Business Accounting: Marks & Spencer - Case Study Example

Business Accounting Assignment Executive Summary Marks & Spencer, one of UK’s leading retailers is also the home to this company. Though the company has world -wide presence, 90 percent of its revenue is generated in UK alone. To determine the financial status of the company an in-depth analysis was done where its performance for the last five years was analysed. Again to determine its competitive position, financial indicators (ratios) of Marks and Spencer were compared with that of its strong competitors Tesco and Sainsbury. The data thus obtained is then used for inferring the competitive position of Marks & Spencer. The opinion of market analysts were also taken into consideration while predicting the future performance of Marks and Spencer. Introduction The economic tsunami (recession) which started in the first half of 2008 and continued throughout 2009, disturbed the financial fundamentals of many well known companies around the world, especially those operating in US and UK. However the effect of recession was uneven and the emerging nations managed to overcome it at a much faster rate. China emerged as the fastest growing economy of the world followed by India in the second position (BBC NEWS, 2010). In an attempt to regain financial stability, companies are restructuring their strategies in such way so as to expand their market share and attain a competitive position in the market. The present market scenario has prompted the belief that in near future demand is most likely to expand in BRIC (Brazil, Russia, India & China) nations; hence the multinational companies are leaving no stone unturned to strengthen their position in the developing nation. Retail is among the one such sector which had to bear the brunt of the financial crisis and economical recession. Though the UK economy is recuperating yet the market experts are of the opinion that it will take a longer time to regain the booming economical condition (BBC NEWS, 2009). Hence for generating better revenue, the retail companies of UK are concentrating more on diversification of their business risk by expanding their overseas markets. The same holds true for Marks & Spencer which is a leading retail company of UK. To understand the financial sustainability of the company an in-depth analysis needs to be done. The main aim of this analysis is to determine the efficiency of the financial policies followed by the company. To obtain a clear picture of the company’s financial condition different economic aspects such as profitability, liquidity, asset utilisation efficiency and stock market performances will be compared with its competitors who belong to same industry in UK. Such comparison will effectively reveal certain buried facts regarding the company’s efficiency in handling financial matters and developing fair management policies. The report generated on the basis of this analysis will assist the investors to understand the true potentials of the company for attaining sustainable market conditions and generating higher returns in future. At the same time this report will help the management to identify the existing loopholes in its financial policies and rectify it in order to enhance their market position and competitive state. Marks & Spencer Marks & Spencer provides its customers with the rare experience where quality meets style. This exclusive combination has gone a long way in making it of the top 10 retailers in UK. According to the data revealed by the Marks & Spencer almost 21 million people visit their stores each week. It has a wide spectrum of products which include food items, high quality clothes and excellent home appliances i.e. everything is available under a single roof. At present the company is concentrating more on environmental friendly policies and has already adopted “Go Green” strategy. For the last five years Marks & Spencer is making a dedicated effort to develop a clean and green supply chain. To have a better understanding of the company’s past performance, certain financial ratios were derived and analysed. From the chart it can be concluded that from 2007 onwards the operating profit margin of the company has deteriorated, which has affected the profitability of the company. The economical downturn has further lowered the profitability because of the decline in demand of the consumers. Liquidity state of the company measures how well the company can handle its short term liabilities that are likely to emerge in near future. The company which has a sound liquidity state can easily grab the emerging opportunities available in the market. Considering the current ratio of Marks & Spencer it can be concluded that company managed to enhance the liquidity from 2007 onwards, and hence it will be easier for Marks & Spence to handle it short term liabilities. Quick ratio is an assessment of the company’s cash and cash equivalent assets against its current liabilites. Quick ratio was calculated for the last five years. It also showed that Marks & Spencer’s liquidity position improved from 2007 onwards. To understand the condition of working capital management, receivable turnover ratio was calculated for the last five years. These ratios revealed that company’s receivable turnover ratio values fell drastically from 2007 onwards. This indicates that company has started using lenient credit policy for enhacing sales. When the receivable turnover is expressed in days it gives a clear picture of management’s credit policy. No doubt the company started using lenient credit policy to have high turnover but on the same time it enhanced chances of high bad debt in near future. Efficiency of the management can be determined by analysing how well it can handle its inventory level. Keeping a higher level of inventory will result in higher inventory cost. However if a company is