Financial Reporting on Tesco - Coursework Example

Financial Reporting Task Table of Contents Financial Reporting Table of Contents 2 Introduction 3 Tesco’s financial performance 3 Investment ratio 3 Profitability ratios 4 Liquidity ratios 5 Effeciency ratios 6 Gearing ratios 7 Growth ratios 8 Non-financial ratio 9 Accounting policies for goodwill and intangible assets 10 List of References 11 Appendix 1: Ratio Calculation. 12 Introduction Tesco PLC is a Supermarket chain store located in the United Kingdom. The business was established in 1919 by Jack Cohen. The industry in which the company operates is food retail. The Supermarket provides both fresh and ready-made foodstuff that comes in varieties. The business operates in twelve countries globally with over 530,000 employees. The Company has more than 6,351 supermarkets spread in 12 countries across the globe. Tesco changed its core purpose from “more is better” to “making what matters better”. This company’s new core of purpose has created a new customer perspective, that is “caring for the customer’s well being”. Therefore, this is a positive perspective that has greatly contributed to the company’s success. Tesco plc has a market share of around 30 %. It is the second largest supermarket in terms of revenues after Walmart. The company targets the general public with its goods and services. It made an expansion and is currently offering financial services via Banking. The bank is known as Tesco Bank. Lastly, Tesco company is a publicly traded Company on the London Stock Exchange. The company’s share prices for 2011, 2012 and 2013 were £ 425, £ 391and £ 336. Therefore, this paper contains analyses on the Company’s financial performance for two years, that is, (2012 and 2013), profitability analysis, leverage analysis, efficiency ratios, investment analysis, and analysis of the segmental performance and lastly, the analysis of the company’s accounting policies for goodwill and other intangible assets. Tesco’s financial performance Below are the financial ratios that have been chosen to aid a comprehensive analysis of the company’s financial performance and its drivers. Investment ratio Return on capital employed (ROCE) – capital employed is total assets – current liabilities. Therefore, return on capital employed ratio indicates the return generated by every pound invested as capital employed. Concerning the case study, in 2012 and 2013, ROCE for Tesco PLC was 8.9% and 0.38% respectively. This means that in 2012, 8.9% of the company’s net profit was generated by the company’s capital employed. However, the company’s ROCE decreased in the year 2013 due to a sharp reduction in the net profit. The profitability level decreased because loss for the year from discontinued operations increased by £ 916 million (Duncan 2009, pp. 42-44). Profitability ratios Gross profit margin – the ratio indicates a company’s financial health after meeting the cost of sales. It also indicates the company’s ability to pay for future operating costs. Concerning Tesco PLC, the ratio for 2012 and 2013 are 8.4% and 6.3% respectively. This means that in the year 2013, 6.3 % of the total revenue were gross profit, whereas, the remaining 93.7% of sales were consumed by costs related to sales. The ratio is a decrease compared to that of the previous year. The decrease is attributed to a reduction in the gross profit due to an increase in cost of sales. The company increased its purchases which increased the carriage in costs and other purchasing related transactions. From this analysis, it can be concluded that the level of operation efficiency for Tesco is low. To rectify the decrease, the company should focus more on reducing the costs related to sales (Sarngadharan & Kumar 2011, pp. 121-135). Net profit margin before tax – this ratio shows how well a company manages its operating expenses. The higher the ratio, the lower the operating expenses of a company. The opposite is true. Concerning Tesco PLC, the margin before tax for 2012 and 2013 are 6.5% and 3.4%. This means that in 2013, only 3.4% of Tesco’s revenue were net profit before tax, whereas, the remaining 96.6% were consumed by operating expenses. The ratio is a decrease from 6.5% of the year 2012 due to a decrease in EBIT. The decrease in EBIT is due to the reduction in the company’s gross profit due to the reasons stated above. To rectify the decrease, the company should implement more stringent cost control methods starting with the cost of sales. The level of gross profit determines the profit level and thus, gross profits should be high to ensure a high net profit assuming a low level of operating costs. The same concept is applied to the net profit margin after tax. The only difference is that the earnings are less the tax expense. The ratios for net profit margin after tax for 2012 and 2013 are 0.19% and 4.4% respectively (Sarngadharan & Kumar 2011, pp. 121-135). Liquidity ratios Current ratio – this ratio measures the ability of a business to meet its current obligations using the current assets. Generally, it is advisable for the ratio of current assets to current liability to be 2: 1. Concerning Tesco PLC, the company current ratio for 2012 and 2013 were 0.67 and 0.69 respectively. The ratios clearly shows that the company is not liquid enough to sufficiently settle its short-term obligations using the current assets due to an increase in the company’s trade and other payables and customers’ deposit in the bank. This conclusion applies for both years under. To rectify the poor liquidity, the company should reduce the level of trade and other payables (Khan & Jain 2007, 6-40). Acid test – the ratio is with immediate liquidity therefore ignores the inventory. It measures the ability of a company to meet the short-term obligations using highly liquid assets. A highly liquid asset is that which is easily converted into cash. A company is considered well off if this ratio is 1. Concerning Tesco PLC, the quick ratio for 2012 and 2013 are 0.48 and 0.49 respectively. From these ratios, the company’s liquidity is low. Therefore, Tesco PLC cannot meet its short-term obligations using the immediate liquid assets. A reduction in the company’s payables and an increase in short-term investment will reduce the company’s illiquidity level (Khan & Jain 2007, 6-40). Effeciency ratios Net asset turnover – this ratio indicates the efficiency with which the net assets were utilized to generate revenue. Concerning Tesco PLC, the asset turnover for the year 2012 and 2013 are 2.02 and 2.06 respectively. This means that in the year 2013, a pound invested in the net assets was utilized to generate £ 2.06 toward the company’s revenue. The ratio increased in the year 2013 as compared to the previous year’s ratio. The increase is attributed to the decrease in the net assets and an increase in revenue due to increased level of purchases. From this ratio, it can be concluded that Tesco company efficiently utilizes its net assets (Khan & Jain 2007, 6-40). Inventory holding period – this ratio indicates the number days it takes for a company to sell its entire inventory. That period is therefore referred to as the inventory turnover period. Generally, the shorter the period, the faster the inventory sells thus more revenue is being experienced. Concerning Tesco PLC, the ratio for 2012 and 2013 is 22 days. This means that in both years, it took 22 days for the company to sell all the available stock. The period is short enough to allow more cash generation from sales (Khan & Jain 2007, 6-40). Trade receivables collection period – this ratio shows the period it takes a company to collect all the accounts receivables. It can also be referred to as the period within which all the company’s debtors must pay their dues. Generally, the shorter the period, the more the cash collected. Concerning Tesco PLC, the ratios for 2012 and 2013 are 15 days and 14 days respectively. For the two years, the company’s debtors had up to 15 days to pay the amount owing. Therefore, more accounts receivable were being collected in both years due to the company’s strict debt policy (Khan & Jain 2007, 6-40). Trade payable payment period – this ratio shows the period it takes for a company to pay its debts (accounts payable). The shorter the period, the quicker the company pays its debts. A quick response to payables is an attraction strategy for potential creditors. In addition, it also invites credit discounts. Concerning the company, the ratio for 2012 and 2013 are 70 days and 67 days respectively. Therefore, the company’s payable period is longer as compared to the debtors’ period. Either Tesco plc has difficulties in paying the creditors or it decided to hold on cash (Khan & Jain 2007, 6-40). Gearing ratios Debt ratio – this ratio indicates the proportion of a company’s total assets that has been financed by the total liabilities. It also shows the value of assets that creditors would claim in case of liquidation. Concerning Tesco Company, the ratios for 2012 and 2013 are 64.9 % and 66.76 % respectively. Both ratios show a high dependency on debt to finance the company’s assets with 2013 having the biggest percentage. This means that in 2013, 66.76 % of the total assets were financed by the total debts. The increase was due to an increase in the level of debt because the company increased the level of MTN debt and the US bond. Secondly, debt/equity ratio indicates the proportion of fixed charge capital in the capital structure of a firm. Concerning Tesco Company, the ratio for 2012 and 2013 are 55.7 % and 60.4 % respectively. For instance, in 2013, 60.4 % of the company’s capital was fixed charge capital. The increase from 55.7 % to 60.4 % was due to an increase in the level of debt (for the reasons stated above) and a decrease in the shareholders’ equity. From the analysis, the company’s leverage level is high. To maintain a low debt level, the company should utilize other sources of finance rather than debt (Bowhill 2008, pp. 265-284). Interest coverage ratio – this ratio evaluates a company’s ability to meet interest payments. It also indicates a company’s possibility of taking on more debt. Generally, the higher the ratio, the greater the company’s ability to pay interest charges. Concerning Tesco Company, the ratios for 2012 and 2013 are 9.8 times and 4.3 times respectively. In 2013, the company could pay interest 4.3 times using the EBIT. The ratio decreased due to a decrease in earnings before interest and tax. The decrease follows the decrease in the gross profit thus, means that the capacity capacity to pay interest also decreased (Bowhill 2008, pp. 265-284). Growth ratios Dividend cover – this ratio indicates the number of time dividend can be paid from earnings per share. The higher the ratio, the greater the ability of a company to pay its dividend from the EPS. Concerning the Tesco Company, the dividend cover for 2012 and 2013 are 3.45 times and 0.152 times. The ratio decreased in 2013 due to a sharp decrease in the company’s EBIT due to an increase in the operating expenses such as the cost of sales. To rectify the decrease, the company should manage its operating costs in order increase the profitability level (Currie 2011, pp. 