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 company’s 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 base—higher levels of

inventory, receivables and fixed assets (plant, property and equipment). As a company’s

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 assets—these 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 others—such 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 company’s financial position the respective

balance sheets reveal that each company’s 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 firm’s 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 the 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 lay-by

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 it’s important to remember 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 “Payments 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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2011 2010 AverageSales revenue $ 52,891.00 $ 49,865.00 $ 51,378.00Cost of sales $ 36,515.00 $ 34,411.00 $ 35,463.00Gross profit $ 16,376.00 $ 15,454.00 $ 15,915.00EBIT $ 2,706.00 $ 2,215.00 $ 2,460.50Net profit $ 1,922.00 $ 1,565.00 $ 1,743.50Total current assets $ 10,218.00 $ 9,674.00 $ 9,946.00Total non-current assets $ 30,596.00 $ 29,562.00 $ 30,079.00Total assets $ 40,814.00 $ 39,236.00 $ 40,025.00Total current liabilities $ 8,722.00 $ 7,852.00 $ 8,287.00Total non-current liabilities $ 6,763.00 $ 6,690.00 $ 6,726.50Total liabilities $ 15,485.00 $ 14,542.00 $ 15,013.50Total equity $ 25,329.00 $ 24,694.00 $ 25,011.50Shares held in trust $ 41.00 $ 51.00 $ 46.00Perfit available to owners $ 1,922.00 $ 1,565.00 $ 1,743.50Net Cash flow from operating activities $ 2,917.00 $ 3,327.00 $ 3,122.00Inventories $ 4,987.00 $ 4,658.00 $ 4,822.50Trade debtors $ 1,989.00 $ 1,629.00 $ 1,809.00Net financing cost $ 1,784.00 $ 2,115.00 $ 1,949.50

2011 Calculation

2010 Calculation

Profitability Ratios1- ROE 7.68% 6.26%2- ROA 6.76% 5.53%3-Gross profit margin 30.96% 30.99%4-profit margin 5.12% 4.44%5- Cash flow to sales revenue ratio 5.52% 6.67%

Asset Efficiency Ratios1- Asset turnover ration 1.321 1.2462- Inventory turnover (Day) 48.21 51.153- Debtors turnover (Day) 12.48 13.24

Liquidity Ratios1- Current ratio 1.172 1.2322- Quick asset ratio 0.600 0.6393- Cash flow ratio 0.334 0.424

Capital Structure Ratios1- Debt to equity ratio 61.14% 58.89%2- Debt ratio 37.94% 37.06%3- Equity ratio 62.06% 62.94%4- Interest coverage ratio 1.5168 1.04735- Debt coverage ratio 2.3185 2.0108

Woolworths Limited annual report 2011 M$ M$ M$

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2011 2010 AverageSales revenue $ 54,142.90 $ 51,694.30 $ 52,918.60Cost of sales $ 40,186.30 $ 38,391.20 $ 39,288.75Gross profit $ 14,093.20 $ 13,393.60 $ 13,743.40EBIT $ 3,276.40 $ 3,082.10 $ 3,179.25Net profit $ 2,140.30 $ 2,038.00 $ 2,089.15Total current assets $ 6,593.00 $ 5,199.00 $ 5,896.00Total non-current assets $ 14,501.50 $ 13,288.30 $ 13,894.90Total assets $ 21,094.50 $ 18,487.30 $ 19,790.90Total current liabilities $ 8,288.30 $ 7,153.40 $ 7,720.85Total non-current liabilities $ 4,960.40 $ 3,516.20 $ 4,238.30Total liabilities $ 13,248.70 $ 10,669.60 $ 11,959.15Total equity $ 7,845.80 $ 7,817.70 $ 7,831.75Shares held in trust $ 56.10 $ 41.20 $ 48.65Profit available to owners $ 1,907.40 $ 2,141.50 $ 2,024.45Net Cash flow from operating activities $ 2,991.10 $ 2,752.00 $ 2,871.55Inventories $ 3,736.50 $ 3,438.80 $ 3,587.65Trade debtors $ 14.90 $ 13.30 $ 14.10Net financing cost $ 0.70 $ 832.90 $ 416.80

2011 Calculatio

n

2010 Calculatio

nProfitability Ratios1- ROE 24.35% 27.34%2- ROA 16.56% 15.57%3-Gross profit margin 26.03% 25.91%4-profit margin 6.05% 5.96%5- Cash flow to sales revenue ratio 5.52% 5.32%

Asset Efficiency Ratios1- Asset turnover ration 2.736 2.6122- Inventory turnover (Day) 32.59 34.113- Debtors turnover (Day) 0.0951 0.0996

Liquidity Ratios1- Current ratio 0.795 0.7272- Quick asset ratio 0.345 0.2463- Cash flow ratio 0.361 0.385

Capital Structure Ratios1- Debt to equity ratio 168.86% 136.48%2- Debt ratio 62.81% 57.71%3- Equity ratio 37.19% 42.29%4- Interest coverage ratio 4680.57 3.7005- Debt coverage ratio 1.658 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 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.

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Woolworths ROE is significantly higher than Wesfarmers. One dollar of Woolworth’s 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.

22.00%

24.00%

26.00%

28.00%

WOW ROE

WOW ROE0.00%

5.00%

10.00%

WES ROE

WES ROE

15.00%15.50%16.00%16.50%17.00%

WOW ROA

WOW ROA

0.00%2.00%4.00%6.00%8.00%

WES ROA

WES ROA

5.90%5.95%6.00%6.05%6.10%

WOW profit margin

WOW profit margin

4.00%

4.50%

5.00%

5.50%

WES profit margin

WES profit margin

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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0.650

0.700

0.750

0.800

0.850

WOW Current ratio

WOW Current ratio

1.1401.1601.1801.2001.2201.240

WES Current ratio

WES Current ra-tio

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.

2.55002.60002.65002.70002.7500

WOW Asset turnover ratio

WOW Asset turnover ratio

1.20001.25001.30001.3500

WES Asset turnover ratio

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.

54.00%56.00%58.00%60.00%62.00%64.00%

WOW Debt ratio

WOW Debt ra-tio

2011 Calcuati

on

2010 Calcuati

on36.50%

37.50%

38.50%

WES Debt ratio

WES Debt ratio

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

liabilities—which indicates a strong investment quality. Woolworths has higher levels of

debt liabilities than equity—which 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. 3rd ed. Milton, Qld. : John Wiley & Sons.

2. Wesfarmers annual report 2011.3. Woolworths Limited annual report 2011.

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