ABP Post Graduate Diploma In Business Management
1.0 Introduction
This report identifies and critically evaluates the costing techniques used by Morrison and the role of such costing techniques in setting prices. The report will also analyse the last three years of the financial statements of the company to evaluate its performance and recommend possible ways to improve the financial performance of the company. Lastly, the report will cover a flexible budget for the actual production of 48,300 units in a small hypothetical electronics company called Safety First Limited, calculate the variances between the flexed budget for 48,300 units and the actual costs for 48,300 units, write an email to the Finance Director Mr. Mike Kenny, evaluating the budget out turns and reasons for these variations and then offer recommendations on how the company’s cost control activities could be improved.
2.0 Company Profile
Morrison Supermarkets PLC is the fourth largest retail chain in the United Kingdom, headquartered in Bradford, West Yorkshire. The company forms part of the FTSE 100 Index of companies with a market share of around 12 percent after Tesco (31 percent), Asda (17 percent), and Sainsbury’s (16 percent). The company started as an egg butter outlet back in 1899 but today it has over 450 outlets across the UK. Its current market share was however, boosted in 2004 when it acquired Safeway (Carollo, 2012). Today the company sells thousands of brands under the “own brand” banner. Some of these own brands include M Savers for all range of low-cost products, M Kitchen for all range of kitchen products, NuMe for all range of health products, and VM Morrison for all range of high-end products (Morrison, 2012).
Over the last three years, the company has however experienced a 0.2 percent drop in market share while the other three largest retail chains expected Tesco have experienced a growth of almost the same margin. This was a time when the market grew by about 4.5 percent, with smaller retail chains such as Waitrose registering huge gains perhaps due to the increasing perception that high-end retail chains are for high-end customers while low-end retail chains are for low-end customers who form the greatest portion of the UK grocers (Carollo, 2012). Again this could be because low-end retail chains tend to open up stores near neighbourhoods unlike high-end retail chains which target customers with cars.
The company registered one of the strongest financial performances in recent years in the 2011/12 financial year – a 7 percent growth in sales (£17.7billion), 8 percent growth in EBIT (£947 million), and a Net debt of £1,471million. This shows the company has been utilizing sound costing techniques especially in creating high returns on equity and reduction of unnecessary costs (Morrison, 2012). Morrison was selected to be the case study for this report because of its ability to achieve huge profits (as shown above) in a highly competitive and unpredictable industry where small players are slowly winning the hearts of the consumers.
3.0 Costing Techniques Employed by Morrison
Morrison utilises the activity-based costing technique. The company utilises this costing technique because it is flexible and allows managers to reduce redundancy by eliminating costly processes in favour of efficient and cheaper ones. Activity-based costing is in line with the company mission to create value for its customers and employees (Morrison, 2012). Though complex, the technique can be broken down into two broad steps. The first step entails the identification of cost drivers (activities) involved during the production of a commodity. The second step entails the assigning of costs (indirect and direct) to each specific activity. A combination of these two steps gives a manager an opportunity to set a reasonable and responsive commodity price while factoring in past, current and future cost indicators (Kaplan & Anderson, 2007).
For instance, when calculating the costs of say, pork, a manager should allocate all direct and indirect costs incurred in acquiring the product in two different pools/stages. The first pool will comprise of distinct sections (the number will be determined by the activities involved) such as procurement, acceptance, processing, delivering, packaging, as well as shelving. The second pool should include the actual cost drivers for each of the specified activities. Such costs should be calculated based on past, prevailing, and future indicators such as the average costs of labour for slicing and packaging pork into one kilogramme packages or even the average costs of transporting pork from the farm to the store. Here, the manager can decide to split the costs into major categories, say, direct and indirect costs. The bottom line is that the cost of every activity (cost drivers) should be clearly established and noted for costing (Baker, 1998).
3.1 Role of the Activity-based Costing Technique
The activity-based costing technique helps Morrison to keep its costs of selling at manageable levels. According to Sibun and Hall (2008), retail chains employ activity-based costing technique when entering into contracts with supplies of critical supplies such as groceries. In fact, when it comes to choosing suppliers, the retail chains try as much as possible to get the lowest bargain so as to keep the cost of selling at relatively low levels compared to their competitors. As it will be demonstrated in the financial analysis section below, Morrison has succeeded in keeping its profitability at low and stable levels because the activity-based costing technique makes it easy to predict costs and therefore make the necessary plans for less costly alternatives.
