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A / General information about Tesco plc and J Sainsbury plc

Tesco plc was founded in 1924. It is one of the world’s largest retailers with operations in 14
countries, employing over 492,000 people and serving millions of customers every week. Tesco
always try to create value for customers and put them at the heart of the business. One of Tesco’s
biggest competitors is J Sainsbury

“J Sainsbury plc was founded in 1869 and today operates a total of 934 stores comprising 557
supermarkets and 377 convenience stores. The Sainsbury’s brand is built upon a heritage of
providing customers with healthy, safe, fresh and tasty food. Quality and fair prices go hand-in-
hand with a responsible approach to business (Sainsbury annual report, 2011)”.

B / Financial comparison between Tesco and Sainsbury using ratio

analysis

All of the figures used to calculate the following ratios are highlighted in yellow in
Appendix 1 and 2

 Table 1 : Accounting ratios for Tesco (Appendix 1)

Tesco Plc 2011 2010

Gross profit percentage

Gross profit × 100 5060 × 100 = 8.3% 4607 × 100 = 8.1%

Sales revenues 60931 56910

Operating profit percentage

Operating profit × 100 3811 × 100 = 6.25% 3457 × 100 = 6.07%

Sales revenues 60931 56910

Percentage change in revenue

(Current year revenue – previous year revenue) × 100 (60931 – 56910) × 100 = 7.06%
Previous year revenue 56910

Major expenses to revenue ( administrative expenses)

Expenses × 100 1676 × 100 = 2.75% 1527 × 100 = 2.68%

Sales revenues 60931 56910

Return on capital employed

Operating profit × 100 3811 × 100 3457 × 100

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Total equity + non-current liabilities 16623 + 12852 14681 + 15327

= 12.9% = 11.5%
Acid test ratio

Current assets – inventories 11438 – 3162 11392 – 2729

Current liabilities 17731 16015

= 0.47 : 1 = 0.54 : 1

Inventory ratio

Inventories × 365 days 3162 × 365 days 2729 × 365 days

Cost of sales 55871 52303

= 21 days = 19 days

Gearing ratio

Non-current liabilities × 100 12852 × 100 15327 × 100

Total equity + non-current liabilities 16623 + 12852 14681 + 15327

= 43.6% = 51%

Basic earnings per share

Profit attributable to owners of the parent 2655 = 33.10 p 2327 = 29.33 p

Number of ordinary shares in issue 8020 7933

Dividend yield

Dividend per share × 100 14.46 × 100 = 3.56% 13.05 × 100 = 3.1%
Market price per share 406.05 420

Dividend cover

Earnings per share 33.10 = 2.29 : 1 29.33 = 2.25 : 1

Dividend per share 14.46 13.05

 Table 2 : accounting ratios for Sainsbury (Appendix 2)

J-sainsbury 2011 2010

Gross profit percentage

Gross profit × 100 1160 × 100 = 5.5% 1082 × 100 = 5.4%

Sales revenues 21102 19964
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Operating profit percentage

Operating profit × 100 851 × 100 = 4.03% 710 × 100 = 3.56%

Sales revenues 21102 19964

Percentage change in revenue

(Current year revenue – previous year revenue) × 100 (21102 – 19964) × 100 = 5.7%
Previous year revenue 19964

Major expenses to revenue ( administrative expenses)

Expenses × 100 417 × 100 = 1.98% 399 × 100 = 1.99%

Sales revenues 21102 19964

Return on capital employed

Operating profit × 100 851 × 100 710 × 100

Total equity + non-current liabilities 5424 + 3033 4966 + 3096

= 10% = 8.8%
Acid test ratio

Current assets – inventories 1708 – 812 1797 – 702

Current liabilities 2942 2793

= 0.3 : 1 = 0.39 : 1

Inventory ratio

Inventories × 365 days 812 × 365 days 702 × 365 days

Cost of sales 19942 18882

= 15 days = 14 days

Gearing ratio

Non-current liabilities × 100 3033 × 100 3096 × 100

Total equity + non-current liabilities 5424 + 3033 4966 + 3096

= 35.9% = 38.4%

Basic earnings per share

Profit for the financial year 640 = 34.4 p 585 = 32.1 p

Number of ordinary shares in issue 1858.7 1821.7

Dividend yield

Dividend per share × 100 15.1 × 100 = 4.3% 14.2 × 100 = 4.26%
Market price per share 351 333.1

Dividend cover

Earnings per share 34.4 = 2.28 : 1 32.1 = 2.26 : 1

Dividend per share 15.1 14.2
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Ratio analysis

1.Gross profit percentage

This shows what percentage of the sales revenue remains after the cost of sales (the direct cost of
providing the products or services) is taken into account. Gross profit percentage is affected by
changes in both selling prices and cost of sales.

