Bohr. Fmr. BOHR International Journal of Finance and Market Research Bohr. Fmr. 2583-4541 BOHR 10.54646/bijfmr.2022.06 Methods Performance analysis through financial modeling Kumar G. Naveen 1 Reddy Podapala Siva 1 * Krishna Mulupur Sai Rama 2 1Department of Business Management, Malla Reddy College of Engineering and Technology, Hyderabad, India 2University of Hertfordshire, Hatfield, United Kingdom *Correspondence: Podapala Siva Reddy, siva.podapala@gmail.com 02 04 2022 1 1 38 42 28 02 2022 22 03 2022 Copyright © 2022 Kumar, Reddy and Krishna. 2022 Kumar, Reddy and Krishna

This is an open-access article distributed under the terms of the Creative Commons Attribution License (CC BY). The use, distribution or reproduction in other forums is permitted, provided the original author(s) and the copyright owner(s) are credited and that the original publication in this journal is cited, in accordance with accepted academic practice. No use, distribution or reproduction is permitted which does not comply with these terms.

Finance is the lifeblood and lifeline of any business entity, either commercial or non-commercial. The survival, stability, and sustainability of a firm are highly associated with its financial wellness. It can be observed through its ability to pay(re) short-term as well as long-term liabilities, meet the regular financial obligations, and increase the value of the firm and generate profit. Financial analysis, evaluation, and assessment help in determining the financial position and financial strength of a firm. Among the plenty of methods and tools available for financial performance, ratio analysis is more useful and meaningful. These ratios can be used to assess the evolution of a company’s financial status (trend analysis), as well as for cross-sectional and comparative studies.

 Financial modeling Performance analysis Financial performance Financial ratios Forecasting Scenario analysis Introduction

This study presents the market competitiveness of four retail giants in the UK, such as Tesco PLC, Sainsbury’s, ALDI, and Lidl with the help of ratios. This study analyses the different study concepts that are related to the establishment of financial stability. The financial position can be evaluated with the help of ratio analysis as well as Du-Point analysis. In addition, the study has also mentioned various financial condition analysis methods to have an understanding of financial ratios. Financial performance analysis holds a significant role in terms of understanding the financial health of the company. The financial records derived from the analysis help the investors to understand the economic conditions of the company, which leads to financial and reputational growth of the company.

Objectives of the study

The main research objectives are:

To study the financial performance of selected companies by assessing their past performances, revenue, and projected future performance.

To analyze the financial performance of the companies to determine the financial health of these companies.

To evaluate the competitive advantages and economic viability of the companies with the help of the ratio analysis framework.

To recommend appropriate strategies that can improve the financial performance of the selected company in this research.

 Ratios: the theoretical framework

The organizing of information pertinent to a choice area has become the major duty of the decision maker in this digital and information era (1). The world is now more complex, uncertain, and dynamic, not because of a lack of information but because there is too much information. In real-life settings, the quality of a choice is frequently shown to be inversely proportional to the amount of information available (2). A business system continuously generates data. A successful management control system must generate relevant, understandable data and identify crucial management variables (3).

A correctly chosen ratio or combination of ratios can not only help with primary decision-making, but can also be used as a powerful monitoring tool (4). Among the many approaches used for data processing, data processing by ratio methods can extract the most information content if the factors that make up a proportion are appropriately chosen. The simplicity and directness of ratios attracted the minds of great analytical thinkers during not only modern times, but even in ancient times too (5).

A ratio is a numeric figure that reveals the association or relationship between two variables. Financial ratios are calculated to establish a meaningful link between two financial statements, and the results are then evaluated to draw significant conclusions. The numerator and denominator must be rationally connected, which is the most important component of the computation. Otherwise, the ratio will not give the information required for decision-making. As a result, financial statement analysis is given as a pro forma examination of the future, with anticipated ratios (6).

The ratios used in the study are listed below.

Current ratio

The current ratio expresses the relationship between a company’s current assets and current liabilities. The current ratio is a static measure of the resources available to satisfy current obligations at a given moment in time. The existing reservoir of financial resources has no logical or physical relationship to its future cash flows (7).

 Quick ratio

A stringent test of liquidity can be expressed by quick ratio (acid test ratio). Inventories of the least liquid current assets are excluded, and our methodology must weigh the benefits of eliminating inventories when evaluating liquidity (8).

 Gross margin ratio

It is calculated as revenue less cost of sales and directs special attention to the factors explaining variations in sales and cost of sales. The gross profit must be big enough to support necessary future-directed discretionary expenditures (9).

 Net margin ratio

This ratio expresses the relationship between total revenue and its net profits. The net profit margin ratio is used to indicate a company’s potential to generate profit while taking into account various circumstances, such as an increase in costs that is judged ineffective. Net profit margin, which is commonly expressed as a percentage, is a powerful measure of a company’s overall success.

 Literature review

Renáta et al made a study on “Comprehensive assessment of firm financial performance using financial ratios and linguistic analysis of annual reports.” According to the study’s findings, businesses with strong financial outcomes not only orally communicate the attained values of financial indicators, but also comment on the sources of the results in more depth. This appears to be true for both good and negative consequences (10). The primary goal of financial statement analysis (ratio analysis) is to use information about a company’s previous performance to forecast how it will perform in the future (11).

