Financial Analysis of Tesco - Coursework Example

1. Tesco is a retail store in UK. The company has a huge presence and deals in “consumer products, groceries, financial services and telecom” (Tesco Website, 2011). The fact that the company deals in so many products and huge reach has given a wide market. The company is planning to expand its reach and enter India as it is one of the most growing hubs for retail business (Mahapatra, 2010) The company has used different source of financing and the capital structure of the company is based on it. A look at the financial report suggest that Tesco has used retained profits, long and short term borrowings, capital market through equity, commercial paper, bank borrowings and leases in their capital structure. (Annual Report, 2010, p. 40) A further analysis of the capital structure of Tesco will help to understand the capital structure better. This ratio is of prime importance and provides relevant information about the company. “It identifies how much of the firm’s assets are financed through debt and includes long term debt”. (Transtutor, 2010) The ratios which help to determine it are as Debt to Equity Ratio: “It determines the proportion of long term debt in relation to the shareholders fund and long term debt”. (Transtutor, 2010) This ratio helps to identify the financial soundness. It is calculated as “Long Term Debts / Equity X 100”. The calculation of the capital ratio is as Ratios Formula 2009 2008 Debt to Equity Ratio Long Term Debts / Equity 15,018 / 12,995 = 1.15 12,995 / 11,902 = 1.09 The ratio indicates soundness on the part of Tesco. It shows that the company has a scope for more investment through debts. This is a good sign and shows the company has a space for future projects. As the company works in a type of market where to grow large debt is needed so the ratio seems to be sound. Interest Coverage ratio: “It measures how well a companies is able to meet its interest cost from in comparison to the finance expenses”. (Transtutor, 2010) It is calculated as “EBIT / Net Finance Expenses”. The calculation of the capital ratio is as Ratios Formula 2009 2008 Interest Coverage Ratio EBIT / Net Finance Expenses 3,206 / 478 = 6.70 2,791 / 250 = 11.15 The performance on Tesco fallen which shows the ability to meet the interest expenses from financing activities has suffered. Tesco needs to continue to perform and look forward to improve it against their competitor. Earnings per Share: “It is defined as the profit attributed to the equity shareholders”. (Joseph, 2010) It is calculated as “Net profit available to ordinary shareholders / weighted number of ordinary shares on issue”. The calculation of the capital ratio is as Ratios Formula 2009 2008 Earning per Share Net Income / Outstanding shares 27.50p cents (given in financial statement) 26.95p (given in financial statement) The above ratio indicates soundness on the part of Tesco. Tesco has a higher earning per share indicating that the shareholders are getting a good return. The returns for Tesco have increased in 2009 as compared to 2008 which shows that the profit has increased. The overall result for the giant seems sound and is a good prospect to invest. The capital structure thus shows soundness for Tesco and the company has been able to maintain their planning well. This has also ensured efficient efficiency which has helped the company to build a strategy for the future. 2. Factoring for business is an alternative means of financing the business and was used in traditional times. In these methods the business sells their accounts receivable to another party at a discount so that ready cash is available to finance the business. In this method the business doesn’t rely on external sources but instead of that uses their own debtors which will be converted into cash sometimes in the future. While deciding the course of action in this method businesses have to give certain discount to lure the third parties. (Factoring, 2011) Factoring provides various advantages to the business over other forms of financing. Some of the advantages which factoring provides to the business are as follows Raising finance through factoring is quick as it doesn’t require approvals and is easy to find third parties who are willing to provide the required liquidity at a certain discount (Rankin, 2009) Factoring ensures that new parties who are into business find it easy to raise finance as they don’t have to approach the bank or other financial institutions and can raise finance in the market (Rankin, 2009) This method doesn’t require a good credit score thereby relieiving the companies as it becomes easy for them to raise finance then (Rankin, 2009) Raising finance through factoring is less risky as the business doesn’t have to raise loan against mortgage or loan which reduces the risk of interest payment and other forms of risk like maturity risk. Thus it becomes easy for business to use this mechanism and raise finance (Rankin, 2009) Factoring thus provides an advantage for companies to raise finance and new companies who find difficult to raise finance look towards this alternative. It is also seen that Tesco doesn’t use this mode of finance. No information regarding the factoring form of finance has been identified. This is due to the fact that the company has grown with time and find it easy to raise finance through other mechanism. This ensures that they don’t have to rely on the traditional ways to raise finance and do it from the market. 