Financial Statement Analysis of Tesco as a Limited Company - Essay Example

Financial ment Analysis Report of Tesco as a Limited Company of Part A Financial ment Analysis Report of Tesco 1. Introduction Using published annual reports for the past three years, this paper seeks to evaluate the financial statements of Tesco for the past four years as to its financial performance in its income statement, liquidity, operating cycle and management of working capital, and its investment ratios. The analysis using appropriate ratios will be undertaken in the light of the general and economic and industry specific contexts. The companys ratios will be compared to its competitors in industry using averages available to enhance analysis. There is need to compare the company to its competitors measure whether the company is performing well in an industry. In particular, the financial ratios of WM Morrison (or “Morisson”) will be compared with Tesco. To further enhance analysis, of each of the four groups of ratios will be examined in rations to each other by taking consideration of the viewpoints of all corporate stakeholders. 1.2 Brief Company Background of Tesco Tesco PLC is an international retailer, having a wider customer base than competitors that may just be operating in Britain. An international scope of business may be readily seen in its having higher amount of investments in terms of total assets as against competitors, which is of course matched by either total equity, or total liabilities or both. The typical local retailer in Britain is Morisson (WM Morisson, 2014a) which will be compared latter with Tesco on the assumption that the amount of investment could influence the level of profitability, liquidity and even investment rations. The company’s retailing business and associated activities could be found in the United Kingdom, the Republic of Ireland, the United States, Malaysia, Thailand, Slovakia, South Korea, India and Turkey (Reuters, 2014b) 3. Ratios Used for Analysis The different ratios for analysis will analyse how Tesco has performed financially for the past four years and how it differs from those of its competitors on the average, of which one them in particular is WM Morisson. 3.1 Tesco’s financial performance, as demonstrated in its Income Statements Performance is basically measured from the data taken from the income statements. The said income statement contains the essentially the revenues and expenses. The excess of revenues over expenses is called net income so that a profitable company should be able to have more revenues over that of expenses (Lee, 200; Pagach, et al; 2006; Porter and Norton, 2010). In this section however, the net income of the company would have viewed in relation to the figures coming from the balance sheet which include the total assets and total equity. When net income is related to total assets (ROA), what is produced as ratio is the so called return on assets and, when related to total equity, what is produced is return on equity (ROE). All of these measure profitability, which is the greater focus of this section. It must be noted that income statement and balance sheet are financial statements need to have degree of reliability on accuracy as they are prepared based on accounting standards (Lawrence, 1996; Hussey & Ong, 2005). Profitability ratios are used to communicate a company’s ability to make a satisfactory net profit margin, operating margin and gross margin. The same is true in terms of return on sales, total assets, and invested capital (Helfert, 2011). Table I: Summary of Financial Ratios (Tesco, 2014a; 2014b, 2014c; WM Morisson, 2014a, 2014b, 2014c; Reuters, 2014c). See Appendices A, B and C. It would not be completely correct to say that Tesco’s 3% average return on sales or net profit margin is less superior to another company earning a 4% if the same ratio is supported with other related ratios of the companies. See Table I above. This may appear as the initial picture of Tesco and Morisson with first having the lower rate and the second company with the higher rate. By investigating the gross margin of Tesco, it averaged 8% for the past four years as shown in Table I above. There appears to be similar profitability to that Morrison at that level and surprisingly, if brought down to operating margin, both companies have the same 6% as four-year average. Since net profit margin would consider all deducted expenses and costs from revenues, Tesco is slightly less profitable than Morisson. The same lower profitability is evident when it comes to return on assets with 4% for Tesco as against 7% for Morisson. But when return on equity is used, both are the same in terms of profitability. It can therefore be deduced that Tesco is as profitable as Morisson but the latter is more efficient slightly because net profit margin and return on assets would tell more of efficiency rather than profitability from the point of owners or stockholders of the business. See Table I above. 