Financial ratio analysis and effects of the downturn experienced by Sainsbury

Contents
SAINSBURY’S OVERVIEW......................................................................................................................... 3
Company's vision for growth. ................................................................................................................. 3
Goals of Sainsbury’s ................................................................................................................................ 4
Accounting of Sainsbury ......................................................................................................................... 4
Financial Tools used for Sainsbury .......................................................................................................... 4
Ratio analysis .......................................................................................................................................... 4
1. Profitability Ratio Analysis .......................................................................................................... 5
a. Gross Profit Margin ................................................................................................................. 5
b. Net Profit Margin .................................................................................................................... 5
c. Return on Capital Employed ................................................................................................... 6
2. Liquidity Ratio Analysis ............................................................................................................... 6
a. Current Ratio ........................................................................................................................... 6
b. Quick Ratio .............................................................................................................................. 7
c. Shareholder's Liquidity............................................................................................................ 7
3. Efficiency/Activity Ratio Analysis ................................................................................................ 7
a. Accounts Receivable Turnover................................................................................................ 7
b. Accounts Payable Turnover .................................................................................................... 7
c. Inventory Turnover ................................................................................................................. 8
4. Investment Ratio Analysis ........................................................................................................... 8
a. Earnings per share .................................................................................................................. 8
b. Diluted EPS ............................................................................................................................. 8
5. Gearing Ratio .............................................................................................................................. 8
a. Return on equity ..................................................................................................................... 9
b. Cash flow to total assets ......................................................................................................... 9
c. Debt-to-equity ratio ................................................................................................................ 9
Limitations of Ratio Analysis ................................................................................................................... 9
Accounting Methods ........................................................................................................................... 9
Information Issues .............................................................................................................................. 9
Changes in account standard in 2008 and 2009 for Sainsbury ............................................................ 10
Effects of Financial Market on Sainsbury .............................................................................................. 10
Bibliography .......................................................................................................................................... 12
Appendix ............................................................................................................................................... 12

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 Financial ratio analysis and effects of the downturn experienced by Sainsbury

SAINSBURY’S OVERVIEW
According to the official website, Sainsbury’s is the third largest British supermarket chain. In 1869,
John James Sainsbury and Mary Ann Sainsbury established the largest supermarket chain -
Sainsbury’s in London. It grew to become the largest grocery retailer in 1922, pioneered self-service
retailing in the UK, and its heyday was during the 1980s. It has approximately 150,000 employees,
including part-time job 70% and 30% full time job. Sainsbury’s can supply 23,000 products to
customers, containing 40% the products with Sainsbury’s brand. Sainsbury’s supermarket provides
service to over 18,000,000 customers each week. It has a market share of around 16 per cent. It set
up about 502 branch stores, 290 convenience stores and Sainsbury’s bank in the U. K. 1

Sainsbury is the UK’s third largest supermarket. Their main competitors are Tesco, Asda and
Morrison. Sainsbury's name has been used in developing the company's own-brand products. This
approach has been applied to other product lines, such as economy goods and organic products. The
Sainsbury brand name has also been used to gain leverage for the business to diversify into the retail
banking market - a move which has since been copied by Tesco.

J Sainsbury PLC is the parent organisation controlling these operating companies: Sainsbury's
Supermarkets; Shaw's Supermarkets; Sainsbury's Bank; JS Developments, and Sainsbury's Property
Company. 2

One core aspect of Sainsbury's activities is its focus on customer/market segmentation. Sainsbury's
divide their customer base into 10 separate segments. Customer intelligence is gathered through
analysis of Nectar Card (formerly Reward Card) purchases. This information is used to tailor what
Sainsbury's offers in terms of goods and services to an appropriate market segment. Sainsbury's tries
to do this by having stores that are differentiated, reflecting the variety of market places that they
occupy.

