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Business and Financial Analysis of Tesco Plc

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1.0 INTRODUCTION

The topic I have chosen is the “Business and financial analysis of a company for previous three years”. The organization chosen for the analysis is Tesco Plc (Period Feb 2008 to Feb 2010).

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1.1 Reason for choosing this topic

I have been studying finance and accounting since my intermediate days, and due to my liking of these subject areas I decided to progress on to ACCA and after studying papers of ACCA I developed an inclination towards analyzing companies from financial and strategic perspective.

Financial analysis has been an area of my prime interest and it is highly related to my studies. This project will help me to explore my financial and business analysis skills in more depth and apply my theoretical knowledge gained in the class into practical situation. The various models that I have used in my report such as ratio and SWOT analyses are all part of my studies.

Furthermore this project will not only help me in enhancing my report writing skills and interpretation skills but also appreciate the better use of financial statement which will further direct me on how to asses any company if the analysis is to be done in the future.

1.2 Reason for choosing the organisation

The company that I have chosen for the analysis is the Tesco plc. Tesco is the largest retailer in UK and third largest in the world with a group sale of £62,5bn (in 2010) and operates in 14 countries with 5008 stores worldwide. According to TNS Worldpanel over £1 in every £7 (14.3%) of UK retail sales is spent at Tesco. It has wide ranges of services and products which would help me to analyse different aspect of the business.

In addition many similar businesses are taking steps to establish their influence against the giants Tesco in recent years and I would like to compare the business and financial performances of such competitor, for which I have chosen Sainsbury and to see its progress and impact on Tesco Plc.

1.3 Background of organisation

Tesco plc is a British international grocery and general merchandising retail chain. It is the largest British retailer by both global sales and domestic market share, with profits exceeding £3 billion, and the third largest global retailer based on revenue, behind Wal-Mart and Carrefour. Jack Cohen is the founder of Tesco and founded in 1919. Tesco was listed on the London Stock Exchange in 1947 as Tesco Stores (Holdings) Limited. During the 1950s and the 1960s Tesco grew organically, and also through acquisitions, until it owned more than 800 stores. Originally specialising in food and drink, it has diversified into areas such as clothing, consumer electronics, financial services, telecoms, home, health and car insurance dental plans, retailing and renting DVDs, CDs, music downloads, internet services and software.( http://en.wikipedia.org/wiki/Tesco)

1.4 Aims and Objectives of my project

The ultimate aim of my report is to evaluate the Business and Financial position of Tesco plc through different business models and accounting techniques and to identify resulting implication and the future prospects of business.

This report will also evaluate the going concern nature of the Tesco plc and its ability to make profits in future and its future strategies to achieve its objectives.

1.4.1 Financial Analysis

Financial Analysis would be done by evaluating different financial ratios calculated from financial statements of Tesco Plc.

The analysis will be based on the following framework:

1. Profitability ratios

2. Working capital ratios

3. Risk ratios

1.4.2 Non-Financial Analysis

To analyze the non financial performance of Tesco plc the Business models that I have selected are SWOT analysis and PORTERS five forces model. SWOT will be used to analyze the internal strength and weaknesses of the company and opportunities and threats outside the business while Porter’s five forces analysis will be used to analyze the factors outside an industry that influence the nature of competition within it, the forces inside the industry that influence the way in which firms compete.

2.0 INFORMATION GATHERING AND ACCOUNTING/BUSINESS TECHNIQUES

2.1 Sources of information

Information gathering is a key part of any research because it is the only way we can clearly understand the nature and function of an organisation. For this reason, information should be ‘ACCURATE’. Otherwise the whole project is meaningless.

(Kaplan Financial 2010, ACCA Paper P1, Professional Accountant)

• A uthentic

• C omplete

• C omparable

• U nderstandable

• R eliable

• A uthorised

• T imely

• E ffecient

To make research more effective, it is important to know the information gathering techniques so that no information is overlooked and only relevant information is gathered.

Information can be gathered from, books, articles, personal experiences, expert opinions, encyclopaedias, and the WEB.

There are two types of sources from where the information can be gathered, they are as follows:-

1. Primary sources

2. Secondary sources

2.1.1 Primary sources:

A primary source is a source that was created during or immediately after the event or period that it documents. Primary sources enable researchers to get as close as possible to what actually happened during an historical event and or time period. A primary source is a first-hand account of an event.