3. Working capital holds an important aspect for any business. It determines the strategy the business will pursue and helps to determine the stability of the business. A business cycle for a business like Tesco is as follows The above cycle shows the manner in which working capital is given importance to. Having identified the areas where the company needs to work upon to ensure stability in working capital goes a long way in building the long term performance of the company. The working capital stability for Tesco can be identified from the liquidity ratios which will help to identify the management of working capital. This ratio looks into both the short and long term financial stability and helps to find the prospective growth opportunity for the company. The ratios which include both the short and long term financial stability are provided below Current Ratio: “It measures the ability to pay the short term liabilities out of short term assets”. (Financial Modelling Guide, 2010) This ratio helps creditors, suppliers and investor to identify the liquid position. It is calculated as “Current Assets / Current Liabilities”. Calculation of is as follows Ratios Formula 2009 2008 Current Ratio Current Assets / Current Liabilities 13,647 / 18,040 = 0.75 5,992 / 10,263 = 0.57 The ratio shows that Tesco has a sound liquidity position. Tesco need to improve it slightly so that the picture becomes better. This might make investors and suppliers stay away. Tesco Ltd on the other hand is in a better position but still needs to take it slightly up around 2. Quick Ratio: It is also known as acid test ratio. “It measures the ability of the firm to meet its short term obligation when inventories are removed as inventories take some time to be converted into cash”. (Financial Modelling Guide, 2010) It is calculated as “(Current Assets – Inventories) / Current Liabilities”. The calculation of the ratio is as Ratios Formula 2009 2008 Quick Ratio (Current Assets – Inventories) / Current Liabilities (13,647 - 2,430) / 18,040 = 0.61 (5,992- 2,669) / 10,263 = 0.31 The ratio also indicates that Tesco is better positioned in 2009. The ratio indicates the efficiency of the company to meet its immediate debt. Tesco still need to improve this as it is a concern and presenting a bleak picture. The company thus has sufficient liquidity which helps to ensure that the working capital is sound. To finance the working capital Tesco has looked towards short term loans, borrowings, derivative instruments, customer deposit and bank deposits (Annual Report, 2010, p. 74). This method of financing has enabled Tesco to ensure that they are able to raise finance easily. A graph which represents the different form of financing the working capital is as follows The above diagram shows that Tesco has relied on different forms of financing their working capital which has ensured stability in their working capital management. This has helped Tesco to ensure sufficient liquidity and has helped the company to plan their future progress based on the strong working capital management which ensures sufficient liquidity. 4. The capital market efficiency implies that shares are traded at a fair value and investors have complete information about the product. In reality it is not true. One of the prime reasons for such an attribute is that there is some information which a normal investor is unaware of in the market. Such a problem arises because insiders have more information about the company compared to the general public. It might be a situation where the market looks efficient and stocks are traded at fair value but it is for a limited frame of time. Since, insiders have more information which influences their decision thereby creating doubts on the market efficiency. (Hypothesis, 2011) Another, information which has an effect on the market efficiency is the relative concept. Share prices are the expectation of people from the company. Any new or incomplete information might result in the share prices either moving up or down. Thus the relevance of information and quantity has an effect on the market efficiency and it is difficult to identify the manner information has an influence on the prices and brings about a change in the market efficiency. (Hypothesis, 2011) Incomplete information and the use of additional powers by certain players have an influence on the share prices and create doubt regarding market efficiency. This has made organizations looks towards agent “who will work on behalf of the principal owner i.e. the shareholders and will be given certain incentive