Finance for Managers - Essay Example

 Finance for Managers Introduction Tesco Plc is one of the top multinational retailers which provide general merchandise and grocery items across several countries. It was instituted in 1919 in the United Kingdom and has acquired second position in terms of revenue globally (Tesco Plc, 2015). The company has commenced its business as a grocery retailer but after sometimes extended to offer various range of products. It has 30% of the UK’s market share and is situated across twelve nations in Europe, Asia, and North America. The product line of Tesco Plc include furniture, books, electronics products, internet services, financial services, clothing, petrol, home entertainment, and general merchandise. The main aim of Tesco is to maintain its top position in the retail business and to maximise their profit. They desire to outshine their rivals by remaining the market leader. The objective of the company is to provide affordable and cheap services and products to their customers. Tesco just not want to become the shop of preference for individuals but also the place where people prefer to work. They always try to offer something new to their customers. The three big ambitions of Tesco include minimising food waste internationally, improving health to tackle the international obesity crisis, and creating opportunities for billions of people across the world (Tesco Plc, 2015). The success of Tesco depends on their effort to understand the requirements of customers in a better way. The main purpose of this paper is to show the financial performance of Tesco Plc by carrying out the ratio analysis and comparing its ratios with its competitor. Ratio analysis will help to identify the profitability, liquidity, and solvency position of Tesco Plc. The paper will also evaluate the performance of the company in comparison to one of its competitor i.e. Wal-Mart for the year 2013. Analysis Preparation of financial statement is very essential for every business because it reflect the net profit as well as the financial position of the company on the end date of reporting period. The main reason of preparing financial statement is to identify the adjustment in the cash position as well as in the position of working capital between the two accounting periods. These statements reflect the combination of personal judgements, accounting conventions, and the recorded facts of the accountants (Sarngadharan and Rajitha, 2011). Ratio Analysis Ratio analysis is the suitable and effective instrument of financial analysis. The financial statement analysis with the help of ratios would direct the organization in significant decision making, control, and implementation. It is also considered as a tool for analysing the financial strength of the company. Various categorizations of the ratios are employed for different reason. The reasons behind carrying out ratio analysis are: to study the liquidity position, to recognize the profitability position, and to recognize the operating effectiveness of the company (Das, 2012). Advantages of Ratio Analysis Ratio analysis helps to simplify the financial statement. The interested individuals can identify the data without any complexity because the whole financial statement is made simpler through the help of ratio analysis. It facilitates the intra-firm assessment. Analysis and understanding of a particular company can be made for a period of time. The comparison among various divisions of the company is made simpler with the assistance of different ratios. Ratios provide suitable direction to organization for formulating different budgets and for constructing appropriate policies. It also helps to organize the future action plan. Ratio analysis helps in the comparison between different firms. Total figures are not enough to verify the exact comparison of companies. With the support of various ratios, one company can compare its performance with other company and can also find out its position in the industry. Analysis of ratios also helps in efficient decision making. It focuses on the level of efficiency of the organization and the utilization of their assets. By helping in the comparison between different firms, it represents the unsuccessful and successful firms. At the comparison time, if any adverse variations are recognized, instantly the corrective measures are taken. The administration wants to create cordial and harmonious relationship amongst all the divisions in the company. Meanwhile, the weakness and strength of the company should be corresponded in a simple