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A Comparison of Financial Reports

Wesfarmers Ltd Vs. Woolworths Ltd

7th May 2012

Financial Analysis of Wesfarmers Limited and Woolworths Limited


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This report provides an analysis and evaluation of the current and prospective financial performance and position of both Wesfarmers Ltd. and Woolworths Ltd. These companies represent the two largest business organisations in the Australian retail sector. Wesfarmers is a diversified company operating supermarkets, department stores, home improvement and office supplies, coal mining, insurance, chemicals, energy and fertilizers, and industrial and safety products. Woolworths is also a diversified company operating supermarkets, department stores, consumer electronics, powerhouse and electrical, petrol and hotels. We utilize data from each companys 2011 annual reports to present and analyze their respective financial performance and make inferences about their future financial prospects. We utilize only the consolidated figures from each company that include the analysis of each respective balance sheet, income statement, statements of cash flow and changes in equity and analysis and interpretation of financial statements. Finally, an overall summary with recommendations will be made including suggestions for future improvement.

Balance sheet The structure and major elements of Wesfarmers and Woolworths respective balance sheets each comprise assets, liabilities and equity. Both firms use a narrative format structured with the following hierarchy: Current Assets Non-Current Assets Total Assets Current Liabilities Non-Current Liabilities Total Liabilities Shareholders Equity Total Equities

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These elements can be expressed in a balance sheet equation: Assets = Liabilities + Equity. The meaning of this equation is important and pertinent to our discussion. Since sales, whether paid or owed to a company, indicate a larger asset basehigher levels of inventory, receivables and fixed assets (plant, property and equipment). As a companys assets increase, its liabilities and/or equity also tend to increase in order for its financial position to stay in balance. It is important to note that the above companies report their financial statements in accordance with the Australian Accounting Standards Board (AASB) and the International Financial Reporting Standards (IFRS). The first elements of the structure are assetsthese are resources of value that the company owns and has in its possession; these will be received and can be measured quantitatively. Wesfarmers and Woolworths both had positive growth in assets in 2011 even though the percentage rates and growth amounts in dollar terms were very different from each other. The second group of elements are liabilities or obligations arising from past events that a company owes otherssuch as creditors, suppliers, tax authorities and employees. These must be paid within certain time frames and conditions. Both companies liabilities increased percentage-wise in 2011. This does not necessarily represent a backward step in the companies overall growth. That is, as the companies assets increased so too did their liabilities to acquire those assets. The third group of elements are equity. A company's equity represents retained earnings and funds contributed by its shareholders, who accept the uncertainty that comes with ownership risk in exchange for what they hope will be a good return on their investment. The equity on the balance sheet also represents the residual interest in the assets of the entity after deducting all its liabilities. Again, equity increased percentage-wise for both companies. The notes of both companies reveal similarities and differences in how they measure assets and liabilities. The balance sheet of Wesfarmers shows that the carrying values of recognised assets and liabilities that are the hedged items in fair value hedge relationships, which are otherwise carried at amortised cost, are adjusted to record changes in the fair value attributable to the risks that are being hedged. For Woolworths when a derivative financial instrument is used to hedge economically the foreign exchange exposure of a recognised monetary asset or liability, hedge accounting is not applied and any gain or loss in the hedging instrument is recognised in the consolidated income statement. Both
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companies adhere to the Australian Accounting Standards Board (AASB) and the International Financial Reporting Standards (IFRS).

Regarding the strengths and weaknesses of each companys financial position the respective balance sheets reveal that each companys assets are supported, or financed, by a corresponding growth in payables, debt liabilities and equity. Even though both companies growth rates are distinct and differ in amounts they reveal overall financial health for both groups. That is, they possess a reasonable mix of liabilities and equity, which is a sign of financial health for both businesses. While analysing and observing the figures in the balance sheet, a good indicator of a good financial position is a larger equity value compared to liabilities as a measure of a firms positive investment quality. Possessing a higher level of debt liability than equity may increase the likelihood that a business will face financial woes if the firm had to become liquid in order to pay off its debts. However, this does not necessarily mean a firm is in a weak financial position since firms do not usually have to pay off all of their debts on a yearly basis. In our case Wesfarmers has a higher level of equity than debt liabilities and indicates a strong investment quality; Woolworths has higher level debt liabilities than equity; though its weakness here is that it does not have a strong investment quality it is still in a strong financial positions due to its positive financial performance. Thus, it may be said that both firms are in strong financial positions. That is, they both performed robustly in 2011, though Woolworths has the above weakness. Income statement

