TESCO's Financial Forecasting - Case Study Example

TESCO Table of Contents Introduction 3 Part 3 Forecasted consoli d income ment 3 Additional fund required in 6 Choice of fund 7 Projected Balance Sheet as on February 28, 2010 7 Part – 2 8 Company’s financial position and performance 8 Conclusion 10 Reference 11 Bibliography 13 Appendix 15 Introduction Tesco is a reputed name in the international market; the company operates in grocery and general merchandising retail chains. This British company is one of the largest retailers in terms of market share & volume in its local market. The company also has considerable market share in the international market and it has occupied the third rank. It is just behind Wal-Mart and Carrefour. The company was founded in the year 1919 by Jack Cohen in eastern London and at present its headquarter is in located at Cheshunt (UK). (Instituto de Empres, n.d.). Through the company is mainly involved in retail business, it diversified its operation and has entered certain other sectors. Tesco is now involved in banking sector manufactures electronic product, telecoms and is involved in other industries like fuel and tech support. It also offers cards schemes to the customers through Tesco Clubcard. In last few years the company was performing quite satisfactorily. In UK, the market share of Tesco’s increased up to 4.3% in the year 2008-09 that makes total market share of Tesco around 30.9% in UK retail market (Hall, 2008). In the financial year 2008-09 too the company registered a healthy growth. To determine the performance of the company in 2010 a forecasted profit & loss account and forecasted balance is being prepared. Part - 1 Forecasted consolidated income statement In the year 2009 Tesco’s revenue after VAT is £ 54,327 million where as in the year 2005 it was £ 33,974 million. Therefore the compounded annual growth rate (CAGR) from 2005 to 2009 is calculated which represents the rate at which the revenue of the company is growing (Gray, et al., 2003, p.156). The CAGR value at which the revenue of Tesco group is increasing is 12.45%. Considering this rate of CAGR, the total revenue for the financial year (FY) 2010 can be forecasted as £61092 million. In the year 2009 the cost of sale was 92.24% of the total revenue (after VAT), if this percentage remains same for the next year then cost of sale for 2010 will be £56349 million. As gross profit is calculated as revenue less cost of sales (Vance, 2002, p.4), so in the FY 2010 gross profit will be £4743 million. There lies a difference between cost of sales and operating expenses, while calculating operating expense certain non-operating expenses should be added back and indirect expenses such as administrative expense needs to be added. The operating expense for the year 2009 was £3,206 million (summation of COGS and administrative cost). It is assumed that with enhancement in sale, administrative cost will also increase. In 2009 the administrative expense was 2.3% of the total revenue so using this same percentage administrative expense cost for 2010 was determined and on adding the COGS and administrative cost for the year 2010 it comes around £3495 million. In the same way financial cost of the company is determined which basically represents the interest paid for debt. In 2005 it was £331 million which turned to £562 the following year. It increased with CAGR of 14.15% hence it will be £642 in the next year. As per the company’s last five years data it appears that it is increasing its long term liabilities to finance new operations. In the coming year it may use the same strategy and can further enhance long term liabilities. In present market, UK government as well government of other nations have reduced the interest rate to inject liquidity in the market. As a result Tesco will prefer to raise the finance further through different debt instruments. Considering all the above given forecasted element of profit and loss account the forecasted EBIT when calculated for 2010, came to £2854. At present the corporate tax rate in UK is 28% (HM Revenue and customer, n.d.). Therefore the forecasted profit after tax will be £2055 million. In the last five years the dividend paid by the company showed healthy growth; in the year 2005 dividend paid per share was 7.56p whereas in 2009 the company announced dividend per share of 11.96p. In these last five year dividend’s CAGR is 10.75%. If the dividend continues to grow in the same rate then by 2010 the total dividend announced by the company can be forecasted as £978 million. Using all this information the forecasted income statement of the company was prepared for the year 2010. It is given as below: Additional fund required in 2010 As per the forecast, revenue of Tesco will be £61092 million in 2010; hence there will be a requirement of addition fund to finance the sale. Increase in sale will be of £6,765 million in 2010. Since the cost of sale is 92.94% of the revenue so the change in cost of sales will be £6,287 million. Retention ratio is the percentage of the profit retained by the company (Mayo, 2008, p.365). At present the company maintains a retention ration of 47.59%, using this for 2010 it can be concluded that the company will retain the same percentage of the earned profit that will amount to £1,077 million. Yet there is a deficiency of £5,210 million that needs to be funded by the company. Choice of fund As per the company’s policy it maintains a healthy reserve and surpluses because the retention ratio is 47.59 % of the total profits. Therefore the company can use its reserve for funding the sales. Apart for this there also lies the option of raising more funds through debt instruments or by issuing more equity share in the market (Baker & Baker, 2009, p.257). After considering the Debt – Equity ratio for the year 2009 is appears that at present it is 2.54 times the prior one. This indicates that the financial risk related to Tesco is quite high and raising more debt may further enhance the risk associated with solvency (Tyson & Schell, 2008, p.242) On the other hand, stock markets are yet to recover the financial crisis of 2008-09. Thus the investors may not be interested in investing in Tesco’s share in the present economic state. Therefore the company should raise funds in countries like UK and US where interest rates are in the range of 0.5% to near zero percent. As soon as the market condition revives the company should issue new