Woolworth vs. Wesfarmers A Case Study

Woolworth vs. Wesfarmers A Case Study

Woolworthvs. Wesfarmers: A Case Study

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Tableof Contents

Introduction and Scope of the Report 1

Comparison of Financial Statements and Performance Metrics 2

Balance Sheet 3

Income Statement 5

Statements of Cash flow and Changes in Equity 6

Comparing Profitability Ratios 7

Sustainability Accounting Report 10

Conclusion 11

References 13

Appendix 1: Wesfarmers Balance Sheet as at 30 June 2015 15

Appendix 2: Woolworths Balance Sheet as at 28 June 2015 18

Appendix 3: Wesfarmers Income Statement 19

Appendix 4: Woolworth Income Statement 20

Appendix 6: Woolworths Cash Flow Statement 23

Woolworthvs. Wesfarmers: A Case Study

Introduction and Scope of theReport

Woolworthsand Wesfarmers are two of the largest companies in the Australianretail industry. This report focuses on evaluating and contrastingdifferent aspects of the two companies, a critical analysis ofbusiness operations, financial reports, the dividend policy regimeand their short-term policy regimes. Both companies are diversifiedoffering a variety of goods and services. Woolworths deals in thepowerhouse and electrical equipment, energy, hospitality, operatessupermarkets and departmental stores. Meanwhile, Wesfarmers offershome and office supplies, insurance services, chemicals, industrialand safety equipment operates supermarkets and retail stores as wellas coal mining. The analysis in this report is majorly informed bythe 2014 financial report of both companies and the data therein willbe used as the base for making statistical inference and projectingthe future prospects of the two companies, albeit in a comparison toeach other.

Onlyconsolidated figures from Woolworths and Wesfarmers will be employedin drawing a comparison between the past, current and futureperformances of the two companies. The documents from whichcomparisons will be drawn include the balance sheet, the incomestatement, changes in equity, and statements of cash flow andrefinements of financial statements of the two companies. In thisendeavor, both the figures in the financial reports as well as thedifferences in the formats and structure employed by the twocompanies to present their financial statements will be analyzed.Adherence to the general accounting standards, that is, theInternational Financial Reporting Standards (IFRS), will also beassessed for the two companies in a bid to ascertain financialprudence and corporate responsibilities. Finally, the report willprovide a general summary of the analysis and make a fewrecommendations based on the assessments.

Comparison of FinancialStatements and Performance Metrics

Thissection comprises the most important part of the report as it relieson a variety of financial reports of the two companies to makecomparisons of performance between the two companies. The financialstatements analyzed here include the balance sheet, the incomestatement, changes in equity, and statements of cash flow andrefinements of financial statements of the two companies.

BalanceSheet

Bothcompanies adopt a similar structure of balance sheet comprisingequity, assets and liabilities. This is important since the specificitems of the balance sheets will be used as units to make comparisonsbetween the two companies. In the balance sheets of the twocompanies, the assets are categorized into current assets and fixedassets a similar structure adopted for liabilities while equity ispresented as a gross figure in both cases. In all cases, the balancesheet items are arranged in the balance sheet equation, that is,Total Equity + Total Liabilities = Total Assets or simply (E + L =A). The balance sheet equation is significant in this part of theanalysis since in determining the asset base of a company, it is bothpaid and debited sales will be taken into account. Moreover,determining the asset base of a company will involve a receivable,fixed assets and inventory signal a higher asset base. In the balancesheet, a company’s assets increase proportionately with theliabilities. This is the underlying concept of a balance sheet thatenables it to balance. Both Woolworths and Wesfarmers align theirbalance sheet and other financial reports with the AustralianAccounting Standards Board (AASB).

Bothcompanies recorded a significant increase in assetsin 2015 (See Appendix 1&amp 2). Much as this was the case, thepercentages differed as well as the dollar terms implied to by bothcompanies. It is important to note that the assets as referred to inthis report denote the resources that can be measured quantitativelyand are in possession of the companies. As for liabilities,this in this report denotes the outcomes of business operations thatresult in a company owing other business associates some resources.In the balance sheet of the two companies, employees, tax, creditorsand suppliers, denote the liabilities. Just as is prescribed by theaccounting equation, the liabilities of the two companies increasedjust as did the assets. An apt interpretation of the proportionalincrease in assets and liabilities from an accounting perspective isthat as the resources in a company’s possession increase, so doestheir liability to acquire such resources (Needles et al., 2012, p.33). Both Woolworths and Wesfarmers had impressive equityas shown in Appendix 1&amp 2 their respective balance sheets in2015. The equity of a company represents the company’s shareholdercontributions in anticipation of better returns by the company.Alternatively, equity represents the residual interest of the companynet assets, that is, assets less liabilities. For both Woolworths andWesfarmers, there was a percentage increase in equity for the year2015.

