Introduction:

Financial statements analysis s is one of the tools that a business can use to evaluate the past performance and make predictions about the future performance. Ratio analysis is one of the quickest analysis tools that can give an indication of business performance in areas such as profitability, liquidity, asset utilisation and business efficiency among others. Ratio analysis uses historical data which is readily available and hence it provides information about past performance which can be used to predict future performance. This paper looks at various ratios for WM Morison followed by an explanation of the ratios and the relevance to the future of the business (Fridson & Alvarez,2011).

a)    Ratio calculations:

Gross profit Margin:

This is a profitability ratio that measures gross profit as a percentage of sales in the business. It is measured as follows:

Gross profit Margin=Gross profit/sales*100%

Year

2010

2011

2012

2013

2014

Gross profit

     1,062.00

     1,148.00

     1,217.00

     1,206.00

     1,074.00

Sales

   15,410.00

   16,479.00

   17,663.00

   18,116.00

   17,680.00

Gross profit Margin

6.89%

6.97%

6.89%

6.66%

6.07%

 

Mark up Ratio:

This is a measure of the profitability as a fraction of the cost and hence shows by how much the profits have covered the costs of goods. Mark up=gross profit/Cost of goods*100%

Year

2010

2011

2012

2013

2014

Gross profit

     1,062.00

     1,148.00

     1,217.00

     1,206.00

     1,074.00

Cost of Goods

   14,348.00

   15,330.00

   16,446.00

   16,909.00

   16,607.00

Mark Up

7.40%

7.49%

7.40%

7.13%

6.47%

Margin

6.89%

6.97%

6.89%

6.66%

6.07%

 

Net Profit Ratio:

This a measure the fraction of sales that constitutes the net profit or net profit as a percentage of sales.Net profit ratio=profit after tax/sales*100%

Year

2010

2011

2012

2013

2014

Profit after tax

-       238.00

         647.00

         690.00

         632.00

         598.00

Sales

   15,410.00

   16,479.00

   17,663.00

   18,116.00

   17,680.00

Net profit Margin

-1.54%

3.93%

3.91%

3.49%

3.38%

 

Return on Capital Employed:

This is a profitability ratio that measures how the capital committed in the business performed over one year period. ROCE=EBIT/Capital employed EBIT is the profit before interest and tax while Capital employed is the Shareholder funds added to debt or Total assets less current liabilities.

Year

2010

2011

2012

2013

2014

EBIT

-           95.00

         949.00

         973.00

         904.00

         907.00

Total Assets

    10,729.00

   10,527.00

     9,859.00

     9,149.00

     8,760.00

Current Liabilities

2873.00

2334.00

2303.00

2086.00

2152.00

Capital employed

      7,856.00

     8,193.00

     7,556.00

     7,063.00

     6,608.00

ROCE

-1.21%

11.58%

12.88%

12.80%

13.73%

 

 

 

 

 

 

 

Return on Equity:

This measures the value created by the shareholders Equity in business. Return on Equity=Net Profit/Shareholder Equity.

 

ROE before Tax

         

Year

2010

2011

2012

2013

2014

Net Profit before Tax

-           (95.00)

        949.00

        973.00

        904.00

         907.00

Shareholder Equity

      4,692.00

    5,230.00

     5,397.00

    5,420.00

     4,949.00

ROE

-2.02%

18.15%

18.03%

16.68%

18.33%

ROE after Tax

         

Year

2010

2011

2012

2013

2014

Net Profit before Tax

      -(238.00)

        647.00

        690.00

        632.00

         598.00

Shareholder Equity

      4,692.00

    5,230.00

     5,397.00

    5,420.00

     4,949.00

ROE

-5.07%

12.37%

12.78%

11.66%

12.08%

 

Interest Cover:

This ratio measures the ease with which a company can pay interest on debt instruments. Interest cover=EBIT/Interest Expense

Year

2010

2011

2012

2013

2014

EBIT

-           95.00

        949.00

        973.00

        904.00

         907.00

Interest Expense

            82.00

          70.00

           26.00

          30.00

           49.00

Interest Cover

-1.16

13.56

37.42

30.13

 18.51

 

Gearing ratio:

This is the proportion of the firm’s capital that constitutes debt and shows how the firm uses a mix of both equity and debt to carry out its operations. The following measures can be used to describe gearing: Debt to Equity which is Long term Debt divide by Equity and the Total Debt to Equity which is both long term and short-term debt divided by Equity.

