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Ratio Analysis Under Different Accounting Rules

1255 words - 6 pages

Summary
Comparing different companies under different rules, or comparing one company in different time period can be complicating and often misleading when differences in accounting methods are not captured. In this essay, I will start the analysis by examining each firm’s change in accounting methods compared to their previous year. Then I will move on to comparing the three companies’ ratios to conduct analysis of each company based on the DuPont Method. In addition, I will also look at how changes in accounting methods affected Seven and I holdings’ results in 2013 when compared to 2012.
Finally, I will conclude my analysis on how comparable it was under different accounting methods ...view middle of the document...

As written above, there is no significant change in accounting methods for Walmart and Sainsbury. There were changes to Seven & I holdings’ accounting methods, however when comparing the three companies I will use original number as I think that would be more objective, and later on examine Seven & I Holdings’ number individually with and without the effects of the change.

Ratio Analysis


* For Seven and I Holdings numbers are not adjusted in above chart

ROE
Return on Equity is a ratio used to measure a company’s profitability based on how much profit the company made for the money invested to the company, hence calculated as Net Income divided by Shareholder’s equity.
Comparing the three companies, Walmart has the highest ROE, more than twice of Sainsbury and more than three times of Seven and I holdings. Amongst stock market participants, Japanese companies are known for its low ROE especially compared to American firms and in case of seven and I holdings, it is consistent with that notion (on a side note, 7&I Holdings’ ROE goal is 10%).

DuPont Method
It is clear that Walmart has quite a high ROE compared to other two companies, however, if we compare three companies by just looking at their ROE, but we don't know what is driving that high ROE.

With the DuPont method, ROE can be divided into three parts:
ROE = (Profit margin) x (Asset turnover) x (Leverage ratio)
= (Net profit/Sales) x (Sales/Assets) x (Assets/Equity)

In general, it is fair to say that consumer retail business doesn’t have a big profit margin compared with big profit margin industry like financial industry or mining industry. So for firms to achieve high ROE, they must maintain a high asset turnover and high leverage ratio.
With the DuPont Method, we can clearly see that Walmart’s high ROE is driven by its high asset turnover and leverage ratio rather than profit margin as there is only about 1% difference in profit margin.
In addition, looking at ROA in each company, we can also see that Walmart has significantly higher ROA compared with others. ROA is used to measure how effectively a firm is turning its invested capital to earnings. Combined with the above DuPont analysis, it is reasonable to say that Walmart is exceling in generating more profit with less capital compared with other two companies.
On a side note, another reason could be that Walmart is using LIFO under inflationary economy based on GAAP, which could be increasing the Net Income compared to Sainsbury (FIFO under IFRS) or Seven and I holdings (FIFO under Japan Standards).
However, at the same time, Japan has been in deflationary economy so in theory Seven and I Holdings’ usage of FIFO can increase their net income as well, so we cannot conclude whether Walmart’s usage of LIFO has significant impact on their Net Income or not.

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