Finance for the Non Financial Manager Finance Essay

This assignment is done on the completion of the paper Finance for the non financial managers for the PGD leading to MBA level. As per the assignment given to us, we are required to analyze the financial performance of a company included in London Stock Exchange. For that purpose, I have chosen one of the biggest public retailers in the U.K., the Tesco. I have reasons to choose it, and the one of the reasons is its unassailable position in the retailing industry, in which it has left many of its competitors far behind. The other reason is its extraordinary sense of public service. These things always left me curious to know about how the organization functions. However, my focus will be concentrated on how such an organization manages its finance, that is to say the financial performance of the company. For that purpose I will briefly analyze the financial performance of the last three consecutive years of Tesco. Financial figures of Tesco in themselves do not clearly states its position in the market, due to that reason I have attempted to do the benchmark analysis comparing its financial performance with Sainsbury's in the year 2009, and at the same time with industry average. For the industry average I have taken three companies in the same industry Tesco, Sainsbury's, and Morrison.

Tesco is the public retailer of groceries, consumer goods, financial services and telecoms. It was founded by Jack London in 1919 in East London. It sells food and drinks in its store and provides the services like clothing, consumer electronics, telecoms, home, health, and car insurance, dental plans, retailing and renting DVDs, CDs, music down loads, Internet services and software. Tesco operates its business in the U.K., the Czech Republic, Hungary, Poland, the Republic of Ireland, Slovakia, Turkey, China, Japan, Malaysia, South Korea, Thailand and the United States. TESCO brand was first used in 1924 and was included in London Stock Exchange in 1947 as Tesco Stores Limited. Tesco has a total of 4,331 stores worldwide; with a total of around 470,000.Currently it holds 28% market share in the U.K.'s retailing industry. (www.investis.com )

2. Financial Analysis of Tesco

Despite the challenging environment, Tesco attained a considerable growth rate in the fiscal year ended in 28th February 2009. For the fiscal year ended in 2009 Tesco PLC achieved revenues of 59.4bn pound, an increase of 14.67% against the previous year's 11.16%. Tesco exhibits an increasing trend in its growth rate. The company's revenues are derived from four major geographical regions: the UK, Rest of Europe, Asia and USA which accounted for 70.30%, 16.31%, 13.01%, and 0.38% of the revenue excluding tax of the fiscal year 2009 respectively. The growth rate of Tesco's revenues in percentage in different region is shown in the pie chart in the appendix. Tesco exhibits a solid growth in the U.K. market despite the challenges of recession and strong competitors. Asia comes second in its growth rate followed by Europe. ( financial highlights.www. tesco.com)

2.1. Profitability Ratio Profitability Ratio in financial analysis is used to measure the business's ability to generate revenue in relation to its expenses and costs. Higher the value of the ratio, the better would be the financial performance of the company. If a company is having a higher profitability ratio compared to its competitor, it can be inferred that the company is doing better than that particular competitor. The higher or same profitability ratio of a company compared to its previous period also indicates that the company is doing well. Profitability ratios are the particular interests of the shareholders.

First profitability Ratio: Gross Profit Ratio: Gross profit/Revenue 100

The gross profit ratio tells how much a company earns after its cost of sales. In 2009, Tesco makes 7.76% gross profit for every 100 pound dollar which is slightly better than the previous year 2008 and worse than 2007 when the company had the gross profit margin 7.67% and 8.12% respectively. Compared to Sainsbury's 5.48% in 2009, Tesco performs better. It operates above the industry average 6.51% in 2009.

Second Profitability Ratio: Net Profit Margin Ratios: Net profit/ revenue*100%

Net profit ratio gives us the net profit a business earns per 1 dollar turnover. It is calculated after taking into account the cost of sales and the expenses but before interest, dividend and taxation. Tesco has the net profit margin 5.44% in 2009 compared to 5.93% in 2008 and 6.22% in 2007.Although the company has the gross profit margin better in 2009 than in 2008, the net profit falls short than the previous year, which is due to the rise in the expenses than the previous year. The company is required to cut the administrative and other expenses to increase its net profit. Compared to the Sainsbury's, the company is better in yielding net profit because Sainsbury's net profit is only 3.55% in the current fiscal year 2009. Tesco exceeds the industry average in its net profit margin by 1.30%.