for it.” (Nicholson, 1998) Despite the efforts to have a manager who monitors all the functions still the manager might act “in his own self interest “. (Fama, Eugene & Jensen, 1983) The objective of both the manager and the shareholder might clash which might result in the manager to act in his own advantage as there is asymmetry of information and uncertainty which will make the shareholders unclear as to what needs to be done. (Fama, Eugene & Jensen, 1983) To ensure that they get proper governance shareholders need to “incur agency cost where they hire someone from outside the organisation who audits the performances, communicates with the shareholders regarding the changes and brings forward issues which might harm the shareholders”. (Fama, Eugene & Jensen, 1983) This cost will help to bring a check and ensure that there is proper corporate governance and shareholders get their dues as well as the society is looked after. This step helps to ensure that there is transparency and no concealment of information which will help to ensure that the market is efficient. This helps to identify the market form of efficiency as follows Strong efficiency: This form of efficiency implies that the market has disclosed all information and the share prices reveal the correct value. (Heakal, 2010) This is hardly a true phenomenon as there remains certain information which is not disclosed thereby leading towards a situation where it is difficult to predict the market. Semi-strong efficiency: This form of efficiency implies that the market has sufficient information but not complete information. The share prices reflects the correct vale through technical and fundamental analysis and it is difficult to earn super normal profits through investment (Heakal, 2010) Weak efficiency: This form of efficiency implies that all past stock prices are reflected in the present price. The market has incomplete information and technical analysis will not help to find the correct value of the shares (Heakal, 2010). Thus markets experience different forms of efficiency and it is important that complete information is passed on so that the share prices reflect the correct value. 5. A. Shareholders wealth: Shareholders wealth is the total value of the shares of the shareholders. The value of their wealth increases through issue of share or increase in the price of share. For example Ajanta Ltd had $100,000 as share capital and the market value is $150,000 so shareholder wealth is $150,000. (Shareholder Wealth, 2011) B. Financial Risk: is the risk that arises when an investment is made in any financial instruments. This is an inherent risk as there is a likelihood that that the price of the financial instrument might fall. For example, investment in shares has a financial risk associated with it through the variations in the share prices. (Financial Risk, 2011) C. Debenture: is a financial instrument used by businesses to raise money. It is non collateral debt which is backed upon the reputation of this issuer. This is a form of finance big corporations rely upon. They are long term in nature and helps businesses to raise finance without issuing shares or collaterals. Example, unsecured bond (Debenture, 2011) D. Beta: Beta helps to measure the relation between the stock and the market. Organizations measure Beta to find out the relative strength. A high beta signifies that stock moves in tandem with the market whereas a weak beta signifies the opposite. This thereby helps in determination of the portfolio which will provide maximum returns (Beta, 2011). E. Leasing: is a process where businesses use certain assets which are fixed in nature for their operations and pay taxes and payments for a fixed interval which is ascertained at the time of entering into a contract. The asset in this case is with the lessee who uses it for his own purpose and usually pays rent on it. F. Gearing: Gearing is measuring the amount of debt constituent in the financials of the organization. This is vital from the perspective of the stakeholders as it helps to understand the capital structure. This is shown in percentage and helps businesses to find the long term stability and the risk involved in their financing pattern (Gearing, 2011). G. Convertible Loan Stocks: is a form of financing. In this form of financing companies can convert their loans which are in the form of bonds to shares after meeting certain conditions. This helps the businesses to stay away from the obligations of paying interest and the main sum thereby relieving pressure from the business and helping them to perform efficiently (Convertible Loan Stocks, 2011). H. Portfolio Theory: is a theory which helps to identify different set of stocks based on risk and the return that stock provides. The portfolio for the stock is determined based on the risk appetite of an individual. This theory looks to develop a portfolio which ensures maximum return at the minimum possible risk. (Portfolio Theory, 2011) I. Overtrading: is a situation when companies looking towards expanding