Informationprovided accompanying the financial reports by both Woolworths andWesfarmers point to a significant similarities and difference in themetrics used to gauge liabilities and assets. For instance, in theWoolworths’ balance sheet, hedge accounting is not applied in thecase where the foreign exchange exposure of an identified monetaryliability or asset is economically hedged using a derivativefinancial instrument. However, for Wesfarmers, the attributable riskfor hedging is used to determine the carrying values of the specificliabilities and assets. Moreover, in the Wesfarmers reports, abalanced value hedged relationship is determined by the amortizedcosts. A striking similarity between the two companies as revealed bythe balance sheets is that in both cases, the company assets arecollateralized using equity and debt liabilities. Moreover, bothcompanies seem to attach a lot of significance and asset security inthe corresponding growth of payables. The level of assetcollateralization is mostly used in accounting spheres to gauge thefinancial strengths and weaknesses of a company. Going by this, bothWoolworths and Wesfarmers are financially strong and have sustainablegrowth prospects going forward. Another accounting technique used togauge future success of a business that may apply to the twocompanies given the items on their respective balance sheets is theequity-liability ratio. Essentially, a higher debt level relative toequity is an indicator of an unsustainable business operation (thus aweak financial position) since the situation may necessitateliquidation to pay off debts (Needles et al., 2012). Given the abovecriteria, Wesfarmers is in a stronger financial position relative toWoolworths since it has a higher level of equity relative to debt.However, Woolworths is also in a stronger financial position on themerit of its stronger financial performance in 2014. In general, fromthe company balance sheets, it can be concluded that both Woolworthsand Wesfarmers are in a stronger financial position.

IncomeStatement

Theincome statement is a financial report that presents the profit andloss of a company for a specified period. There is a slightdifference in the structure of the income statements for bothWoolworths and Wesfarmers with the latter having a clearer financialstatement for the period ending July 30, 2014. This clarity is seenin the definition of report items such as the profits, expenses andincomes. Meanwhile, Woolworth’s income statement breaks up the keyitems into smaller elements. However, both Woolworths and Wesfarmers’income statements adhere to the accounting standards required by theAustralian Accounting Standards Board (AASB). It is important to notethat in both statements, the companies have the key items of astandard income statement, that is, profits, earnings per share,finance costs, share of profit/ loss for associates and revenue.

Inthe cost of goods sold in both retail outlets are $43425 million, forWesfarmers and $44179 million for Woolworths. Both companies havesignificantly increased their revenues relative to the previousperiods. Both Woolworths and Wesfarmers use a tax rate of 30 % and aprovision of a differed income tax made for all variations in assetand liability base. The two companies also have expenses relating tothe operating lease rent. Another similarity displayed by the incomestatements is that both companies record a significant increase inincomes in 2014. It is also important to note the difference inclassification of expenses where Wesfarmers classifies employees,amortization and depreciation due to their naturewhileWoolworth classifies, by function,the administrative expenses. The income statements also show that themain expenses are the cost of sales.

Giventhe 2014 income statements, the net income for Woolworths is $2,146million while that of Wesfarmers is $2440. Much as one company isslightly profitable compared to the other, it is clear that bothcompanies are very profitable. From an investor perspective, theearnings per share item are very critical since t is what ashareholder is entitled to. The earnings per share is the amount ofrevenue that remains after tax and “profit normalization”. Theoperating incomes of the two companies are $3,388 million and$3,748.4 million for Wesfarmers and Woolworths respectively. In orderto recognize financing income and cost of sales, both Woolworths andWesfarmers use specific criteria hinged on the lay-by transactionprinciple. The two companies are also similar in that they bothrecognize inventory as expenses (SeeAppendices 3 &amp 4 for the respective Income Statements).

Statementsof Cash flow and Changes in Equity

Cashflow statements essentially indicate the rate at which a businessoperation is profitable through its operations, how the businessraises money for such operations and finally, how this money isinvested by the business. Both Woolworths and Wesfarmers adhere tothe structure of cash flows recommended by the Australian AccountingStandards Board (AASB). A striking difference between the two cashflow statements is in the items that signify a difference in themanner in which the two companies operate. For instance, the item inWoolworth’s statement reading “payments for purchase of business”shows that the company is acquiring assets, while the correspondingstatement in Wesfarmers’ report reads “Proceeds from sale ofentities” implying that the company is disposing its entities togenerate cash. These are differing techniques in company operationsas revealed by the statements and have to be taken into account whenanalyzing the business strengths of the two companies. Moreover, suchstatements also provide some insight into the trends adopted by thecompanies, which are likely to influence future business operations.

