Analytical Review of Tesway Plc for the Year 2001 to 2002 - Assignment Example

ANALYTICAL REVIEW OF TESWAY PLC FOR THE YEAR 2001 TO 2002 In this paper, the Tesway plc’s financial performance for the year 2001 to 2002 was analytically reviewed. Comprehensive auditing process was used to test the horizontal and vertical relationships among the various accounts and identify the material changes. That is, significant ratios and trends for the unusual changes and questionable items were analyzed. These ratios were used to judge the comparative performance of the Tesway Group and the Tesway Company in 2001 and 2002 in terms of profitability, asset utilization, liquidity and debt utilization. The relative success or failure of this company was evaluated through these financial ratios. The financial statements of the Tesway plc are the main materials that will serve as the springboard into a comprehensive financial analysis of the Tesway Group and the Tesway Company. The results of the analysis are demonstrated and explained fully. 1. Tesway’s Rate of Return on Assets = Net Income / Total Assets Group Company Year 2002 2001 % Increase/ Decrease Year 2002 2001 % Increase/ Decrease Net Income 58.00 188.00 -69.15% 153.00 350.00 -56.29% Total Assets 12747.00 11618.00 9.72% 9801.00 9670.00 1.35% Rate of Return on total assets 0.46% 1.62%   1.56% 3.62%   Analysis: The rate of return concept was employed to evaluate the earning power of the Tesway Group and the Company. The earning power of the Group's total assets is only 0.46% during the year 2002. From a rate of return of 1.62% in 2001, the earning power of Tesway Group was further reduced by 1.16%. It was affected by the significant decrease (69.15%) of the Group's income earnings and minimal increase (9.72%) of the asset base. This decrease illustrates that there has been a less effective use of company assets in 2002 compared to 2001. This reflects that the Tesway plc has not been successful at earning income on its assets and investments. That is, the Tesway plc’s assets are not effectively used to generate profit. Comparatively, the earning performance of the Company is more discouraging than the Group. It attained only 1.56% rate of return on total assets in 2002, but the decrease in its performance (2.06%) from 2001 is much higher than the Tesway Group. Analysis also showed a significant decrease in net income during the year 2002. 2. Tesway’s Current Ratio Group   Company Year 2002 2001 % Increase/ Decrease Year 2002 2001 % Increase/ Decrease Current Assets 3820 2901 31.68% 561 3202 -82.48% Current Liabilities 4810 5036 -4.49% 5355 2808 90.71% Current Ratio 0.79 0.58   0.10 1.14   Analysis: The current ratios of Tesway Group and the Company are both less than 1 in year 2002. The figures showed signs that both business units are already in trouble or might be facing trouble meeting their obligations because of their liquidity problems on both business units. Failure to meet any financial obligations will endanger the position of the Tesway plc. The Company is more liquid towards the end of 2001 than during the year 2002. From a good showing in 2001, the current ratio of the Company significantly decreased from 1.14 in year 2001 to just 0.10 in year 2000. It only means that every pound of liability is supported only by 0.30 pound. This decrease can be linked to low management ability, depress economic conditions for that year such as the foreign exchange decline which has increased cash outlays on costs. There has also been a less efficient cash flow. 3. Tesway’s Rate of Return on Shareholders' Equity Group Company Year 2002 2001 % Increase/ Decrease Year 2002 2001 % Increase/ Decrease Net Income 58 188 -69.15% 153 350 -56.29% Shareholders' Equity 3886 4027 -3.50% 3631 3624 0.19% Rate of Return on Equity 1.49% 4.67%   4.21% 9.66%   Analysis: During the year 2002, the rate of return on shareholders' equity of the company (4.21%) is better than the returns realized by the Tesway Group during the same period (1.49%). However, the rate of returns of both the Group and the Company showed decreasing trend in net income realized respectively by the Group (69.15% decrease) and the Company (56.29% decrease). This means that the Tesway Group and the Company has decreased its capacity to earn profit on the capital owned by investors. The reason for the decrease on the rate of return on shareholders funds is due to the decrease in Net profit. 4. Comprehensive Analysis of the Group Income Statement The income statement of Tesway Group was analyzed in terms of percentage increase or decrease of each item over the base year 2001 (Exhibit 1). For this analysis of the income statement, there is a very significant trend observed. Significance of the amount involved and trend percentages were noticeable because they call attention to large proportionate changes to the statement or financial condition of the firm as follows: 1. Profit for the financial year 2002 is only 58 million. When compared to year 2001, the base year profit of 188 million decreases by 130 million or 69.15%. This is a very significant decrease. 