understandable manner. This form of clear and quick communication can attain better co-ordination (Palanivelu, 2007). Interpretation of Financial Ratios Liquidity Ratios Current ratio: It is defined as a financial ratio which evaluates whether or not the firm has adequate resources in order to pay the debt over the subsequent business cycle by comparing current assets of the firm to its liabilities. An acceptable current ratio is 2:1. It is affected by the seasonality. It also provides an idea of operating efficiency of the company. It is calculated by dividing the current assets by current liabilities. The current ratio of Tesco Plc for the year 2009 is -3.27 which has improved to some extent and comes at -2.22 for the year 2013. However, it is less that the current ratio of Wal-Mart which is 0.83 in 2013 (See Appendix 1). The lower ratio of Tesco indicates that they will face difficulties in paying their bills on required time. Liquid ratio: Liquid ratio is also known as quick ratio. It evaluates the company’s ability towards utilizing its liquid assets in order to pay the current liabilities. Liquid ratio indicates whether the assets which can be rapidly transformed into cash are enough to cover the current liabilities. The liquid ratio of Tesco Plc is -2.63 for the year 2009 which has improved to -1.59 for the year 2013. Though, it is less than the liquid ratio of Wal-Mart which is 0.22 (See Appendix 1). The lower ratio of Tesco signifies that they depend excessively on inventory to pay their liabilities of short term. It also shows that they are taking excessive risk by not keeping an appropriate cushion of the liquid resources. Profitability Ratios Net profit ratio: It is the main financial indicator which is used to evaluate the profitability position of the company. Net profit ratio gives clues to the pricing policies, production efficiency, and cost structure of the company. Different strategies cause this ratio to fluctuate among various companies. It signifies how competent a firm is and how efficiently it manages its costs. The net profit ratio of Tesco Plc was 3.97 for the year 2009 which have continuously increased till 2012 but suddenly decreased to 0.19 in 2013. It is also less than Wal-Mart for the year 2013. The ratio of Wal-Mart is 3.62% in 2013 (See Appendix 2). The lower ratio of Tesco in comparison to its previous year as well as Wal-Mart shows the low safety margin and high risk for the company. PBIT ratio: PBIT ratio is also known as operating profit ratio. It is the profit which comes out before considering the income taxes and interest payments. The PBIT ratio of Tesco Plc for the year 2009 was 5.88% which has increased continuously till 2012 but was suddenly decreased to 3.38% in 2013. It was also less than the ratio of Wal-Mart which was 5.93% for the year 2013 (See Appendix 2). Solvency or Leverage Ratios Debt to equity ratio: It compares total debt of the company to its total equity. It indicates the percentage of organization financing which comes from investors and creditors. It is evaluated by dividing long term debt by the total equity. The debt to equity ratio of Tesco Plc for the year 2009 is 0.95 which has decreased to 0.60 in 2013. It is good sign for the company. A lower debt to equity ratio implies that Tesco is a stable company. The company is considered less risky to investors and creditors. However, its ratio is higher than Wal-Mart in 2013. Wal-Mart’s debt to equity ratio in 2013 is 0.47 (See Appendix 3). The higher ratio of Tesco in comparison to Wal-Mart signifies that more bank loans are used than shareholders financing. Debt ratio: It is one of the solvency ratios which assess total liabilities of a company as a proportion of the total assets. It shows the ability of the companies to pay off their liabilities with their assets. This ratio is used to evaluate the monetary leverage of the companies. Firms which consist of more liabilities in comparison to their assets are deemed as highly leveraged as well as more risky for the lenders. The analysis of debt ratio helps to know the total burden of debt on the firm and also the ability of the firm to pay off its debt in the near future. The debt ratio of Tesco in 2009 is 0.41 which is same for the year 2013 also. The ratio of less than one indicates that Tesco is a less risky company. Its ratio is also less than Wal-Mart which is 0.60 in 2013 (See Appendix 3). A debt ratio of .5 is standard ratio. A lower ratio of Tesco signifies that their business is stable with the likelihood of longevity. Activity Ratios Asset turnover ratio: It