Barnes (12) explained the application and importance of ratios in brief. They measured the performance of a firm and use it as a tool to measure and predict financial position. The ratios are used for both credit and managerial analysis purposes and also for measuring the profitability of various business entities.

Warui (13) analyzed the credit risk management strategies and the performance of commercial banks in Kenya. He adopted the credit risk theory and found that credit risk is among the critical factors for any financial institution involved in any lending activity. The study added that financial institutions have to find themselves in making decision on giving credit to potential borrowers, despite effectively growing their balance sheets and effectively increasing their returns and cautions to any losses incurred.

 Methodology

The study is based on pure secondary data, including financial statements of selected companies, i.e., Tesco PLC, Sainsbury’s, Aldi, and Lidl. As part of the analysis, the researcher focused on liquidity position (current ratio and quick ratio) and consistency (gross margin ratio and net margin ratio). The ratios of the selected four companies are presented and discussed as follows.

Analysis of the data

The performance of any business entity can be measured with money in a business tycoon. A firm will be considered strong if it has sufficient financial reserves, funds, and liquidity. At the same time, their performance also depends on some other variables like assets (both fixed and current), liabilities, sales revenue, expenses, and cost of goods sold. The researcher considers these variables for the study and presented here.

In this study, a total of four financial ratios are calculated: current ratio, quick ratio, gross margin ratio, and net margin ratio. According to the above ratio analysis spreadsheet (Table 1), it is observed that Tesco PLC faces fundamental business losses in the 2020 financial year due to the COVID-19 pandemic. As per the overview of this organization, Tesco PLC faces around a 4.9% reduction in operating profit (2021).1 Moreover, from the financial data of this organization, it is also identified that the organization experiences around 0.7% reduction in the annual sales volume.

Ratio analysis of Tesco PLC.

Ratio analysis spreadsheet
No. Years 2016 2017 2018 2019 2020 2021
Balance sheet ratio (plausible)
1 Current ratio 3.03479 3.86585 2.4902 0.60783 0.71841 2.08227
Current assets 14828 15417 13726 12570 12879 10807
Current liabilities 4886 3988 5512 20680 17927 5190
2 Quick ratio 0.00594 0.01204 0.00798 0.00106 0.00128 0.00193
Cash + accounts 29 48 44 22 23 10
Current liabilities 4886 3988 5512 20680 17927 5190
Income statement ratio (consistent)
1 Gross margin 0.01952 0.02567 0.03603 0.03785 0.04389 0.03248
Gross profit 944 1280 1837 2153 2518 1736
Sales 48352 49867 50991 56883 57370 53445
2 Net margin 0.009 0.00291 0.02546 0.02943 0.02292 0.01544
Net profit before tax 435 145 1298 1674 1315 825
Sales 48352 49867 50991 56883 57370 53445

Source: calculated by the researcher.

 Sainsbury’s

According to the detailed ratio analysis of the mentioned organization, it is observed that Sainsbury’s also faces huge business losses in the 2020 financial year due to the pandemic.

The figure in Table 2 represents the financial overview of Sainsbury’s over the six financial years. As per the annual report of this organization, Sainsbury’s also experiences significant business losses in the 2021 financial year due to the business losses in 2020, and it reduces the overall sales volume of this enterprise by 0.3% (2021).2 However, while comparing those financial statements with Tesco PLC, it can be considered that Sainsbury’s faces minimal business losses from the financial perspective compared with Tesco PLC.

Ratio analysis of Sainsbury’s.

Ratio analysis spreadsheet
No. Years 2016 2017 2018 2019 2020 2021
Balance sheet ratio (plausible)
1 Current ratio 0.66131 2.80853 3.22906 1.9825 1.70052 1.52304
Current assets 4444 6322 7866 7589 7586 7073
Current liabilities 6720 2251 2436 3828 4461 4644
2 Quick ratio 0.33497 0.255 0.30542 0.17268 0.02892 0.01335
Cash + accounts 2251 574 744 661 129 62
Current liabilities 6720 2251 2436 3828 4461 4644
Income statement ratio (consistent)
1 Gross margin 0.05637 0.07053 0.06735 0.06192 0.07082 0.06743
Gross profit 1456 1634 1882 2007 2294 2177
Sales 25829 23168 27944 32412 32394 32285
2 Net margin 0.02273 0.02171 0.01464 0.00737 0.01809 0.01103
Net profit before tax 587 503 409 239 586 356
Sales 25829 23168 27944 32412 32394 32285

Source: calculated by the researcher.

 Aldi

For Aldi organization, we consider the financial data from the years 2016 to 2021.

According to Table 3, it is observed that Aldi faces huge losses after the 2018 financial year due to inappropriate operational processes. As per the current information, it is also identified that the organization faces a significant reduction in annual profit margin that is reduced by 11.28% in the gross profit margin of the 2018 financial year compared with the previous year (2021).3 In this regard, it can be considered that Sainsbury’s and Tesco PLC are in better financial conditions compared with this enterprise from the perspective of competitive advantages.