2. This proportionate decrease in profit can be attributed to significant decrease of 20 million in profit on the sale of properties (95.24%), cost items such as increase in Information Technology insourcing costs amounting 63 million, cost increase for financing fair value movements in the amount of 12 million and debt restructuring costs of 38 million. 5. Comprehensive Analysis of Balance Sheets The balance sheet of the TESWAY Group and the Company was also analyzed in terms of percentage increase or decrease compared to the base year 2001 to determine the performance of the business (Exhibit 2). Significant findings are as follows: 1. The Group’s total assets during the year 2002, increase by 1,129 million (or 9.72 %) from the year 2001, while the increase in the Company’s assets is 131 million representing only 1.35% increase from the base year. 2. Decrease in net assets amounting to 147 million (or 3.57% decrease from 2001) was incurred by TESWAY Group in 2002. The decrease was proportionately affected by significant increase amounting to 1,502 million representing 60.81% increase in non-current liabilities. 3. Increase in net assets amounting to 7 million was realized by the Company in 2002 representing only 0.19% increase. Minimal growth was brought by minimal increase in assets (1.35%), significant increase derivative financial instruments and long-term borrowings. Exhibit 1. Comprehensive Analysis of the Group income statement for the 52 weeks to 31 December xxx2. Note xxx2 £m xxx1 £m Amount of Increase/ (Decrease) % Increase/ (Decrease) Continuing operations revenue 1 16,061 15,202 859 5.65% Cost of sales   -14,994 -14,544 -450 3.09% Gross profit 1,067 658 409 62.16% Administrative expenses -839 -830 -9 1.08% Other income   1 21 -20 -95.24% Operating profit/(loss) 2 229 -151 380 251.66% Finance income 3 30 44 -14 -31.82% Finance costs 3 -155 -132 -23 17.42% Share of post-tax profit from joint ventures 0 1 -1 -100.00% Profit/(loss) before taxation   104 -238 342 143.70% Analysed as: Underlying profit before tax from continuing operations 267 238 29 12.18% Other operating costs -51 -497 446 89.74% IT insourcing costs -63 -63 6300.00% Profit on sale of properties 2 1 21 -20 -95.24% Financing fair value movements 3 -12 -12 1200.00% Debt restructuring costs 3 -38 -38 3800.00%     104 -238 342 -143.70% Income tax (expense)/credit 5 -46 51 -97 -190.20%       Profit/(loss) from continuing operations 58 -187 245 -131.02% Discontinued operations Profit attributable to discontinued operations 375 -375 -100.00% Profit for the financial year   58 188 -130 -69.15%   Attributable to:     Equity holders of the parent 64 184 -120 -65.22% Minority interests -6 4 -10 -250.00%       58 188 -130 -69.15%       Earnings/(losses) per share pence pence Basic 3.8 4.1 0 -7.32% Diluted 3.8 4.1 0 -7.32% From continuing operations: Basic 3.8 -17.4 21 -121.84% Diluted   3.8 -17.4 21 -121.84% Exhibit 2. Comprehensive Analysis of Balance Sheets for the 52 weeks to 31 December xxx2 Group Amount of % Company Amount of % Note xxx2 £m xxx1 £m Increase/ (Decrease) Increase/ (Decrease) xxx2 £m xxx1 £m Increase/ (Decrease) Increase/ (Decrease) Non-current assets Property, plant and equipment 6 7060 7076 (16) (0.23) 251 330 (79) (23.94) Intangible assets 191 203 (12) (5.91) 0 0.00 Investments 7 10 20 (10) (50.00) 7231 5770 1461 25.32 Available-for-sale financial assets 113 0 113 11300.00 0 0.00 Amounts due from Tesway Bank customers 1473 1331 142 10.67 0 0.00 Other receivables 8 0 0 1751 368 1383 375.82 Deferred income tax asset 55 55 5500.00 7 7 700.00                     8902 8630 272 3.15 9240 6468 2772 42.86 Current assets               Inventories 9 576 559 17 3.04 0 0.00 Trade and other receivables 8 276 319 (43) (13.48) 150 2885 (2735) (94.80) Amounts due from Tesway Bank customers and other banks 1888 1227 661 53.87 0 0.00 Available-for-sale financial assets 52 52 5200.00 0 0.00 Investments 90 (90) (100.00) 0 0.00 Cash and cash equivalents 1028 706 322 45.61 411 317 94 29.65                 0 0.00 3820 2901 919 31.68 561 3202 (2641) (82.48) Non-current assets held for sale 25 87 (62) (71.26) 0 0.00                 3845 2988 857 28.68 561 3202 (2641) (82.48)                     Total assets 12747 11618 1129 9.72 9801 9670 131 1.35                     Current liabilities               Trade and other payables 10 (2094) (2093) (1) 0.05 (5119) (2483) (2636) 106.16 Amounts due to TESWAY Bank customers and other banks (2299) (2464) 165 (6.70) 0 0.00 Short-term borrowings 11 (253) (354) 101 (28.53) (233) (283) 50 (17.67) Derivative financial instruments (10) (10) (1000.00) (10) (10) (1000.00) Taxes