IFRS Financial Reporting for Sainsbury’s

A.Y 2011 & 2012

Objective of Financial StatementFinancial statement is the key to find out “gold nuggets” and “red flags” attached to the entity as it contains four most important general information’s which are as below:

• Balance sheets – Objective to provide information related to the financial position of an entity for a particular financial period which includes Assets, Liability, and equity amount.

• Income Statements – Objective to provide information about how much expenditure has happened and how much revenue is earned by an entity during a particular financial year.

• Cash flow statements – Objective to provide information about how much cash is coming in and going out along with information how much cash which is being used and left as balance with an entity.

• Statement of retained earning – Also known as statement of owner’s equity and its objective to provide information about change in retained earnings (Year beginning retained earnings + Net income – Dividends).

Above all, financial statement also contains information such as disclosure of risks (notes and schedules). This information can be used for analysing past control (management), present financial position, and reasonable future economic predictions about an entity. Therefore, it helps the investors and lenders to find out the incentives attached to their investments with particular entity.

Importance for external users

Reporting of accounts is divided into two parts like management accounting which basically focus on management needs and the next is financial accounting which contains information for external users. Financial statement is used in both cases and it contains crux of business information. Financial statement can be useful for the following external users.

• Existing lenders (Investors): To monitor the performance of Sainsbury’s and the return on their investments.

• Potential Lenders: To judge the financial strength of Sainsbury’s and look forward for further investment decisions.

• Government: For government such information is useful for two reasons. Firstly, for taxation purpose and secondly, for macro and micro economic decisions as whole.

• The public: To have information about Sainsbury’s social economic contribution (e.g. money contributed for charity purpose, environment betterment and etc.).

• Employee groups: Information is useful for collective bargaining on wages as well as assessment of present and future job security (Alexander D, Britton A, and Jorissen A, Year 2011, International financial reporting and analysis, fifth edition, P.P 4 and 5).

Importance for external users• Stockbroker: To buy and sell or suggest the Sainsbury’s shares to the clients so that they can

invest or sell their shares.• Existing and potential competitors: Competitors can use Sainsbury’s financial reports to set

the benchmark for themselves and knowing incentive attached in supermarket business can attract new competitors in market.

• Rating agencies: Rating agencies (e.g. Moody’s, Standard & Poor’s, and Fitch) can use the Sainsbury’s financial report to conclude the financial strength of Sainsbury and then further publish their findings for general purpose (can help in making rational economic decisions).

• Banks: To check the credit worthiness (leverage) of Sainsbury’s and further lending decision into business.

• Suppliers: To check the financial strength of Sainsbury’s before giving any stock on credit. • Customers: Sainsbury’s customers may also be interested in getting the financial statement as

they also want to ensure about continuity and stability in operations.

Hence, financial statement is very useful tool for above mentioned groups as it helps them to make their best decisions (rational economic decisions).

Analysis of Statement of Comprehensive Income

Income statement which is also called as profit and loss account contains useful information like revenue, expenses, losses and gains incurred in one particular financial year. Sainsbury’s Income statement (Group) issued for Assessment Year 2011 and 2012 is holding information for past 52 weeks (19th March 2011 to 17th March 2012).

Sainsbury’s Income statement reflects that prime source of income is retail business wherein revenue has gone up to £22294m from £21102m (5.6%) and these figures are supported by activities like grocery sales and own business range which also grow up by 10% (www.walesonline.co.uk 27th March 2013). Sainsbury’s also performed well in merchandising and banking business where the growth is 40% moreover, massively supported by record Christmas sales in UK (www.reuters.com 27th March 2013).

There is 23% drop in current year revenue earned through disposal of properties £83m (2010/11: £108m) but it is still a major contributor for the revenue. The prime reason for drop down in property transactions can be because of economic downturn and high rate of interest charged by landing authorities which further resulted less buyers available in market. The other reason could be poor bargaining while dealing in property transitions.

Analysis of Statement of Comprehensive Income

Underlying operating profit gone up by 6.91% to £789m (2010/11: £738m) which further benefited in increasing underlying profit before tax by 7.07% to £712m from £665m (2010/11). However, profit before tax has gone down £799m from £827m (2010/11) which is 3.39% down from the last year but still Sainsbury’s reported it as a “good year“ and said it had hit the highest of almost a decade which is 16.6% (www.bbc.co.uk, 28th March 2013). Earlier Sainsbury’s biggest competitor Tesco reported fall in UK profits in 20 years as well as Morrison’s also reported fall in like-to-like sales for the first time in seven years (www.guardian.co.uk, 28th March 2013).