The gross profit for Tesco in 2011 is calculated to be 8.3%, which is 0.2% higher than in 2010. The
difference may indicate an increase in selling prices while the cost of sales remains the same or
decreases.

The gross profit of 5.5% for Sainsbury in 2011 is higher than that in 2010. The difference of 0.1%
may also imply the same things as for Tesco.

The gross profit ratios for Tesco are greater than those for Sainsbury in both years. Tesco seems
to make a better profit than Sainsbury. However, it’s more accurate to evaluate the profitability of
the two companies based on operating profit ratio.

2.Operating profit percentage

This shows what percentage of the sales revenue is left after all of the expenses of running the
business (cost of sales and operating expenses) for the period have been met. Operating profit is
affected by changes in gross margin and operating costs.

As can be seen from the tables of ratios above, the operating profit percentages for both
companies in 2011 are bigger than those in 2010, and Tesco has got larger figures in both years
than Sainsbury. This further confirms that Tesco is making more profit than its competitor.

3.Percentage change in revenue

This is a key indicator of growth, which expresses what the change in revenue from one year to the
next represents as a percentage of the first year.

The percentage change from 2010 to 2011 for Tesco is 7.06%. This means that the change in
revenue between these two years represents 7.06% of the revenue in 2010. In other words, there
is a rise in revenue of 7.06% from the previous year. The company seems to make more sales in
2011.

On the other hand, the percentage change for Sainsbury is 5.7% over the same period. This lower
figure indicates that there is a smaller increase in revenue for Sainsbury in comparison with Tesco.

4.Major expenses to revenue

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This expresses how much of the revenue a particular major expense makes up. The purpose of
calculating this ratio is to improve the control of expenses if necessary.

Administrative expenses for Tesco in 2011 and 2010 are estimated to be 2.75% and 2.68%
respectively. These expenses make up very small percentages of the sales revenues, which is
advantageous to the business. The increase of 0.07% in administrative expenses in 2011 may
result from a rise in the administrative cost per transaction.

In contrast, Sainsbury’s administrative expenses go down to 1.98% from1.99%. This suggests that
administrative fees might have decreased per transaction for Sainsbury.

5.Return on capital employed (all capital)

Operating profit is compared with the total capital employed in order to measure the return on
investments from long-term providers of funds (shareholders and other long-term lenders). The
operating profit figure (profit before interest and tax) is used because we are considering the
effectiveness of the assets financed by both the shareholders and outside lenders (fixed interest
capital providers). Therefore, the profit shared between these two groups must be applied.

According to table 1, return on capital employed for Tesco in 2011 is higher than in 2010. The
company generates more profit from the capital employed. Hence, the shareholders are likely to
get a higher return after fixed interest payment. According to table 2, Sainsbury also has a higher
rate of return on capital employed in 2011 compared with 2010. Nonetheless, their return in both
years is lower than Tesco. It appears that Tesco’s shareholders benefit more from their
investments.

6.Acid test

Current assets minus inventories are expressed as a multiple of current liabilities. This is a test of
liquidity. It shows whether a company has sufficient liquid assets to cover its current liabilities in
case short-term creditors demand payment of their claims more or less immediately. The acid test
ignores stock and concentrates on those assets which can be more quickly converted into cash if
liquidity problems occur (Articles Database, 1998). This ratio should be about 1:1 irrespective of
the nature of business involved. However, supermarkets tend to have ratios below 1:1 without
implication of liquidity difficulties as they have faster-moving inventories than manufacturers.

Acid test ratios for Tesco in 2011 and 2010 are 0.47:1 and 0.54:1 respectively. This means every
one pound of current liabilities is covered by 47 pence of current assets (excluding inventories) in
2011 and 54 pence of current assets (excluding inventories) in 2010. Thus, Tesco is more
dependent on short-term debts to finance their operation in 2011. The same situation can be
applied to Sainsbury as their acid test in 2011 is lower than in 2010. Nevertheless, Tesco are more
properly liquid than Sainsbury since their figures for both years are higher than those of Sainsbury.
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7.Inventory ratio

This ratio shows the average number of days that inventories are held in the business. The fewer
days the better, because less money is tied up in inventories and they will be turned in cash more
quickly (Articles Database, 1998).

The inventory ratios for Tesco reveal that on average it takes about 2 more days to sell goods in
2011, which requires a better system of stock control and management. On the other hand, it only
takes Sainsbury about one more day to turnover their inventories in 2011. Furthermore, the fact
that Sainsbury’s turnover periods in both years are shorter than those of Tesco may imply a more
efficient resource management from Sainsbury.

8.Gearing ratio

Gearing is a measure of risk. It shows the proportion of long-term debt (fixed interest capital) within
the total capital of a business, and how dependent the business is on its fixed interest capital. The
higher the ratio, the greater the risk that the business will be unable to meet interest payments on
long-term borrowing when they fall due (Articles Database, 1998). Hence, the figure shouldn’t
exceed 50%.