payable (63) (55) (8) 14.55 9 (29) 38 (131.03) Provisions (91) (70) (21) 30.00 (2) (13) 11 (84.62)                     (4810) (5036) 226 (4.49) (5355) (2808) (2547) 90.71                     Net current (liabilities)/assets (965) (2048) 1083 (52.88) (4794) 394 (5188) (1316.75)                     Non-current liabilities               Other payables 10 (30) (31) 1 (3.23) (782) (1501) 719 (47.90) Amounts due to TESWAY Bank customers and other banks (1009) (22) (987) 4486.36 0 0.00 Long-term borrowings 11 (2178) (1793) (385) 21.47 (1704) 1704 (100.00) Derivative financial instruments (2) (2) (200.00) (2) (2) (200.00) Deferred income tax liability (1) 1 (100.00) 0 0.00 Provisions (95) (87) (8) 9.20 (31) (33) 2 (6.06) Retirement benefit obligations (658) (536) (122) 22.76 0 0.00                     (3972) (2470) (1502) 60.81 (815) (3238) 2423 (74.83)                     Net assets 3965 4112 (147) (3.57) 3631 3624 7 0.19                     Equity               Called up share capital 489 620 (131) (21.13) 489 620 (131) (21.13) Share premium account 782 761 21 2.76 782 761 21 2.76 Capital redemption reserve 668 547 121 22.12 668 547 121 22.12 Other reserves (1) 87 (88) (101.15) 0 0.00 Retained earnings 1948 2012 (64) (3.18) 1692 1696 (4) (0.24)                     Equity shareholders' funds 3886 4027 (141) (3.50) 3631 3624 7 0.19 Minority interests 79 85 (6) (7.06) 0 0.00                     Total equity   3965 4112 (147) (3.57) 3631 3624 7 0.19 6. Gross Profit Margin Comparative analysis of Tesway Group’s gross profit margins during the year 2001 and 2002 showed improvement from only 4.33% to 6.64% gross margin. The 2.3% increase in profit margins was due to the reduction of the cost of sales, which is around 95.7% of total sales in 2001 to only 93.4% in 2002. With this increase in profit, this analysis reflects some concern with regards to the Tesway plc’s ability to increase profits and growth each year. Computation of gross profit margin   2002 2001 Gross profit 1,067 658 divided by: Net sales 16,061 15,202 Gross Profit Margin 6.64% 4.33% 7. Net Profit Margin Computation of Net profit margin   2002 2001 Net income 58 188 Net sales 16,061 15,202 Net profit margin 0.36% 1.24% In contrast to the trend of gross profit as shown in the previous table, net profit further decrease by almost 1%, from 1.24% net profit margin in 2001 to only 0.36% net profit margin in 2002. The decrease in net profit was due to the payment of income tax during the year 2002 amounting to 46 million (Exhibit 1). The above “number-crunching” process is not fully adequate to have a comprehensive review of the Tesway plc. There is still a need to supplement the financial findings illustrated and discussed above with an evaluation of the Tesway plc stores, assessment of the Tesway plc management, physical facilities and numerous other factors. 8. Evaluation of the Tesway plc Stores Aside from a bank and an online home delivery shopping service, the Tesway plc has numerous supermarkets and convenience stores with around thirty thousand products, half of which are the Tesway’s own product lines which ranges from manufactured goods and apparels, fresh agricultural products, electrical goods and leisure goods. Other array of products that are available at every stores are seasonal items during the Easter, Christmas and BBQs, food items, animal foods, baby products, beauty products, newspapers and magazines, compact discs, digital video discs and many others. The chains of stores operate day and night. The impact of inflation and disinflation on the financial operations over the two years, 2001 to 2002 can be explored to evaluate the Tesway stores. Rising prices or declining prices has an effect on various financial ratios. Last year, grocery deflation or the percentage reduction in price of products sold was 1.5 per cent. This was largely a result of the 8,500 price reductions made by the Tesway stores. This underlines how competitive prices have become. This reinforces competitiveness by assisting the buyers to identify offers, promotions and price-checked products. The positive sales growth of Tesway stores in 2002 was achieved with increased volumes, being offset by grocery price deflation of 1.5 per cent as a result of continued investment in the customer offer. In analyzing the Tesway stores, the question that is relevant to ask from the staff members of the supermarkets in order to better plan the audit is what are the receivables. The details of the trade and other receivables will be very important in comprehensively analyzing the operational status of the Tesway stores. 