Financial Forecasting TESCO Plc - Case Study Example

Financial Forecasting – TESCO Plc Table of Contents Introduction 3 Income ment Projection 3 Computation of Additional funds needed 5 Forecast of financial position 5 Ratio Analysis 7 Conclusion 8 Reference 10 Bibliography 11 Tesco Plc. 2005. Annual report and financial statements 2005. 11 Annexure- 12 Introduction The financial statements reflect the performance of a company for the year. With the help of the information presented in the financial statements, the ratios are computed which can be compared with the past figures to highlight any improvement or deterioration. A fall in the profitability ratio indicates inefficient cost management. To correct this, the management can initiate necessary action. Using the financial statements of Tesco Plc for the previous years, the performance of the company for 2010 has been forecasted. A comparison of the ratios for 2009 and 2010 has been done to evaluate the anticipated performance of the company in the following year. Income-Statement Projection For estimating the revenues earned by the business, the Compounded Annual Growth Rate (CAGR) over the last four years has been used. The revenue earned by the company during the year 2005 was £33974 million. This increased at a CAGR of 12% to £54327 million in the year 2009. Assuming that the rate of growth remains the same in 2010, the estimated revenue of the company for this year is estimated to be £61091.81 million. The cost of sales is taken as a percentage of revenue at 0.92. Therefore the estimated cost of sales of the company for 2010 is £56348.58 million. The “Normal Operating Expenses” of £31845 million for the year 2005 is assumed to be the ‘cost of sales’ for the year. The operating costs of the company depend on the level of sales. Higher the sales level, higher is the amount of operating expenses of the company. This ratio is calculated as 0.02. Based on this ratio the operating cost of the company is estimated as £1403.40 million. It has been assumed that the net interest payable of the company grows at a compounding rate of return. Based on the net interest expense of £170 million in 2005, the CAGR for the four year period is calculated as 21% making the estimated net interest payable of the company for 2010 to be £437.29 million. Taxation and dividend- In the year 2005 and 2010, Tesco Plc paid taxes at a rate of 20% and 40% respectively. The CAGR of taxes is calculated as 19% making 48% as the forecasted tax rate for 2010. Therefore the estimated taxation of Tesco Plc is £1386.44 million. The dividend paid by the company has increased at a CAGR of 19% from £587 million in 2005 to £883 million in 2009. From this the forecasted dividend of Tesco Plc is estimated as £977.89 million. The net profit of Tesco Plc for 2010 is estimated as £1516.09 million. Computation of Additional funds needed The revenue of Tesco Plc is expected to grow in 2010 by £6765 million. For this the company will need total funds of £5734.52 million. As a part of this amount can be financed through credit and retained earnings, the additional funds required by the company is estimated as £1079.93 million. Choice of funding- To meet the revenue estimate of 2010, Tesco Plc will require total fund of £5734.52 million. Out of this, £4654.59 million can be financed through credit purchase and by the internal mode of financing. For the remaining amount of £1079.93 million, the company can use either equity or debt. The choice in this regard will depend on the position of debt and equity in the capital base. For 2009 the debt position of the company is more than double the equity. This means that the company already has significant amount of debt. The inclusion of additional debt will increase the financial risk of the company. For funding its revenue plan the company can opt for rights issue. As the company has already established itself in the eyes of the investors it will not face any difficulty in the issue of new shares. Forecast of financial position Assuming that the assets and liabilities of the business will grow at a compounded annual growth rate, the figures in the Forecasted Balance Sheet have been adjusted with the CAGR factor. For the purpose of estimating the CAGR of assets and liabilities the compounded growth achieved by the company in the last four years from 2005 to 2009 has been taken into consideration. The non-current assets of the company like Property, Plant and equipment, Investment Property, Good-will, Loans and Advances etc in the year 2005 was £16953 million. This grew at a CAGR of 17% to £32008 million in 2009. Assuming this growth rate to be constant, the non-current assets of Tesco Plc for 2010 is estimated to be £37449.4 million. The Current Assets of the company increased at a CAGR of 42% from £3457 million in 2005 to £14045 million in 2009. Taking this growth rate to be the same the amount of Current Assets in 2010 is estimated as £16432 million. Current Liabilities of the company increased at a CAGR of 31% during this period. With this rate of growth, the Current