In order to make the most of their 463 stores, these are classified according to three different
formats:

• 275 stores are classified as 'Main Mission' outlets. This means they concentrate on providing
for the weekly family shop. These stores vary in size between 20 000 and 48 000 square feet
• 64 stores are in the 'Main Plus' format. These are the very large supermarkets (otherwise
known as hypermarkets). They occupy in excess of 45 000 square feet area and focus on a
wider range of food products as well as more non-food items
• The remaining 124 stores are in the 'Mixed Mission' format. They include Sainsbury's Central
(which range from 7000 and 20 000 square feet) and Local stores (ranging from between 2000
and 6000 square feet area)

Company's vision for growth.

"Sainsbury plc's present focus is to improve the performance of the core UK supermarket chain.
Whilst doing so we will continue to explore and develop growth opportunities in other markets.

1
Sainsbury Online www.j-sainsbury.co.uk
2
Sainsbury Online www.j-sainsbury.co.uk

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 Financial ratio analysis and effects of the downturn experienced by Sainsbury

Through implementing 'Managing For Value' we will stretch our ambitions and challenge the
conventional wisdom within the Company, thereby unlocking our potential and delivering value." 3

Goals of Sainsbury’s
The goals of Sainsbury’s has been listed below. (14, J Sainsbury PLC page)

1. Best for Food and health.

2. Sourcing with Integrity.
3. Respect for our environment.
4. Making a positive difference to our community.
5. A great place to work.

Accounting of Sainsbury
Sainsbury annual fiscal year ends in the third week of March each year. They previously used the UK
GAAP accounting format up until 2005 and in 2006 they changed over to the IFRS. Their auditor is
PricewaterhouseCoopers. The company uses the going concern concept 4.

Financial Tools used for Sainsbury

The financial tools used are the Income statement, Balance sheet, Cash flow statement and financial
ratios. (MONEY, MSN) 5

Ratio analysis
A tool used by individuals to conduct a quantitative analysis of information in a company's financial
statements. Ratios are calculated from current year numbers and are then compared to previous
years, other companies, the industry, or even the economy to judge the performance of the
company. Ratio analysis is predominately used by proponents of fundamental analysis. 6 (RATIO
ANALYSIS, Investopedia)

A three year comparative analysis and the effect of financial crisis over the company financial
performance of Sainsbury is demonstrated by the following ratio below.

 Profitability Ratio Analysis

o Gross Profit Margin
o Net Profit Margin
o Return on Capital Employed (ROCE)

3
Sainsbury Online www.j-sainsbury.co.uk
4
This ensures that the company will continue to operate in the foreseeable future.
5
Financial information obtained from MoneyCentral MSN website the link has been provided in Bibliography.
6
The information has been taken from the website of Investopedia.

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 Financial ratio analysis and effects of the downturn experienced by Sainsbury

 Liquidity Ratio Analysis

o Current Ratio
o Quick Acid Test
o Shareholder’s Liquidity

 Efficiency/Activity Ratio Analysis

o Debtor Days
o Creditor Days
o Stock Turnover

 Investment Ratio Analysis

o Earnings per share
o Diluted Earnings per share
 Gearing Ratio Analysis
o Debt-to-equity ratio
o Return on equity
o Cash flow to total assets

1. Profitability Ratio Analysis 7

When new investors consider that whether they can invest the money into the company, the profit,
cost and expense about the company are the first step they have to notice.

Years 2009 2008 2007 2006

Gross Profit Margin 5.48% 5.62% 6.83% 6.64%
Net Profit margin 3.56% 2.97% 3.03% 0.65%
Return on Capital Employed (ROCE) 9.46% 7.10% 7.59% 1.31%

a. Gross Profit Margin

GPM over the 2008 and 2009 have decreased slightly from 5.62% to 5.48% due to the
downturn. Interestingly though, sales increased throughout 2006 to 2009, however,
expenses also increased contributing to the slight decrease in the GPM . Because of
decreased disposable household income Sainsbury acted swiftly to diversify risks to ensure
they maintain their GPM 8.

b. Net Profit Margin

Net Profit Margin increased from 2.97% to 3.56% from 2008 to 2009 which is a 16%
increase and by 0.53% over 2006 to 2009. The net profit margin shows how well Sainsbury’s
control its overheads. These increases continue despite the economic slowdown showing
their financial power. Because strategic plans were properly planned and executed and sales
volume increased without increasing costs.