Anothersignificant difference between Wesfarmers and Woolworths is in thefinancing activities segment. The difference comes in the receivablesand external borrowings repayment. Here, Wesfarmers appear to bereducing debts since their receivables (proceeds) were lower thantheir repayments, a complete contrast to the Woolworth situation. Forboth companies, the statements of equity as provided only seek toreconcile the balance sheet with the income statements. The key roleof a statement of equity is to usually ensure coherence of financialreports in instances where certain items are subject to exceptions(Penman&amp Penman, 2007, p. 477).As concerns the mode of presentation of the cash flow statements,both Wesfarmers and Woolworths employ the direct method but they alsoemploy the indirect method for their statements of equity. In lightof the cash flow statement and the statement of equity for the twocompanies in 2014, it come out that both companies are in a strongfinancial position much as they employ different approaches toraising and investing funds.

ComparingProfitability Ratios

Aprofitability ratio is a measure of a business’ ability to makeprofits and is usually used to gauge the performance of a business.The figure below shows the profitability ratios for the two companiesbetween 2006 and 2015.

Figure1.0:Profitability Ratios for Wesfarmers and Woolworths between 2006 and2015

Adoptedfrom Morning Star Financials (2015)

Thebusiness ratios that will be discussed in this section include thereturn on assets (ROA), return on equity (ROE) and return on InvestedCapital (ROC) for the year 2014 for Wesfarmers and Woolworths.Moreover, the asset turnover will also be compared for the twocompanies. In 2015, Woolworths’ return on assets was 8.66%relative to Wesfarmers’ return on assets, which was 6.09%. SinceWoolworth has a higher return on assets compared to Wesfarmers, itimplies that Woolworths earns a higher profit based on its resources(read total assets) as compared to Wesfarmers. However, Wesfarmershas a much higher return on equity that is 9.61% as compared toWoolworths’ 2.34% implying that the former earns more profit onshareholder equity than the latter. Therefore, from an investorperspective, Wesfarmers performs much better as compared toWoolworths since for every $1 invested in shares, one stands to gaina return of $9.61. As for the returns on invested capital (ROC),Woolworth is on a much stronger financial position as its return oncapital is 15.40 % as compared to Wesfarmers’ 8.48 %. This showsthat for every $1 invested in both companies, Woolworth would return$6.92 more than Wesfarmers. Additionally, the asset turnover ofWoolworth is higher than Wesfarmers’ by 0.91 implying thatWoolworth, which has a higher asset turnover ratio, has a much lowerprofit margin as compared to Wesfarmers. In summary, theprofitability ratios of Wesfarmers and Woolworths give a mixedoutcome as far as company performance is concerned. From an investorperspective, Wesfarmers is much better than Woolworths while from anorganizational perspective, Woolworth is much more impressive. Thefigure below shows the variations in profitability ratios for the twocompanies for 2015.

Figure2.0:Profitability Ratios for Wesfarmers and Woolworths for 2015

Source:Own Graph, data obtained from Morning Star Financials (2015)

Sustainability AccountingReport

Thissection presents the non-financial information that may be requiredas an extra information to supplement the financials in decisionmaking by the creditors, investors and other parties that areexternal to organizations (in this case, the organizations areWoolworths and Wesfarmers). The essence of such information isusually to enable ascertainment of business existence in future. Therecent oil price plunge is expected to deliver mixed profitabilityresults for both Woolworths and Wesfarmers. According to the GlobalCredit Research (2015, n.p), Australian retailers like Wesfarmers andWoolworths are likely to experience reduced returns especiallyaccruing from high disposable incomes and lower logistics costs. Theimplication herein is that investors and creditors should be cautiousof the impending macroeconomic environment in Australia within whichthe two companies operate. For creditors, this implies that theyshould lend with certain well-calculated reservations, an action thatshould be replicated by shareholders.

