Financial Analysis of Tesco Plc - Case Study Example

college TESCO PLC Word Count: words Table of Contents Table of Contents 2 TESCO PLC 3 Introduction 3 Financial Analysis 3Liquidity Ratios 4 Acid Test Ratio/ Quick Ratio 5 Gearing Ratio 5 Debt/Equity Ratio = Total Debts: Total Equity 6 Interest Cover 6 Profitability Ratios 7 Gross Profit Margin 7 Gross Profit as a percentage of Cost of goods sold 8 Net Profit Margin 8 SWOT Analysis 9 Conclusion/Recommendation to the Directors 11 References 11 TESCO PLC Introduction Tesco is a huge British retailer having strong business operation around the globe. It is considered as the third largest retailer globally based upon the revenue that it generates. It was started in the year 1919 by Jack Cohen as a simplified grocery store until 1924 when the Tesco brand was initially launched in 1924. Tesco is a well diversified company working in many different ventures; it has over the years created a great deal of value in the eyes of their customers. Its shares are currently traded in the London stock exchange under the code of TSCO. (London Stock Exchange, 2010) “Tesco operates 923 stores and employs 240,000 people, giving us access to a population of 260 million across our nine markets. Over the past five years, we have expanded from our traditional UK supermarket base into new countries, products and services, including a major non-food business, personal finance and internet shopping. The increasing scale and internationalization of our sales and purchasing operations makes a significant contribution to our efficiency and profitability, as we progress towards our long-term goal of becoming a truly international retailer” (Global Sources). Financial Analysis The company’s performance and Financial Analysis is done using ratio analysis. Ratio analysis is a procedure where an item of financial data is compared with another item of financial data so as to interpret the relationship between the two so that an understanding can be developed about the information and hence conclusions could be drawn. (Morley, 1984) “Ratio analysis is one of the most common types of financial analysis and is thought to be the most important method of financial analysis of an enterprise. It is a more advanced approach to analysis of structure and dynamics of the balance sheet and profit and loss account than the initial analysis. It was introduced by banks which use it to examine solvency of businesses which they credit. The ratio analysis enables examination of various aspects of business operations.” (Business-explained, 2008) The main ratios used to analyse the company’s financial performance are; Liquidity Ratios Gearing Ratios Profitability Ratios Liquidity Ratios Liquidity ratios give insight about a firm’s ability to meet its shot term financial obligations. These kinds of ratios are of great importance to those people who are willing to extend short term credit facility to an organization. (Financial Ratios, 2007) Liquidity Ratios evaluate a company’s ability to pay off their debts when they fall due. It gives a snapshot of the running position i.e. the working capital position of a company. There are two basic ratios that are calculated to ascertain a company’s liquidity position: Acid Test Ratio/ Quick Ratio This ratio shows the company’s ability to pay off its current liabilities with the most liquid assets (assets easily convertible into cash) that it holds. The formula to calculate acid test ratio is: Acid Test Ratio = Current Asset less Stock/Inventory Current Liabilities The liquidity Ratios calculated for TESCO plc are as follows: Ratio Calculation 2009 Calculation 2008 Calculation 2007 2009 2008 2007 Quick Ratio 13,647 – 2,669/18,040 5,992 – 2,430/10,263 4,168 -1,931/8,152 0.61 : 1 0.35 : 1 0.27 : 1 (Annual Report, 2009) According to the ratios calculated, TESCO does not have the necessary current assets to deal with its current liabilities. The company as per the calculations above seems to have too many current liabilities (almost double the amount of the current assets), such an effect is really alarming for any company and Tesco should clearly employ techniques to overcome this issue. (Yoder, 2008) Gearing Ratio Gearing is an essential element which helps in deciding upon the balance between equity and debt financing. The more highly a company is geared, the more difficult it would be for the company to raise further debt finance as high level of gearing denotes that the company is highly involved in debt financing. The higher the level of gearing, the higher would be the return required from the loan provider as he would be exposed to greater risk and the susceptibility that his money might go unpaid if the company goes bankrupt. Debt/Equity Ratio = Total Debts: Total Equity This ratio gives the proportion of the Debt and Equity acquired by any company