3.2. Liquidity Good liquidity ratios are the targets of almost all companies as a way to show their capacity to pay current obligations. Lacking ability to meet currently maturing obligations could mean bankruptcy, which is bad for said investors. Performance is demanded from management of a company or these managers would better find other jobs if they not making the company to float amidst the strong currents of cash requirements where the business organization operates. When companies are liquid, their contractors or suppliers are paid on their deliveries and salaries of its employees are given on tome. Failing to these would mean failing in operation and maintaining the life of the business in the short-term. If they fail, the consequences could be bankruptcy and possibly which could cause either company to stop doing business and let creditors take their money and resources (Helfert, 2011) Tescos average latest current ratio for the past four years is at 0.67, which was higher than Morisson at 0.55. Both ratios are below the industry average of 1.02. The same reality is evident in terms of their quick assets r average ratios, where Tesco exhibited 0.46 while Morisson showed 0.20 and both 4-year average ratios. Again both their ratios are below industry average of 0.87. See Table I above. The meaning then of having profitability ratios lower than industry average are interesting for evaluators as they would answer the question whether the company can survive in the short-term. The answer of course for Tesco may still be positive considering that the company‘s current ratio is not very far from 1.0 level. Considering also that they are in the retail industry where goods are easily converted to cash, their liquidity could not be a serious problem still. 3.3 Operating cycle and management of working capital The operating cycle and management of working capital is already seen in the company’s liquidity ratios. The fact that management was able to maintain liquidity indicates that it has done well to manage is working capital at is has resulted to continued operation for the past four years. Net working capital is the positive difference between current assets and current liabilities (Kieso, et al 2007). Maintenance of good working capital or excess of current assets over current liabilities entails liquidity. Operating cycle basically refers to a process of conversion starting from cash assets of the business being used to purchase goods for sale and converting the inventories into receivable and finally the latter being converted into cash. The measure of this process could be seen by looking at the return on assets of the business. As found earlier, Tesco’s average return on assets was lower at 4%, although lower than Morisson’s at 7%, is still almost within industry average of 5%. This indicates lower but still acceptable efficiency of the Tesco compared with Morisson and rest of the industry. See Table I above. 3.4 Investment ratios The investment ratios are used to check investors’ response to the companies as they assist them to make decision in making valuations of their investments. Are their investments with the company making them wealthy? Investors can answer these from the valuation ratios? (Higgins, 2007; Brigham & Ehrhardt, 2010). One of the most important ratios used is price-earnings (P/E) ratio. The other valuation or investment ratios include, price to tangible book value, price to sales, price to book ratio and even price to cash flow. Table II below provides a summary of these ratios. Table II- Comparative Investment Ratios (Reuters, 2014c) The more risky position of Tesco as against Morisson is evidenced by its higher beta yet the higher P/E of the former makes it favourable to the company. This valuation ratio as against higher risk simply means that investors are willing to give a higher price for earning of the company on a per share basis. Thus in terms of P/E ratio for the last twelve months, Tesco showed higher ratio than Morisson. This partly creates an issue as since despite its having lower efficiency than Morisson, Tesco is having higher risk. In a deeper analysis however, Tesco may actually be more stable in the long-term which could assure investors that they could have their stocks earn more over the long-run in Tesco over that of Morisson because of better valuation ratios. . The finding of higher risk with Tesco is also evident in terms of, price to tangible book, price to sales, price to book ratio and even price to cash flow. Internally the riskier position of the company could actually be verified by checking the company’s gearing ratio, which is computed by dividing the total liabilities by it total equity. This basically the so called debt to equity ratio, whereby the company had an average of 1.97 for the past four years as compared with that of Morisson at 0.82 and industry average of 0.83. This is verifiable form Table I above. It could be observed that its financial leverage is more than double that of Morison, which a very clear evidence of higher risk is. The higher risk is however not necessarily bad for the investors and the price-earnings ratio could reflect higher trust by investors for Tesco over that of Morisson which actually has showed better profitability. 4. Conclusion This paper has found profit maximization strategies employed by Tesco to be almost similar with Morisson and industry averages for the past four years. However it was found to have slightly lower efficiency compared with Morisson and the industry averages. Tesco’s liquidity is also more superior to Morisson but less than the industry. On other hand, Tesco’ higher financial leverage is worse than Morrison and therefore more risky than Morisson. However, the higher valuation or investment ratios justify the higher risk shown by company compared with Morisson, which means that investors are willing to offer a higher price to the level of earnings per share of Tesco compared with Morrison. In terms of hierarchy of values to the stockholders of Tesco, wealth maximization is higher objective than efficiency, profitability, liquidity and solvency. This appears consistent with the finding of similar profitability, higher liquidity for Tesco as compared with that for Morrison. In other words, investors are like saying, Tesco are saying that the company will make them wealthier when they put their money into