holding a lower level of inventory it may be unable to meet the customer’s demand. Higher the stock turnover ratio, lower will be the working capital requirement and thus the net profitability of the company will improve. The graph reflects that from 2005 onwards stock turnover ratio of Marks & Spencer declined gradually. Decline in stock turnover ratio adversely affects the days required for having a complete stock turnover cycle. Hence from 2005 onwards stock turnover cycle is expanding that will result in high stock management cost and high requirement of working capital. The above given analysis assists in comprehending the fundamental financial position of Marks & Spencer for the last five years. Through this analysis the management can find out which financial policies adopted by the company needs to be revived to overcome the existing financial problems. Comparison of Marks & Spencer with the competitors At present more than 90 percent of the revenue earned by Marks & Spencer is generated in its home country, UK. However day by day competition is increasing in retail sector and the market share of Marks & Spencer is shrinking. In April 2009 market share of Marks & Spencer fell from 10.78 percent to 10.66 percent whereas its competitors like NEXT and TESCO enhanced their market share (Rowena, 2009). Tesco plc: Among the major rivals of Marks & Spencer, Tesco plc is the one which has the largest market share in UK. The company is a British international glossary chain which also deals with general merchandise. Tesco occupies the third position in the world in terms of revenue with Wal-Mart occupying the first position followed by Carrefour in the second place. Tesco through its unique strategy has been able to successfully attract most of the customers belonging to different market segment; hence the products range offered by the company contains the “Finest” as well as the mid & low cost “Value” products. This variation is present in all the product lines offered by the company (food & beverages, clothes, home appliances, mobiles and even financial services). The core competency of the company is its “people based strategy” which takes into account both the customers and the employees related in Tesco. The company’s ability to use technology in a unique way for solving minor operational problems has gone a long way in expanding the company’s market share both in the local as well as international market. In UK, Tesco’s stores are divided into 6 distinct categories depending on the size occupied by them. The company has a total of 2,306 stores which cover an area of around 30,877,000 square feet. The company has strong overseas market and it is trying hard to expand its business in the emerging economies. Sainsbury’s: It is a subsidiary of J. Sainsbury and occupies 16.3 percent of market share in UK. The company is the third largest chain of supermarket which also has existence in property and banking sectors. It is an old company that was started in the year 1869 and managed to retain its existence till date by constantly improving its strategies. The stores operated by the company can be differentiated into two distinct group namely super market and convenience store which are all together 792 in number. The floor area occupied by all these stores is around 16,703,000 square feet. The company has many products under its own label, around 20 percent of the items offered in the store are self branded. The products are diverse and cater to the specific need of different customer groups. Sainsbury’s focuses strongly on its supply chain and also provides online services to the customers. There are many other companies in the retail chain business who also a source of serious threat for Marks & Spencer. However this report will only deal with two of the above mentioned companies and a comparative study will be made with Marks & Spencer to analyse the latter’s financial position in the market. Critical appraisal of accounting policies Marks & Spencer follows IFRS (International Financial Reporting Standards) for preparing the final accounts. As per the reviewed definition of net debt, the directors of the company believe that it is more appropriate to use fair value of the derivatives which forms a vital part of the debt instrument. When the economy was booming, value of derivative was quite high because market price of different financial products also rose due to high demand. This resulted in high debt in the balance sheet of the company but when the market fell and value of financial instruments declined, the value of derivative was also reduced. This affected the balance sheet of Marks & Spencer and it very difficult for the stakeholders to analyse the real state of company’s financial position. Even when the derivative balances of previous years were compared with each other, they provide misleading information due to fluctuation in their fair market price. Being a diversified multinational company, Marks & Spencer has to make certain adjustment while consolidating its balance sheet. This is because different countries have distinct accounting policies. This allows the company to make certain adjustments which assist in getting desired outcome to some extent. Such adjustments also affect the transparency in the accounting practices of Marks & Spencer. Again, the company has a policy of not revaluing the land and building while calculating the depreciation and neither do they capitalise the interest related to the properties. The company follows a straight line depreciation policy for calculating the depreciation amount where the value of non-current asset is reduced by residual value of the asset and then divided by the estimated economical value (Marks & Spencer 2009). Straight line method of depreciation has one major disadvantage, as the asset attains age its economical value is reduced but the annual depreciation