Interpreting Accounts – Tesco v Sainsburys 2006

Tesco is the Number 1 UK retailer, leaving Sainsburys, Asda and Morrisons trailing. What
if you were appointed Managing Director of Sainsburys, and were required by your Board
of Directors to ‘become as efficient as Tesco within 3 years’? Not ‘as big as’, note, nor ‘as
profitable’. Just, ‘as efficient’. How might a look at company accounts help you out?

Below is an edited version of the latest accounts for Tesco and Sainsburys. See what you
can tell from the information provided.

Profit & Loss Account for year ending (all figs in £millions)
Tesco (YEAR TO FEB 28TH) sainsbury (YR TO MARCH 31)
2006 2005 2006 2005
Sales turnover 39,454 33,866 16,061 15,202
Cost of sales 36,426 31,231 14,994 14,544
Gross profit 3,028 2,635 1,067 658
Administrative expenses 825 732 839 830
(overheads)
Operating profit 2,203 1,903 228 (172)

Balance sheet as at … (all figures in £millions)

Tesco (AS AT FEB 28TH) sainsbury (AS AT MARCH 31ST)
2006 2005 2006 2005
Fixed assets 18,644 16,931 8,902 8,630
Stock 1,464 1,309 576 559
Debtors 892 769 276 319
Cash 1,563 1,146 2,993 2,110
Current liabilities 7,518 5,680 4,810 5,036
Net current assets (3,599) (2,456) (965) (2,048)
ASSETS EMPLOYED 15,045 14,475 7,937 6,582
Long term loans 5,601 5,821 3,972 2,470
Share capital 4,447 4,144 2,018 2,100
Reserves 4,997 4,510 1,947 2,012
CAPITAL EMPLOYED 15,045 14,475 7,937 6,582

Questions (30 marks; 40 minutes)

1a) Calculate the operating profit margins and the return on capital for Tesco and
Sainsbury for 2006. (4)
1b) Comment on the differences between the two companies’ profitability. (7)

2. Look carefully at the accounts for the two companies, especially the asset turnover.
a) Identify two features that show a lot of scope for efficiency improvement by
Sainsburys. (2)
b) Explain how each of these features might be improved in future. (8)

3. Evaluate the financial health of each business, using two accounting ratios. (9)

Topical Cases October 2006, A-Z Business Training Ltd.

Mark Scheme

1a) Calculate the operating profit margins and the return on capital for Tesco and
Sainsbury for 2006. (4)
See table below.
Formula tesco sainsburys
Operating margin Op profit/Turnover * 100 5.6% 1.4%
Return on capital Op profit/cap employed * 14.6% 2.9%
100

1b) Comment on the differences between the two companies’ profitability. (7)

3 4
kCONTENT APPLICATION
3 4-3
Good understanding shown of the ratios Relevant issues applied in detail to the data and
business context
2-1 2-1
Some understanding of the relevant terms Relevant issues applied to the data or the business
context

Possible answers include:

• The enormous differences may be down to economies of scale (Tesco’s size allows
them to buy significantly more efficiently)
• Sainsburys appears hopelessly far behind Tesco, yet when you see the recovery
since the loss-making 2005, if Sainsbury could repeat that improvement in
2006/07, it could start to catch Tesco up
• Tesco is significantly more efficient than Sainsburys when it comes to controlling
overhead expenses. Tesco is more than twice the size of Sainsbury, yet has admin
expenses that are similar.

2a) Identify two features that show a lot of scope for efficiency improvement by
Sainsburys. (2)

2.1 Reducing the level of admin expenses

2.2 Increasing the asset turnover (from Sainsburys’ 2006 figure of 2.02 to the Tesco
level of 2.62)

2b) Explain how each of these features might be improved in future. (8)

4 4
CONTENT APPLICATION
4-3 4-3
Good understanding shown of the ratios Relevant issues applied in detail to the data and
business context
2-1 2-1
Some understanding of the relevant terms Relevant issues applied to the data or the business
context
Possible answers include:

Topical Cases October 2006, A-Z Business Training Ltd.

 • Increase asset turnover by either working to boost sales turnover from within the
same asset base, e.g. not by opening new stores, but by squeezing more out of the
existing ones, or by cutting back on the asset backing given to the stores, e.g.
renting out poorly used floor space
• Cutting overheads in half is essential if Sainsburys is ever to regain its position as
Britain’s most profitable supermarket. This will require a much leaner management
and leadership style

3. Evaluate the financial health of each business, using two accounting ratios. (9)

Tesco’s position
Formula tesco 2006 tesco 2005
Acid test ratio Debtors & cash/current 0.33 0.34
liabilities
Gearing ratio Loans/Capital employed 37.2% 40%
* 100

Sainsburys position
Formula sainsburys 2006 Sainsburys 2005
Acid test ratio Debtors & cash/current 0.68 0.48
liabilities
Gearing ratio Loans/Capital employed 50% 37.5%
* 100

MARKING GRID (Out of 9)

2 2 2 3
CONTENT APPLICATION ANALYSIS EVALUATION
2 2 2 3
Good understanding Relevant issues applied Analysis of question Judgement shown in
of relevant terms in some detail to the set, using relevant discussing the issues
case theory raised, reaching a balanced
conclusion
1 1 1 2-1
Some understanding Relevant issues applied An attempt at building Some judgement shown in
of the relevant terms to the case an argument, but text or conclusions
weakly

Possible themes might include:

• Both have remarkably low acid test ratios, but Tesco’s is far ‘worse’ than
Sainsburys. In 2006 Sainsbury seems to have made a huge effort to improve its
liquidity. Perhaps its bankers were unhappy to keep funding the company given that
it was making losses than year.
• Gearing looks manageable for both, though Sainsbury should try to keep it down
over the coming financial year – perhaps try to get it down to 45% or so.
• Overall there is no reason to feel concerned about the financial health of either
company.

Topical Cases October 2006, A-Z Business Training Ltd.