to finance its operations. The financial gearing ratio and the debt to equity ratio for Tesco are the same in all the years concerned i.e. 2007 to 2009. Due to the increasing debt financing in the company, shareholders might seem threatened because their return would be left after giving out the fixed commitment of interest. This effect can also reduce the share price of the company. Hence it would be better for the company to pay off some of the debt and try to keep a proper balance between the debt and the equity financing. (Swanson et al, 2003) Interest Cover Interest Cover = Profit before interest and tax Interest Interest cover is a measure of financial risk i.e. it shows a company ability to pay off its interest obligation on any borrowings that it has made with the profit that it makes in that period. The interest cover for the company has been reducing since 2007 and all of this reduction is due to the company’s debt financing mode. The company has to pay more interest because of the heavy debt financing and this is clearly reflected in the interest cover ratio which has reduced from 13.3 in 2007 to 7 times in 2009. According to the financial statements of TESCO, the ratios calculated would be as follows: Gearing Ratios - TESCO Ratio Calculation 2009* Calculation 2008* Calculation 2007* FY 2009 FY 2008 FY 2007 Interest Cover Ratio 3,432/ 478 3,053/ 250 2,869/ 216 7 times 12 times 13.3 times Debt to Equity Ratio 14,255/ 12,955 7,174/ 11,902 5,524/ 10,592 109.6% 60.3% 52.3% The figures used to ascertain the prior charge capital include borrowings, derivative financial instruments and other liabilities, post employment benefit obligations and other non-current payables. Profitability Ratios “Profitability measures are important to company managers and owners alike. Profitability ratios show a companys overall efficiency and performance. We can divide profitability ratios into two types: margins and returns. Ratios that show margins represent the firms ability to translate sales pounds into profits at various stages of measurement. Ratios that show returns represent the firms ability to measure the overall efficiency of the firm in generating returns for its shareholders”. (About.com) (Berman et al, 2006) Gross Profit Margin The Gross Profit Margin for Tesco has crept down by 0.45% from the year 2007 to the year 2008. This reduction has been primarily because of an increase in the cost of goods sold for the company. The cost of goods sold has increased by 11% from the year 2007 to 2008; in contrast the revenue has only increased by approximately 5%. The Gross Profit Margin has only increased by an approximate 0.1% from the year 2008 to 2009, this increase can be clearly explained, according to the financial statements of Tesco, the cost of goods sold has increased by 14.7% in 2009 as compared to 2008 and the revenue in that period has increased by 14.8%. Gross Profit as a percentage of Cost of goods sold This has decreased by 0.5% in 2008 as compared to 2007 but later on there was a 0.1% increase in the year 2009 which clearly goes on to suggest that a greater portion of cost is converted into gross profit. Net Profit Margin The Net Profit Margin just crept up by 0.1% in the year 2008 as compared to 2007 but later decreased by 0.5% from 2008 to 2009, there are many factors that have contributed towards this decrease. Some of the major factors affecting this reduction are the administrative costs, taxation, finance costs, etc. (Bull, 2008) Ratio Formula Calculation 2009 Calculation 2008 Calculation 2007 FY 2009 FY 2008 FY 2007 Gross Profit Margin Gross Profit/Sales × 100% 4,218/54,327 × 100 3,630/47,298 × 100 3,463/42,641× 100 7.76% 7.67% 8.12% Gross Profit as a percentage of Cost of Goods Sold Gross Profit/Cost of Sales × 100% 4218/50,109 × 100 3,630/43,668 × 100 3,463/39,401 × 100 8.4% 8.3% 8.8% Net Profit Margin Net Profit/Sales × 100% 2,166/54,327 × 100 2,130/47,298 × 100 1,881/42,641 × 100 3.99% 4.5% 4.4% (Annual Report, 2009) The non-financial analysis of the company is done using the SWOT analysis. SWOT Analysis “SWOT analysis is a tool for auditing an organization and its environment. It is the first stage of planning and helps marketers to focus on key issues. SWOT stands for strengths, weaknesses, opportunities, and threats. Strengths and weaknesses are internal factors. Opportunities and threats are external factors.” (Marketingteacher.com, n.d.) This technique summarises the key issues from the business environment and the strategic capability of an organisation that are most likely to impact on strategy development. (United States, 2008) (CORCORAN, 1994) The company’s SWOT analysis is as follows; Strengths The major strength for Tesco plc has been its ability to respond to the economic and the global downturn. The company performed exceptionally well during such a recessionary