remains constant. Hence the depreciation charged on the assets after few years appear unjustified and quite high. This method of depreciation always makes a negative impact on the profitability of the company, but still it is practiced in order to save tax. To provide a true and realistic position of the company, Marks & Spencer needs to introduce certain change in its accounting policies. To gather information on the common accounting practices followed in retail industry, the accounting policies of Sainsbury’s & Tesco were compared with that of Marks & Spencer. Tesco prepares the final accounts as per the guidelines of IFRS, but it uses US GAAP for presenting the interim financial reports, hence it prefers to represent the income in terms of EBITDA. According to the management, it is a better way to present the operating profits because EBITDA is neither affected by the depreciation (non-cash expense) nor by the interest, tax and amortization. Hence the true picture of the company’s operating efficiency can be presented through it. (Trading Markets, 2009). As Sainsbury’ is a subsidiary of J Sainsbury plc, hence clear information regarding its actual depreciation is not well presented. The consolidated balance sheet presents revenue for the year, gross profit, operating profit and net profit in the income statement. The proper breakup of the depreciation is not well explained. As per the accounting principle of J Sainsbury, property, plants and equipments are presented as cost- less accumulated depreciation; hence the income statement provides no clear information regarding the deprecation (J Sainsbury, 2009). From the above mentioned comparison it appears that all these retails companies operating in UK present their income statement as well as balance sheets according to the format prescribed by IFRS, but certain variations do exist. Due to a large variety in stock items, accounting process of the retrial stores becomes complex and this result in reduced transparency throughout the accounting techniques. The companies try their level best to hide the information which can hinder their market image by making best use of the loopholes existing in the accounting policies prescribed by the government. Therefore it can be concluded that the government as well as the international accounting authorities need to pay more attention to the methods employed by the companies in the retail chain for maintaining their accounts. Analysis of Financial position of M&S Marks & Spencer (M&S) has a well defined position in the retail market of UK and the company is expanding its overseas business in Eastern Europe and Asia so as to capture the emerging markets. To have a better understanding of the company’s financial position its competitive state, vital financial ratios were calculated and were compared against its two major competitors, Tesco and Sainsbury. The main aim of these ratios is to cover the major financial aspects of the company for example profitability, liquidity, asset utilisation efficiency and stock market performance. Profitability One of the primary aims of any company is to enhance the stakeholder’s fund by making profit, for it is the profit that lures stake holders and also the potential investors. Considering the profitability of the company, its management analyse the efficiency of their operation and then after develops the future strategy. The same is true for other stake holders like creditors, suppliers and shareholders. Even the society and government being the stakeholder of the company take interest in its profit generating capabilities. For determining the profitability of the company two effective financial ratios are, gross profit ratio and net profit ratio. Gross profit ratio is calculated by expressing gross profit as a percentage of the sales for a specific year. On comparing the gross profit ratio of all the three companies it appears that Marks & Spencer has much higher gross profit making potential in respect to the other two competitors. However again it is also a fact that a high gross profit ratio does not necessarily mean that Marks & Spencer has the ability to manage its operating activity much better than its rival firms. So to have a better idea of the company’s ability to generate profit through operations, operating profit ratio was calculated. From the above comparison it is quite clear that Marks & Spencer produced marginally higher operating profit even in the phase of recession. Hence the company’s profitability state is quite good when compared to others. For an investor Return on Equity is a tool which helps him to determine the profitability of his investment in equity share, hence when the ROE of Marks & Spencer was compared with that of its rival it appeared that its position is quite moderate. Hence the company is generating good returns for its investor. Liquidity To ensure smooth running of business, the management needs to have adequate amount of cash in hand. Generally the liquidity of the firms signifies its ability to meet the short term liability thereby giving an indication of its solvency position. On the other side excessive liquidity reflects that the company is retaining too much idle cash which can be used for generating extra income. For comparing the liquidity state of the three companies, quick ratio is used because it reflects a more stringent liquidity state. After considering the graph it can be concluded that liquidity of Marks & Spencer is not too low but the management needs to pay more attention towards it. Leverage The company’s capital structure affects its financial risk to a great extent. To acquire financial leverage, management introduces debt instruments. Due to its low cost, total cost of capital is also reduced. Due to financial leverage EPS of the company moves up in favourable economical condition but in the unfavourable economic state it