Sainsbury’s paid £201m tax with tax rate of 26.1% and it is 7.49% higher than the previous year (£187m). The higher tax is paid under deferred tax heading which is £124m (2010/11: £24m) and provision also increased by £20m from £15m (2010/11). Corporation tax reduced to 26% from 28% for current year which helped in saving £6m (change in rate effective from 23rd March 2011).

Profit left after taxation was £598m (2010/11: 640m) out of which £285m is used to pay dividend to investors which is 6% higher than previous year (2010/11: £269m). However, as mentioned earlier profit for 2011-12 has gone down so the dividend given is just to make its investor satisfied and to further boost in market share price. The same can be seen through the share price performance of Sainsbury’s where we can notice on 16th March 2013 share price was 303p and thereafter it was 316.40p on 23rd March 2012.

Analysis of Statement of Financial Position

Sainsbury’s statement of financial position report contains information about Group as well as company (subsidiary and joint venture).

Total assets value of Sainsbury’s group is £12340m out of which the biggest item PPE (Property, plant and equipment) is £9329m (2010/11: 8784m), total change of 6%. Group is more focused on widen their horizon by investing in PPE and joint ventures which can be seen through the amount of depreciation charged on PPE which is £486m (2010/11: 468m), 4% more in comparison with previous year. Total addition in PPE is of £1265m (2010/11: £1236m), 2% higher than the previous year.

Intangible assets as the name suggest ‘an asset which is not physically present but still exist in system’. For Sainsbury’s intangible assets have gone up by 7% from £298m to £320m wherein Goodwill remain same throughout the year (£100m) and computer software has gone up by 13% from £152m to £172m. Investment in computer software is encouraged by last year performance when Sainsbury’s made huge profits through online sales. Sainsbury’s service “Click and Collect” is now run through 900 stores and almost 50% merchandising orders comes through this channel (www.stockmarketwire.com, 1st April 2013).

Analysis of Statement of Financial Position

From external user’s point of view it is very difficult to measure the value of the items which do not exist and figures mentioned (e.g Goodwill) can be overstated and misleading. Therefore, IAS 38 had introduced guidelines which clarifies that ‘Intangible asset should be separable and can arise from legal and contractual rights’ (www.iasplus.com, 1st April 2013). Under the light of IAS 38 price for few intangible assets such as customer contacts, patents, and trademarks are easily identifiable (www.kpmg.com, 1st April 2013).

While checking the liabilities side the biggest item is trade and other payables £2740m which is very basic as the business (supermarket) is getting goods and services from vendors on credit basis. The second, big item is borrowings which has gone up by 12% from £2339m (2010/11) to £2617m (2011/12) which is primarily because of huge investment in property, plant and equipment (new stores) wherein the major source of funds is through investment banks .

Provisions for current year is £72m (2010/11: £73m) wherein, addition in provision is of £11m and utilization from previous year is £7m. These figures can create ambiguity for the general users as provision reflect as expense in current year and reduce the equity in balance sheet (www.e-conomic.co.uk, 2nd April 2013). However, next year an entity can use this provision to boost its profits (overstated profits) hence; a user must do careful examination of financials while checking the provisions.

Analysis of Statement of Financial Position

Equity amount has gone up by 10% from £3374m (2010/11) to £3715 2011/12) which is a positive sign as Sainsbury’s is increasing its shareholders capital. Post tax (£201m) deduction from profits an amount of £285m and £3m paid as dividends under share options schemes but most of the amount is added back into the equity.

Analysis of Cash Flow StatementAs the name suggests cash flow statement provide information about inflow and outflow of cash from an entity during a particular period and the main objectives of cash flow statement are:

• Help in identifying entities strength that whether an entity will be able to generate enough profits without interrupting business operations.

• Help in estimating that how a particular transaction will put effect on cash flow.• Help in forecasting future operations by doing trend analysis.• Help in making investment decisions by predicting future cash flow against debt and whether

an entity will be able to pay dividends or not.

Cash flow and profitability create obscurity for many users hence, critical evaluation for both is very much required before making any investment decisions. For example:Sales can be overstated as most of the companies sell goods and services on credit by using ‘buy now and pay later’ technique during year end to reflect more profit in financials. A competent user will always cross check if there is any sudden sales increment during last quarter or by cross examining that how much time an entity takes to convert its profit into cash. Profitability can also be predicted by measuring some amount of bad debts on sales booked (with the help of trend analysis).