Total debt to Equity

         

Year

2010

2011

2012

2013

2014

Total debt

      6,037.00

    5,297.00

     4,462.00

    3,729.00

     3,811.00

Equity

      4,692.00

    5,230.00

     5,397.00

    5,420.00

     4,949.00

Gearing Ratio

1.29

1.01

0.83

 0.69

0.77

           
           

Long term Debt to Equity

       

Year

2010

2011

2012

2013

2014

Long Term Debt

      3,164.00

    2,963.00

     2,159.00

    1,643.00

     1,659.00

Equity

      4,692.00

    5,230.00

     5,397.00

    5,420.00

     4,949.00

Gearing Ratio

0.67

0.57

0.40

0.30

0.34

 

Stock turnover:

Stock turnover is one of the most commonly used efficiency ratio and measures the movement of stock in and out of the business. Stock Turnover= Cost of Goods/Average Inventory.

Year

2010

2011

2012

2013

2014

Cost of Goods

    14,348.00

  15,330.00

  16,446.00

  16,909.00

   16,607.00

Average Inventory

          852.00

        781.00

        759.00

        638.00

         577.00

Gearing Ratio

16.84

19.63

21.67

26.50

28.78

 

b)    Discussion on ratios:

Ratio analysis is one of the most powerful tools in evaluating the past performance of a business entity and hence the important leads in predicting the future of the business. Ratios allows for comparison of different companies in different industries regardless of their sizes. The data for calculating ratios are easily available from the company financial statements such as the balance sheet, income statement and the cash flow statements. Financial ratios therefore give a clear indication of the weakness and strength of business (Tracy,2012).From the financial ratios for WM Morrison calculated we can make the following observations:

The company has seen fairly constant level of profitability throughout the five year period and as seen in the gross profit and the net profit ratios there was a slight decline from 6.89% to 6.07% between 2010 to 2014.The Company realised of net profit of approximately 4% throughout the period except 2010 when it made losses. The two ratios indicate a weak performance over the period as the company could not realise double digit percentage performance. There is a growing trend of high costs of production that has eaten into its profits. The operating expenses are however lower as seen from the slight difference between the gross profit ratio and the net profit ratio. The company therefore need to check on ways of controlling costs of production (Tracy, 2012). Other return ratios such as such as ROCE and ROE were steadily on an increasing trend and as such the firm recovered from negative levels of ROCE in 2010 to positive figures of 11% in 2011 and 14% in 2014.The same trend was evidence in ROE after tax which was negative in 2010 but returned positive in 2011 and maintained the trend of 18% throughout the period to 2014 (Tracy, 2012).

            Gearing ratio is another key financial ratio that has been evaluated in the company and as such the calculation strengthening position in gearing. Debt to Equity Ratio for instance shows that the company has improved from 1.2:1 to 0.77:1 over the period. This means that the company has been gradually reducing the level of debt financing and hence the interest payment burden (Fridson & Alvarez,2011). The long term debt component is very low and hence the reduction in long term debt to Equity ratio from 0.67:1 in 2010 to 0.34:1 in 2014.This is also a pointer that the firm short term liabilities need to be efficiently managed. Another key indicator strengthening gearing position is the interest cover which has shown an improved position from negative 1.2 in 2010 to 18 in 2011 and further 37 and 30 in 2012 and 2013 respectively. This position has however weakened possibly due to a high magnitude of interest payment coupled with declining net profits in 2014.Generally the firm is in a better position since it’s not highly geared (Tracy,2012).

Efficiency in operations is another key area in business and hence the calculation of efficiency ratios shows how good the management are using the business resources in the course of achieving the business objectives. Stock turnover is an important measure of efficiency in management operations with regards to inventory processes. The stock turnover measures the ability of the firm to turn its inventory into sales and hence the higher the number the more efficient the company is. The company has seen a very steady increase in its stock turnover and hence it means it has turned the stock into sales many times from 17 in 2010 to 29 in 2014.This indicates efficient inventory processes. It should however be noted that stock turnover must also be matched with client needs and hence inadequate supplies could lead to higher figure yet clients have to wait as stock runs out faster (Tracy,2012).

Although the company has done well in areas of gearing and some parts of efficiency, much needs to be done in other areas of operational efficiency such as account receivables and payables which is seen as the weakest point in the company. Production costs must also be checked as this is the biggest problem in achieving higher profitability (Mayo.2013 p.282).