Tesco’s gearing ratio in 2011 is 43.6%, which is 7.4% lower than the previous year. So, for every
£100 of the total capital employed, only £43.6 is from long-term borrowings. This may be because
the business has made a greater profit in 2011 or they have paid off some of their long-term debt.
The gearing ratio for Sainsbury is also lower in 2011 than in 2010. Since the figures for Tesco in
both years are higher than those for Sainsbury in the same period, Tesco tend to be more
dependent on their fixed interest capital.

9.Basic earnings per share

The earnings per share figure is the profit available for distribution as dividend per share. That’s
why the profit amount attributable to owners of the parent (profit after tax and interest) is used in
the calculation of this figure. The basic earnings per share ratio helps to measure the possible
return on each ordinary share, enabling shareholders to determine the company’s performance
level.

As one can see from the tables of ratios, the basic earnings per share figures for both Tesco and
Sainsbury in 2011 are higher than those in 2010. This may be due to the profit increase for both
companies in 2011. However, Tesco have lower earnings per share than Sainsbury over these two
years, which may suggests that Sainsbury are performing better than their competitor.

10.Dividend yield
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The dividend yield expresses the shareholder’s dividend as a percentage of the market value of a
share (Articles Database, 1998). This ratio seeks to assess the cash return on investment earned
by the shareholders.

Tesco’s dividend yield ratios in 2011 and 2010 are 3.56% and 3.14% respectively. This indicates
that Tesco’s shareholders are more satisfied with the return received in 2011. The dividend yield
for Sainsbury in 2011(4.3%) is also a little higher than in 2010 (4.26%). Over these two years,
Tesco’s dividend yield ratios are lower than Sainsbury’s. Therefore, Sainsbury seem to keep their
shareholders more pleased with the company’s performance.

11.Dividend cover

Earnings per share is divided by dividend per share to calculate this ratio, which shows how many
times dividend can be covered by earnings or profit. The higher the ratio, the more confident
shareholders can be about the company’s performance.

Dividend cover for Tesco in 2011 is 2.29:1, whereas it’s 2.25:1 in the previous year. So, for every
£2.29 or £2.25 made in profit, £1 was distributed to shareholders as dividend. Since the figure in
2011 is higher than in 2010, dividend is better covered by earnings in 2011, and more profit is
retained to fund next year’s operations. The same situation can be applied to Sainsbury as their
dividend cover in 2011 (2.28:1) is higher than that in 2010 (2.26:1).

C / Reasons given in the annual report for the year-on-year performance

of Tesco and Sainsbury

1. Tesco

Tesco has achieved a good set of results with good sales, profit and earnings per share growth
despite challenging economic conditions in 2011. ROCE grow strongly to 12.9%. The Group has
also increased their dividend for the 27 th consecutive year. The Board has proposed a final
dividend of 10.09p per share, taking the full-year dividend to14.46p. This represents an increase of
10.8% on last year’s full-year dividend (Tesco report, 2011).

This success is due to the implementation of a five-part strategy regarding the following purposes:

- Be a successful international retailer

Tesco has made good progress in increasing scale and competitiveness of their international
businesses. As a result, sales, market share, profits and returns have strongly grown, especially in
Asia and Europe.

- Grow the core UK business

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Tesco has delivered a solid performance in the UK by creating more value for customers. The
group remained focused on helping customers spend less through frequent sales promotion, and
encouraging loyalty by rewarding customers with Clubcards. This, in return, stimulates purchases.

- Be as strong in non-food as in food

With regards to non-food, Tesco has achieved a particularly strong performance in electrical,
entertainment and toys. Their clothing range is becoming an international success, led by F&F
range which is growing rapidly in European markets.

- Developing retailing services

Tesco has seen the growth in sales and profits from retailing services while they moves towards
becoming a full service bank offering a broad range of products.

- Put community at the heart of the business

Tesco is strongly supported by communities both at home and abroad because of their
commitment to work on environmental issues, such as reducing the carbon impact of products and
help customers halve their own carbon footprint.

The strategy has given the business momentum to grow well and improve shareholder returns
even during the economic recession.

2. Sainsbury

According to 2011 annual report, Sainsbury has delivered good profit growth, Outperforming the
market in challenging environment and increasing market share. Some of the group’s key financial
performance indicators are as follows:

- Return on capital employed of 11.1 per cent, up 11 bps (2009/10: 11.0 per cent)
- Proposed full year dividend of 15.1 pence, up 6.3 per cent, cover 1.75x (2009/10: 14.2
pence, cover 1.68x)
- Basic earnings per share up 7.2 per cent to 34.4 pence (2009/10: 32.1 pence)

These good results are achieved through a strategy, which focuses on five areas of significant
concern to the business

- Great food at fair prices

Sainsbury have tried to offer fresh, tasty and healthy food at a competitive price in order to attract
more customers. As a consequence, weekly customer transactions rose to 21 million in 2011, up
one million on the previous year.
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- Accelerating the growth of complementary non-food ranges and services

This is an important area of focus as non-food sales are now growing at more than three times the
rate of food.