Analysis of Cash Flow StatementEntity which is making huge profits can also go under liquidation (administration) if, entity is unable to maintain positive and timely cash flow. Hence, investors should check the cash flow in business along with profitability of the business.

Fair value gain is another business practice which an investor must know about. It allows entity to revaluate its assets which can help them to overstate their net asset value even though there is no cash transaction involve and when these assets put for selling then there can be huge variation in fair value and actual amount received against the asset which can further lead to write off of excess amount (www.thetradercentral.com, 4th April 2013)

Such business practice helps external users to enhance their knowledge about practices adopted by businesses and further trigger the alarm that high cash flow doesn’t mean a high profitable business.

Sainsbury’s cash flow statement is divided into three parts firstly; cash flow from operating activity where the cash generated from operations has gone up by 13% from £1138 (2010/11) to £1291m.

Analysis of Cash Flow StatementSecondly, cash used in investment activities (outflow) where the outflow of cash is because of investment in property, plant, and equipment £1227m (2010/11: £1136m) and investment in intangible assets have also gone up by 67% (2011/12: £25m and 2010/11: £15m). Thirdly, cash flow from financing activities where there is major inflow of cash from long term borrowings (£391m) wherein for 2010/11 it was £45m. The borrowing has gone up because of huge investment done in infrastructure (PPE) and it further increases the gearing.

Sainsbury’s cash position reflects that entity generate £739m (Cash and cash equivalents) from its operations which is 48% higher than previous year (2010/11: 500). However, if we will check the free cash flow then we can see Sainsbury’s free cash flow for 2011/12 is minus £220m (2010/11: - 465) but a negative cash flow reflects that Sainsbury’s is making huge investments and cash flow is routed towards investments. Moreover, if these assets will be fruitful then Sainsbury’s will be able to pay off its debt soon.

Calculation of ratios for profitability, liquidity, gearing and investors.

From an investors point of view it is essential to calculate profitability, liquidity, gearing, and investors ratios which can be very useful for rational economic decision making. So let’s check the appended profitability ratios:

Return on capital employed (ROCE):

Profit before Interest and Tax (PBIT)Fixed assets + current assets - current liabilities

ROCE is considered as prime profitability measurement technique for any business. It is normally used by investors to measure the return on assets introduced in business which means how efficiently capital has been used to produce profits. For Sainsbury’s, ROCE figures has dropped to 10.18% from 11.15% (0.97% change) but is it just Sainsbury’s or the entire market is in bad shape which is causing supermarkets to produce less ROCE?

Calculation of ratios for profitability, liquidity, gearing and investors.

• To understand the correct picture we can do the industry analysis and compare the results. For example, ROCE for Sainsbury’s and Tesco is as below:

From the above example we can see that ROCE for Tesco has also gone down by 0.35% as Sainsbury’s. Low ROCE for Sainsbury’s is mainly because of low PBIT and there are various reason for low PBIT e.g. low profit earn in property transaction, high cost of sales etc. But ROCE is not the only measure of profitability. Hence, it is important to check all the aspects specially, that how effective and profitable the sale is or if, the business is getting enough price for the good and services provided by them. To check the sales effectiveness we can go ahead with gross profit margin ratio:

Sainsbury's TescoCurrent Year (11/12) Last Year (10/11) Current Year (11/12) Last Year (10/11)

937 943 4252 4124

9204 8457 44395 41523

10.18% 11.15% 9.58% 9.93%

Calculation of ratios for profitability, liquidity, gearing and investors.

Gross Profit MarginGross profitRevenue

Sainsbury’s gross profits margin drop to 0.07% from 5.50% to 5.43% even though the business book increments in gross profits for current year. On the other hand, Tesco gross profit margin is also drop down to 8.15% from 8.48%. The biggest reason for this is the price war in supermarket business. According to the newspaper ‘The Guardian’ Asda (supermarket) running a campaign of 10% cheaper than other supermarkets and Tesco is running £500m price drop strategy to attract more customers (www.guardian.co.uk, 2nd April 2013).

Sainsbury's Tesco

ParticularsCurrent Year (11/12) Last Year (10/11)

Current Year (11/12) Last Year (10/11)

Gross Profit 1211 1160 5261 5125

Revenue 22294 21102 64539 60455

Gross profit margin 5.43% 5.50% 8.15% 8.48%

Calculation of ratios for profitability, liquidity, gearing and investors.