7
The calculation done is shown in the excel sheet attached in the appendix.
8
From the annual report of Sainsbury 2008 and 2009.

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 Financial ratio analysis and effects of the downturn experienced by Sainsbury

c. Return on Capital Employed

An investor might compare the return on capital employed and return on equity with the
possible return if the money was invested elsewhere. ROCE from 2008 to 2009 increased
from7.10% to 9.46% mainly because of proceeds attained from property disposal, used to
finance overall operations 9. From 2007 to 2008, however, it decreased slightly because of oil
related costs and increased business rates 10. Therefore, Sainsbury’s have to think about
some measures to get more profit from the business to attract more investors. Ordinary
(equity) capital has higher return, also has the higher risky if the business fail. So the ROCE
and ROE must be far greater than return that could be earned a safe investment.
Nevertheless, the general trend from 2006 to 2009 indicates proper assets utilisation and
investor confidence.

2. Liquidity Ratio Analysis 11

Using current ratio, we can focus on current assets and current liabilities. By calculation, the
shareholders could know that Sainsbury’s holds the number of money and how the business of
Sainsbury’s performs. It is also known as the working capital ratio. But actually the ratio that tests
the liquidity of capital for the Sainsbury’s is the acid test ratio or quick ratio. Liquidity ratios are
financial ratios measuring the company’s ability to meet short-term obligations. Sainsbury liquidity
ratio analysis is illustrated in Table below.

Years 2009 2008 2007 2006

Current Ratio 0.55 0.65 0.70 0.79
Quick Ratio 0.31 0.39 0.49 0.67
Shareholder's Liquidity 1.66 2.24 1.86 0.98

a. Current Ratio
If the current ratio is between 1.5:1 and 2:1, it means that the business will have sufficient
liquid resources. But from 2008 to 2009, the current ratio of Sainsbury’s was much lower
than the 1.5:1 and 2:1. It can show that the business may be argued that its business does
not have enough working capital. Its business may be over borrowing or overtrading.
However, Sainsbury’s is a retailer, and retailers often have very low current ratios, perhaps
1:1 or below. The above Table indicates that Sainsbury has adequate current assets to match
their current liabilities; however in 2009 the current ratio dropped slightly below the
previous year 2008 . Current assets are continuing to decrease most likely from investing
rigorously in long-term ventures or because current liabilities are rising faster than current
assets. Sainsbury used their liquid assets to finance their business through marketing and
promotions to make it profitable, hence profitable during the downturn.

It is common to see that the current ratio of retailers is 1:1 or below it. But Sainsbury’s still
need to improve its current ratio by increasing its current assets relative to its current
liabilities, or reducing its current liabilities relative to its current assets. Maybe Sainsbury’s

9
From the annual report of Sainsbury 2009.
10
From the annual report of Sainsbury 2008.
11
The calculation done is shown in the excel sheet attached in the appendix.

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 Financial ratio analysis and effects of the downturn experienced by Sainsbury

can improve its current assets though controlling the credit to the companies. Current
liabilities could be reduced by reducing short term creditors.

b. Quick Ratio
Quick Ratio illustrates a steady decline by almost 50% over 2006 to 2009. If the quick ratio of
the business is less that 1:1, it represents its current assets less stocks do not cover its
current liabilities. From the table, it can be seem that all the acid test ratios were below 1:1.
Again, retailers have their strong cash flow. They can operate comfortably with acid test
ratios of less than 1. Nevertheless, Sainsbury has a remarkable debtor payment period 12 and
recovered debts quickly even during the downturn. Therefore, the decline in the quick ratio
may have resulted from investing in long-term activities to ensure profitability and increase
market share.

c. Shareholder's Liquidity
Shareholder’s Liquidity have increased during the downturn overall by 25% but declined in
2009. However, the figures from Table illustrates that shareholders should be satisfied as
Sainsbury is still managing to remain profitable well into the long-term.