Ratio analysis of Aldi.

Ratio analysis spreadsheet
No. Years 2016 2017 2018 2019 2020 2021
Balance sheet ratio (plausible)
1 Current ratio 0.60725 0.56915 0.5175 0.4878 0.5130 0.3664
Current assets 728.7 739.9 724.5 756.2 667 458
Current liabilities 1200 1300 1400 1550 1300 1250
2 Quick ratio 0.23733 0 0 0 0 0.0992
Cash + accounts 284.8 0 0 0 0 124
Current liabilities 1200 1300 1400 1550 1300 1250
Income statement ratio (consistent)
1 Gross margin 0.03863 0.04258 0.03365 0.2695 0.0304 0.0279
Gross profit 324.5 417.3 370.2 398 345 276
Sales 8400 9800 11000 14765 11348 9876
2 Net margin 0.02557 0.02254 0.01656 0.0182 0.0227 0.0187
Net profit before tax 214.8 220.9 182.2 198 170 143
Sales 8400 9800 11000 10870 7483 7642

Source: calculated by the researcher.

 Lidl

According to this total ratio analysis of Lidl organization, it is seen that Lidl also got major losses from the year of 2020 years due to the COVID-19 outbreak and post-COVID-19 situation.

From Table 4, it is seen that Lidl was improving its businesses before the situation of the COVID-19 pandemic. After COVID-19, this organization is facing a huge loss in their business that may pose a huge challenge to continuing their business as their liabilities may be increased. In 2019, they get their maximum market share that is almost 10% in the UK; however, it has been reduced after the COVID-19 pandemic.

Ratio analysis of Lidl.

Ratio analysis spreadsheet
No. Years 2016 2017 2018 2019 2020 2021
Balance sheet ratio (plausible)
1 Current ratio 1.0390 1.0406565 1.0029 5.69367 2.81145 2.0849
Current assets 24849 24982 793498 821466 659435 512351
Current liabilities 23916 24006 791185 144277 234574 245743
2 Quick ratio 0.01363 0.01945 0.011109 0.024016 0.01369 0.009579
Cash + accounts 326 467 8790 3465 3212 2354
Current liabilities 23916 24006 791185 144277 234574 245743
Income statement ratio (consistent)
1 Gross margin 0.0458 0.0532 0.0484 0.0662 0.0567 0.0617
Gross profit 356 456 478 654 418 336
Sales 7765 8565 9865 9866 7370 5445
2 Net margin 0.0315 0.0402 0.0571 0.0665 0.0769 0.0793
Net profit before tax 245 345 564 657 567 432
Sales 7765 8565 9865 9866 7370 5445

Source: calculated by the researcher.

 Results and discussion

It is observed that Tesco PLC faces fundamental business losses in the 2020 financial year due to the COVID-19 pandemic. Sainsbury’s also experiences significant business losses in the 2021 financial year due to the business losses in 2020, and it reduces the overall sales volume of this enterprise by 0.3% (see footnote text 2, 2021). Aldi faces huge losses after the 2018 financial year due to inappropriate operational processes, and even Lidl also performed along the same lines with huge losses.

http://www.tescoplc.com/

http://www.sainsburys.co.uk/

http://www.craft.co/

 References World Bank Development Report. Data for Better Lives. Washington DC: World Bank (2021). Financing India’s MSMEs. Estimation of Debt Requirement of MSMEs in India, IFC Report. Washington, DC: IFC (2018). SME Competitiveness Outlook. COVID 19: The Great Lockdown and its Impact on Small Business. Geneva: International Trade Centre (2020). Stein P Goland T Schiff R. Two Trillion and Counting: Assessing the Credit Gap for Micro, Small, and Medium-size Enterprises in the Developing World, McKinsey USA. Washington, DC: IFC (2010). Hrishikesh. (2015) Nissim D Penman SH. Ratio analysis and equity valuation: from research to practice. Rev Account Stud. (2001) 6:109–54. Altman EI. Financial ratios, discriminant analysis and the prediction of corporate bankruptcy. J Finance. (1968) 23:589–609. Tracy JA. How to Read a Financial Report: Wringing Vital Signs Out of the Numbers. New York, NY: John Wiley and Sons (2004). 173 p. Farris PW Bendle NT Pfeifer PE Reibstein DJ. Marketing Metrics: The Definitive Guide to Measuring Marketing Performance. Upper Saddle River, NJ: Pearson Education, Inc (2010). p. 88–96. Renata (2017) Hasanaj P Kuqi B. Analysis of financial statements: the importance of financial indicators in enterprise. Hum Soc Sci Res. (2019) 2:17–27. Barnes P. The analysis and use of ratios: a review article. J Bus Fin Account. (2006) 14:449–61. Warui. (2017) Altman EI Iwanicz-Drozdowska M Laitinen EK Suvas A. Financial distress prediction in an international context: a review and empirical analysis of Altman’s Z-score model. J Int Finan Manage Account. (2017) 28:131–71. MacCarthy J. Using Altman Z-score and Beneish M-score models to detect financial fraud and corporate failure: a case study of Enron Corporation. Int J Fin Account. (2017) 6:159–66.