is an activity or efficiency ratio which measures the ability of a company to create sales from the assets through comparing sales or revenue with total assets. This ratio gives creditors and investors a thought on how a firm is managed as well as utilizes its assets in order to produce sales. The asset turnover ratio of Tesco Plc for the year 2009 is 1.17 which has continuously increased throughout the period of five years and comes at 1.29 for the year 2013 (See Appendix 4). The higher ratio of Tesco signifies that they are making use of their assets more resourcefully. However, its ratio is less than Wal-Mart which is 2.31 in 2013 which means that Tesco may face some production or management problems. Debtor turnover ratio: It evaluates how many occasions the debtors are collected throughout a particular time period. It is a useful tool to measure the liquidity of debtors. It is calculated by dividing sales revenue by the average debtors. The debtor turnover ratio of Tesco Plc in 2009 is 29.61 which has increased to 30.14 in 2010 but again decreased to 25.65 in 2013. It is also less than the ratio of Wal-Mart for the year 2013 which is 69.32 (See Appendix 4). It is much higher than Tesco. A lower ratio of Tesco indicates that the company has less liquid debtors and they may not be collected promptly. Discounted Cash Flow The investigation of discounted cash flow is a method of valuing a company, asset, or project. All cash flows are assessed and discounted to provide the present values which are the amount of all the future cash flows. Discounted cash flow is a summary of cash flow adjusted to show time value of money. The discounting factor is assumed as 10% for both the companies. The cash outflow for Tesco is assumed at £550 and that of for Wal-Mart is assumed at £1200. The total discounted cash flows of Tesco Plc come at £397.04 and that of Wal-Mart is £1491.54 (See Appendix 5). Net Present Value (NPV) NPV is an arithmetical calculation which indicates the present worth of an investment which is based on anticipated earnings from the investment in future minus the project cost. The rate of discount symbolizes time value of money. It is an evaluation of the discounted cash inflow in order to present the cash outflow to decide whether a future investment would be profitable. Net present value is utilized in the process of capital budgeting and also used to analyze the project or investment profitability. The analysis of net present value is susceptible to the consistency of expected cash inflows which may yield by a project or investment. The NPV of Tesco Plc is £63,459.71 and that of Wal-Mart is £291.54 (See Appendix 5). The net present value of Tesco is more than Wal-Mart which represent good position of Tesco. Generally, a project or company with positive or higher net present value is accepted and considered feasible for making investment. It means that if anyone is deciding to make investment then they should go for Tesco Plc as its NPV is higher than Wal-Mart. Internal rate of Return (IRR) and the Payback Period It is known as the rate of discount at which the company can make sure that its investment makes additional money than its real cost. The internal rate of return should not be less than discounting factor. If it happens then the project or investment is rejected otherwise, could be accepted. The internal rate of return of Tesco Plc comes at 49% and is much higher than Wal-Mart which is 36% (See Appendix 5). So, in terms of both, the internal rate of return and NPV, Tesco Plc demonstrates good result in relation to Wal-Mart. The payback period should be less the investment which is reimbursed in less time is regarded as the better option. A payback period which involves less number of years is considered as less risky. The payback period of Tesco comes at 1.5 years and that of Wal-Mart comes at 3.7 years (See Appendix 5). The shorter period of Tesco indicates that it is a less risky company to make an investment. Limitation of Ratio Analysis Ratio analysis provides several benefits to the company but there are also certain limitations or drawbacks of the ratio analysis. It relies on the information provided from the financial accounting process and if that information is inaccurate, then the data acquired from ratio analysis will also be incorrect and it will depict the wrong performance of the company. Ratios are computed on the earlier results so; a proper forecast may not at all times be dependable. The comparison of intra-firm through the method of ratio analysis might be proved useless if the