100-120). Price /earning ratio – this ratio indicates the payback period for the share prices. That is, the number of years it will take to, recover the market share price from annual earnings per share of a firm. The smaller the ratio, the bigger the earnings per share, thus, good news for the investors. Concerning Tesco PLC, the price/earnings ratio for 2012 and 2013 are 9.29 years and 223 years respectively. In 2013, the ratio increased due to a sharp decrease in the Company’s earnings per share. The decrease in the earnings per share was due to a decrease in the company’s net profit due to the reasons stated above. To rectify the decrease, the cost should be reduced in order to increase the net profit and thus earnings per share (Currie 2011, pp. 100-120). Earnings per share – the companys basic EPS for the years 2012 and 2013 are £ 34.98/ share and £ 1.54/ share. EPS is another criterion for measuring a company’s profitability. Tesco’s EPS decreased in the year 2013 to £ 1.53/share due to a decrease in the operating profit by more than 50%. The decrease was caused by a sharp decrease in the company’s EBIT due to an increase in the operating expenses such as the cost of sales. To rectify the decrease, the level of net profit should be maintained high by reducing the company’s operating costs (Currie 2011, pp. 100-120). Share prices – the company’s share prices increased from £ 325 in 2012 to £ 344 in 2013. An increase in share price as is the case is an indicator of an increase in the company’s value (Bloomberg: The wealth watch newsletter 2014). Segmental analysis – Tesco Company has four business segments namely, the UK, Asia, Europe and Tesco Bank. The company’s revenue is generated in these segments. The company’s revenue for 2013 is £ 64,826,000. The contribution of each segment is as shown in the pie chart below. The diagram below shows that the UK segment generates 65.8 % , Asia generates 17.4 %, Europe 15.2 % and Tesco bank 1.6 % of the total revenue (Tesco annual report 2013, pp. 84). Non-financial ratio Male: female retirement ratio in years) – this ratio indicates the number of times the male employee is expected to retire at the age of 65 as compared to the female employee. Concerning Tesco Company, the retirement ratios for 2012 and 2013 are 0.92: 1 and 0.94: 1 respectively. Using the ratio of 2013, female employees were more likely to retire at the age of 65 as compared to the male employees (Tesco annual report 2013, pp. 118). Accounting policies for goodwill and intangible assets Intangible assets are non-monetary assets that cannot be seen or touched. They include goodwill, trademarks and other. Goodwill is an intangible asset that arises when a company acquires another and pays a price higher than the fair value. According to Deloitte: IAS 38 (2014, par 1-30), intangible assets should be measured at cost. On the other had, measurement after acquisition should be done using cost or revaluation model. Concerning Tesco plc, the goodwill accompanying an acquisition is measured using the revaluation model (fair value – amortization and impairment losses). On the other hand, separately acquired intangible assets such as software and various business licenses are measured at cost. Whereas, the intangible assets acquired in a business combination are recognized at their fair value on the acquisition date. Lastly, the intangible assets with limited useful period are carried at cost and are amortized using the straight - line method. Comparatively, the accounting treatment for intangible assets implemented by Tesco plc complies with the provisions of the IAS 38 (Tesco annual report 2013, pp. 79). In conclusion, the company’s financial health using liquidity analysis is low for the reason that the company cannot meet its short-term obligations. The gearing ratios show that the company is fairly leveraged thus does not face a big risk. Surprisingly, the share analysis indicates an increase in the company’s share prices. List of References Currie, M 2011, The search for income: an investors guide to income-paying investments, Harriman House Ltd, Hampshire, England. Bowhill, B 2008, Business planning and control: integrating accounting, strategy, and people, Wiley, Chichester, England. Khan, M. Y., & Jain, P. K 2007, Financial management, Tata McGraw-Hill, New Delhi. Sarngadharan, M., & Kumar, R. S 2011, Financial analysis for management decisions, Wiley, NY. Duncan Hughes 2009, Asset management in theory and practice, New Age International Pvt, [S.l.]. Tesco annual report 2013, Viewed 29 March 2014, http://www.sec.gov/edgar/searchedgar/companysearch.html. Bloomberg: The wealth watch newsletter 2014, Viewed 29 March 2014, http://www.bloomberg.com/quote/TSCO:LN. Deloitte: IAS 38 2014, Viewed 1 April 2014 http://www.iasplus.com/en/standards/ias/ias38. Appendix 1: Ratio Calculation. 2013 2012 ROCE (Net profit/Net asset) 0.38% 8.90% Gross profit margin (Gross profit/sales) 6.30% 8.40% NPM(before tax)(EBIT/Sales) 3.40% 6.50% NPM(after tax) (EAT/ Sales) 0.19% 4.40% EPS (EAT/No of share) £1.54 £34.98 Net asset turnover (Sales/net assets) £2.06 £2.02 Current ratio (CA/CL) 0.69 0.67 Price/earning ratio (MPS/EPS) 223 9.29 Acid test (CA-Stock/CL) 0.49 0.48 Inventory holding period 22 days 22 days Receivables collection period 14 days 15 days Payables payment period 67 days 70 days Debt ratio (Total debts/Total assets) 66.76% 64.90% Interest coverage ratio (EBIT/Interest charges) 4.3 times 9.8 times Dividend cover (EPS/DPS) 0.152 3.45 Share prices 344 325 Male: Female retirement ratio (years) 0.94 : 1 0.92 : 1 Debt/equity ratio 60.40% 55.70% Read More