Liabilities for 2010 is forecasted as £21106.8 million. During the same period the Non-current liabilities and Total equity of the company grew at a CAGR of 30% and 9% respectively. Assuming this growth rate to be the same the amount of Non-current liabilities and Total equity is estimated as £17571.1 million and £15204.2 million respectively. An analysis of the growth rates shows that the company has increased its reliance on the short term and long term liabilities over the years. Compared to this, the growth rate in equity has been merely 9% in the last four years. This indicates that Tesco Plc is using more of debt to finance its expansionary programs. Ratio Analysis The current ratio gives an indication of the liquidity position of the company. It measures short-term business solvency i.e. the ability of the business to honour its short term liabilities (Tracy, 2008, pp. 287). The liquidity position of the company is expected to remain same in 2010. Tesco Plc reported a current ratio of 0.78 in 2009 and this is expected to remain unchanged in the following year. The inventory position of the company is expected to increase at a CAGR of 19% from £2669 million in 2009 to £3189.34 million in the year after. Quick ratio indicates the ability of the company to meet its obligations out of the most liquid resources. This is expected to deteriorate from 0.63 in 2009 to 0.63 in 2010. The gross profit margin of a company is expressed as Gross Profit/Revenue. This highlights the efficiency of the company in managing the operating expenses (Shaw & Incitti, 1995). This is expected to remain the same in the following year at 7.76%. The net profit margin of a company is expressed as Net Profit/Sales. This measures the ability of the management to control the administrative expenses of the company. Tesco Plc reported a net profit margin of 3.98% in 2009. This is expected to decline in the following year to 2.48%. This can be due to a fall in the estimated net profit of the company in 2010. Despite the rise in the revenue the net profit margin of the company is expected to decline in the following year. This can be on account of excess costs incurred by the company. In order to boost its profitability margin the company management must try to reduce the administrative expenses. The return on equity (ROE) is expressed as Net Profit / Total equity. It is a measure of how well the company is utilizing the shareholders fund in the business. The ROE of Tesco Plc in 2009 was 16.66%. This is expected to decline in the following year due to a fall in the net profit of the company. A high ROE indicates that the company is able to generate significant returns for its shareholders. Tesco Plc must try to raise the amount of business profits as ROE is an important tool used by the investors in assessing an investment. The asset turnover ratio is measured as Sales/Assets. It measures the ability of the management in using the asset base to generate sales. An underutilization of assets results in low asset turnover ratio (Nelson, 2008, pp345). The higher the ratio, the better is the company’s position, in terms of asset utilization. The asset turnover ratio of Tesco Plc is expected to fall marginally in 2010 to 1.17 from 1.13 in 2009. This shows that the company management is not making an optimum utilization of the asset base. Considering the increase in the asset base of the company the management should try to raise the level of sales. The debt-equity ratio of the company measures the leverage position of the company. Higher the leverage higher is the risk. This ratio is expected to remain same in the following year. Tesco Plc already has a high debt equity ratio as compared to the industry average of 0.72 (MSN Money, 2010). This increases the financial risk of the business. The high debt component in the capital base is not in the financial interest of the company as this will expose it to the burden of contractual payments. Conclusion An analysis of the forecasted financial statements of Tesco Plc indicates that the revenue of the company will move as per the compounded annual growth rate of the previous years. Despite the rise in the revenue, the profitability position of the company is expected to deteriorate on account of poor cost management. Reference MSN Money. 2010. Industry. Financial Condition. Available at: http://moneycentral.msn.com/investor/invsub/results/compare.asp?Page=FinancialCondition&Symbol=WFMI [Accessed on April 3, 2010]. Nelson, L.S. 2008. QuickBooks 2009 All-in-One For Dummies. Wiley Publishing Inc. Shaw, M. Incitti, M. 1995. Profit ratios. Financial analysis ratios. Available at: http://aiken.isy.vcu.edu/classes/bizstrat/ratios.htm [Accessed on April 3, 2010]. Tracy, J. 2008. Accounting For Dummies. Wiley Publishing Inc. Bibliography Albrecht, S.W. Stice, D.J. Stice, K.E. Swain, R.M. 2007. Accounting: Concepts and Applications. Cengage Learning. Tesco Plc. 2005. Annual report and financial statements 2005. Tesco Plc. 2009. Annual Report and Financial Statements 2009. Annexure- Workings- Ratio analysis- Read More