Corporate Finance
Introduction
Morrison’s is one of the largest supermarket chains in the United Kingdom. It was founded by
William Morrison in 1899 in Bradford, West Yorkshire in England. The company is registered as
Wm Morrisons Supermarket plc. Morrison’s controls about 11% of the total retail market among
the top supermarkets in the United Kingdom.
Tesco,29%
Sainsbury’s,17
%Asda,17%
Morrisons,11%
Co-operative
Food,6%
Others ,20%
Market Share for Supermarkets in
UK
Financial statements are basically formal financial records that indicate the financial activities or
operations of a company or an organization, individual or any business entity for a particular
period of time. These statements include the statement of financial position or the balance sheet,
the cash flow or the statement that reflects the changes in the sources and application of funds,
income and expenditure account or the profit and loss account or the statement of comprehensive
income and expenditure. These financial statements are mostly complex and they often require
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explanation on how the calculations of some of the figures were obtained in the financial
statements that were arrived at. The notes at the bottom of the statements that usually accompany
the statements mostly explain these figures as to where they appear in the subsidiary books of
accounts and how they were calculated. Large corporations or organizations have very complex
accounting structures that may require adequate analysis, detailed explanation and methods used
to arrive at the figures including the policies adopted and when they were adopted (Hermanson,
Edwards & Invacevich, 2011).
Purpose of Income and Expenditure Account and statement of financial position
The major purpose of the Income and Expenditure Account is to provide a financial statement
for a specified that summarizes all the transactions for that particular period and which shows the
net loss or profits. The income statement provides the measurement of a company’s financial
operations or performance over a particular accounting period. Its also known as the profit and
loss account. The income and expenditure account is mostly prepared for a year. The income for
the year is mostly entered on the right side while the expenditure is entered on the left side. The
difference of the two sides can be a surplus or deficit. It’s a deficit if the expenditure is more than
the income and the balance is entered on the expenditure side. If it’s a surplus then it means that
the income is more than the expenditure and the difference is entered on the expenditure side.
The major purpose of preparing the income and expenditure account is to determine whether the
business or the entreprice has made a surplus or deficit in its operations. This process is done
systematically. The first process is to determine the Gross Profit for the business. All the direct
expenses that were spent to buy or facilitate the acquisition of the goods to be sold are deducted
from the total sales that have been made. The Gross Profit is the initial surplus which is derived
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when all the direct expenses that were used to acquire the goods to be sold are deducted from the
sale of the goods for a specified period of time. For example, in the income and expenditure
account for morrison’s plc, the Gross Profit for the year 2014 and 2013 amounted to £1074
million and £1206 million respectively. The cut of procedures have to be adhered to strictly. For
example the differences between the receipt and payments is that the income statement is
prepared according to the accrual system and the transanctions that relate to the accounting
period are the only ones that are entered on the books of the account where as in the receipts and
payments account all the expenses incurred are entered whether they relate to the current period
or not. For exanple, when goods are purchased worth $1000 and only goods worth $500 are sold
then the entries in the income and expenditure will reflect that the purchases were $1000 as spent
but the closing stock have to be deducted in order to reflect the right quantities of the goods that
were sold. However, in receipt and payments accounts the whole amount of $1000 dollars will
be entered in the books of account. The same case applies where goods have been obtained on
credit. The receipt and payments account will reflect no entry while the income and expenditure
account will recognize the purchases which have to be entered but they will be reflected in the
Statement of Financial Position as Creditors. These process distinguish the accrual system from
the cash system. The income statement is based on the accrual system while the receipt and
payments is based on the cash system.
The other purpose of the income and expenditure account is to determine whether business
operations made a surplus or a deficit during its financial year. All the expenses that were spent
in the financial year are recorded and entered on the income and expenditure account. All the
direct expenses that were inccurred for the financial period are recorded and expenses that relate
to the future financial periods are deducted and entered as current assets in Statement of
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Financial Position as prepayments. The income and expenditure is also known as the Profit and
Loss account where the excess of the income against the expenditure is known as the Net profit
and the excess of the expenditure against the income is known as the Net Loss. For example,
according to the income statement of Morrison’s plc, in the year 2014 the company made a Net
Loss of £238million while in the year 2013 the company a profit of £647 million. The expenses
are all the amounts spent to facilitate the sales of the business. For example, salaries to staff, rent,
postage, transport, advertisements, insurance and stationaries like pens and note books.