3. Efficiency/Activity Ratio Analysis

The efficiency ratio or activity ratio can express that how Sainsbury’s measure effectively a
business and the resources of business.

Years 2009 2008 2007 2006

Accounts Receivable Turnover 3 2 2 45
Accounts Payable Turnover 35 37 39 35
Inventory Turnover 14 15 13 14
a. Accounts Receivable Turnover
The period of debt collection for Sainsbury’s is about 3 days. It prefers a short debt
collection period because the cash flow will be improved. Sainsbury’s had the lower
debt collection period, because it is a retailer. Most of their sales are for cash.
Sainsbury’s sales will be for cash and the debtors’ value on the balance sheet is likely to
be for not customer debts. So the director of Sainsbury’s will be willing to look at the
lower figures, as the fewer days. It means that they can get back the money quickly.

b. Accounts Payable Turnover

The period of credit collection for Sainsbury’s has been down from 35 days to 37 days in
2008 and 2009 respectively. Credit collection period means how long Sainsbury’s pay
the money to the suppliers. So it is certainly that they are willing the longer days to pay
the money back to suppliers, especially the retailers. If Sainsbury’s have more time to
pay back the money, they not only have much more capital at that moment, but also
have much more liquidities to be working capital.

12
Please look at the Accounts Receivable Turnover which is very low.

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 Financial ratio analysis and effects of the downturn experienced by Sainsbury

c. Inventory Turnover
Stock turnover differs considerably between different markets. The days of stock
turnover for Sainsbury’s were around 15 days. It shows that they sell the value of their
average stock every two weeks. But in manufacturing market, it generally has much
slower stock turnover as the time spent processing raw materials.
As a result of faster stock turnover, Sainsbury’s is not likely to hold very much stock. In
the past two years, the stock turnover of Sainsbury’s has not worsened. Those were
around the common figures which the investors were willing to see. Nonetheless,
Sainsbury also stock household and domestic items which remains a long while to be
rotated.

4. Investment Ratio Analysis

Years 2009 2008 2007 2006

EPS 16.48% 18.83% 18.74% 3.74%
Diluted EPS 16.39% 18.62% 18.90% 3.78%

a. Earnings per share

EPS is the portion of a company's profit allocated to each outstanding share of common
stock. EPS serves as an indicator of a company's profitability. EPS fell by 16.48% in 2009 from
18.83% in 2008 , shareholders therefore received a lower rate per share in 2008-2009.
However, balance sheet and cash flow statements reveal that shareholders are investing by
acquiring properties to access more space for future expansion.

b. Diluted EPS

Diluted EPS slightly declined by the same rate as EPS from 2008-2009. This is not a major
concern for Sainsbury presently, since it shows that shareholders are willing to forego some
of their personal wealth to ensure the business remains profitable.

5. Gearing Ratio

Creditors are likely to be considered about a firm’s gearing, loan. Dividends do not have to be paid to
ordinary shareholders. As Sainsbury’s becomes so higher geared, it is considered more risky by
creditors. Sainsbury’s may prefer to extra capital by borrowing rather than getting the capital from
the shareholders. They retain control well of the business. And in the ratio part, we have analysis the
gearing ratio of Sainsbury’s. Gearing affects the shareholders wealth, and it has the other factors to
influence the shareholders wealth, like return on equity and cash flow to total assets.