Primary sources may include Original documents (excerpts or translations acceptable): Diaries, speeches, manuscripts, letters, interviews, news film footage, autobiographies, and official records.

(Source: http://libguides.library.cofc.edu/primarysources)

2.1.2 Secondary sources:

A secondary source is any item that was created significantly after the events it describes or is related to, or that was created by someone who was not directly involved in or an eye-witness to the events. Secondary sources also include simple descriptions of primary sources that do not reproduce the original “word-for-word.”

Secondary sources my include Publications: Textbooks, magazine articles, histories, criticisms, commentaries, and encyclopaedia.

(Source: http://www.somegreymatter.com/primaryvssecondarysources.htm)

2.2 Method Used

As can be seen from the above comparisons between primary research and secondary research, as constrained by time and resources, I chose to carry out secondary research when gathering information about Tesco Plc.

2.2.1 Secondary Sources used:

Information could be obtained from variety of sources but as a professional we have to make sure that we should not be involved in any kind of unethical issues and the information that we gather should be reliable and useful in our report. I used variety of sources, such as:

1. Financial statements of Tesco plc and J Sainsbury plc for years 2008, 2009 and 2010

This is one of the ideal sources to get the financial information required in carrying out a Business and Financial analysis of a company and which also helps in predicting the future performance of a company. They contain both the quantitative and qualitative data which is required for this report. Using annual reports as a source of information is of maximum advantage, because they contain all the reports of chairman, directors and CEO and also they contain all the financial and non-financial data which is very helpful for business and financial analysis.

These were accessed from the official website of Tesco Plc:

http://ar2010.tescoplc.com/downloads.aspx

The annual reports of Tesco’s competitor Sainsbury’s for the years 2006, 2007, 2008 were accessed from:

http://www.j-sainsbury.co.uk/index.asp?pageid=20#

This is done for the comparison purpose.

1. Tesco’s Website (http://www.tescoplc.com/)

Tesco’s Website was very useful in my research as it has all the information required for the project and it was very user friendly. It gave me all the developments the company was making as Tesco regularly updates its website; therefore latest information was easily accessible.

1. Text books

The knowledge that I’ve gained from the ACCA text books used in class helped me to get the theoretical aspect of the business and financial analysis and to develop a sound understanding of all accounting principles. Without the proper knowledge of these business models I would not be able to analyse the business performance of Tesco Plc. These books helped me a lot throughout my project and were also the accurate source of information.

The books that I have used and referred during my research are as follows……..

F5-performance management (Kaplan publishing),

F7-Financial Reporting (Kaplan financial),

F9-Financial Management (Kaplan publishing),

P1-Professional Accountant (Kaplan financial).

P3- Business analysis (Kaplan financial).

‘Cite them right’ which provided in-depth explanation of Harvard referencing system.

1. Newspapers

While doing this project I read different Newspapers like Financial Times, Telegraph and Guardian, including both old and the latest, in order to get information, about the changes in environment that affected the company financial performance. These Newspapers also brought me all the current information and issues which helped me in business analysis and showed that how different actions could influence the business strategies and future plans of the company.

1. Wikipedia:

It has helped to gather detailed history and background of the Tesco plc and some of its performance detail.

1. Other sources for E-news papers, journals and articles used include :

http://www.morningstar.co.uk http://www.ft.com http://www.telegraph.co.uk/ http://money.cnn.com/

www.time.com http://www.businessweek.com/ http://www.nytimes.com/ http://europe.wsj.com

http://www.bbc.co.uk/ http://uk.reuters.com/ http://www.guardian.co.uk/

2.3 Limitation of information gathering

Primary source of information

1. Is expensive and time consuming to conduct and analyse.

2. Primary data has design problems like how to design the surveys.

3. Some respondents do not give timely responses.

4. Sometimes, the respondents may give fake, socially acceptable and sweet answers and try to cover up the realities.

5. In Primary data collection methods there is no control over the data collection.

6. Incomplete questionnaire always give a negative impact on research.

Secondary source of information

1. The major limitation of secondary data is time and reliability.

2. With the passage of time the data becomes obsolete.

3. Very old secondary data collections can distort the results of the research.

4. Secondary data can also raise issues of authenticity and copyright.

Apart from the above said, there is too much information available on the websites many of which is irrelevant and it’s not easy to determine the accuracy of the data and information collected.