ForWesfarmers, the sale of the insurance and gas business recentlyresulted in a 4% drop in half-year profits to $1,376 million.Moreover, the company immediately announced an interim dividend of 89cents per share from the previous 85/share which raises suspicion(Letts, 2015, n.p). The fall in business profits accompanied by theraising of dividends to 89 cents per share (note that this is interimfigure) is not rational and hence appears like a well-calculatedscheme to appease shareholders, albeit temporarily. Woolworths is notany different, the financial statements as discussed in the previoussections of this report paint it as the ultimate profit-generatingfirm, which is not absolutely true. Janda (2015, n.p) reported thatthe 12.5% slump in Woolworths profits followed by the appointment ofa new chairperson are significant indications that “things are notadding up” at the giant retailer.

Conclusion

Woolworthsand Wesfarmers are two of the largest companies in the Australianretail industry. This report focused on evaluating and contrastingdifferent aspects of the two companies, a critical analysis ofbusiness operations, financial reports, the dividend policy regimeand their short-term policy regimes. In this endeavor, the balancesheet of the two companies as well as the income statement and thecash flow statements of the two companies were contrasted.Additionally, profitability ratios of Wesfarmers and Woolworths werecompared to assess performance from a profitability perspective. Theanalysis, however, yield mixed results for the two companies. Thebalance sheets showed slight substantial differences but demonstratedthat both Woolworths and Wesfarmers are in a stronger financialposition as so did the income statements. A major operationaldifference was manifested in the cash flow statements of thecompanies. For instance, the item in Woolworth’s statement reading“payments for purchase of business” shows that the company isacquiring assets, while the corresponding statement in Wesfarmersreport reads “Proceeds from sale of entities” implying that thecompany is disposing its entities to generate cash.

Comparingthe profitability ratios only served to show that both companies arefinancially strong only that this is on different preferences. Forinstance, Woolworths has a very high ROC compared to Wesfarmers(15.4% to 8.48%) which has a very high ROE as compared to Woolworths(9.61% to 2.34%). This shows that Woolworths is a better performer tothe owners and management while Wesfarmers is a better performer tothe shareholders. The sustainability accounting report implies mixedfortunes and sheer uncertainty for the Australian retail sector inwhich both Wesfarmers and Woolworths operate. Nevertheless, bothcompanies come across as very profitable and operationally effective.

References

Bloomberg(2015). Woolworth Financials, .Retrieved on September 27, 2015from&lthttp://www.bloomberg.com/research/stocks/financials/financials.asp?ticker=WOW:AU&ampdataset=cashFlow&ampperiod=A&ampcurrency=native&gt

GlobalCredit Research (2015). Moody’s:Oil Price Plunge Delivers Mixed Results for Australia’sNon-Financial Corporates,., Retrieved on September 27 2015from&lthttps://www.moodys.com/research/Moodys-Oil-price-plunge-delivers-mixed-results-for-Australian-non–PR_318682&gt

Letts,S. (2015).Wesfarmers profit slides due to sold businesses underlying earningssurge…Retrieved on September 27 2015from&lthttp://www.abc.net.au/news/2015-02-19/wesfarmers-profit-slides-due-to-sold-businesses/6146534&gt

MarketWatch (2015), WesfarmersFinancials.Retrieved on September 27, 2015from&lthttp://www.marketwatch.com/investing/stock/wfaff/financials/balance-sheet&gt

MorningStar Financials., (2015)., WesfarmersandWoolworthProfitability Ratios.,Retrieved on September 27 2015from&lthttp://financials.morningstar.com/ratios/r.html?t=WOLWF&gt

Needles,B., Powers, M., &amp Crosson, S. (2012). Principlesof accounting.Cengage Learning. Retrievedon September 27, 2015from&lthttps://books.google.co.ke/books?hl=en&amplr=&ampid=pa4WAAAAQBAJ&ampoi=fnd&amppg=PR3&ampdq=Principles+of+Accounting&ampots=GHxjEfiOrd&ampsig=gv5Y8Ikg5JwfhzX4bSpSPAZRM7o&ampredir_esc=y#v=onepage&ampq=Principles%20of%20Accounting&ampf=false&gt

Penman,S. H., &amp Penman, S. H. (2007). Financialstatement analysis and security valuation(p. 476). New York: McGraw-Hill.

Appendix1: Wesfarmers Balance Sheet as at 30 June 2015

Appendix1: Continuation

Appendix1: Continuation

Appendix 2: Woolworths BalanceSheet as at 28 June 2015Appendix 3: Wesfarmers IncomeStatementAppendix 4: Woolworth IncomeStatement

Appendix5: Wesfarmers Cash Flow Statement

Appendix5: Continuation

Appendix 6: Woolworths CashFlow Statement