The activity-based costing also helps Morrison to make future strategic plans. Recent industry statistics show a decrease in consumer purchasing power yet the costs of manufacturing has escalated. This has made it hard for prices of critical household commodities to remain low. To mitigate this adverse scenario, retail chains always look for the best deal so as to keep their shelf prices at relatively low levels. An activity-based costing enables retail chains to approach each product line independently as determined by the cost of producing it (Baker, 1998). At Morrison, for example, the activity-based costing helps the company to distinguish between commodities for both high-end and low-end – M Savers versus VM Morrison.
By using an activity-based costing technique, Morrison gets an opportunity to set responsive prices for its products as well as to constantly review its product prices in order to make align with the prevailing economic standards. This is in line with the company mission to be a unique grocer that delivers to its customer’s fresh, high quality, accessible, and affordable groceries. Specifically, the company believes its futuristic strategy is based on its clear view of the future of the retail industry (Morrison, 2012). Arguably, such clear view of the industry cannot be achieved without getting a clear glimpse of the trends of key cost drivers.
2.0 Analysis of Financial Performance of the Company in the Last Three Years
2.1 Profitability
Profitability 2012 2011 2010
Morrison
GP 6.9% 7.0% 6.9%
NP 3.9% 3.8% 3.9%
ROCE 9.7% 9.7 % 9.4%
ROE 12.8% 11.7% 12.1%
Tesco
GP 6.1% 6.4% 6.1%
NP 4.4% 4.4% 4.1%
ROCE 13.3% 12.9% 12.1%
ROE 15.81% 16.07% 15.91%
Morrison has a “healthy” GP that beats the industry leader, Tesco for the three years but it has a smaller NP than Tesco for the same period of time as the table above shows. Even so, Tesco seems to enjoy strong and stable profitability than Morrison given, its GP has the smallest change for the three years. This is an indicator that Morrison costing techniques are not as efficient as Tesco’s.
Again, Morrison does not perform well in managing costs of sourcing capital given its low NP during the three years – Tesco score well on this front too. Since Morrison has low ROCE and ROE ratios than Tesco it can also be argued that the company does not fare well in investing its capital – its investing activities yield more expenses perhaps because it is in a period of laying down a strong foundation for competing with Tesco, Asda, and Sainsbury’s.
2.2 Liquidity Ratio
Liquidity 2012 2011 2010
Morrison
Current Ratio 0.57 0.55 0.51
Acid Ratio 0.24 0.24 0.24
Tesco
Current Ratio 0.67 0.68 0.71
Acid Ratio 0.48 0.50 0.54
Though most retail chains have liquidity ratios of less than 1 as they tend to rely more on inventories in cushioning short-term debt, it is clear that Tesco beats Morrison in paying its short-term debts – as it has a relatively higher current ratio and acid ratios when compared to the case of Morrison as shown above in the table. Nevertheless, Morrison has a more stable liquidity ration than Tesco, an indicator that the company relies on long term than short term financing and that it in deficit of short term assets and liabilities.
2.3 Asset Management
Asset Management 2012 2011 2010
Morrison
Stock Turnover 21.67days 24.03days 24.87days
Asset Turnover 3.27 3.04 3.1
Tesco
Stock Turnover 16.48days 17.50days 19.17 days
Asset Turnover 3.67 3.69 3.87
Morrison converts its stock at a slower rate than the industry leader, Tesco. Tesco seems to be improving its rate of converting stock, moving from 19.17 days in 2009 to 16.48 days in 2012 compared to Morrison which seems to have a stable but slower stock conversion rate, at 24.87 days in 2009 and 21.67 days in 2012.
Again, Morrison scores low in terms of converting assets into revenue, at 3.1 in 2009 and 3.27 in 2012 when compared to Tesco, at 3.87 in 2009 and 3.67 in 2012. Nevertheless, Morrison rate of converting assets into revenue has improved while Tesco has experienced a reducing asset conversion rate. Morrison long-term strategic plan seems to be slowly yielding fruits.
2.4 Gearing Ratio
Gearing 2012 2011 2010
Morrison
Debt Ratio 27.25% 15.07% 18.67%
Interest Cover ratio 33.58 times 30.13 times 18.51 times
Tesco
Debt Ratio 38.41% 40.85% 54.0%
Interest Cover ratio 16.54 times 11.76 times 11.09 times
Debt Ratio 38.41% 40.85% 54.0%
Morrison gearing ratio can be described as future-oriented in nature when compared to the case of Tesco. They are future-oriented because they portray a company that is keen to keep its short-term liabilities at low levels while relying much on long-term funding. Nevertheless, this situation can be interpreted to indicate that the company relies so much on its inventories to cushion its short-term debts as the higher interest cover ratio indicates when compared to Tesco.