The income statement reflects the accounting return for the entity for a specified time period, and reports on the income and expenses of an entity for that period, including the resulting profit and loss. The appearance of the income statements for both companies and the structure of income statements are slightly different. The income statement for the year ending 30 July 2011 for Wesfarmers has a clearer structure than Woolworths for the same period. For example, in Wesfarmers income statement it clearly defines the main elements such as income, expenses and profit. It is a very simple and clear structure. Woolworths income statement is not as simple. That is, the structure of the statement breaks up all the
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necessary elements into smaller segments. However, despite these small distinctions all major elements of the income statement are present in both statements. Both companies abide by the accounting standards set by the Australian Accounting Standards Board which comply with International Financial Reporting Standards. Both firms have the following elements in their income statements: Revenue Finance Costs Share of Profit of Loss of Associates Tax Expense Profit Earnings Per Share

Unlike Wesfarmers, Woolworths has included specified gross profit and earnings before interest and tax. Also, the components of income are shown in the respective income statements and notes. It is obvious that the major element of income is revenue from the sale of goods and is similar for both retail companies. Furthermore, the figures of sale of goods are also similar, $52,891 million and $54,142.9 million (Wesfarmers and Woolworths respectively). Compared with previous periods both companies have increased their revenue. The other sub-classifications of income include rents, interest, dividends (Woolworths), and rendering of services, interest (Wesfarmers). According to the income statements both companies record financial income, which included interest income and dividends. Other differences in the structure of the income statement for Woolworths are its aggregate interest income, and dividends income is represented as financial income. In Wesfarmers income statement structure only interest income is represented here, whereas dividends are included in another income category.

Considering that both companies are reporting entities, they have to classify their expenses by nature or by function. Expenses on both income statements are classified according to their natures (employee benefits, depreciation and amortization (Wesfarmers), and their function (administration expenses, Woolworths), occupancy-related expenses

(Wesfarmers).
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According to the companies income statements the main expenses are th e cost of sales (Woolworths: $ 40,186.3 million) or raw materials and inventory (Wesfarmers: $ 36,515 million). The expenses in Wesfarmers are more detailed, compared to the Woolworths income statement which does not include an additional sub-classification of expenses (but is specified in the notes). The notes in Woolworths stipulate that it has such expenses as depreciation and amortization and employee benefits expense. Both companies have operating lease rental expenses.

Both companies specify profit before income tax. Income tax according to notes 5 (Wesfarmers and Woolworths) include current income tax and deferred income tax. Current tax assets and liabilities for the current and previous reporting periods are measured at the amount expected to be recovered from or paid to the taxation authorities. Both companies use a tax rate of 30 %. Deferred income tax is provided on all temporary differences at the balance sheet date between the tax bases of assets and liabilities and their carrying amounts for financial reporting purposes.

The bottom line figures net profit attributable to member of the parent is very important for analyses of profitability. The net profit of Wesfarmers equals $1,922 million; and Woolworth equals $2,140.3 million. It is obvious, that both of these companies are very profitable through their activities.

Earnings per share is one of the most important elements of the income statement for investors and is defined as the net income (or profits) of a company divided by the shares of common stock outstanding. With earnings per share, you are looking at the amount of money left over for shareholders, after taxes, and "normalizing" those profits by stating them on a per share basis. Comparing the two companies it is obvious that Woolworth (174, 64 cent per share) has had a better result than Wesfarmers (166, 7 cents per share).

Revenue is recognized and measured at the fair value of the consideration received or receivable to the extent that it is probable and that the economic benefits will flow to the groups and the revenue can be reliably measured. Wesfarmers and Woolworths disclose
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their revenue and expenses recognition policies in the notes to the accounts. Note 2 and 1 of Wesfarmers and Woolworths accounts respectively determine specific recognition criteria that must also be met before revenue is recognized.

Both companies specify the criteria for the recognition of sales of goods as revenue when the significant risks and rewards of ownership of the goods have passed to the buyer and can be measured reliably (they also specific criteria for the revenue from layby transactions, from the sale of gift cards and from the loyalty points program). Furthermore, both companies use the similar method to recognize financing income (interest and dividends).

Expenses according to p. 94 of the Framework recognize when decreases in economic benefits have arisen and can be measured reliably (Birt 2010, 211). In the notes both companies define that they use such methods and criteria. Additionally, the specific methods used to recognize finance cost as expenses when incurred, with the exception of interest charges attributable to major projects with substantial development and construction phases (note 2 (g) Wesfarmers) and net finance cost comprise interest payable on borrowings calculated using the effective interest method, interest receivable on funds invested, dividend income, foreign exchange gains and losses and gains and losses on hedging instruments that are recognised in the income statement (Note 1(u) Woolworths). Both companies recognize inventory as expenses and are valued at the lower of average cost and net realizable value. Finally, it is obvious that both companies use the same methods and criteria to recognize their expenses and revenue.

