Evaluation of financial performance



Ratio analysis is a tool which is used for the evaluation of the financial performance of the business. By the use of the ratio analysis we can find out how the business is performing in terms of profitability. As a result it can ensure that the business has enough money to pay its bills and also make its share holder happy. Not only this, ratio analysis also was helps to check whether the business is doing better this year than it doing last year.

The financial statement (please refer appendix 3) Tesco is taken to understand its performance. The main areas of ratio analysis are profitability, efficiency, liquidity and growth. With ratio analysis we can find out the current financial standing of Tesco in the market. As a result of this we can come to the conclusion that whether the company is making profit for the share holder and how their future growth looks like. The positive result of the finical statement not only encourages its share holders to invest more but also attract others to invest.

Background of the company:

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Tesco plc is a UK based international grocery and general merchandising retail chain. It is the largest British retail by both global sale and domestic shares, with profit exceeding £3 billion. It is the third largest global retailer based on revenue, behind Wal- Mart and France's Carrefour, but second largest based on profit, ahead of Carrefour.

Jack Cohen founded Tesco 1919 when he began to sell surplus groceries from a stall in the east end of London. In may 1987 Tesco completed its hostile take over of the Hillards chain of 40 supermarket in the north of England for £220 million. In 1994 the company took over the super market chain William low, successfully fighting off Sainsbury's control of the Dundee-based firm which operated 57 stores.

Tesco has made commitment to corporate social responsibility in the form of contributions of 1.87% in 2006 of its pre tax profit to charities and local community organization.

Profitability ratio:

Profitability ratio measures the overall financial performance of the business. The ratio examines the profits made by the company and compares this figure with the size of the company, its assets employed or its level of sales. In case of investment on any company, the profitability ratio can be used in order to understand the financial condition of the company.

The financial statement of Tesco for the year 2008 and 2009 is considered and with the different figures from the statement the performance of the business is measured. By comparing the current year results with the second year we can conclude whether the business is performing well in the current than the previous year than not.

Gross Profit Margin:

It is defined as gross profit as percentage of sales revenue. In this profit the indirect expense is taken into account. The higher the gross profit is better for the company. There can be a situation when the gross profit can fall and that may be for the likely reason of increase price of raw materials, price discounting and stock loss etc.

The gross profit margin of Tesco has increased from 7.67% to 7.77%. The year 2009 witnessed huge economic crisis but even though they raised the bar of gross profit from the previous year. It may have been possible due to the fact of entering totally new market for cheaper raw material and also can be greater stock control to avoid any unwanted damage or loss of goods.

Net Profit Margin:

It is defined as the measurement of the overall profitability of the business. This ratio I very important as its satisfactory result will decides whether the firm will be able to achieve a satisfactory return with its investment.

The ratio also indicates the company's capability to face the adverse economic condition such as price competition, low demand etc. obviously higher the ratio higher is the profitability. It should be noted that profit performance of the company should not be in relation of sales only but also be seen in relation with capital or investment.

Tesco has witnessed a fall in net profit in the current year than its previous year. In year 2009 most of the western countries was hit by recession which led to inflation as a result of which the price of the material increased unconditionally.

Return On Capital Employed:

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The return on capital employed is used to measure the success of the business in relation with the capital employed. It indicates the percentage of return on capital employed in the business and it can be used to show the overall profitability and efficiency of the business.

Return On Equity:

Return on equity is the relation between the capital and its equity. The performance of the company should be judged on the basis of return on equity of the company.

Efficiency Ratio:

Efficiency ratios are the financial statement ratios that measures how a business uses and control its assets. Efficiency improvement helps to increase profitability and case flow.

Assets Turnover:

Asset turnover is a financial ratio that measures the efficiency of the company's use of asset in generating sales revenue or sales income to the company.

The asset turnover for the company has increased from 3.97 to 4.1 in the current year. This signifies the point that the company is using its asset more effectively to generate more sales.

Liquidity Ratio:

Liquidity ratio expresses company's financial capabilities to repay short term creditors out of its total cash. Liquidity ratio is the result of dividing total cash by short-term borrowings. By the help of this ratio we can understand how many times the short term borrowing can be covered by the cash.

Stock Turnover:

Stock turnover measures how efficiently a company converts stock into revenue. Stock turnover is more specific than the asset turnover. It measures how well the company is making use of working capital that has been invested in stock. Stock turnover is the main component of asset turnover for companies that have little tied up to the fixed assets.

The higher the stock turnover is better for the company because money tied with the assets is less time in stocks.

The stock turnover has increased for the company from 17.97 to 20.35 times. This improvement is good for the company as money available can be used for other purpose.

Current Ratio:

Current ratio is defined as the relationship between the current assets with the current liabilities. This ratio is also known as 'working capital ratio'. It is mostly used to measure the financial position or liquidity of the firm. Normally 2:1 is look for. Above this ratio is considered surplus assets and below this ratio is considered that the company is undergoing some liquidity problem.

The current ratio of Tesco is not very much encouraging which 0.77 is. Although it is better than the previous year which was 0.61. The increase in the ratio shows the improvement liquidity of the company.

Acid Test:

Liquid ratio measures the ability of a company to use its near cash or quick assets to retire its current liabilities. (Tracy, John A. (2004)).By excluding stock from the current assets, the ratio focuses on company's liquid assets, and helps to determine if the company can meet its current liabilities encase if the sales ceases. A company is considered sound when quick assets exceed current liabilities.

The current result of acid test of Tesco is 0.63 which is far better than the previous year which was 0.37. This has been possible by not keeping the stock for longer period of time.

Debtor Collection Period:

It is termed as the average time taken to collect the trade debt. The lower the debtor collection period is good for the business as it indicates the increasing efficiency. It also helps the company to compare the real collection period with the granted credit period.

The debtor collection period for the year 2009 is 12 days which have increased from the previous year which was 10 days. The increase in the time period may suggest that the company is having difficulty in collecting its money owed.

Creditor Collection Period:

It is similar to the debtor collection period with the core difference that it measures how long it takes for a company to repay their debt to their supplier rather collecting the owed money. In general the creditor collection period is higher than the debtor collection period in order to avoid any cash flow problem.

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The creditor collection period for Tesco has increased in its current year than its previous year i.e. 61 days to 62 days. Increase in credit collection period can have adverse affect in its reputation as it will reduce future credit facilities.

Gearing Ratio:

It is used to measure the amount of long term debt the company has in relation to its capital structures. A company which has higher gearing ratio implies that the company is heavily relies on the borrowing for the large proportion of its capital. On the other hand a company with lowering gearing ratio means the company is heavily financed by the equity