2.4 Ethical issues

Before starting gathering information one has to be fully aware of the ethical issues related to those such as one should avoid financial inducements, access to confidential information and copying the work of others. While conducting the research I had always kept in my mind such ethical issues and the guidance given by my mentor.

2.5 Framework

2.5.1 Financial analysis framework:

The Financial health of Tesco’s had been assessed by doing a ratio analysis which included ratios such as:

Profitability Ratios

Return on capital employed: It is a measure of the return earned by the business from the capital employed. It can be used to assess whether the business is earning enough to meet its cost of capital.

Gross profit margin: This ratio would explains the movement in the profitability of Tesco plc

I would compare the profitability of Tesco plc with the prior periods and its competitors and analyse the reasons for the movements.

Working Capital ratios

Payable days: This would aim to analyse whether Tesco have gone slower or faster in its payments to suppliers who are largely depended on them and the reason for its changes.

Inventory turnover: This ratio is a measure of number of times that on average company’s inventory is sold or replaced over the period.

Risk Ratios:

Current ratio: this would establish an understanding of the liquidity of the company and aim to analyse the movements of the ratio.

Gearing ratio: this ratio would measure the degree of risk involved with Tesco i.e. the bigger the gearing ratio, the more risky is the company.

Interest cover: this would aim to measure the strength of Tesco plc in meeting its interest expense and I would analysis any unusual movements.

While illustrating ratio analysis I would compare ratios of Tesco plc with the prior periods and its competitor and I would also add bar chart, pie charts and graphs so that the reader can comprehend my analysis quite easily.

2.5.2 Non financial analysis framework

Swot Analysis:

Source: http://www.maxi-pedia.com/web_files/images/Swot_Matrix.png

A swot analysis can be used as an analysis tool in its own right or can be used as a summary sheet on which other results can be placed.

1. Strengths and weaknesses relate to resources and capabilities.

-What is Tesco good at?

-What is it poor at?

-Where resources are in short supply?

-Where are resources excellent?

1. Opportunities and threats relate to external factors.

-What will the effect on the Tesco be of economic changes?

-Can the Tesco make use of new technologies?

-Are new entrants likely to enter the market place?

-Can a powerful customer dictate terms?

(Source: Kaplan Financial, ACCA Paper P3, Business Analysis)

Porters Five Forces:

Source:http://www.maxi-pedia.com/Five+Forces+model+by+Michael+Porter

2.5.3 Limitations of the techniques

Limitation of Ratios

1. Ratios are not definitive measures; they need to be interpreted carefully. They can provide indication to the company’s performance or financial situation. But on their own, they cannot show whether the performance is good or bad.

1. Ratios are based on historic information in financial statements.The figures in a set of accounts are likely to be at least several months out of date, and so might not give a proper indication of the company’s current financial position.

2. Comparison of performance over time can be distorted by inflation which leads to price increases. Inflation makes comparisons of results over time misleading as financial figures will not be directly comparable.

3. For Ratios to make sense, they are ought to be compared to an industry standard, competitor, or previous data.

4. As different industries use different accounting standards sometimes it is irrelevant to compare the ratios between them.

Limitation of SWOT

1. It does not address how to identify the elements of SWOT. The framework does not provide any guidance. Therefore it becomes very difficult for the management to recognise what are the strengths, weaknesses, opportunities and threats.

2. It does not provide guidance for prioritising or ranking the threats or weaknesses. Therefore, it becomes difficult to analysis which one to deal with first and rank them according to their severity.

3.0 Business Analysis

3.1 Company Overview

Tesco plc is one of the largest retailers in the world, operating more than 5008 supermarkets and convenience stores and employing 472,000 people with a group sale of £62,5bn (2010). Tesco’s core business is in Britain, where the company ranks as the largest private sector employer in the United Kingdom and the largest food retailer, operating nearly 2,545 stores.