time period and recorded a group sales figure of £59.4 billion. This figure is approximately 15% higher than the previous year group sales figure. This growth in sales clearly suggests that the company has got proper strategy in place to cope with the economic recession. Besides this the company has kept a long term consistent strategy to answer the global downturn. The company has opened many stores during the year 2009 and have also acquired the remaining 50% of Tesco Personal Finance from Royal Bank of Scotland. The fact that Tesco is a grocery retailer is in itself a major strength for the company as eating is a basic need of a human being. Weaknesses The weakness that exists for Tesco is its use of fossil fuel in its transport network and supermarket heating systems. This is expensive, and might alienate green consumers. With oil prices rising and, green taxes looming, Tesco might see an opportunity to invest in energy economy, although the company has introduced its green store, it might still need some heavy investment to reduce its fossil fuel expenditure. Opportunities There are many opportunities that exist for Tesco, one of them being the improvement of customer relationship. This customer relationship can be improved by the encouraging the customer to make greener decisions. This way the company can enhance its image and be recognised as an environmental friendly company. Threats The threats that exist for Tesco plc are; Instability of the economic environment. Exchange rate risks in all the different countries in which the company operates. Tax rate increase Inflation rate increase in some countries where the company operates. (Datamonitor Plc, 2003) Conclusion/Recommendation to the Directors Tesco’s performance in the three preceding years 2007, 2008 and 2009 has been good and the company has been performing with its best abilitites. Although the company has operated well, there are few areas that may need improvement. The initial issue is the gearing issue, the company may need to alter its gearing and keep a balance between debt and the equity as their source of financing. Besides the gearing the liquidity position of the company is qustionable, the working capital position of the company seems to be worrying and needs clear improvement. The profitability of the company has been good but there are certain areas that need to be investigated in order to improve the profitabilty postion further. The administrative expenses have increased immensely, there is almost an increase of 21% in the administrative expenses in the year 2009 as compared to 2008. The other major increase that has reduced the profit making ability of the company are increased finance costs, this increase in the finance costs is mostly because of the loans and the debt financing. With all such issues and few hiccups, the company has been performing well and has been creating good value for its sharholders. Tesco has been operating well in all aspects and is by far one of the most successful supermarket chain around the globe. References Annual Report and Financial Statements 2009 www.tescoplc.com/annualreport09 BERMAN, K., KNIGHT, J., & CASE, J. (2006). Financial intelligence: a managers guide to knowing what the numbers really mean. Boston, Harvard Business School Press BULL, R. (2008). Financial ratios building a model of success for your business. Oxford, CIMA Pub. http://www.myilibrary.com?id=107160 Business-Explained.com, Ratio Analysis, 2008 http://www.business-explained.com/courses/finance/financial_analysis/ratio_analysis/ CORCORAN, M. (1994). The development of non financial performance measures in manufacturing industry: a new challenge for management accountants. Dublin, University College Dublin, Graduate School of Business Financial Ratios, Liquidity Ratios, NetMBA, Business Knowledge Center, 2007 http://www.netmba.com/finance/financial/ratios/ Global Sources, Buyer Profile, TESCO http://www.globalsources.com/PEC/PROFILES/TESCO.HTM London Stock Exchange, FTSE 100 Constituents, 2010. http://www.londonstockexchange.com/exchange/prices-and-news/stocks/indices/constituents-indices.html Marketingteacher.com, Swot Analysis http://marketingteacher.com/lesson-store/lesson-swot.html MORLEY, M. F. (1984). Ratio analysis. Berkshire, England, Published for the Institute of Chartered Accountants of Scotland by Gee & Co SWANSON, Z., SRINIDHI, B. N., & SEETHARAMAN, A. (2003). The capital structure paradigm: evolution of debt/equity choices. Westport, Conn, Praeger (2003). Tesco Corporation SWOT Analysis. Datamonitor Plc. TESCO online, 2010 http://www.tesco.com/ UNITED STATES. (2008). SWOT analysis: a tool for making better business decisions. [Washington, D.C.], U.S. Dept. of Agriculture, Risk Management Agency YODER E. (2008). Current ratio and quick ratio (acid) tests. Radiology Management. 30 Read More