9. Assessment of the Tesway plc Management The organizational structure of the Tesway plc is shown below: The newly appointed Financial Director undertook a cost-cutting exercise. Among these measures is the appointment of the new auditor with the hope of reducing the 2001 audit fee by ten per cent. The Tesway plc takes steps to manage risks. To hedge risks, the Tesway plc uses financial instruments. Interest rate and currency risk are managed through the use of interest rate swaps and options. On the other hand, liquidity risk is managed through pre-funding cask flow requirements and maturing debt obligations, maintaining a diversity of funding sources and spreading debt repayments over a range of maturities. However, aside from this cost-cutting aim which can be transformed to savings, the appointment of this in-house auditor will encourage check and balance. If the new auditor is competent, he/she will be alarmed at the result of the financial analysis above. The data above clearly reflects that this company is on the verge of trouble. The Accounting and Internal Audit Departments also play their respective roles to assure check and balance in the financial matters of the company. The Accounting Department of the Main Office of Tesway plc performs monthly financial reconciliation reports and reviews the stores weekly financial reconciliation reports. Every store manager has access to the store’s data. Every month, these store managers receive from the Main Office summary of the Balance Sheet and P/L for each store to the respective store managers. With this kind of transparent systems, it will not be difficult for the executives of this company to notice the deteriorating financial status of the company. 10. Evaluation of the Tesway plc’s Physical Facilities It is evident from the financial statements of the Tesway plc that this company has complete physical facilities, land and buildings, fixtures, equipment, vehicles and others that are essential in the efficient performance of the company. It can be observed that the expenditure on purchase of property, plant and equipment is relatively high. Purchase of the Tesway group is very much higher than the purchase of the Tesway company. For every store, the computers are in placed. This computer system is use by the Tesway plc mainly for its purchasing and sales system and other minor usage. The new hand-held stock and sales system increases productivity since this gives updated sales and supply information to the store crew. This system aids the employees/workers on the stores to monitor and quickly respond to stock levels. It also gives a relatively accurate idea of the physical stock versus the required stock. This system reduces wastage and cost. 11. Working Capital Cycle The working capital cycle of the Tesway plc is that period of time which elapses between the point at which cash begins to be expended on the Tesway’s product and the collection of cash from a customer. The diagram below illustrates the working capital cycle of the the Tesway plc. The upper part of the figure above indicates the sequence of events in the Tesway plc. Every box on that upper portion of the illustration is a tank through which the funds flow. These tanks relate to the daily activities at the Tesway plc. These tanks have funds that are continuously streaming into and out of them. The series begins with the Tesco plc purchase of merchandise. After a while this merchandise stock will be used in retailing. Then work will be carried out on the stock. Then, it will become fraction of the Tesco plc’s work-in-progress. As the process progresses, labor costs and retailing overheads have to be met. A number of stage trade creditors will need to be paid. When the merchandises are vended on credit, debtors are increased. They will in due course pay, so that cash will be infused into the Tesway plc. Each of these, stocks (work-in-progress and merchandise), trade debtors, cash (positive or negative) and the trade creditors, can be perceived as tanks into and from which funds flow. Aside from the working capital as one feature of a business that influences the amount of cash, the business will likewise have to pay for taxation to the government. The fixed assets will be bought and sold. Lessee of fixed assets will be paid their rental fee. Current and new investors will be afforded with new funds in the form of cash. Some shares may be cashed in. Dividends may be paid. Current and new long-term loan creditors may be afforded with loan finance. Loans will have to be paid back from time to time. Interest responsibilities will have to be met by the business. Dissimilar movements in the working capital items as well as majority of the non-working capital cash transactions are not usual, daily events. A number of these are annual events. Such yearly events are the lease payments, tax payments, dividends, fixed asset purchases, interest and sales. The new equity and loan finance and redemption of old equity and loan finance can be one of the events in the Tesway plc. However, the latter is one type of a rare event. Read More