The major pupose of the income and statement account is to determine whether the business
made a Net Profit or a Net Loss. The investors need this information to determine whether the
business is profitable or not as they are interested in investing their investments in profitable
businesses while the creditors use these statement to determine whether they will loan the
business some funds or not. When the business is making Net Losses it becomes unattractive to
creditors and investors as it represent a position where their investments or advances can be lost.
The Statement of Financial Position basically like a snapshot of the financial position of a
company at a particular period of time mostly at the end of the financial period. Its one of the
most important books of a company’s financial positions. The other ones are the income and
expenditure account and the cash flow. Its major difference from the other books is that its only
applies to one moment of time. These is mostly because details like valuation of stock and fixed
assets have to be carried out and their correct valuation at a specified moment in time be entered
on the Statement of Financial Position.
The major purpose of the Statement of Financial Position is that it determines the value of the
Fixed Assets or the Non-current assets. These are the investments that a business makes in order
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to facilitate the generation of profits. Examples of Non- current assets are like land, buildings,
motor vehicles and furniture. Proper provisions have to be made in order to provide for their
replacement in future.
Non-current liabilities are financial obligations and commitments that have to be repaid within
the financial period mostly before the end of twelve months. They are known as long-term
liabilities. They are mostly reflected on right side of the balance depending on the country’s
accounting policies which reflect the sources of financial funds.
The other important feature of the balance sheet is the Current assets which represent the assets
that relate to the financial period which is mostly within the twelve months of trading. The
current liabilities are the financial obligations that have to be honoured within the financial
period i.e. periods not exceeding twelve months. The current liabilities for Morrison’s plc were
£2873 million and £2334 million for the years 2014 and 2013 respectively while the current
assets were £1430 million and £1342 million for 2014 and 2013 repectively.
Net assets is the difference between the total assets and the total liabilities. For example, the Net
assets for Morrison’s plc for the year 2014 and 2013 were £4692 milion and £5230 million
respectively.
Retained earnings are generally the profits that have been generated by the company and which
have not been distributed as dividends. Dividends are the earnings that a business distributes to
its shareholders at the end of the financial period as proceeds from their investments. The
retained earnings are basically the accumulation of profits since the commencement of business
operations and they are basically accumulated surpluses or profits that have not been divided
among the shareholders. Retained earnings are mostly reduced by Net losses when they occur.
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The other important feature is the creditors that are found under the current liabilities. These are
the amounts that are deducted as owings or accounts payables. In the case of Morrison’s plc they
amount to £2272 million and £2130 million for the years 2014 and 2013 respectively. In the
income and expenditure account they are deducted and entered as payables in the balance sheet.
The same case applies to debtors who are listed as account receivables in the balance sheet and
they represent the total amounts that are owed to the company from the sustomers. In 2014 and
2013, the amounts owed to Morrisons amounted to £ 316million and £291 million respectively.
Profitability ratios
The sales growth rate for the year 2014 was -2.41%. The sales reduced by 2.41% in 2014
compared to 2013.
The gross sales margin for Morrison’s plc was 6% in 2014 compared to 7% in 2013 which
represents a reduction of 8.75% in 2014 compared to 2013.
The Return On Investments (ROI) for the year 2014 was -0.02 or -2%. The ROI reduced by 0.02
times in 2014 compared to an increase of 0.06 in 2013 which represented a reduction of 136.1 %
in 2014 compared to 2013.
The Return On Equity (ROE) for Morrisons plc for the year 2014 was 8.4 and 9.6 for the years
2014 and 2013 respectively. The ROE decreased by 12.% % in 2014 when compared to 2013.
The rate of return on assets was -2.22 and 6.15 in 2014 and 2013 respectively. This represented a
decrase of 136.1% in 2014 when compared to 2013.