Through Tesco.com, the company ranks as the largest online supermarket in the world. The company also operates stores in the rest of Europe and Asia and US. (www.tescoplc.com)

Tesco plc group revenue growth over 5 years:

(Source: Annual Report of Tesco plc 2010)

3.2 Future Strategy

Tesco’s strategy is well established and is consistent with its growth. The justification for the strategy is to expand the area of business that can generate strong sustainable growth in long term. Tesco has followed customers into growing markets at home such as telecommunications, non-food and financial services. It has expanded in new markets abroad starting with central Europe and Asia and more recently in the United States.

This strategy is based on five elements which includes four established areas of focus and Tesco’s commitment to environment and the community. They are as follows:

* To grow the core UK business;

* To be a successful international retailer;

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

* To develop retailing services; and

* To put community at the heart of what we do.

Core UK business-To grow the core UK business Tesco is focusing on helping customers spend less, encourage repeat sales and loyalty with a high investment in Club card. Tesco core UK business is significant within the group as about 70% of group sales came from the UK in 2010. Growth in the UK business is dependent on new space, extensions to existing stores and a multi-format approach. Sales of non-food, which forms another key part of Tesco strategy, also contribute to the overall UK growth picture. Tesco UK business grew by 10.6 % over a period of three years (2008-2010).

(Source: Annual Report of Tesco plc 2010)

International- To grow Internationally Tesco is investing in new markets overseas looking for new opportunities for growth and ways of generating long term returns for the shareholders. Tesco’s approach has been to be flexible in each market and act locally. Its main aim is to give customers great service, great choice and great value so that it can establish itself as the leading local brand. It has used multi formats-no single formats, as it can reach the whole of the market. Tesco is also investing in people, processes and systems so that people can appreciate and live Tesco’s values and bring net business benefits in it. Strategy also includes focusing on building brand which enables it develop long lasting relationship with customers.

Non-Food- To be strong in non –food as in food Tesco is offering the same great customer services to customers as they do in their food business. Tesco has 25 distribution centres, 6 of which handle non-food and clothing ranges. Getting the right product to the right store at the right time means customers can get what they want, when they want it. Tesco now has a team of people sourcing non-food products globally, to make sure Tesco can buy in the most efficient way and pass on the savings to customers.

Retailing services- Tesco has well known presence in retail services such as Tesco Personal Finance, tesco.com (Online shopping) and Tesco Telecoms.

In December 2008 Tesco completed acquisition of 50% of Tesco Personal Finance from royal bank of Scotland, and is now planning to establish its own personal finance and building its own bank headquartered in Edinburgh.

Tesco launched its online shopping and delivery services and now has over 1 million active customers who chose to buy online.

Tesco Telecom offer simple, straightforward telecom services with great value tariffs

It offers mobile network, internet access, home phone services and internet phone services. It also offers a wide range of telecom product in store and online.

Community-Tesco fully appreciates that their success is based on behaving responsibly and earning the trust of customers, suppliers and other stakeholders.

The well management of all aspects (customers, operations, people, finance and community) is based on the emphasis that corporate responsibility is not a specialist function in Tesco, it’s a part of everybody’s everyday job.

The community segment of the business promises:

-Caring for the environment

-Actively supporting local communities

-Buying and selling our products responsibly

-Giving customers healthy choices

-Creating good jobs and careers

These principles have been integrated into the day to day management of the business, and are applied by staff from the shop floor to the board room.

(Source: http://www.tescoplc.com/plc/about_us/strategy/)

3.3 SWOT Analysis

Strengths

Weaknesses

1. Strong Brand Name.

2. Affordable Prices.

3. Tesco Club Card.

4. Leading market position in UK.

1. High reliance on UK market.

2. Product Recalls.

Opportunities

Threats

1. Strategic Alliance with other companies.

2. Improvement in online sales.

3. Enter in new Asian market.

1. Intense competition in UK grocery market.

2. Increase in VAT.

3. International Expansion.

4. Economic Factors.

3.3.1 STRENGTHS

Strong Brand Name- Tesco is Britain’s most valuable retail brand; Intangible Business identifies Tesco, the UK’s biggest retailer as the most valuable brand on the high street with Sainsbury’s second.