It should however be noted that the ratios figures given above were historical and hence the business environment may change thereafter and hence they cannot be relied upon to predict the future performance of the business. The ratios also leads to decision making based on past information that could be irrelevant in the future. Ratios are only meaningful when compared with others from other companies or industry and hence the company will need to get comparable ratios to derive accurate meaning from them (Mayo.2013 p.282).

c)     Liquidity of the Business:

Liquidity is a ratio that shows how good the firm is able to meet its short term obligations during the normal course of the business operations. Liquidity ensures that the firm has enough cash or cash equivalents that can easily be converted to cash to meet liabilities. The two common liquidity measures are current ratio and quick ratio. Current ratio measures how the current assets are able to cover the current liabilities (Sagner,2010). A very accurate measure such as quick ratio measures how the firms cash and near cash securities can cover the current liabilities. The liquidity ratios are calculated below:

Current Ratio:

         

Year

2010

2011

2012

2013

2014

Current Assets

      1,430.00

    1,342.00

     1,322.00

    1,138.00

     1,092.00

Current Liabilities

      2,873.00

    2,334.00

     2,303.00

    2,086.00

     2,152.00

Current Ratio:

0.50

0.57

0.57

0.55

0.51

Quick Ratio

         

Year

2010

2011

2012

2013

2014

Current Assets

      1,430.00

    1,342.00

     1,322.00

    1,138.00

     1,092.00

Less Inventory

          852.00

        781.00

        759.00

        638.00

         577.00

Net Current Assets

578.00

561.00

563.00

500.00

515.00

Current Liabilities

      2,873.00

    2,334.00

     2,303.00

    2,086.00

2152.00

Quick Ratio

               0.20

             0.24

             0.24

             0.24

                   0.24

The calculations above shows a lower ratio for both current ratio and quick ratio and this basically means that the firm is struggling to meet its short term debt obligations. A current ratio of 0.5 throughout the five year period and the same for quick ratio at 0.2.

A closer look at other competitors shows a similar trend as shown below:

The liquidity ratios for Tesco:

Current Ratio:

         

Year

2010

2011

2012

2013

2014

Current Assets

                   -  

  12,039.00

  12,863.00

  13,096.00

   15,572.00

Current Liabilities

                   -  

  17,731.00

  19,249.00

  18,985.00

   21,399.00

Current Ratio:

0.00

0.68

0.67

0.69

0.73

Quick Ratio

         

Year

2010

2011

2012

2013

2014

Current Assets

                   -  

  12,039.00

  12,863.00

  13,096.00

   15,572.00

Less Inventory

                   -  

    3,162.00

     3,598.00

    3,744.00

     3,576.00

Net Current Assets

0.00

    8,877.00

     9,265.00

    9,352.00

   11,996.00

Current Liabilities

                   -  

  17,731.00

  19,249.00

  18,985.00

21399.00

Quick Ratio

                   -  

             0.50

             0.48

             0.49

                   0.56

 

Liquidity ratios for Sainsbury:

Current Ratio:

         

Year

2010

2011

2012

2013

2014

Current Assets

                   -  

    1,721.00

     2,032.00

    1,914.00

     4,369.00

Current Liabilities

                   -  

    2,942.00

     3,136.00

    3,115.00

     6,765.00

Current Ratio:

0.00

0.58

0.65

0.61

0.65

Quick Ratio

         

Year

2010

2011

2012

2013

2014

Current Assets

                   -  

    1,721.00

     2,032.00

    1,914.00

     4,369.00

Less Inventory

                   -  

        812.00

        938.00

        987.00

     1,005.00

Net Current Assets

0.00

        909.00

     1,094.00

        927.00

     3,364.00

Current Liabilities

                   -  

    2,942.00

     3,136.00

    3,115.00

6765.00

Quick Ratio

                   -  

             0.31

             0.35

             0.30

              0.50

 

 

 

 

 

 

 

From the above ratios it’s very clear that the industry has very low levels of liquidity as seen in all the three companies. This shows that the firms operate with high levels of short term debts and low levels of working capital. It’s however worth noting that both Sainsbury and Tesco have a slightly higher liquidity level compared to Morrison. They have an average of 0.65 in current ratio and 0.5 for quick ratio for the between 2011 and 2014.This is higher than Morrison that posted 0.5 current ratio and 0.2 quick over the same period. Morrison must therefore work on its working management to be more liquid but the industry in general operates with low liquidity levels (Sagner, 2010).

 

 

 

 

References:

Fridson,S.M. & Alvarez,F.(2011). Financial Statement Analysis: A Practitioner's

Guide. John Wiley & Sons.

Mayo, H. (2013).Investments: An Introduction. Cengage Learning

Tracy,A.(2012). Ratio Analysis Fundamentals: How 17 Financial Ratios Can Allow

You to Analyse Any Business on the Planet. Ratio Analysis.net.

Sagner,J.S.(2010).Essentials of working capital management. Hoboken, NJ: Wiley.

 

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