Basically, the income statements show the profitability of the companies. The key figures here are the net profit figures along the bottom. Positive figures mean the company can be profitable through its operation. As was noticed the net profit of Wesfarmers which was $1,922 million and Woolworth $2,140.3 million. It is obvious, that both of these companies are very profitable through their activities. Moreover, the income statements show that both companies have increased their profit in comparison with the previous period. Thus, it shows strong financial positions for these companies and it is clear to see the positive trend in making a profit.
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Also, the income statement of Woolworths shows that sales of $54,143 million, up 4.7% including petrol (excluding petrol, up 4.1%); 6.6% increase in earnings before interest, tax, depreciation and amortization; 6.3% increase in earnings before interest and tax to $3,276.4 million; 5.1% increase in net profit after tax to $2,124.0 million (6.4% excluding natural disaster costs); 6.5% increase in Earnings per Share to 174.6 cents. The income statement of Wesfarmers shows that operating revenue of $54.9 billion, up 5.9%; earnings before interest and tax (EBIT) of $3,232 million, up 12.7%; finance costs of $526 million, down 19.6%; net profit after tax of $1,922 million, up 22.8%; earnings per share of $1.67, up 22.8%.

Statement of cash flow and changes in equity When looking at the cash flow statement its important to rememb er the major elements and structure on how it is created. The first section, Operations, shows how the business is making money by selling goods and services. The second section, Financing, shows how the business is raising money and the third section, Investing, shows how the business is spending money. Both companies we have chosen to look at follow the same structure and format as the design if the cash flow statement is governed by accounting standards set by the Australian Accounting Standards Board which comply with International Financial Reporting Standards. Both Woolworths and Wesfarmers follow the structure described above under the main headings as follows: Cash Flows from Operating Activities Net Cash Provided by Operating Activities Cash Flows from Investing Activities Net Cash Used in Investing Activities Cash Flows from Financing Activities Net Cash Used in Financing Activities

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The breakdown shown within these headings vary due to the differences in activities each company performs. For example Woolworths has Receipts from vendors and tenants in it operating activities, showing that it must lease out property to third parties and receive funds from vendors, that could be in the form of rebates on purchases, adding to its operating activities total. In the investing activities we have noticed that Wesfarmers have received funds due to the Proceeds from sale of controlled entities, this shows Wesfarmers is getting out of some businesses that it has ownership of, yet Woolworths shows Pa yments for purchase of business. This shows that Wesfarmers is selling off assets yet Woolworths is acquiring assets, giving an insight into the direction each company is currently taking. Another difference highlighted in the financing activities is the difference in proceeds and repayments of external borrowings. Wesfarmers proceeds were lower than the repayments showing that they were reducing debt, yet Woolworths proceeds were higher than repayments showing they had increased their borrowings for the financial period. This would fit on with our previous findings in the investing activities where we believe Woolworths was acquiring assets. The structure of the two cash flow statements includes reference to notes that support the figures provided but a major difference was that Wesfarmers provided its reconciliation of net profit after tax to net cash flows from operations as a note to the cash flow statement and Woolworths included this as a second page to the consolidated cash flow statement. There is no wrong or right way of reporting this; it is just the requirement that these details are included in the financial reports of the businesses Annual Reports. The statement of changes in equity provides a more in depth view of changes over a period of time. It helps explain the link between the income statement and balance sheet and allows the reader to understand how the capital or funds of an entity is used, showing where it came from and where it went. As the income statement and balance sheet only show a figure at one point in time the statement of change in equity helps explain these changes. Woolworths had an increase of approximately $28M in equity and Wesfarmers had an increase of approximately $635M.