(Source:http://www.telegraph.co.uk/finance/newsbysector/retailandconsumer/2789827/Tesco-brand-is-UKs-most-valuable.html)

Tesco is the World’s Third largest retailer after Wal-Mart and Carrefour. It was founded in 1919, more than 90 years of history. It has been famous for food and drink but now it also deals in clothing, electronics, financial services, telecoms, home, health, car and dental insurance, retailing and renting DVDs, CDs, and music downloads, Internet services and software.

Affordable prices – Tesco is also known for offering it products at affordable prices. In the period of recession Tesco has launched 500 new products as part of its “discount brand at Tesco”, with this Tesco ensured that their products are matched with customer’s budget without compromising on quality or choice.Tesco.com and Tesco direct has grown rapidly by more than 50% in 2008 to 2009 which proves their low prices.

Tesco Club Card- Tesco’s clubcards are very well known, In 2009 Tesco relaunched Clubcard 2, with the benefits of double clubcard points on every £1 spend. The club card does not merely store points but also collects data from customers and then sends them targeted offers. The data is also used to assess the needs of the customers and therefore respond quickly to their changing needs. Tesco has also introduced a contactless Clubcard app for the iPhone.

Leading Market position in UK-Tesco has strong market position in local markets .The Kantar World panel data, formerly known as TNS, shows Tesco’s market share climbed from 30.4% to 30.5% in the 12 weeks to 24 January compared to the same period a year ago. This provides Tesco an easy entry to new market and able to offer a good bargaining price . This also shows the knock on effect of the steady growth in Tesco’s online sales through tesco.com in the Britain’s market therefore making it apparent that Tesco has tapped this area very well. Tesco.com is selling grocery items and it is one of the world largest online grocers and they are also growing the sales of their non-food item through direct.tesco.com.

3.3.2 WEAKNESSES

High reliance on UK market-

UK Revenue excluding VAT (Source: Annual Report of Tesco plc 2010)

Tesco has high dependency on UK market. Therefore the failure in UK market can cause serious damage to its revenue and hence profit. In 2010 Tesco made revenue of £38,558m in U.K, £8,695m in Europe, £349m and 8,432m in U.S and Asia respectively i.e. 68.8% the total revenue came from the UK In 2010. It was 69.8% in 2009 and 73.4% in 2008. One of Tesco’s strategy objectives is to become a successful retailer internationally and it is clear from this assessment that it is growing in the international market and may eventually become a successful international retail. Tesco has reduced its dependency by 4.6% from 2008 to 2010.

Product Recalls -Tesco has recalled few of its products in 2010.It has recalled Baby Boutique Sequin Dress that went on sale in February 2010 because of sharp edges on some sequins of the dress. Tesco has also recalled Hovis Hearty Oats Loaf, 800g and Nescafe Collection Range 100g JAR due to containment of pieces of glass in them. Recall of these products suggests lack of quality control and may discourage customers from buying. This may result in loss of customers and brand image. This could also be the reason for reduced dependency by 4.6 % from 2008 to 2010.

3.3.3 OPPORTUNITIES

Strategic alliance with other companies -Strategic alliance can help Tesco to deal with the threat of multinationals and compete on an international scale. In this way Tesco will be able to get access to better locations and reach out to its customers.

Tesco can improve their services and overcome their weaknesses by merging or forming a strategic alliance with another company .It can reduce the cost of investment needed for expanding in an international market and it can also be used to confront competition.

In 2008 Tesco has confronted Wal-Mart’s presence in India by forming a strategic alliance with Tata Group of India.

(Source http://www.independent.co.uk/news/business/news/tesco-enters-india-with-cashandcarry-891979.html)

Improvement in Online Sales- In spite the fact that recession has taken over and online sale has been affected and has faced minor decline there is a huge growth potential in the online retail market for Tesco as the number of people using the internet rise. Similarly the advanced banking and secured online payment system such as the PayPal has enabled users to have greater trust and has made online trading suitable.

Online shopping in the UK continues is to gain a foothold, with the average online spending rate per shopper increasing to GBP 71 per month, a recent study has unveiled.

(Source: http://www.thepaypers.com/news/e-commerce/uk-e-commerce-on-the-rise-online-individual-spending-rate-hits-gbp-71-research/741728-25)

Tesco’s increasing online presence will enable the company to reach new customers, save infrastructure costs, and earn better margins.