their business takes steps which are not warranted. This results in a situation where the business has to pay interest more than required which affects the profits and making the business fall in a different cycle thereby affecting their working capital and growth trajectory (Overtrading, 2011) J. Time Value of Money: is a method of finding out whether a business or a project is profitable or not. In this method the future earnings are discounted back using a rate of return which helps to determine the present value of the money. While ascertaining the discount rate it is important to find out the correct rate by identifying the return that could have been possible has the resources used elsewhere. This method helps to find the value and whether entering into a new project or contract is beneficial. (TVM, 2011) K. Issuing Houses: are financial institutions which are controlled by the government. The role of these institutions is to help companies who are going public by helping them in issuing shares to the public. This eases the pressure from the company and simplifies the process. (Issuing Houses, 2011) L. Capital Asset Pricing Model (CAPM): helps to find the relationship between risk and return. This model helps to identify the risk that a particular stock has and the expected return. It has been identified that risky stocks have higher return compared to the less risky ones as they are volatile. This takes into consideration the time factors and the risk involved to find out the expected return from the stock (CAPM, 2011). M. Average Cost of Capital: is ascertaining the average cost of capital in the business after considering all the factors and investment like stocks, debt, debentures and other factors to gauge the proportionate share of each in the capital structure. This helps to improve the understanding of the capital structure and helps to take decision based on it. N. Spot rate: is the rate at which the commodity is settled. This usually takes place in the commodity market where the commodity in hand is to be set off and spot rate helps to determine it. This rate is normally the rate which is prevalent in the market and is one or two business days from the trade date. O. Exchange rate risk: is the risk which arises due to changes in the currency value. With most of the currency being floating where the rate is determined by the demand and supply of the currency in the market helps to determine the exchange rate for a country. The magnitude of this risk increases when dealing in other currency as fluctuations in the value of currency has a toll on businesses dealing in it. P. Coupon Rate: is the rate which is mentioned in the bond. This is the rate which is prescribed in the bond and is done at the time of issuing a bond. Q. Hedging: is a method which investors in the market use to reduce their risk which arises due to fluctuations. This is a method which reduces the downside risk of the investors to a large extent as investors take an opposite stand as well which reduces the magnitude of the risk (Hedging, 2011) R. Preference Share: is a medium of raising money from the public. This is different from equity shares as preference share holders have a preferential right in regard to dividend and final pay off at the time of maturity. This is issued in addition to the equity shares so that the business is able to raise sufficient funds for their business. (Preference Share, 2011) S. Outsourcing: is a method employed by business to part certain production process to third parties. This is done due to the fact that the business doesn’t have the resources to produce that part in the cheapest way and procuring from others would be cheap. This happens due to the excellency acquired by other parties which helps the business to be cost effective. Share Premium value: is the extra amount that the investors pay while subscribing for a share of a new company. The extra premium that investors have to pay arises due to goodwill and image of the company. The amount earned over and above the value of the share is credited to share premium account and can be sued for specific purposes only. References Annual Report of Tesco. 2011. Annual Report of Tesco. Retrieved on April 11, 2011 from http://www.tesco.com/ Beta. 2011. Beta. Retrieved on April 11, 2011 from http://moneyterms.co.uk/beta/ Convertible Loan Stocks. 2011. Convertible Loan Stocks. Retrieved on April 11, 2011 from http://lexicon.ft.com/Term?term=convertible-loan-stock CAPM. 2011. Capital Asset Pricing Model. Retrieved on April 11, 2011 from http://www.investopedia.com/terms/c/capm.asp Debenture. 2011. Debentures. Retrieved on April 11, 2011 from http://finance.mapsofworld.com/debenture/ Factoring. 2011. Factoring. Retrieved on April 11, 2011 from http://www.entrepreneur.com/encyclopedia/term/82044.html Fama, Eugene & Jensen, M. 1983. Agency Problems & Residual Claims. Journal of Law & Economics, Volume 26, page 327-349 Financial Modelling Guide. 2010. Liquidity ratios. 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