Tesco Analysis - Assignment Example

Accounting and Finance Introduction The company selected for financial analysis is Tesco. Plc, which is leading supermarket in Europe and outside Europe. It is a leading seller of food related as well as everything that satisfy consumers from say books, household appliances, household equipments, flowers ,and even up to apparel. The company has flourishing on- line sales business as well. The company also owns petrol pumps under the name of Tesco Express. It has financial services business as well. Wal- Mart Stores Inc., which is company in the same industry and such big range of trading activities as Tesco Plc., is selected compare the performances of Tesco Plc. In this financial analysis of Tesco Plc., the areas that are concentrated are profitability, efficiency, liquidity, capital gearing, and the investors attractions. Contents Introduction Profitability Efficiency Liquidity Gearing Investors’ ratios Conclusion References Annexure containing ratio calculations Profitability The profitability of Tesco Plc. has been analyzed using four ratios, namely Gross Margins, Net margins, Return on Assets, and Return on Equities. “Gross margin measures the percentage of each sales dollar remaining after the firm has paid for its goods. The higher the gross profit margin, the better (that is, the lower the relative cost of merchandise sold)” (Lawrence J. Gitman). The Gross profit margin of Tesco Plc. has increased to 8.12% in 2007 as compared to 7.87% in 2006. This is basically because of increase in turn over by 8.08% in 2007 over the sales of 2006. This also reflects the efficiency of the company in effective control over cost of sales. On the other hand, the Gross Margins of Wal- Mart, which ahs been chosen as other company in the industry for comparison purposes, are huge 23.43%. Though the gross of firms even in the same industry are not comparable, but this is margin that other companies don’t realize even after best of their efforts. But when will review net margins of Wal- Mart in next paragraphs , we will find that net margins of Wal- Mart are even lower than Tesco Plc, whose gross margin in 2007 is just 8.12 % as compared to 23.34% of Wal Mart. The difference lies in approach and methods involve enhancing sales. Wal- Mart believe in enhancing overheads like advertise and other promotional activities to get larger sales, and to meet those extra overheads, huge gross margins are required. This factor speaks in the quality of goods being dealt in by the company. That is why Wal- Mart is known for stores for persons form all walks of life, but Tesco Plc. has maintained its qualitative standards and its stores are known for such a reputation. Net profit margins are the earnings before interest and taxation (EBIT). In fact these are the net margins remaining after meeting all related and allocated overheads. Naturally the higher the net margins, the better theses are for the company. Tesco Plc. has earned net margins of 6.21% in 2007 as compared to 5.93 in 2006. The performances of the company shows that company has not been able control its overhead expenditure this year. The comparative figure of Wal-Mart Stores is just 5.94%; and when this figure is compared to its gross margins of 23.43, one get an idea that how large are overheads of Wal- Mart as compared to other firms in the same industry. The ratio of Return on assets represents the earnings on investments on total assets of the firm. In fact this ratio tells how best the assets have been utilized to generate sales and thus the gross margins. Return on assets of Tesco Plc in 2007 is 7.66, which is an improvement over 6.98% in 2006. The company is effectively and efficiently using fixed assets for operational activities of the company. The return on assets of Wal- Mart is also around 7.44% and that reflects the industry trend. The return on equity (ROE) presents the earnings on total equity invested into company. The investors are particularly interested in this ratio. The respective ratios for 2007 and 2006 for Tesco Plc. are 17.96% and 16.76. There is definite improvement trend in the year 2007. The ratio for Wal- Mart is much better placed at 18.33%. Overall Tesco Plc. has shown progress and improvement in profitability in 2007 when compared to 2006. Efficiency Ratios used to judge the efficiency in working of the company are inventory turnover ratio and average collection period. Inventory Turnover indicates how fast and effectively the inventory is used in the operations of the company to turn it into sales. In common sense this ratio measures the activity of a company’s inventory. When compared with other firm in the same industry, the inventory turnover reflects the overall operational efficiency of the company. The efficiency ratio of Tesco Plc. is fantastic 20.4 times in 2007, which in fact a comedown from 24.88 times in 2006. That shows that inventory has rotated 20.4 times itself in the year 2007. This quick turnover of the inventory also suggest that company is maintaining the quality of goods being sold at its outlets, and quantity sold is kept only that much that does not vitiate their quality. On the other hand the Wal- Mart has very poor inventory turnover as compared to Tesco Plc. Wal-Mart Stores Inc. has inventory turnover of 7.84 in 2007. When this ratio is studied alongside the profitability ratio, this will reveal the differentiation in the type of business two giant firms are carrying on in the same industry. The Wal- Mart believe in bulk purchases to lower the cost of sales and thus earns higher gross margins; whereas Tesco Plc. believe in comparable lower quantities of qualitative purchases, and increasing the business by making higher inventory turnover. Tesco Plc. definitely cares for its customers. Average collection period is the average age or number of days of accounts receivables. The faster collection is good sign of using the capital