standardized accounting policies and principles are not examined in different divisions of the similar concern (Debarshi, 2011). Conclusion The financial statements are considered as the periodic re-evaluation of the growth made by the company. The purpose of this paper is to show the financial performance of Tesco Plc by conducting its ratio analysis. The effectiveness of ratio analysis is for both, the financial manager and different parties who want to know various functions of the financial information. Analysis of profitability, liquidity, solvency, and activity ratios for the time period of five years has been carried out to show the financial performance of Tesco. The ratio of Tesco is also compared with Wal-Mart for the year 2013 in order to reflect which company is better in terms of liquidity, profitability, solvency, and efficiency position. The liquidity position of Tesco is not good as compared to Wal-Mart which indicates that Tesco will face difficulties in paying their bills on required time. The low profitability ratios of Tesco represents low safety margin for Tesco Plc. A lower debt ratio of Tesco signifies that their business is stable in relation to Wal-Mart. The asset turnover ratio of Tesco has continuously increased which indicates that they are efficiently utilizing their assets. The NPV and IRR of Tesco is more and the payback period is less than Wal-Mart which shows that Tesco is less risky company. The ratio analysis might be a valuable instrument in the expert analyst’s hands, but is not so in common people’s hand. However, analysis of various ratios helped to know the financial performance of the company. Table of Contents Introduction 1 Analysis 1 Ratio Analysis 2 Advantages of Ratio Analysis 2 Interpretation of Financial Ratios 3 Liquidity Ratios 3 Profitability Ratios 3 Solvency or Leverage Ratios 4 Activity Ratios 5 Discounted Cash Flow 5 Net Present Value (NPV) 5 Internal rate of Return (IRR) and the Payback Period 6 Limitation of Ratio Analysis 6 Conclusion 7 Reference List 9 Appendix 1 11 Appendix 2 11 Appendix 4 12 Appendix 5 13 Reference List Das, B., 2012. Management Accounting. New Delhi: Pearson Education. Debarshi, B., 2011. Management Accounting. New Delhi: Pearson Education. Palanivelu, V.R., 2007. Accounting for management. New Delhi: Laxmi Publications Ltd. Sarngadharan, M. and Rajitha, K.S., 2011. Financial Analysis for Management Decisions. New Delhi: PHI Learning Pvt. Ltd. Tesco Plc., 2009. Value travels: Annual report and Financial Statements 2009. [online] Available at: < http://www.tescoplc.com/files/pdf/reports/annual_report_2009.pdf.> [Accessed 23 Jan 2015]. Tesco Plc., 2010. Tesco PLC Annual Report and Financial Statements 2010. [online] Available at: [Accessed 23 Jan 2015]. Tesco Plc., 2011. Annual Report and Financial Statements 2011. [online] Available at: http://www.tescoplc.com/files/pdf/reports/tesco_annual_report_2011.pdf. > [Accessed 23 Jan 2015]. Tesco Plc., 2012. Annual Report and Financial Statements 2012. [online] Available at: http://www.tescoplc.com/files/pdf/reports/tesco_annual_report_2012.pdf.> [Accessed 23 Jan 2015]. Tesco Plc., 2013. Tesco PLC Annual Report and Financial Statements 2013. [online] Available at: https://files.the-group.net/library/tesco/annualreport2013/pdfs/tesco_annual_report_2013.pdf. > [Accessed 23 Jan 2015]. Tesco Plc., 2015. Tesco and Society: Our three big ambitions. [online] Available at: http://www.tescoplc.com/index.asp?pageid=562. > [Accessed 23 Jan 2015]. Walmart., 2013. Walmart 2013 Annual Report. [online] Available at: < http://c46b2bcc0db5865f5a76-91c2ff8eba65983a1c33d367b8503d02.r78.cf2.rackcdn.com/88/2d/4fdf67184a359fdef07b1c3f4732/2013-annual-report-for-walmart-stores-inc_130221024708579502.pdf> [Accessed 23 Jan 2015]. Appendices Appendix 1 Liquidity ratios of Tesco Plc and Wal-Mart (Source: Tesco Plc, 2009; Tesco Plc, 2010; Tesco Plc, 2011; Tesco Plc, 2012; Tesco Plc, 2013; Wal-Mart, 2013) Appendix 2 Profitability ratios of Tesco Plc and Wal-Mart (Source: Tesco Plc, 2009; Tesco Plc, 2010; Tesco Plc, 2011; Tesco Plc, 2012; Tesco Plc, 2013; Wal-Mart, 2013). Appendix 3 Solvency ratios of Tesco Plc and Wal-Mart (Source: Tesco Plc, 2009; Tesco Plc, 2010; Tesco Plc, 2011; Tesco Plc, 2012; Tesco Plc, 2013; Wal-Mart, 2013). Appendix 4 Activity ratios of Tesco Plc and Wal-Mart (Source: Tesco Plc, 2009; Tesco Plc, 2010; Tesco Plc, 2011; Tesco Plc, 2012; Tesco Plc, 2013; Wal-Mart, 2013). Appendix 5 DCF, NPV, IRR AND DCF of Tesco Plc and Wal-Mart Note: The values of Wal-Mart are multiplied by 0.66 to convert them into pound. Read More