Enter new Asian markets- Asia is a developing continent i.e. most of the countries are developing countries. Therefore, the opportunity for supermarket retailer like Tesco is massive .For instance, in India the cash and carry format of shopping is getting quite popular. The reason for such demand is largely because it is an emerging economy. Therefore the life style and society is changing. These changes caused modernisation of shopping system. It is the second-largest populated country in the world with over 1.18 billion people and consists of more than one-sixth of the world’s population(http://en.wikipedia.org) Therefore securing market share in country like this can bring significant changes in its revenue and profit.

3.3.4 THREATS

Intense competition in the UK grocery market-Tesco is the biggest grocer in the UK and it is leading the UK market for more than a decade but still it is facing intense competition from other major grocers. In current market Tesco remains dominant with 8% growth to a share of 31.5% but it is seeing solid competition from Asda, Sainsbury and Morrison’s. Both Asda and Sainsbury continue to grow, with share increases to 16.8% and 16.5% respectively and Morrison’s remains stable with sales increase of 4% over the last year – the ninth successive period of growth. In terms of smaller retailers both Waitrose and Iceland post robust figures with Waitrose tapping into current ethical trading and healthy eating consumer trends.

(Source:http://www.marketresearchworld.net/index.php?option=com_content&task=view&id=1129&Itemid=48)

International Expansion- Growing internationally could be expensive for Tesco as it will require substantial amount of capital investment in marketing, land prices, and extra operational/distribution expenses .This might result in escalation of debt for Tesco.

On 14 May 2008, Tesco agreed to purchase 36 hypermarkets in South Korea with a combination of food and non-food products from E- for $1.9 billion (£976 million) in its biggest single acquisition, making Tesco the second largest retailer in the country (http://en.wikipedia.org/wiki/Tesco).

Due to country’s current unrest Tesco’s profits may be jeopardized. This poses high risk to Tesco’s large Investment.

VAT increase from Jan 2011- Sir Terry Leahy, the Tesco chief executive, has warned that raising VAT from 17.5pc to 20pc next January will hit consumer spending

According to comparison website Kelkoo, the VAT rise could cost each household in the UK almost £500 a year, with reduced spending notably on computing and electronic devices, holidays and eating out. Kelkoo also estimated that annual spend on retail goods by Britons would fall by £324 per person to £1,464.

(Source:http://www.telegraph.co.uk/finance/financetopics/budget/7852544/Budget-2010-VAT-rise-to-hit-spending-says-Tesco-chief-Terry-Leahy.html)

This could have a huge effect on Tesco’s profit as people spending power could be decreased.

Economic factors – Economic factors are of concern to Tesco, because they are likely to influence demand, costs, prices and profits. One of the most influential factors on the economy is high unemployment levels, which decreases the effective demand for many goods, adversely affecting the demand required to produce such goods.

These economic factors are largely outside the control of the Tesco, but their effects on performance and the marketing mix can be profound. Although international business is still growing and is expected to contribute greater amounts to Tesco’s profits over the next few years, the company is still highly dependent on the UK market. Hence, Tesco would be badly affected by any slowdown in the UK food market and are exposed to market concentration risks.

3.4 PORTER’S FIVE FORCES

Porter’s 5 Forces analysis deals with factors outside an industry that influence the nature of competition within it, the forces inside the industry (microenvironment) that influence the way in which firms compete, and so the industry’s likely profitability is conducted in Porter’s five forces model

Porter (1980a) defined the forces which drive competition, contending that the competitive environment is created by the interaction of five different forces acting on a business.

Main aspects of porter’s five forces analysis are:

Threats of New Entrants

Setting up a new supermarket chain is not easy and comparing to the enormous size of Tesco and other established retailers such as Sainsbury’s and Asda there will be little room for new entrant to attain any remarkable market share.

Tesco is well established and has features which would be a barrier to entry for other new entrants such as:

-Access to Distribution Channels

-Strong Brand name

-Capital Availability

-Massive Economies of Scale

Tesco is the largest retailer in UK and third largest in the world with a group sale of £62,5bn (in 2010) and operates in 14 countries with 5008 stores worldwide.

Therefore the Threat of new entrant is quite low.

