Print Email Download Reference This Send to Kindle Reddit This
submit to reddit

Ratio Analysis Of The Financial Statements Of Tesco Finance Essay

I will be showing an individual analysis of the financial statements of Tesco plc in order to show whether or not it would be worth buying shares and ultimately investing in the company. I will be doing this by using the five main financial ratios which are:

Efficiency: used to measure the efficiency within the business of particular resources.

Profitability: used to show the profit made in the business and how successful it is. This ratio is really important for business owners as they could see how much money they are actually making.

Liquidity: in order for the survival of a business their needs to be adequate liquid resources available to meet obligations. This ratio helps examine the relationship between the two.

Financial gearing: when making financial decisions gearing has to be considered. This ratio helps show the risks associated with the business as gearing is the input of finance from the owners and others such as loans.

Investment: the performance and returns of shares in the business are assessed in this ratio.

Efficiency ratios

Average period of trade credit

2009

2008

2007

2006

Average Period of Trade Credit

62 days

61 days

56 days

51 days

Those who supply Tesco with goods and services do so on credit, this ratio measures how long they take to pay back on average. Businesses tend to increase the time taken to pay back the suppliers as it is a free source of finance and therefore they are able to make the most of this. As you can see there was an increase year by year in the days taken to pay back the money they owed. The increases over the last four years have been very minor which shows they have taken just longer to pay back. On the other hand they do not want to keep increasing too much as it could lead to a loss in trust by the suppliers.

2009

2008

2007

2006

Returns on capital employed

11.44%

14.02%

15.89%

15.15%

The efficiency and profitability of a company’s capital investment is indicated through ROCE. The return on capital employed is one of the fundamental ratios in the performance of a business. The principal measure of profitability is considered to be ROCE. This ratio is used to assess the efficiency with which business funds have been deployed. Since 2007 ROCE has been decreasing, with the biggest % change occurring in the last year, which could be a slight cause for concern. A possible cause for this could be the recession as more people are buying the simpler products.

2009

2008

2007

2006

Inventory turnover

20.35 days

19.46 days

22 days

27 days

A considerable investment for a business is often represented by inventories. This ratio is the measurement of how long inventories are being held. As you can see from 2006 to 2008 the inventory turnover period was shortened significantly and although it increased in the last year it was only a small percentage. This is quite good for Tesco as the shorter it takes, the higher the cost. The reason for this being the fact that holding inventories costs money such as the opportunity costs of the funds tied up. Companies must be aware of things such as demands and changing of prices for inventories when considering the amounts they carry.

Financial gearing and investment ratios

2009

2008

2007

2006

Gearing

53.61%

40.19%

36.53%

37.23%

The involvement of long term leaders to the long term business structures is measured in the gearing ratio. Downturn in the company business cycle is more likely to occur when gearing is higher, since no matter how bad sales are they will have to maintain service of their debts. Tesco’s level of gearing has been increasing every year, the most considerable one being the last year with an increase of more than 10%. If the gearing of the company continues to increase then it could be risky for them (www.investopedia.com).

2009

2008

2007

2006

Earnings per share

27.02p

28.92p

22.36p

20.30p

One of the indicators of a company’s profitability is the earnings per share ratio. It is the relationship between the earnings available to the shareholders, generated by the business, and during the period to the number of shares in issue. The profit for the year less any preference dividend will represent the amount available to equity shareholders. As you can see since 2006 Tesco’s EPS has been improving showing the investment potential of the business shares in improving.

2009

2008

2007

2006

Acid test

0.63:1

0.38:1

0.33:1

0.33:1

In order for a company to cover their immediate liabilities, without selling inventory, they need to have enough short term assets. Atrill suggests that the minimal level for this ratio should be 1 although it is very common for highly successful businesses to be under 1. This seems to be the case as there was nominal rise until 2008; however in 2009 the acid test ratio increased considerably. This shows Tesco are becoming much more ablwe to cover immediate liabilities.

2009

2008

2007

2006

Operating profit

5.90%

5.90%

6.21%

5.78%

The total pre tax profit a company generates is known as operating profit. It is the money available to the owners before tax payments and stock dividends. Tesco’s profits seem to be really stable and this is a really good sign since this is one of the most important figures for a business. Lenders and shareholders will be watching these profits with close inspection and they should be quite happy as they are operating very well. Money which will be flowing to the shareholders will be coming from sales and these percentages show the operations of Tesco to be really good (beginnersinvest.about.com).They will probably target to have them as high as they did in 2007 throughout the year.

2009

2008

2007

2006

Return on shareholders’ funds

23.90%

25.10%

26.70%

24.90%

This ratio shows the amount of profit available to the owners in comparison to their average stake in the business. Businesses seek to produce high percentages in order to keep shareholders happy. They need to ensure this is not achieved at the cost of potential future returns. After a brief rise in 2006 the return on shareholders’ funds have been going down perhaps showing Tesco have not been efficient enough. The figures are not low enough to be a major concern as they are still producing profit. On the other hand Tesco needs to be ensuring shareholders of improvement instead of decline.