The Financial Ratios and Trend For Morrison’s Plc
2014 2013 Trend
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Current Ratio Total Current Assets/Total current liabilities 0.50 0.57 -13.43
Quick Ratio TT C/ Assets – inventories /TT/ C Liabilities 0.20 0.24 -16.30
Receivable turnover Annual credit sales/average receivables 58.25 59.69 -2.41
Inventory Turnover Cost of goods sold/Avg inventory 20.34 20.71 -1.80
Asset turnover Sales/Average total assets 312% 320% -2.41
sales margin GP/total sales 0.06 0.07 -8.75
Return on
investments
Net income/total assets -0.02 0.06 -136.09
Net assets turnover Net assets / total sales 27% 29% -8.07
Times interest
earned
EBIT/Annual Interest Expense 10 14.6 -31.51
Debt to total Asset Debt/Assets % 0.26 0.21 26.73
Interest cover EBIT/Annual Interest Expense 10 14.6 -31.51
Profit margin on sale GP/sales 6.07 6.66 -8.75
R.R return on assets EAT/Total Assets -2.22 6.15 -136.09
R.R com stock equity Profit after taxes/Shareholders equity % -5.07 12.37 -141.00
Earnings per share
(p)
Profit after taxes-pref div)/No. of comm O/S 10.23 26.65 -61.61
Payout Ratio cash dividends/income -2.59 1.08 -339.50
ROE Return On Equity (ROE) 8.4 9.6 -12.50
ROA Return on average Assets -0.04 0.11 -136.79
Liquidity
Liquidity refers to the process of converting asserts to cash. Liquid assets can be converted to
cash much faster than the rest of the assets. The most liquid asset is cash and securities. Liquidity
ratios indicates a company’s ability to honor its short term commitments and obligations. A
higher ratio indicates more or greater liquidity.
Financial ratios provide a system of valuation to most organization’s financial positions and
statement of affairs as they determine, analyze and provide accurate financial information on the
potential company. They reveal any major weaknesses, strengths or threats and opportunities that
the company may face or exploit. The most common ratios are gearing, profitability ratios and
liquidity ratios. They provides a basic and reliable diagnostic tool that exhaustively identifies the
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danger zones that a company may be prone of while analyzing the opportunities or threats that a
company may face from its competitors in the same industry or from other external markets
(Vance, 2003).
The major liquidity ratios are Current and quick ratios are some of the important ratios that
reflect the liquidity position of a company. The current ratio indicates the ratio at which the
current liabilities are covered by the current assets. The rule of thumb is usually 2:1. The current
liabilities should be covered at least twice by the current assets. This ratio is arrived by dividing
the total current assets and the total current liabilities. The other ratio is the quick ratio which
indicates the rate of liquidity of a company when the inventories are deducted from the current
assets and the results are divided by the current liabilities. The rule of thumb for this ratio is
usually 1:1. The amount of current assets after deducting the cost of inventories should be equal
to the current liabilities. The ratio of the current asset in either ways should be equal or higher in
the case of the quick ratio but in the case of current ratio, it would be sustainable or reliable if the
ratio of current assets is twice the ratio of current liabilities or even more than twice the rate.
The current ratio for Morrisons for 2014 and 2013 respectively amounted to 0.5 and 0.57 which
represents a reduction of 13.43% from the year 2013. The current ratio for 2014 indicates that
the current assets are 0.5 less than the current liabilities. It means that the current liabilities are
twice the current assets. The quick ratio reduced by 17.67 percent from 0.2 in 2012 to 0.24 in
- The quick ratio for Morrisons plc shows that the current assets ( less the inventories) are
less than 0.2 times the current liabilities for year 2014 while in 2013 it was less by 0.24 times.
The debt to total assets ratio for Morrisons for 2014 was 0.26 and 0.21 in 2013. The ratio
improved by 26.73 % in 2014 as compared to 2013. The debts represent only 26% of the total
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assets in 2014 as compared to 21 % in 2013.
The times interest earned for the years 2013 and 2014 were 10 and 14.6 respectively and which
means the EBIT covers the annual interest expense 10 times and 14.6 times for 2014 and 2013
respectively.
Asset turnover for Morrisons plc amounted to 312% or 3.12 times and 320% or 3.20 for the
years 2014 and 2013 respectively. The sales cover the average total assets 3.12 times and 3.2
times for 2014 and 2014 respectively.
Creating Accounting
An indicator to creative accounting refers to a process of providing cosmetic accounting by
income smoothing, financial engineering and earnings management. In the US the process is
known as earnings management while the phrase creative accounting is mostly used in Europe.
Creative accounting relates mostly to the balance sheet and the entries that relate to the balance
sheet.