equity shares and should pay back the debt. Projected Balance Sheet as on February 28, 2010 For forecasting the balance sheet of Tesco, CAGR is calculated for current assets, non-current assets, current liabilities and non-current liabilities for consecutive five years. Assuming that this rate of growth continues in the next FY, values of all the vital elements of the balance sheets are calculated. The difference between total asset and total liabilities represents net asset. It is also assumed that Tesco will raise more debt and will issue more equity share in the FY 2010. Hence the equity is expected to grow by 9.45% whereas long term liabilities will grow with a growth rate of 29.86%. The forecasted balance sheet is given as below: Part – 2 Company’s financial position and performance While analysing the financial position of the company for the predicted financial year (2010) ration analysis was conducted. The ratio analysis assists in analysing the true financial condition of the company and hence almost all the stakeholders of the company rely heavily on the financial ratios. There are different kinds of ratios to analyse the financial position of the company and potential. Basically these ratios are used to analyse liquidity state, profitability of the company, the efficiency with which it gears its capital and manages its cash. Some of its vital ratios are calculated as below: As per this analysis it can be concluded that though the revenue is likely to increase in the FY 2010 but operating profit ratio as well as net profit ratio both will decline marginally. There is no meaning in enhancing the profit until and unless the profit margins are increased, hence it can be said that profitability position of the company will decline in 2010. To determine the liquidity state of the company, current ratio for both the years are calculated. The results indicate that in 2010, current ratio will increase. The results of acid test ratio also give the same indication. Therefore it can be concluded that in 2010 the company’s liquidity position will improve. As the shareholders of the company are the real owners, ROE is calculated for both the years, but due to fall in net profit the company ROE will decline in 2010. This may be taken as a negative indication by the potential investors (Shim, 2000, p.156) To determine how well the company manages its asset and inventories, asset turnover ratio and inventory turnover ratios are calculated. It appears that the company will succeed in managing its asset more efficiently but the rate with which its inventories are moving might decline in 2010. As a result, requirement of working capital will increase and the cost of financing may be high. Conclusion Tesco is the third largest retailer in the world and company’s past data reveals that it maintained a healthy growth in the last few years. To comprehend the efficiency with which the company will perform in the next financial year (2010), forecasted income statement and forecasted balance sheets were developed. For forecasting, CAGR was calculated for 2005 to 2009. Using this as base other vital components were calculated. Ratio analysis was conducted to determine the actual financial position of Tesco in 2010; i.e., whether the financial position will improve or will deteriorate. As per this analysis the Tesco’s net profitability may decline by marginal rate but its liquidity state will improve and the company will succeed in maintaining its asset in a much better way. However there is a possibility that ROE might be reduced and which will affect the market position of the company. The changing economic conditions might propel the company to take the requisite action to enhance profitability and ROE of the company. Such initiatives will assist the company to reach its desired position. Reference Baker, J. J. & Baker, R. W. 2009. Health Care Finance: Basic Tools for Nonfinancial Managers. 3rd ed. Jones & Bartlett Learning. Gray, G, Cusatis, P. & Woolridge, J. R. 2003. Streetsmart guide to valuing a stock: the savvy investors key to beating the market. 2nd ed. McGraw-Hill Professional. Hall, J. December 09, 2008. Tesco to be world number two by 2012. Telegraph. [Online]. Available at: http://www.telegraph.co.uk/finance/newsbysector/epic/tsco/3691672/Tesco-to-be-world-number-two-by-2012.html [Accessed on April 20, 2010]. HM Revenue and Customer. No date. Corporation Tax rates. [Online]. Available at: http://www.hmrc.gov.uk/rates/corp.htm [Accessed on April 20, 2010]. Instituto de Empres. No date. Tesco History. Tesco: Every Little Helps. ICA16/237-I. [Online]. Available at: http://profesores.ie.edu/enrique_dans/TESCO/TESCO.pdf [Accessed on April 20, 2010]. Mayo, H. B. 2008. Investments: an introduction. 9th ed. Cengage Learning. Shim, J. K. 2000. Accounting and finance for the nonfinancial executive: an integrated resource management guide for the 21st century. CRC Press. Tesco. 2009. Annual Report. [Online]. Available at: http://www.tescoplc.com/annualreport09/tools/chartingtool/?t=chartingtool [Accessed on April 20, 2010]. Tyson, E. & Schell, J. 2008. Small Business for Dummies. 3rd ed. For Dummies. Vance, D. E. 2002. Financial analysis and decision making: tools and techniques to solve financial problems and make effective business decisions. McGraw-Hill Professional. Bibliography Antonymous. 2005. Business management: fresh perspectives. Pearson South Africa. Besley, S. & Brigham, E. F. 2008. Principles of Finance. 4th ed. Cengage Learning. Brigham, E. F. & Ehrhardt, M. C. 2008. Financial management: theory and practice. 12th ed. Cengage Learning. Ehrhardt, M. C. & Brigham, E. F. 2009. Corporate Finance: A Focused Approach. 3rd ed. Cengage Learning. Ernst, S. & Hooker, N. H. No date. E-Grocery: Emerging trend or just another case study?. Ohio State University. [Pdf]. Available at: http://aede.osu.edu/programs/e-agbiz/pageegrocery/2003%20Outlook.E-Grocery.pdf. Grossman, T. & J. L. 2009. The Portable MBA in Finance and Accounting. 4th ed. John Wiley and Sons. Marks, H. K., Robbins, L. E., Fernandez, G., Fernandez, J. P. & Williams, D. L. 2009. The Handbook of Financing Growth: Strategies, Capital Structure, and M&A. 2nd ed. John Wiley and Sons. Mladjenovic, P. 2006. Stock Investing For Dummies. Wiley. Spurga, R. C. 2004. Balance sheet basics: financial management for non-financial managers. Ronald C. Spurga. Yescombe, E. R. 2002. Principles of project finance. Academic Press. Appendix Read More