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We believe Wesfarmers Ltd are trying to increase equity maybe due to the current economic climate (GFC) and this also fits with what was highlighted in the cash flow statement as discussed when identifying that they were selling off assets. In the case of Woolworths and Wesfarmers they both follow the same structure in their statement of changes in equity, outlining the ins and outs over two financial periods. One of the major differences in design is that Woolworths shows the current financial period first, then the previous period for comparison. Wesfarmers then shows the previous financial period first then the current period for comparison. Again there is no right or wrong way for this comparison to be displayed; it is a matter of personal choice for the person/company preparing the report. Both companies have used the direct method for presenting the Cash Flow Statement and the indirect method for the reconciliation of cash. In the Statement of Changes in Equity financial report both companies show the method in fair value hedges is discontinued if the hedging instrument expires or is sold, is terminated or exercised or no longer qualifies for hedge accounting. They then both state the adjustment to the carrying amount of the hedged item arising from the hedged risk is amortised to profit and loss from the date of occurrence. When looking at the methods each company uses it is almost word for word in the notes describing these accounting policies, which I would believe to be best practice for this industry they both belong to. In summary, we can determine that both companies are in a fairly good financial position even though both companies are taking two very different approaches to their business. Wesfarmers is trying to increase its cash by selling off assets and improving its cash flow, yet Woolworths is trying to increase its assets by buying into new ventures which it hopes will also help to increase its cash flow. On comparison of both the statement of cash flow and changes in equity, Woolworths and Wesfarmers both had an increase in net profit for the year, resulting in dividends being paid to shareholders, which is another positive sign the businesses are performing strongly. Analysis and interpretation of financial statements
Wesfarmers annual report 2011 M$ M$ M$

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Sales revenue Cost of sales Gross profit EBIT Net profit Total current assets Total non-current assets Total assets Total current liabilities Total non-current liabilities Total liabilities Total equity Shares held in trust Perfit available to owners Net Cash flow from operating activities Inventories Trade debtors Net financing cost

$ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $

2011 52,891.00 36,515.00 16,376.00 2,706.00 1,922.00 10,218.00 30,596.00 40,814.00 8,722.00 6,763.00 15,485.00 25,329.00 41.00 1,922.00 2,917.00 4,987.00 1,989.00 1,784.00

$ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $

2010 49,865.00 34,411.00 15,454.00 2,215.00 1,565.00 9,674.00 29,562.00 39,236.00 7,852.00 6,690.00 14,542.00 24,694.00 51.00 1,565.00 3,327.00 4,658.00 1,629.00 2,115.00

$ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $

Average 51,378.00 35,463.00 15,915.00 2,460.50 1,743.50 9,946.00 30,079.00 40,025.00 8,287.00 6,726.50 15,013.50 25,011.50 46.00 1,743.50 3,122.00 4,822.50 1,809.00 1,949.50

2011 Calculation Profitability Ratios 1- ROE 2- ROA 3-Gross profit margin 4-profit margin 5- Cash flow to sales revenue ratio Asset Efficiency Ratios 1- Asset turnover ration 2- Inventory turnover (Day) 3- Debtors turnover (Day) Liquidity Ratios 1- Current ratio 2- Quick asset ratio 3- Cash flow ratio Capital Structure Ratios 1- Debt to equity ratio 2- Debt ratio 3- Equity ratio 4- Interest coverage ratio 5- Debt coverage ratio 7.68% 6.76% 30.96% 5.12% 5.52%

2010 Calculation 6.26% 5.53% 30.99% 4.44% 6.67%

1.321 48.21 12.48

1.246 51.15 13.24

1.172 0.600 0.334

1.232 0.639 0.424

61.14% 37.94% 62.06% 1.5168 2.3185

58.89% 37.06% 62.94% 1.0473 2.0108

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Woolworths Limited annual report 2011 Sales revenue Cost of sales Gross profit EBIT Net profit Total current assets Total non-current assets Total assets Total current liabilities Total non-current liabilities Total liabilities Total equity Shares held in trust Profit available to owners Net Cash flow from operating activities Inventories Trade debtors Net financing cost $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $

M$ 2011 54,142.90 40,186.30 14,093.20 3,276.40 2,140.30 6,593.00 14,501.50 21,094.50 8,288.30 4,960.40 13,248.70 7,845.80 56.10 1,907.40 2,991.10 3,736.50 14.90 0.70 $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $

M$ 2010 51,694.30 38,391.20 13,393.60 3,082.10 2,038.00 5,199.00 13,288.30 18,487.30 7,153.40 3,516.20 10,669.60 7,817.70 41.20 2,141.50 2,752.00 3,438.80 13.30 832.90 $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $

M$ Average 52,918.60 39,288.75 13,743.40 3,179.25 2,089.15 5,896.00 13,894.90 19,790.90 7,720.85 4,238.30 11,959.15 7,831.75 48.65 2,024.45 2,871.55 3,587.65 14.10 416.80

2011 Calculation Profitability Ratios 1- ROE 2- ROA 3-Gross profit margin 4-profit margin 5- Cash flow to sales revenue ratio Asset Efficiency Ratios 1- Asset turnover ration 2- Inventory turnover (Day) 3- Debtors turnover (Day) Liquidity Ratios 1- Current ratio 2- Quick asset ratio 3- Cash flow ratio Capital Structure Ratios 1- Debt to equity ratio 2- Debt ratio 3- Equity ratio 4- Interest coverage ratio 5- Debt coverage ratio 24.35% 16.56% 26.03% 6.05% 5.52%