The indicators to creative accounting are mostly detected by the control accounts and also when
balancing the trial balance. There are many types of errors that affect both the accounts. Errors of
omission and commission will be revealed automatically when balancing the books of account.
However compensating errors are difficult to detect when conducting ordinary internal control
procedures as more detailed analysis of the financial documents have to be conducted. When
reconciling the trial balance and it fails to balance then the source of the extra funds or deficit
must be investigated. The deficits or the extra funds serve as indicators that some entries are
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either missing, overstated or understated.
The cash flow also reveals details of creative accounting if there are any inconsistencies in the
accounts. The indicators of creative accounting can be the regulatory flexibility that’s available.
In accounting, there is a lot of flexibility in the choice of accounting policies that can be used.
For example, in asset valuation the International Accounting Standards allows non-current assets
to be revalued using historical cost valuation or other depreciation methods as approved by the
tax agencies that exist in different countries (Mulford and Comiskey, 2002) .The changes in
accounting policies are mostly announced when they are being introduced but they can be
changed backed to their original forms quietly and without any notification at the convenience of
the managers (Largay, 2002).
Some organizations suffer from dearth of regulation where regulations are not fully
implemented. For example, accounting in stock options regulation is limited and most
requirements and policies are not mandatory in most countries like Spain where pension
liabilities and other financial instruments are prone to manipulations.
The provision of bad debts and other provisions in different sections of accounting practice
provide discretionary areas where considerable ground has been allowed for estimation and
which can be easily manipulated to provide room for earnings management.
Some transactions may be genuine but they can be applied under certain timings that provide the
desired outcomes. For example, investment can be valued under historical costs where inflation
or economical factors have made the historical cost valuation to be higher than the market rates.
Managers are allowed to sell the company assets when they can fetch the highest returns so as to
increase the company profits (Hermanson, Edwards & Invacevich, 2011).
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Doctored transactions can be used to manipulate the entries in the balance sheet and transfer
profits from one accounting period to another. This information can be achieved by involving the
bank as a third party to manipulate the banking records. An asset can be sold to a bank but later it
can be leased back to the company for the remainder of its useful life. The difference between
the selling price and the leasing amount can be manipulated to reflect the figures desired in the
balance sheet.
To conclude, the reclassification and subsequent presentation of financial figures can be utilized
to reclassify liabilities and other financial obligations to smoothen the earnings into achieving the
desired liquidity and other leverage ratios.
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References
Hermanson, R.H., Edwards, J.D., & Invacevich, S.D. (2011) Accounting Principles: A Business
Perspective. First Global Text Edition, Volume 2 Managerial Accounting, 37-73.
Mulford, C.W. and Comiskey, E.E., 2002, The financial numbers game: detecting
creative accounting practices. New York: Wiley.
Largay, J., 2002, Lessons from Enron’, Accounting Horizons, Vol. 16, No. 2, p.154
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Appendix
Morrison’s Plc Financial Information
2014 2013 2014
£ millions 000,000 000,000 Trend
GP 1074 1206 -10.95
Net Profit -238 647 -136.79
EAT -238 647 -136.79
Shareholders’ Equity 4692 5230 -10.29
Total Assets 10729 10527 1.92
Total Liabilities 6037 5297 13.97
Inventories 852 781 9.09
Cost of Goods 16,606 16910 -1.80
Average inventory 816.5 816.5 0.00
Debt 2817 2181 29.16
EBIT -95 949 -110.01
Sales 17680 18116 -2.41
TT Assets-
Inventories
9877 9746 1.34
Interest Expense 81 65 24.62
Average Receivables 303.5 303.5 0.00
Current Assets 1430 1342 6.56
Current Liabilities 2873 2334 23.09
Average total assets 5667 5667 0.00
Receivables 316 291 8.59
Outstanding shares 2327 2428 -4.16
Payables 2272 2130 6.67
Earnings per share
(p)
10.23 26.65 -61.61
Net assets 4692 5230 -10.29
Net assets turnover 26.54 28.87 -8.07
Net profit margin -1.35 3.57 -137.69
Total Dividend Paid 617.55 700.9516 -11.90
ROCE 8.4 9.6 -12.50
Net debt/Ebitda 2.4 1.7 41.18
Gearing 60 42 42.86
interest cover 10 14 -28.57