2.5 Investment Ratio
Investment 2012 2011 2010
Morrison
Dividend pay-out ratio 1.6% 1.5% 0.9%
Dividend per share 10.70p 9.60p 8.20p
Earnings Per share 78.31p 70.36p 65.67p
Price/earnings ratio 11.40 11.60 14.10
Tesco
Dividend pay-out ratio 0.5% 0.5% 0.6%
Dividend per share 14.76p 14.46p 13.05p
Earnings Per share 110.91p 105.13p 90.32p
Price/earnings ratio 8.50 11.10 13.20
Compared to Tesco, Morrison has registered low dividends per share for the last three years, yet it has a higher dividend pay-out ratio than Tesco. This situation can be interpreted to mean that Morrison has lower net income, earnings per share and price earnings ratio than Tesco – these are all indicators that Morrison offers a lower value to its shareholders than Tesco. Even so, both companies can be described as stable investments whose actual value is in the long-term rather than short-term.
3.0 Hypothetical Company Costing
3.1 Flexible Budget for the Actual Production of 48,300 Units
Actual Budget Variance
Materials £410,550 £361,776.7 (£48,773.4)
Labour £320,800 £331,386.4 £10 586.4
Overheads £346,430 £339654.5 (£6,775.5)
Fixed costs £200,000 £200,000 0
Total costs £1,277,780 £1,232,817.6 (£44,962.4)
3.2 Variances between the Flexed Budget and the Actual Costs
Variance for material costs = £410,550 – £361,776.7 = (£48,773.4)
Variance for labour costs = £320,800 – £331,386.4 = £10,586.4
Variance for overheads costs = £436,430 – £339654.5 = (£6,775.5)
3.3 Evaluation of the Budget
From: HYPERLINK “mailto:financeassistant@safetyfirst.co.ke/” financeassistant@safetyfirst.co.ke/
To: HYPERLINK “mailto:financedirector-kenny@safetyfirst.co.ke/” financedirector-kenny@safetyfirst.co.ke/
Subject: Evaluation of the Budget for Producing 48,300 units of Secure
Dear Mr. Kenny,
I am writing to respond to the attached flexible budget. The overall cost for producing 48,300 units of Secure is £1,232,817.6. This is actually a favourable variation given the actual cost for the same was £1,277,780.0. It is a favourable variation because the overall cost has reduced by £44,962.4. The favourable variation can be broken down as follows: Materials costs reduced by £48,773.4; Labour costs increased by £10,586.4, and; Overheads costs reduced by £6,775.5. As expected, the fixed costs did not change.
This is actually a good situation for the company given it has succeeded in reducing production costs and that it can use the £44,962.5 for other productive activities such as increasing the number of units of Secure it produces. However, the company needs to work on reducing the labour costs as they have increased when other costs were on downward trend. For instance, the company should consider hiring fewer employees who are more qualified – those with necessary skills in operating high-tech equipments. The company can still consider sourcing less costly materials as well as durable office equipments to reduce on overhead costs.
It is my hope that the budget captures the actual situation at the ground and that it reflects the set financial goals of the company. I will be looking forward to making any additional interpretation of the flexible budget if required.
Yours sincerely
XXXXX XXXX
Finance Assistant
References
Baker, J.J. (1998). Activity-Based Costing and Activity-Based Management for Health Care. Aspen Publishing, Inc.
Carollo, B. (2012). Audit Report for Wm Morrison Supermarkets PLC. Scholarly Research Paper. Grin Verlag.
Kaplan, R.S. & Anderson, S.R. (2007). Time-Driven Activity-Based Costing: A Simpler and More Powerful Path to higher profits. Boston, MA: Harvard Business School Publishing.
Morrison PLC (2012). Annual report and financial statements 2011/12. Wm Morrison Supermarkets PLC.
Sibun, J. & Hall, J. (27 April 2008). Supermarkets & suppliers: Inside the price war. Available at: HYPERLINK “http://www.telegraph.co.uk/finance/newsbysector/retailandconsumer/2789020/Supermarkets-and-suppliers-Inside-the-price-war.html/” http://www.telegraph.co.uk/finance/newsbysector/retailandconsumer/2789020/Supermarkets-and-suppliers-Inside-the-price-war.html/ (accessed 13 July, 2012).