Years 2009 2008 2007 2006

Return on equity 6.60% 6.67% 7.47% 1.65%
Cash flow to total assets 9.15% 8.02% 7.77% 4.90%
Debt-to-equity ratio 0.49 0.41 0.47 0.82

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 Financial ratio analysis and effects of the downturn experienced by Sainsbury

a. Return on equity

From the table we see that the return on equity in fluctuation during the years of 2008
to 2009 and efficiency of business for Sainsbury’s. Investors often look at the return on
equity that they are high and growing. In 2009, return on equity of Sainsbury’s was
slightly lower than 2008. It means that how much profit it can produce given the
resources providing its shareholders.

b. Cash flow to total assets

About cash flow to total assets, between 2008 and 2009, the cash flow to total assets of
Sainsbury’s increased from 8.02% to 9.15%. Although the figures of ratios were not
quite good for the company, all ratios are below 10%. Sainsbury’s may have some
concerns.

c. Debt-to-equity ratio

The Debt-to-equity ratio increased by 17% from 0.41 to 0.49 in 2008-2009 indicating
that risks are increasing due to the changes that were made to survive the economic
slowdown. Interest rates decreased considerably causing imports to be more costly and
the gearing ratio to increase due to market volatility.

Limitations of Ratio Analysis

Ratio analysis uses parts of a financial statement to compute various ratios, then, using a system
known as benchmarking, compares the ratios of one company to those of another company or to
the ratios for an industry. Ratio analysis is a widely used concept, but does have several limitations
that must be considered before using the analysis. 13

Accounting Methods

The business can use creative accounting to indicate enhanced performance which can be
misleading to the users. Window-dressing can occur to improve current and quick ratios to make
balance sheet and cash flow statement look better.

Information Issues

During the downturn the ratios may not reflect the true overview of the company. The ratios can
supply some information to Sainsbury performance or financial position but when used alone, it
cannot suggest whether performance was good or poor.
Additionally, information in the financial statements can be outdated during the year depending on
when the financial year ends. It may not indicate the current financial status of the company
especially before or during a downturn. Sometimes, at the end of the financial year, it may not
present a true reflection of the overall year’s performance.

13
General Limitations of Ratio Analysis http://www.ehow.com/list_6626788_general-limitations-ratio-
analysis_.html?ref=Track2&utm_source=ask

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 Financial ratio analysis and effects of the downturn experienced by Sainsbury

Changes in account standard in 2008 and 2009 for Sainsbury 14

The unprecedented economic slowdown and reducing job security has resulted in an increasing
demand for value from customers. Challenges to household disposable income, competitor pricing
positions and product costs can affect the performance of the Group in terms of both sales and
costs. (PAGE 22, Annual report 2009)

In 2008 there were new standards or amendment for International Financial Reporting Standards
which Sainsbury in its annual report has told that it's not yet effective and concluded that except for
the amendment to IFRS 2 ‘Share based payment’, they are either not relevant to the Group or that
they would not have a significant impact on the Group’s financial statements, apart from additional
disclosures. The Group was assessing the potential effect of the amendment to IFRS 2 ‘Share-based
payment'. Two new accounting standard were implemented. (ANNUAL REPORT 2008, Page 39
Sainsbury)

 IFRIC 12 ‘Service Concession Arrangements’

 IFRIC 14 ‘IAS 19 — The Limit on a Defined Benefit Asset, Minimum Funding Requirements
and their Interaction’

In 2009 the group is yet to include IFRS 2 ‘Share based payment’ to its report and is currently
assessing the potential effect of the amendment to IFRS 2 ‘Share-based payment’ (ANNUAL REPORT
2009, Page 47 Sainsbury)

Effective Accounting standard for the Sainsbury in future financial years.

 Revised IFRS 3 ’Business Combinations’ and consequential amendments to IAS 27

‘Consolidated and separate financial statements’, IAS 28 ‘Investment in Associates’ and IAS
31 ‘Interests in Joint Ventures’.
 Amendments to IAS 39 ‘Financial Instruments: Recognition and Measurement’ relating to
eligible hedged items, embedded derivatives when reclassifying financial instruments.
 I FRIC 17 ‘Distributions of Non-cash Assets to Owners’.
 Amendments to various IFRSs and IASs arising from April 2009 Annual Improvements to
IFRSs.