The Third Profitability Ratio: Return on Capital Employed Ratio

Operating profit/ capital employed*100

The ROCE tells the profit a company earns from the total investment made in the company. ROCE is calculated by dividing the operating profit by the total capital employed in percentage. Tesco earns 11.44 dollar for every 100 pound investment in the year 2009. ROCE for the company in the year 2009 is worse than then the last year's ROCE which was 14.25 pounds which definitely accounts for the increasing expenses and decreasing operating profit and minority interests. Other factors in the decreasing ROCE of Tesco are: Heavy rise in borrowing, increase in past employment benefit obligations, heavy rise in provisions, and heavy rise in differed tax liabilities. Tesco performs better ROCE in the year 2009 compared to Sainsbury's 9.46%., and at the same time exceeds the industry average by 2.22%.

The Fourth Profitability Ratio; Return on Equity: Profit after tax/total equity*100%

It measures how much a company earned from the total amount of shareholder's equity found in the balance sheet. For every 100 pound investment by the shareholders of the company, Tesco earns 16.68 pound in the year 2009. Compared to the last year the performance is worse. The possible reasons are, finance cost is higher, and finance income is lower than in 2008 and taxation is higher. Compared to the Sainsbury's, Tesco's performance is better, for Sainsbury's ROE for the year is 6.60%.

Fifth profitability Ratio; Earning per Share Ratio: Profit after tax/No. ordinary share

The company earns 27.50 pence for every ordinary share in the year 2009 which is slightly better than the previous year. This is because of the increase in the profit after the tax. Earnings per share of Tesco are better in the year 2009 than Sainsbury's, for Sainsbury's earnings per share for the year 2009 is 16.66 pence. In this regard also, Tesco far exceeds the industry average, 20.25 pence.

2.2. Liquidity Ratio.

Liquidity ratios measure the ability of the company to meet the short term and long term obligations of the company. Liquidity ratios are the particular interests to those who are extending short term credit to the firm. Short term creditors prefer a high current ratio since it reduces risks, shareholder may prefer a lower current ratio so that more of the firm's assets are working to grow the business.

First Liquidity Ratio; Current Ratio: Current asset / Current Liability

Current ratio is used to measure the company's ability to meet its short term commitments that is its debt and payables with its short term assets like cash, inventory and receivables. The higher the current ratio, the better the company is in paying its obligations. A ratio underA 1 suggests that the companyA wouldA beA unable to pay offA its obligations if they came due at that point. The current ratio can give a sense of the efficiency of a company's operating cycle or its ability to turnA its product into cash. Analyzing Tesco's current ratio we find for every 1 pound current liability Tesco has 0.79 worth of current assets in the year 2009. The company is weak in short term solvency and is not able to meet the short term obligations, but compared to last year it is better. The causes responsible for the better current ratio are: decrease in current tax liabilities, increase in the loans and advances to banks and other financial assets, increase in short term investments, cash and cash equivalents, increase in trade and other receivables and derivative financial instruments. Compared to Sainsbury's in the year 2009, Tesco is better in fulfilling the short term obligations. It exceeds the industry average by 0.17, pushing the others behind.

Second Liquidity Ratio: Acid - Test Ratio or Quick Ratio or Liquid Ratio.

Current asset- Inventories/ current liability

Acid test ratio measures a company's ability to meet short term financial liabilities like the current ratio, but unlike current ratio it does not take into account the inventories, because inventories are not rapidly convertible to cash. Tesco has 0.63 of its liquidity assets for every pound current liability in the year 2009. It is weak because it is below the standard ratio 1:1. Acid ratio of Tesco for the 2009 is better than the year 2008 which suggests that the company is having the solid top line growth, quickly converting receivables into cash. Compared to Sainsbury's in the year 2009, Tesco position is far better, for Sainsbury has only 0.31 pence worth of liquid asset for every 1 pound current liability. In this regard as well, the company pushes the company average behind.