Hence, it was very difficult for Sainsbury’s or any other supermarket to make sales more profitable than before. To increase the profitability in business Sainsbury’s invested massively in property, plant, and equipment as well as adopted the new information technology system which is ‘Making Sainsbury’s Great Again’ (www.ft.com, 14th April 2013). According to www.stockmarketwire.com, 50% buying orders are coming through this way. But the investment cost was also huge so it put effect on liquidation and, gearing of the business.

Calculation of ratios for profitability, liquidity, gearing and investors.

To check the liquidation of in business we can use the following method:Current Ratio

Current AssetsCurrent Liabilities

Current ratio explains the relationship between current assets and current liabilities and it also helps in identifying any potential liquidation problem within the entity. For Sainsbury’s current ratio has gone up to 0.65 times from 0.58 times (previous year) which is a positive sign. However, Tesco has reported drop down in its current ratio from 0.68 times to 0.67 times. It’s a positive sign for Sainsbury’s investors as we can see that when other competitors are reporting downfall Sainsbury’s is enjoying the positive movement in current ratio.

Sainsbury's Tesco

ParticularsCurrent Year (11/12)

Last Year (10/11)

Current Year (11/12)

Last Year (10/11)

Current Assets 2032 1708 12863 12039Current Liabilities 3136 2942 19180 17731Current Ratio 0.65 0.58 0.67 0.68* Current ratio in times

Calculation of ratios for profitability, liquidity, gearing and investors.

As mentioned earlier to support the sales function Sainsbury’s have invested huge amount in PPE (Property, plant, and equipment) and to develop the robust IT system. The main source of funds is through investment banks as the lending rate (rate of interest) is quite low with banks as compare to other sources. The Bank of England is running scheme ‘Funding for Lending’ to attract more and more banks to take and land the money (www.ft.com, 6th April 2013). High borrowing has resulted change in gearing ratio for the business which can be calculated through following way: • Gearing

DebtEquity

Sainsbury's TescoParticulars Current Year (11/12) Last Year (10/11) Current Year (11/12) Last Year (10/11)Debt 3575 3033 13731 12852Equity 5629 5424 17801 16623Gearing 63.51% 55.92% 77.14% 77.31%

Calculation of ratios for profitability, liquidity, gearing and investors.

Gearing ratio for Sainsbury’s has rose 7.59% from 55.92% to 63.51% but there is minor dip in Tesco’s gearing ratio as the gearing has gone down to 77.14% from 77.31%. In any business High gearing (Less then 80%) can help in near future if the future economic benefit derived from these assets is more than the amount invested today and the asset covers its net present value as earlier as possible. On the other hand, less gearing reflects that the major source of funds is through investors or the entity is using previous years saving into investment purpose which can further create liquidation problems (decrease in current assets) In addition, it can reduce the earning per share also.

Calculation of ratios for profitability, liquidity, gearing and investors.

To check the earning per share we can use the following formula:Earnings per share (EPS)

Profit after tax and Preference dividends Number of equity share in issue

Earnings per share which is also called as investor ratio as the investment decisions are significantly influenced by this ratio.

Sainsbury's Tesco

ParticularsCurrent Year (11/12)

Last Year (10/11)

Current Year (11/12)

Last Year (10/11)

Profit after tax and preference dividends 598 640 2814 2671* 100 (pens) 59800 64000 281400 267100Number of equity share issue 1883 1871 8040 8040Earning per share 31.76 34.21 35.00 33.22* EPS in pens

Calculation of ratios for profitability, liquidity, gearing and investors.

EPS for Sainsbury’s have gone down to 31.76pence from 34.21pence on the other hand; EPS for Tesco rose to 35pence from 33.22pence. However, the figures calculated by users at their own can be bit misleading as full information is not provided to the general users for e.g. exact number of ordinary shares not given and etc . Therefore, it is advisable to take help of specialist accountancy firms before making any investment decisions. According to the given trend analysis in financial statement of Sainsbury’s EPS has gone up year by year from 26.5pence to 28.1pence (www.j-sainsbury.co.uk, 6th April 2013).

Calculation of ratios for profitability, liquidity, gearing and investors.

Dividend cover is another way of measuring the profit attached to with an entity and that can be measured through the following way: Dividend cover

Profit after tax and Preference dividendsOrdinary dividends appropriated in period

Sainsbury's Tesco

ParticularsCurrent Year (11/12)

Last Year (10/11)

Current Year (11/12)

Last Year (10/11)

Profit after tax and preference dividends 598 640 2814 2671Ordinary dividends appropriated in period 285 269 1183 1083Dividend cover 2.10 2.38 2.38 2.47

* Dividend cover in times

Calculation of ratios for profitability, liquidity, gearing and investors.