Effects of Financial Market on Sainsbury

In 2008, all the companies faced the credit crunch and met the recession. That year is the
challenged and competitive year. The companies must get more effort in the particular markets to
cope with drastic competition, like the supermarkets in the U.K. For responding to those pressures,
accounting tools have been developed to ensure on financial performance and create competitive
advantages. The One of crucial tools which helps management in making strategic decision is cost
accounting. Financial crisis did not have much impact on Sainsbury but still it experienced slow
growth rate when compared to past trend.

14
Sainsbury Annual Reports 2008 and 2009

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 Financial ratio analysis and effects of the downturn experienced by Sainsbury

In 2008, Sainsbury experienced a slower sales growth when compared to past trends. The effects of
the downturn caused Sainsbury to put measures in place to increase profitability in 2009. Some of
the changes to strategies they made are discussed below.

• Increase in unemployment, rise in food inflation and decrease in disposable income.

Household budgets were clearly under pressure from the effects of the downturn. Sainsbury
had to slash the cost of essentials and basic products as customers faced the biggest
squeeze on income in 50 years. Marketing strategy shifted to focus on cost and their value
chain was adjusted to improve layout, increase space, future hedge with suppliers, and shed
off unnecessary costs. Customers were demanding low cost products and Sainsbury adjusted
to suit demands.
• Decreased Interest rate and decreased CPI annual inflation rate.
Sainsbury benefited from decreased interest and CPI inflation rates as more customers were
able to take advantage of lower borrowing. Sainsbury took advantage of this by lowering
prices, and intensified marketing of their cheaper own label goods.
• Lifestyle changes.
As the economy dipped, more people chose to prepare home-cooked meals to eliminate the
costs attached to eating out. Penny-pinched consumers depended on Sainsbury to provide
low cost vegetables and meats from tied in suppliers.
• Competitive rivalry, customer loyalty.
Fierce competition caused Sainsbury to focus on value, price and advertising while
reinforcing excellent customer service Sainsbury annual report (2009) stated that a clear
strategy was developed to focus on five main areas: great product at fair prices, increase
growth of non-food ranges, additional marketing channels to reach more customers,
increase space and active property management (includes disposal of property and investing
in increasing space in profitable areas). Sainsbury increased promotions and marketing
strategies such as ‘Making Sainsbury’s Great Again’, loyalty discount cards, online shopping,
cheaper and high quality own brand goods and increase in technology and faster checkout
time. They additionally branched out spreading risks into the financial sector, oil-related
areas and department stores.

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 Financial ratio analysis and effects of the downturn experienced by Sainsbury

Bibliography
14, J Sainsbury PLC page. [online]. [Accessed 03 Aug 2010]. Available from World Wide Web:
<http://www.j-sainsbury.co.uk/files/reports/ar2009_report.pdf>

ANNUAL REPORT 2008, Page 39 Sainsbury.

ANNUAL REPORT 2009, Page 47 Sainsbury.

MONEY, MSN. [online]. [Accessed 03 Aug 2010]. Available from World Wide Web:
<http://ca.moneycentral.msn.com/investor/invsub/results/statemnt.aspx?Symbol=GB%3aSBRY>

PAGE 22, Annual report 2009.

RATIO ANALYSIS, Investopedia. [online]. [Accessed 04 Aug 2010]. Available from World Wide Web:
<http://www.investopedia.com/terms/r/ratioanalysis.asp>

Appendix

• Excel sheet of income, cash flow, balance sheet and working of ratio

Working excel
sheet.xlsx

• Annual report of Sainsbury 2006, 2007, 2008 and 2009

ar2009_report.pdf ar2008_report.pdf ar2007_report.pdf ar2006_report.pdf

12