2009

2008

2007

2006

Current ratio

0.78:1

0.61:1

0.56:1

0.52:1

This compares the company’s liquid assets to the current liabilities. All businesses will have a different current ratio depending on what kind of market they are in. The ideal current ratio is said to be 2:1 although this can only be true in some companies (Atrill et al, 2008, p222). The current ratio for Tesco has been improving year by year, although it is relatively lower than 2:1. This is not a problem as supermarket chains tend to have low ratios since they only hold fast moving inventories of finished goods. Another reason is that they do not sell on credit instead making sales for cash. As their ratios are going it up it is showing the business is becoming more liquid and this is essential for the survival of a business.

2009

2008

2007

2006

Dividend yield

3.60%

2.70%

2.20%

2.60%

This ratio shows how much a company pays out in dividends in relation to its share price. Investors are able to assess cash returns on their investments. This helps investors compare their investments to other investments which they have made, enabling them to make future decisions regarding share purchases. Although there was a decrease from 2006 to 2007 the percentages rocketed up by more than 1% from 2008 to 2009 showing investors that is worthwhile investing in the company. Future investors would also be really happy with these figures.

2009

2008

2007

2006

Dividend cover

2.43 times

2.51 times

2.32 times

2.35 times

The numbers of times earnings cover the dividends yield payout. In order for a company to meet its dividends yield obligations, they need to be earning enough amounts not only to meet dividends but to also ensure profits. Although the dividend cover has gone down in the last year it was on the rise the previous year and should be quite stable. The higher the percentage is, the more comfortable the company is to meet dividends commitment.

2009

2008

2007

2006

Sales per square foot

£672

£678

£684

£781

One of the largest costs for a business is retail real estate and this ration tells us how successful the business is at making the most out of this key asset (www.wikinvest.com). Although there has been a decrease in this ration over the last 4 years there is a simple explanation for this. The size of the Tesco brand enables it to open new stores every year and this could be the reason the ratios show that they are not making the most out of their retail space.

Total shareholders return

The return on investment a shareholder receives over a specified time frame is shown by the TSR. It takes into account dividends received and the appreciation and depreciation of share prices. In order to calculate the TSR dividend per share is added to capital gain or loss and then dividing it by the share prices. As you can see below the total shareholders return showed significance increase from 2006 to 2008. From 2008 to the end of the year there was a major decrease however percentages rose and are continuing to rise.

( www.tescoplc.com)

Their will now be a comparison of Tesco to two other supermarkets to see how they are performing in that particular industry.

RATIOS

Tesco

Morrison’s

Sainsbury’s

Profitability:

 

 

 

Sales

59426

14528

20383

Operating profit margin

5.90%

4.62%

3.56%

ROCE

11.44%

10.80%

9.50%

Efficiency:

 

 

 

Sales per square foot

£672

£1,305

£1,220

Gearing & investment ratios:

 

 

 

Gearing

53.60%

27.10%

38.50%

Dividend yield

3.27%

1.76%

4.93%

 

 

 

 

As you can see from the bench marking, Tesco is a really profitable business and is a major force in the supermarket industry. Their sales were considerably higher than both other supermarkets. It seems that a large proportion of consumers shop at Tesco and this could be a huge influence on their sales figures. The percentage of Tesco’s operating profit was also the highest showing pre tax profits to be high; this is good news for them since they know they have higher profits than their competitors. Although ROCE was down for Tesco noticeably in the last year they still have the highest returns compared to Sainsbury who are second and Morrison’s who are third. This shows that they are still strong in the market as a whole. In comparison to Sainsbury’s and Morrison’s, Tesco have the lowest sales per square foot ratio out of the three chains which is understandable. Sainsbury’s have 820 stores (www.j-sainsbury.co.uk) in the UK whilst Morrison’s have 328 stores (www.supermarket.co.uk). Compared to Tesco this is quite low since they have almost double the amount of Sainsbury’s with 1,500 stores in the UK (www.telegraph.co.uk). So although they have the lowest sales per square ratio it does not mean they are performing badly in the industry. It just means that they need to make better use of all their store models in order to produce more sales per square foot. The level of gearing for Tesco is a major concern as they are more vulnerable than both their competitors of downturn in the business cycle. Morrisson’s seemed to be in a really comfortable position and wouldn’t seem to be risky. After Morrison’s Tesco have the highest dividends yield ensuring that it is worthwhile for investors to invest in the company.

After consideration of all the ratios I would say that I would invest in Tesco as they are major pace setters in the supermarket industry. Although they could make significant improvements on their sales per square foot, they have good dividends yield ratios showing that investors are not in threat of losing money but instead profiting from the company. This shows that the company is worth investing in since returns to investors have increased significantly in the last year and with the worst of the recession out the way, there are profitable times ahead for Tesco.

Word count: 2065

Print Email Download Reference This Send to Kindle Reddit This

Share This Essay

To share this essay on Reddit, Facebook, Twitter, or Google+ just click on the buttons below:

Request Removal

If you are the original writer of this essay and no longer wish to have the essay published on the UK Essays website then please click on the link below to request removal:

Request the removal of this essay.


More from UK Essays