Third Liquidity Ratio; Working Capital to Net asset ratio

WC/NA* 100 or CA-CL/NA*100

This ratio provides the percentage of remaining liquid assets. An increasing working capital to net asset ratio is a positive sign which shows the company's increasing liquidity and the vice versa. This ratio for Tesco in the year 2009 is negative which shows the company is undergoing severe short term liquidity problem. However, compared to the last year the company has brought slight change in the ratio showing its improvement. Compared to Sainsbury's in the same year that is 2009, both companies seem to have passing through the same kind of problem. Both of them are in the same range though Sainsbury's seems better, though insignificantly.

2.3. Efficiency Ratio:

The purpose of using the efficiency ratio is to measure the efficiency of the company in utilizing its assets / resources to generate sales or profit. It looks at the internal working of the company. Efficiency Ratios types are as follows.

Debtors Collection Days: Trade receivables/sales turnover*365

It is used to measure the efficiency of the credit control management. It is used to measure how quickly the company recovers debts from its credit customers. Most businesses make a large proportion of their sales on credit. Debtor days are a measure of the average time payment takes. Increases in debtor days may be a sign that the quality of a company's debtors is decreasing. This could mean a greater risk.

Debtor's collection days of Tesco for the year 2009 are only 12 days, which is more than the previous year, which is not definitely a positive sign. It exhibits the growing trends in the debtors' collection days for the last two consecutive years when it was 10 and 9 days respectively. Compared to Sainsbury's, Tesco exhibits worse scenario this is much higher than Sainsbury's 0.95 days. Tesco bears high risk at collecting money from its debtors; however sounds it appears in other respects. It falls short to the industry average in this regard as well.

Creditors Payments Days: Trade Payables/cost of sales or credit purchases *365

This ratio measures the promptness of the company in paying back to its suppliers or creditors. The company takes 32 days on average to pay back the debts it owes to its suppliers in the year 2009. The creditor's payment days of 2009 are more than the year 2008 which is worse and indicates that the company has the weak liquidity ratio. Due to its cash problem, the company delayed the payment of debts than in the previous year. While comparing Sainsbury's and Tesco, Tesco's position is better, for Sainsbury's pay back to its suppliers in 33.35 days. It outruns the industry average in this respect.

Stock Turn over Days: Average Inventory/cost of sales*365

This ratio measures the efficiency of the inventory management or control.

The company's stock turns over every 20 days in the year 2009. The stock maintained by the company is sufficient to meet the sales for 20 days, whereas it was 19 days in 2008 and 22 days in 2007 which means that the company is slower in 2008 and quicker in 2007 to sell the stocks than in the year 2009. Sainsbury's stock turns over days are 27.45 days, worse than Tesco in the year 2009. Tesco makes quicker sell than Sainsbury's. The company exacts the industry average in this respect.

Asset turns over: Revenue/Net asset or capital employed.

It measures the efficiency of the company in utilizing the assets to generate income.

For every 1 pound the company invested in net asset, the company generates 1.94 worth of sales in the year 2009 which is worse than the previous years 2008 and 2007 when it was 2.36 and 2.56 respectively. Sainsbury's generates 2.66 pound worth of sales for every 1 pound investment, better than Tesco in the year 2009 where as the industry average is 2.31.

2.4. Financial Position Ratios:

It measures the long term solvency of the company, the ability of the company to meet long term commitments i.e. financial commitments. It measures the financial risk involved in the company. This is the particular interest of the shareholders and long term creditors like bank who leverage the company.

D/E Ratio: D/E*100

For every 100 pound shareholders' equity, the company has 149.14 long term liability in the year 2009 which involves high financial risk. The company is in worse condition than in the year 2008 and 2007 because the company's debt increased considerably from 87.06% and 74.54% of the last two years considerably. Sainsbury's has only 62.57 long term liability for every shareholder's equity. Tesco is high geared company whereas Sainsbury's is a low geared company. Tesco exceeds the industry average, for the industry average for the year 2009 is 76.48%.

Interest cover

Earnings before tax and interest/ Interest expenses

Higher the ratio, the better the position

This ratio is used to determine how easily a company can pay interest on outstanding debt. The interest coverage ratio is calculated by dividing a company's earnings before interest and taxes of the period by the company's interest expenses of the same period.

For every 1 pound interest payable, the company earns 7.18 earnings before interest and taxation which is sufficient to meet the interest expenses. However, compared to its past two consecutive years, the company is not generating income in the same ratio. IT operates better than Sainsbury's and almost exacts the industry average.