it rather than with Morrison. Part B Discussion of a Statement This part discusses the statement: "Extensive as it is, the accounting information within the annual report does not provide appropriate information to serve the needs of the directors and managers charged with running the company." By reference to this researchers understanding to the specific industrial setting in relation to Tesco, there is basis to subscribe to the above statement. A number of good reasons could justify the validity of the statement based on the purpose of the annual report, which is primarily addressed to the stockholders and the investing public (Gabriel, 2010). On the other hand, director and managers charged in running the company need management accounting data in order to plan evaluate and control the business. This makes the function of management to be concerned more on present and future on what managers would do as contrasted to the accounting information found in the annual report, which focused on what happened in the past. Moreover, accounting information for management must include the cost of each department within the whole organization so that cost could be controlled and revenue centres may be evaluated as basis for further improving or justifying operation of certain department. The accounting information from the Annual report however is concerned with how the organization performed in relation to other competitors in the industry for the past for purposes of guiding investors and stockholders on where to put their money. The financial statements from the Annual Report are also prepared in accordance of externally imposed standards like the generally accepted accounting principles of financial reporting standards, which are legal in character (Lawrence, 1996; Hussey & Ong, 2005). Accounting information for management is governed by rules as set by management. The costs as shown in the income statements are basically prepared under the full-costing method and some costs cannot be used solely to decide what level of operation the company management should choose in the short-term. Thus management accounting would rather have the costs information classified into fixed cost and variable cost to allow the company to manage its short-term objectives, as its management need to plan, evaluate and control operations (Needles, Powers & Crosson, 2010). Moreover, financial statements are prepared annually or quarterly or semi-annually but the management may need information even daily, weekly or monthly. As applied in the case of Tesco, which is a retailer, relevant management information is needed by managers on how to address short-term objectives of the company. This may involve however using still the information from the financial statements particularly from the income statement but the accounts must be converted to more flexible information. In deciding the level of operation in the short terms, there is information that must only to be considered relevant excluding the sunk cost (Kieso, et al, 2007). Thus management accounting is more concerned with the variable cost and fixed cost if they are to decide whether to continue providing a number of a group of products or services for a certain month which may be seasonal. References: Brigham, E. & M. Ehrhardt (2010). Financial Management: Theory and Practice. Connecticut: Cengage Learning. Helfert, E. (2011). Techniques of Financial Analysis: A Mode. New Delhi: McGraw-Hill Education (India) Pvt Limited Higgins, R. (2007). Analysis for Financial Management, Eighth Edition. New York: The McGraw−Hill Companies. Hussey, R. & Ong, A. (2005). International Financial Reporting Standards Desk Reference: Overview, Guide, and Dictionary. New Jersey: John Wiley and Sons. Gabriel, J (2010). Financial Accounting. New Delhi: Tata McGraw-Hill. Kieso, D. et al (2007). Intermediate Accounting, New Jersey: Wiley and Sons Lawrence, S. (1996). International Accounting. Connecticut: Cengage Learning Lee. T. (2007). Financial Reporting and Corporate Governance. New Jersey: John Wiley and Sons Needles, M. Powers & S. Crosson (2010). Financial and Managerial Accounting. Connecticut: Cengage Learning Pagach, et al (2006). Intermediate accounting: financial reporting and analysis. Connecticut: Cengage Learning Porter, P. and Norton. C. (2010). Financial Accounting: The Impact on Decision Makers Connecticut: Cengage Learning Reuters (2014a). WM Morisson Company Profile. Retrieved February 5, 2014 from Reuters (2014b). Tesco Company Profile. Retrieved February 5, 2014 4 from http://www.reuters.com/finance/stocks/companyProfile?symbol=TSCO.L > Reuters (2014c). Industry Ratios. Retrieved February 5, 2014 from < http://www.reuters.com/finance/stocks/financialHighlights?symbol=MRW.L> Tesco (2014a). 2013 Annual Report. Retrieved February 5, 2014 from < http://files.the-group.net/library/tesco/annualreport2013/pdfs/tesco_annual_report_2013.pdf > Tesco (2014b). 2012 Annual Report. Retrieved February 5, 2014 from < http://www.tescoplc.com/files/pdf/reports/tesco_annual_report_2012.pdf > Tesco (2014c). 2011 Annual Report. Retrieved February 5, 2014 from < http://www.tescoplc.com/files/pdf/reports/tesco_annual_report_2011.pdf> WM Morisson (2014a). 2012/2013 Annual Report. Retrieved February 6, 2014 from < http://www.morrisons-corporate.com/Documents/Annual-Review-2012-13.pdf > WM Morisson (2014b). 2011/2012 Annual Report. Retrieved February 6, 2014 from < http://www.morrisons-corporate.com/Documents/Final%20annual%20report%202011_12.pdf > WM Morisson (2014c). 2010/2011 Annual Report. Retrieved February 6, 2014 from < http://www.morrisons-corporate.com/Documents/Morrisons-Annual-Report-2011.pdf > Appendices: Read More