investment and other resources in more resourceful manner. The average age of collection of receivables for Tesco Plc. in 2007 is 9.24 days, which shows a creeping deficiency when compared to 8.25 days in 2005. For Wal- Mart average collection days are only 3 days. That reflects that Wal- mart has comparatively low credit sales, and most of its sales are cash sales. Sales through credit cards are considered cash sales. Overall the Tesco has shown better inventory turnover in the industry, and its average collection period also signs of sluggishness into the operations of Tesco Plc. Liquidity The overall liquidity of a firm exhibits its solvency. When current assets meet current obligations timely as those become due, the company is said to be solvent. The best way to analyze the liquidity position of a company is though its current ratio. Current ratio is measured by dividing its current assets with current liabilities in order to find out how many times the current assets are as compared the firm’s current liabilities. Normally the acceptable current ratio in any industry is 2:1, that is to say current assets being double the current liabilities. However, the acceptable ratio changes from industry to industry. The current ratio of Tesco Plc. is very poor in both 2007 and in 2006. The current ratio in 2007 is hardly 0.56 and even in 2006 it was 0.52. This shows that the liquidity position of Tesco. Plc. is very precarious. The company may be finding very difficult to meet its current obligations. The situation has further worsened when we observe that its average collection period of receivable has increased as compared to 2006. This would have further worsened the liquid position. The company must take some innovative actions to improve its liquidity. One such ways is to raise long term debts and use some of the funds initially to meet short term liabilities till the situation improves. The situation Wal- Mart is no better. It has a current ratio of 0.9 only during 2007. Capital Gearing or leverage Capital Gearing is “the mixture of debt and equity in a firm’s capital structure, which influences variations in shareholders profits in response to sales and EBIT.” (LSE) Capital Gearing implies the ratio of debt and equity funds employed in the company to finance the assets of the company. The company having high ratio of debt financing as compared to owned funds is called high geared company; and the company with more of equity funds as compared to debts funds is low geared. Tesco Plc is a low geared company. Its debt ratio is only o.37 in both the year. For that matter Wal- mart is also a low geared company. Low gearing of capital implies that equity holders cannot take advantage of the fixed nature of interest payments on bonds and fixed dividend on preference shares. Once the payment of fixed interest and dividends is distributed, the balance entire profit of the company to equity holders. Accordingly in good times when the company earns more the equity holders can play with gearing of capital and have the advantage of earning more on their contributions in the equity funds of the company. As both Tesco Plc. and Wal- Mart are lowly geared, their equity holders cannot take advantage of gearing on capital contributions. Investors’ ratios The major ratios that attract the investors are earning per share(EPS) and Price/ earning (PE) ratio. Earning per share is of interest to both present and future investors and also to the management. In fact EPS represent the earning on behalf of each outstanding common share of the company. It is not the distribution of dividend but the earning per share that may or may not be distributed by the company. But EPS has a definite bearing on the market value of shares. Tesco Plc. has a fantastic EPS of 23.84p per share n 2007 and in 2006 it was 20.07p per share. The company has taken big stride in 2007 in earning per share. The EPS of Wal- Mart is 2.92p and this is also very attractive considering the face value of share. Price Earning ratio indicates the price the investors are ready to make for the shares of the company. In fact P/E ratio reflects the confidence of investors into the company. P/E ratio of Tesco.Plc. is 15.9 in 2007 and this has come down from the ratio of 18.63 in 2006. This means the confidence of investors was shaken in the company during 2007. This lowering of P/E ratio can be attributed to general gloominess in the market, when we consider that EPS has in fact gone up in 2007 as compared to 2006. Conclusion The financial review and analysis of Tesco Plc. suggests that the company has performed remarkable well in 2007 so far as profitability is concerned. Not only its turnover has gone up but gross as well net margins have shown a rise to prove that company is performing well on operational front. The company inventory turnover further proves that the company is turning its inventory more frequently into revenue to give a boost to already good operational activities of the company. The liquidity wise the company is in difficult position. It is facing difficulty in meeting its current obligations as they become due. Some concrete steps are required to improve liquidity of the company. The company is low geared and the equity holders are not in a position to take advantage of higher earnings of the company that is available under high geared capital structure. Though EPS is great but the company is facing problems in building confidence of investors. This is not because of operations of the company but effects of market changes in the last few years. References: Annual Returns, Wal Mart Stores Inc., http://walmartstores.com/Investors/7666.aspx Lawrence J. Gitman, Principles of Managerial Finance, Eleventh Edition, Gross Profit Margin, page 67 LSE, Capital Gearing Definition, viewed on May 4, 2008, http://www.lse.co.uk/financeglossary.asp?searchTerm=&iArticleID=1651&definition=capital_gearing Annexure Read More