Investment Ratios:

Investment ratios are used to understand the investment prospect of the company. These ratios are used by investors to estimate the attractiveness of a potential or existing investment and get an idea of its valuation. For example, the most well-known investment valuation ratio is the P/E ratio, which compares the current price of company's shares to the amount of earnings it generates. The purpose of this ratio is to give users a quick idea of how much they are paying for each $1 of earnings. And with one simplified ratio, one can easily compare the P/E ratio of one company to its competitors and to the market.

P/E Ratio (market Price of the share /Earnings per share Ratio)

Market value per share of the company is about 12 times of its earnings per share in the year 2009. Compared to the previous year the company has its share value decreased in 2009. In 2008 and 2007, the ratio was 14.61 and 18.30 respectively. In the same period of the year 2009 Sainsbury's market price per share is 18.67 times of its earnings, better than Tesco. Tesco falls short by 3.45 times than the industry average.

Dividend Yield Ratio: Dividend per share/market price per share

A financial ratio thatA shows how much a company pays out in dividends each year relative to its share price There is increasing trend in dividend paid out which is 3.59, 2.77 and 2.23 for every 100 pound share in 2009, 2008 and 2007 respectively. It is better than the current interest rate and inflation rate. Sainsbury's position is better than Tesco. Tesco outsmarts the industry ratio in this regards as well.

Dividend Payout Ratio: Dividend per share/Earning Per share*100

It is the percentage of earnings paid to shareholders in dividends. The payout ratio provides an idea of how well earnings support the dividend payments. More mature companiesA tend toA have a higher payout ratio.

Tesco paid 43% of profit after tax as dividend which is higher than the last year when they paid only the 40.44% of profit after tax as dividend. Sainsbury's paid out 80% of the profit after the tax to the shareholders in the year 2009, more than the Tesco. Tesco paid lesser than the industry average.

Net Asset Value per Share

Net asset/No of ordinary Share

The net asset value per every 1 pound share of Tesco in the year 2009 is 1.65 which is more than in the years 2008 and 2007 when it was 1.51 and 1.33 respectively. Compared to Sainsbury's, it is worse. It worse than the industry average also.

3. Nonfinancial performance of Tesco

3.1. Strategy of Tesco

Tesco Plc has consistent growth strategy which strengthens its business in the U.K. and other markets. Tesco Plc's has five objectives in its strategy .They are given as follow:

To be a successful international retailer;

To grow the core UK business;

To be as strong in non-food as in food;

To develop retailing services - such as Tesco Personal Finance, Telecoms Tesco. Com and

To put community at the heart of its activities.

With these objectives in the core of its strategy, Tesco began to broaden its business embracing the customers in the large expanding market of the U.K. and abroad in central Europe, Asia and USA. It adopted the strategy of diversifying its business in 1997. Tesco's strategy is competitive and profitable that has made it the market leader in many markets outside the U.K. Tesco exhibits a solid growth in the U.K. market despite the challenges of recession and strong competitors. Asia comes second in its growth rate followed by Europe.

3.2. SWOT analysis of Tesco.

Tesco entails Strengths, Weaknesses, Opportunities and Strengths in its businesses and I have attempted to make short overview of SWOTs of Tesco in the following way.

Strengths

TESCO have secured commercial standing within the global market place winning Retailer of the Year 2008 at the "World Retail Awards". This can be used for marketing campaigns to drive advantage towards the demographic base for future growth and sustainability. Similarly, in an environment where global retail sales are showing decline or level performance on a like for like basis TESCO Group have published sales gain of 13% for UK markets and 26% growth in international markets. As a business looking for continued expansion TESCO have reserve funds of credit coupled with income derived from property portfolio development funds.

Besides these, Tesco has a lot of strengths: Increasing market share, Tesco personal insurance, Tesco online, price adjustment to address the customers crushed by credit crunch, store variety, Economies of scale etc.

Weaknesses

Despite its strengths in the retailing market, TESCO Finance profit levels were impacted through bad debt, credit card arrears and household insurance claims. TESCOs position as a price leader in UK markets can lead to reduced profit margins in order to retain the key price points on most of the commercial items. Moreover, the grocer outlets are not set up to operate as specialist retailers in specific areas of product which can be capitalized on by other smaller retailers.