adversely affects profitability of the company. Debt/Equity ratio for all the three companies is used to determine the financial risk and chances of long term insolvency. When compared to Tesco and Sainsbury, the Debt/Equity state of the Marks & Spencer is comparatively high. The economic state of UK is recoving from the financial crisis which took place in 2008-09. As per the market experts this recoverly process will take few more years, hence the management of Marks & Spencer will need to reduce the debt accumulated in capital structure to attain a moderate risk position. Valuation For an investor there are many things that matters and book value per share is one among them. The investors compare the book value per share with current market price of the share to determine the future movement in the stock value. In a bear market, theoritically they both need to be same, and high market price indicates that the stock is overpriced. From the above given data it can be concluded that shares of both Marks & Spencer and Tesco are overpriced. If the market sentiments remains bearish, prices of these stocks may decline, so investors might not be interested in investing in these two companies on short term basis. Price Earning (P/E) ratio is also a factor which is taken into consideration by an investor before investing in a particular stock. P/E ratio of a stock indicates the units of currency which needs to be invested in a specific stock to earn single unit of currency. Generally a high P/E ratio of a stock indicates that investors expect the share price to move up in the near future. From the given graph it appears that the share price of Marks and Spencer might not show a strong hike as compared to its competitors. For further analysis of the stock market performance the share price movement of all the three companies are presented below. This comparison will assist an investor to take appropiate decision regarding Marks & Spencer’s future performance. Figure 1: Share price movement of Marks & Spencer Group Plc (Source London Stock Exchange-a, 2010) Figure 2: Share price movement of tesco plc (Source: London Stock Exchange-b, 2010) Figure 3: Share price movement of Sainsbury (J) Plc (Source: London Stock Exchange-c, 2010) It appears that Marks & Spencer has a strong financial position and its strength is due to its good liquidity position, high operating profitability and satisfactory returns on equity. However the company’s high Debt/Equity ratio is a strong negative aspect which needs to be reduced as soon as possible. The market ratios also gave a weak signal regarding the future performance of the company’s share price. Market Review Recent data revealed by the company indicated that its market share has increased due to good sale at Christmas time and that the company is recovering at a fast rate. However the market researcher believe that situation will be tougher for Marks & Spencer when in near future the tax rise will be accompanied by lower public spending. Kate Calvert, the analyst at brokerage Shore Capita said “Marks & Spencer had respectable Christmas, but not necessarily a sparking Christmas” (Potter & Davey, 2010). From January 2010 the share prices of Marks & Spencer are gradually declining which reflects poor confidence of the investor in the company. As per the market data, customer purchasing power is improving in UK at a moderate rate, but conditions are much better in the emerging nations like China, India and Brazil. Since the sale demand will be high in these nations hence the overseas revenue of Marks & Spencer is expected to improve and provide positive results. The UK retail market is highly competitive and saturated hence Marks & Spencer needs to renovate its store to make it more attractive and modify its marketing strategy to attract and retain customers. According to market analyst, 2010 will be a tough phase for the company in UK retail market. Conclusion Marks & Spencer is one of the well known companies operating in retail chain business. The company has a good brand name even in overseas market. With the advent of economic recession in 2008, the profitability of the company was badly affected and its stock price fell drastically. However market sentiment has changed considerably over the past few months and the economic recession is fast receding; hence this is the ideal time for the company to revive its strategy so as to regain a strong market position. The results of analysis indicated that Marks & Spencer had improved in terms of sales and profit but the rate of recovery is not strong enough to accelerate its competitive position against its industry rivals. When compared to Sainsbury the financial fundamentals of Marks & Spenser seem quite satisfactory but it falls short of Tesco, the market leader in UK. Therefore the management of Marks & Spencer needs to introduce certain strategic changes and concentrate more on overseas business. Reference BBC NEWS. July 22, 2009. UK recovery 'to take five years'. [Online]. Available at: http://news.bbc.co.uk/2/hi/8162217.stm Accessed on March 6, 2010]. BBC NEWS. February 13, 2010. China country profile. [Online]. Available at: http://news.bbc.co.uk/2/hi/africa/country_profiles/1287798.stm [Accessed on March 6, 2010]. J Sainsbury. 2009. Notes on Financial Statement. Annual Report. London Stock Exchange. 2010. MKS MARKS & SPENCER GROUP PLC ORD 25P. [Online]. 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M&S is losing fight against its competitors after seeing market share fall. [Online]. Available at: http://www.marketingnews.co.uk/2009/04/ms-is-losing-fight-against-its-competitors-after-seeing-market-share-fall/ [Accessed on March 6, 2010]. Trading Markets. August 05, 2009. Tesco Corporation Reports Q2 2009 Results. [Online]. Available at: http://www.tradingmarkets.com/.site/news/Stock%20News/2463409/ [Accessed on March 7, 2010]. Read More