- Reaching more customers through additional channels

Sainsbury has opened more than 50 new convenient stores now bringing in annual sales of over
£1 billion, and continued to develop the online operations to make shopping an easier experience
for customers.

- Growing supermarket space

This has been fundamental in helping Sainsbury to grow market share to over 16.1 per cent of the
UK grocery market. They’ve continued to grow supermarket space successfully and exceeded the
space growth target of 15% set two years ago.

- Active property management

During 2011, Sainsbury generated £275 million proceeds from the sale and leaseback of stores.
The value of their property estate has increased by £0.7 billion to £10.5 billion in the year.

In short, Sainsbury have made strong progress on their strategic areas of focus over the past year,
thus improving their performance level.

D / Comparison between the information disclosed by the ratio analysis

in B and the information disclosed by the companies in C

According to the ratio analysis in B, Tesco have improved their performance over the last two
accounting periods. This is expressed by the increase in gross profit and operating profit
percentages, whereas gearing ratio is reduced. The business is less financed by long-term
borrowings. Since return on capital employed, basic earnings per share and dividend per share in
2011 are higher than in 2010, Tesco’s shareholders are getting a greater return on their
investments.

There are some differences between the figures calculated in B and the ones provided by the
company. For example, ROCE is estimated to be 11.5% in 2010, while the figure released by the
company is 12.1%; gearing ratios are calculated to be 43.6% for 2011 and 51% for 2010, whereas
the company’s figures are 40.8% and 54% for these two years.

Despite the above differences, the information disclosed by the ratio analysis still conforms to the
information found in C as they both show a rise in Tesco’s performance level in 2011.
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Sainsbury have also made a good progress in 2011 by obtaining a bigger profit. The decrease in
gearing ratio shows the business is less dependent on its fixed interest capital. Moreover, higher
ROCE, dividend per share and basic earnings per share indicate an increase in the wealth of the
business as well as its shareholders.

The above information basically corresponds to the information disclosed in the company’s annual
report although there are some differences in the figures. For instance, ROCE is calculated to be
only 10% in 2011 and 8.8% in 2010, while the figures provided by the company are 11.1% and
11%. However, both sets of figures suggest an improvement in the company’s performance.

E / Limitations of ratio analysis

In order for the accounting ratios to be comparable between two different companies, these
companies must operate within the same sector, and the ratios must be calculated with the figures
from the same period. Tesco and Sainsbury are within the same sectors as they’re both chains of
supermarkets. Their performance is compared over the same years. However, their accounting
periods end in different dates (for example, 26 Feb 2011 for Tesco and 19 Mar 2011 for
Sainsbury). Even a slight difference of less than one month can reduce the accuracy of ratio
analysis because economic conditions are highly volatile and can change just overnight, affecting
business performance.
The companies compared must have the same accounting policies for items relating to the
calculation of the ratios, such as depreciation and stock evaluation. Since Tesco and Sainsbury
don’t apply the same accounting policies for all of their items, accounting ratios can’t be used to the
maximum level of their accuracy.
Ratios might be misleading if considered in isolation. For instance, a great operating profit
percentage doesn’t necessarily indicate a great stock control or credit control. A business can still
make a good profit but takes quite a lot of time to sell stocks and get cash back from customers.
Therefore, a number of certain ratios must be put together to create a more accurate picture of the
business performance.
Accounting ratios can’t help predict future trends since they’re based on past information.
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F / References

1. Tesco annual report and financial statements 2011 [online]. Available at:
http://ar2011.tescoplc.com/ (accessed 8 November 2011).

2. Tesco annual report and financial statements 2010 [online]. Available at:
http://ar2011.tescoplc.com/ (accessed 8 November 2011).

3. J Sainsbury annual report and financial statements 2011 [online]. Available at: http://www.j-
sainsbury.co.uk/investor-centre/reports/2011/annual-report-and-financial-statements-2011/
(accessed 8 November 2011).

4. J Sainsbury annual report and financial statements 2010 [online]. Available at: http://www.j-
sainsbury.co.uk/investor-centre/reports/2010/annual-report-and-financial-statements-2010/
(accessed 8 November 2011).

5. Articles Database (1998) Making more sense of financial accounts through the use of Ratio
Analysis [online]. Available at:
http://weblearn.londonmet.ac.uk/webct/urw/lc4130011.tp0/cobaltMainFrame.dowebct (accessed 14
November 2011).
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G / Appendices

Appendix 1 : figures for Tesco’s ratios