2010 Calculation 27.34% 15.57% 25.91% 5.96% 5.32%

2.736 32.59 0.0951

2.612 34.11 0.0996

0.795 0.345 0.361

0.727 0.246 0.385

168.86% 62.81% 37.19% 4680.57 1.658

136.48% 57.71% 42.29% 3.700 1.278

The profitability ratio (ROA, ROE, profit margin) show that Woolworths Ltd has better profitability than Wesfarmers. All Woolworths profitability ratios are higher than Wesfarmers. In 2011 11 | P a g e

Woolworths generated 16.56 cents of EBIT per dollar of investments in assets, whereas Wesfarmers generated only 6.76 cents, that less in 2.4 times. Woolworths ROE is significantly higher than Wesfarmers. One dollar of Woolworths shareholders equity returned 24.35 cents of earnings available for shareholders distribution. As for Wesfarmers only 7.68 cents returned. Profit margin ratios are not so high at Woolworths and almost similar, this ratio measures the net profit earned on each pound of sales, which refers to the proportion of sales achieved in profit after covering the cost of sales and all other expenses, such as: General and administrative expenses, financing and other expenses. Thus this ratio shows that every dollar of sales revenue generated 6.04 cents of EBIT for Woolworths and 5.12 cents for Wesfarmers.

WOW ROE
28.00% 26.00% 24.00% 22.00% 2011 2010 calculation calculation WOW ROE 0.00% 10.00% 5.00%

WES ROE
WES ROE 2011 2010 Calcuation Calcuation

WOW ROA
17.00% 16.00% WOW ROA 15.00% 2011 2010 calculation calculation 0.00% 10.00% 5.00%

WES ROA
WES ROA 2011 2010 Calcuation Calcuation

WOW profit margin


6.10% 6.05% 6.00% 5.95% 5.90% 2011 2010 calculation calculation 5.50% 5.00% WOW profit margin 4.50% 4.00%

WES profit margin


WES profit margin 2011 2010 Calcuation Calcuation

As for liquidity position Wesfarmers has a better current ratio 1.172 times to compare with Woolworths 0.795 times. For Woolworths there may be a liquidity problem to pay their short-term obligations.

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WOW Current ratio


0.850 0.800 0.750 0.700 0.650 2011 2010 calculation calculation WOW Current ratio 1.240 1.220 1.200 1.180 1.160 1.140

WES Current ratio

WES Current ratio 2011 2010 Calcuation Calcuation

Asset turnover ratios show that Woolworths investment in one dollar generated 2.74 dollars of sales revenue, as for Wesfarmers only 1.32 dollars generated of sales revenue an investment of 1 dollar assets.

WOW Asset turnover ratio


2.8000 2.7000 2.6000 2.5000 2011 2010 calculation calculation WOW Asset turnover ratio

WES Asset turnover ratio


1.3500 1.3000 1.2500 1.2000 2011 2010 Calcuation Calcuation WES Asset turnover ratio

The debt ratio shows that Woolworths funded every 1 dollar of its assets with 62.81 cents of debts, compared to 37.94 cents of Wesfarmers.

WOW Debt ratio


65.00% 60.00% 55.00% 2011 2010 calculation calculation WOW Debt ratio 38.50% 38.00% 37.50% 37.00% 36.50%

WES Debt ratio


WES Debt ratio 2011 2010 Calcuation Calcuation

Overall summary and recommendations

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As we have seen from all the financial analyses of both Wesfarmers and Woolworths they both performed robustly and ended up in strong financial positions at the end of the 2011 financial period. We noticed that Wesfarmers has a higher level of equity than debt liabilitieswhich indicates a strong investment quality. Woolworths has higher levels of debt liabilities than equitywhich indicates it does not have a strong investment quality though it is still in a strong financial position due to its positive financial performance. Both companies run their businesses differently. For example, Wesfarmers is selling off assets yet Woolworths is acquiring assets. It is recommended that Woolworths lifts its level of equity (which it appears to be doing by buying more assets) above its debt liabilities in order to be positively liquid and have a strong investment quality. It is concluded that both companies are managed differently due to all the factors discussed in this report. The companies have both been very strong performers with very robust financial positions geared towards growth and improvement in the near future. The prospects, from these predictors, indicate that both companies will keep growing and be financially strong and healthy over at least the next 3 years.

References

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1. Birt, Jacqueline. 2010. Accounting: business reporting for decision making. 3 rd ed. Milton, Qld. : John Wiley & Sons. 2. Wesfarmers annual report 2011. 3. Woolworths Limited annual report 2011.

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