Dividend cover ratio reflects the number of times dividend can be paid out of the amount (profit) left after tax. This ratio works as cushion or provide safety on the investor investment. For Sainsbury’s current dividend cover is 2.10 times which has gone down by 0.28 time from the previous year (2.38 times) and for Tesco also there is 0.09 times drop booked in current year from 2.47 to 2.38. This is a positive sign for any investor as this ratio help in minimizing the risk and reflects that his earnings are safe with double of the amount. However, a short term investor can take this information in negative form as he is aware that supermarket is able to pay double dividend but he is getting just one time of it (helped by EPS ratio) and rest of the amount is again add back into equity which is not useful for short term investor.

Calculation of ratios for profitability, liquidity, gearing and investors.

Considering the above mentioned strategies one of the key questions remained unanswered is;How much price an investor should pay today for the amount he probably can get back in year time (dividend)? To find out the answer for this an investor can rely on price earnings ratio which can be calculated through following way:Price earnings ratio (P/E ratio)

Market price of equity shareEarnings per share

Sainsbury's Tesco

ParticularsCurrent Year (11/12)

Last Year (10/11)

Current Year (11/12)

Last Year (10/11)

Market price of equity share 305.2 346 320.9 383.25Earning per share 31.76 34.21 35 33.22Price earning ratio 9.61 10.12 9.17 11.54

Calculation of ratios for profitability, liquidity, gearing and investors.

P/E is the price which an investor pays for $1 earning of an entity (www.beginnersinvest.about.com, 15th April 2013). For Sainsbury’s P/E ratio has gone down to 9.61 times from 10.12 times and for the Tesco also it has gone down to 9.17 times to 11.54 times which shows that supermarket industry is facing the economy down turn but from investors point to view it should be clear that different industries have different price earnings ratios hence, investors can make decision according to the return on their investments and the price they are paying now.

Conclusion

Investors can calculate the following ratios to know the return on their investments but to get the clear and more reliable information they can seek help of professional investment firms as the information provide to such companies are more diverse than a general investor. Another important way is to have eye on rating agencies reports about entities performance and grading.

Additional useful Information

There are numerous additional reports are attached with Sainsbury’s financial report which can be very helpful for external users in various decision making. To find out their relevance in normal life let’s focus on appended reports:

• List of directors: Employees are seen as key business resource in any business hence they should be used effectively in any business which includes proper usage of their knowledge and experience in business. David Taylor (chairman) from Sainsbury’s has years of experience as chairman, non-executive director, and finance director with multiple organisations and there are many more such experienced people are there in Sainsbury’s employees list. This information is useful for external (non-operating) users as they can be bit assure about the return on their investments.

• Corporate governance: It plays an important role and describes the set of guidelines, processes, and principals. Under the light of corporate governance Sainsbury’s is maintaining balance approach for risk management, shareholder relation, and director’s remuneration.

• KPI’s (Key Performance Indicators): KPI’s are also very helpful to understand the strategy of any business but the only problem is that different organisations can have different KPI’s and then it can be very difficult to compare two entities performance on the basis of KPI’s.

Additional useful Information• Management Commentary: Considering the complexity of accounting terminology in today’s business it

is very much required to explain the accounting figures mentioned in financials though, it is not mandatory but still advisable in public interest.

• Supplementary Notes: Supplementary notes are the useful guide which contain crux of financials. It further helps in elaborating figures mentioned in Income statement, statement of financial position, and cash flow statement.

• Corporate social responsibility (CSR): In recent year an entities impact on society (environment, and people) has been taken more seriously and a business must pay back or benefit the society for any damage. Sainsbury’s has adopted a very balanced approach in CSR as we can see with following examples:

• Environment benefit:• Sainsbury’s is using recycled material for packing• Reduced the water and electricity consumption by using it an appropriate way • Invested huge money in equipment’s which produce less carbon • Social benefits:• Donated over 115m worth equipment’s in schools• Invested 10m in Sainsbury’s school games• 25.4m amount is given in national charity• Hired 12000 employees under various schemes • Moreover, Sainsbury’s received ‘Platinum plus status award’ from community on its social welfare

activities (http://www.stockmarketwire.com/ , 6th April 2013).