is unworthy, and in either instance, the business may
skip out on a potential investment tool.
 Difficult to built common base: There really is no basic price or basis for analysing
investments amongst similar companies, so an expenditure that is excellent for one
business may not necessarily be excellent for just another. Such asset assessment
approaches, on the other hand, disregard such considerations and produce the same
results in both companies. The efficiency of such approaches is harmed as a result of this.
There really is no agreed-upon standard technique for determining accounting rate of
return, for instance.
 Ignores time value of money: The time worth of money is ignored by certain investing
strategies, such as payback period and accounting rate of return. Payback time also
disregards any cash flows cost of the investment beyond payback period, and also cash
flow schedules inside payback period. As a response, the suggested project's viability
rating is erroneous, and the financial advice responsible for the production could be
guaranteed to be true (Ngo, Mai, Siguaw and Jory, 2021).
 Complicated to understand: Payback period is a useful tactic to learn and apply,
however it does not determine proper sustainability as well as Net Present Value.
Nevertheless, understanding net present value is difficult and determining return on
equity needs technical skills on the side of management. Other methods, such as expected
return, are similarly difficult to comprehend because it is the pace at which NPV equals

zero. Non-traditional cash flows can result in numerous IRRs, and there is a significant
likelihood of conflicting IRR and NPV recommendations in mutually contradictory
ventures.
CONCLUSION
According to the aforementioned study, evaluating a corporation's economic performance is
crucial not only from a management standpoint, but also by the standpoint of shareholders. For
examination, a variety of methods and procedures are accessible. Management assesses financial
data to guarantee the most efficient use of cash, whereas buyers assess similar data to make
investment decisions. Organizations also use capital budgeting tools to evaluate the financial
feasibility of various financing options.

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