Whilst current economic conditions suggest TESCOs key value message will succeed there is a weakness in non-essential, mid to high ticket price items which will suffer from the rising cost of living and lower disposable incomes. Tesco's heavy reliance on the U.K. market might dwindle its growth rate as the U.K. is slow to emerge out of recession.

Opportunities

Statistics suggest TESCO is the third largest global grocer which indicates a level of buying power to ensure mainstream economies of scale. At the same time, the acquisition of Homever provides the opportunity to develop the brand through Asia, specifically South Korea and further grow International markets for the group. The development of Tesco Direct through online and catalogue shopping will grow the use of technology, providing the launch pad for larger non food based products with moderate to high margin returns and less focus on sales and margin per foot return to space.

TESCO mobile have grown A¼ million customers in 2008 and moved into profitable status suggesting further growth and development within this technological area can be developed.

Threats

UK and American markets have been affected by economic concerns through the "credit crunch". Lower available income will impact and strategic focus may need to change to lower priced basic products with less focus on higher priced brands suggesting a switch in price architecture. Rising raw material costs from both food and non food will impact profit margins overall.

Sourcing changes to Far East locations with regards exporting restrictions on some non food product areas will reduce margin rates on products with already low margins. Changes to consumer buying behaviors require further analysis - as technology develops consumer buying patterns change which will result in product areas requiring evaluation. For TESCO there is a persistent threat of takeover from the market leader Wal-Mart who has both means and motive to pursue such action.

3.4. PESTEL analysis of TESCO:

The external factors have a great impact in a business. The external factors impacting a business are dealt under PESTEL analysis. PESTEL stands for political, economic, social, technological, legal and environmental factors a business operates in.

Political factors include tax policies, trade restrictions, tariffs etc.

Economic factors include economic growth, interest rates, and inflation rates, Employment level etc.

Sociological factors includes culture, health consciousness, working condition

Technological factors include ecological aspects, research and development, the rate of technological change.

Environmental factors includes recycling policies and pollution

Legal aspects include health and safety laws, consumer laws and regulations.

The global recession has a negative impact on the businesses. It is very hard for businesses to sustain in such an environment. Credit crunch has given rise to the unemployment rate. It has impact on Tesco, too. However, Tesco has been doing well by selling everything to everyone everywhere. In such a situation Tesco can give employment to people by opening new stores in many places. Tesco has to follow the laws and regulations about monopolies and competition protecting consumers. Meanwhile Tesco has to ensure the entrepreneurs' right to compete. Many small businesses are falling due to recession, and Tesco has to consider the location of establishment. The UK's law that presupposes the organization with a large market share dominant will lead Tesco to continuous assessment to ensure it is not being exploitative. Planning Permission law of UK has made Tesco to identify the relevant laws on planning permission. The increase in immigration of Eastern Europeans or the increase in young professionals has given rise to quick microwavable meals that the Tesco has to bear in thinking. The technological factor that has assisted Tesco is the growing use of internet that made on line shopping in Tesco and provides delivery service through Tesco's website www.tesco.com. With growing public concern about social responsibility Tesco has to make its corporate responsibilities to address the environmental issues like encourage the customers to make low carbon choices. The growth of unemployment rate is also likely to impact the business of Tesco.

4. Conclusion.

The financial analysis of Tesco exhibits that Tesco is true to its strategy in acquiring the large portion of market share delivering customer focus service in its diversified business portfolio. It attained noteworthy growth in sales, left behind its competitors in many ratios. However, Tesco's creditors' payment days are high which involves high financial risks and sometimes it sounds like that it excelled others because it provides large credit sales to the customers for many days. But it would be rash to assess its performance that way ignoring its strength in many other respects. As a whole Tesco is doing well and will do better in the times to come. Tesco is a real business owner in the retailing industry.

Although Tesco is doing well in the retailing industry, it runs the risks of running the jack of all but ace on none. It has its hand in everything but fails to outsmart the companies that have come up with specialized product even in a single product. It should focus on specializing in some most demanded product. Tesco has to extend its businesses in the countries like India and china with the large population and rising economy.

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