Bargaining Power of Suppliers

The Bargaining power of suppliers is low because larges supermarkets like Tesco’s and Sainsbury have ability to dictate to the price they pay to the supplier as they buy in extremely large quantities from suppliers hence providing them huge market for their products. If the Supplier doesn’t agree to the Tesco’s price then the supplier will be left with no retailers to sell to.UK based suppliers are also threatened by the growing ability of large retailers to source their products from abroad at cheaper deals.

Bargaining Power of Customers

As the products in major retailers become more undifferentiated coupled with lower switching cost, the bargaining power of customer becomes more significant. If a customer finds a price of a particular item higher than it can easily switch between the retailers therefore bargaining power of customer is high in supermarkets.

Although Tesco’s Club Card has been a spearhead in its customer retention strategy and ensures low prices, customising service, better choices and meeting customer needs and retains their customer base yet bargaining power of customers for Tesco remains high.

Competitive Rivalry

Tesco is facing competition from many retailers such as Sainsbury Asda, Wal-Mart and Carrefour. Industry being concentrated with large number of retailers, there is a high level of competition in terms of price cuts and non financial basis such as brand quality. If the customer sees little difference between the product and that of competition then they will tend to choose on price.

In spite of many retailers in the same industry Tesco is said to be in a dominant position in the UK market in relation to its competitor’s .Tesco can offer lower prices to the customers in this economic crisis period where consumers are tight on their spending.

Threat of Substitute

Generally substitution reduces demand for a particular product as the customers can easily switch to the alternatives In a market where Tesco operates, The Products are normally of similar kind and not much different in terms of prices therefore there is a high threat of substitute products but the scale of Tesco’s operations is so big that it can easily offer products at a much lower prices compared to its rivals therefore customers are inclined to buy from Tesco, despite the presence of substitutes in other retailers.

4.0 Financial Analysis

4.1Revenue analysis

(Source: Annual Report of Tesco plc 2010)

The revenue has grown by 20.8% from Feb 2008 to Feb 2010 which can be considered to be a satisfactory growth which is evident from what chief executive Terry Leahy said in the earnings statement. “By remaining focused on our strategy, we’ve weathered the economic storm well.” (Source: Annual report 2010)

The increase in sales is due to:

1. Increase in product demand because of Tesco’s technology that allows price matching on substitutions, Increase in sign-up to its Clubcard as a result of its Double Points scheme as 18 per cent more households have redeemed their Clubcard vouchers than in 2010 as compared to last year, and heavy discounting of its products.

2. Tesco Introduced more affordable products to tackle the recession, around 500 new discount Brands products were introduced, which created a completely new way to shop for customers who want to spend less.

3. Tesco.com is the world’s most successful online grocery retailer and is the third most-visited retail web site in the UK and is growing with a decent pace. Tesco has seen their web revenues rise by 14% in the 12 months proceeding 27th February 2010. This has given their annual profits a 10.1% boost to £3.4 billion.

4. Tesco is growing extensively in the international market along with the core business in UK. In UK Tesco has grown at 4.2 per cent year on year to revenue of £42.3bn (in 2010), which is mmainly due to recession and competition, the market which generates half of the total group revenue.

5. Increase in sales in the non-food items: Group non-food sales rose 6% to £12.5 billion in 2009, which is an increase of £700 million from the year 2008, including £3.8 billion in International.One of the objectives of Tesco’s strategy is to be as strong in non-food as in food.this indicates that they are progressing as per their objective.

4.2 Ratio Analysis

In order to evaluate Tesco’s financial health and performance I will conduct a ratio analysis of Tesco over 3 years period from Feb 2008 to Feb 2010.

Ratio analysis is the process of comparing and quantifying relationships between financial variables, such as those variables found in the statement of financial position and the statement of comprehensive income of a company (Kaplan Financial, ACCA Paper F9)

4.2.1 PROFITABILITY RATIOS:

Return On Capital Employed (ROCE)

ROCE gives a measure of how efficiently a business is utilising its funds available. It measures how much is earned from each £1 invested in the business.

(Kaplan Financial, ACCA Paper F9, Financial Management)

ROCE Is largely used in investment appraisal of a company, it measures of the return earned by the business from the capital employed, assesses whether the business is earning enough to meet its cost of capital and it shows the trend of return that investors are earning on their investment. This ratio is very important because both potential investors and existing investors take decision whether to invest or withdraw investment from the Company.

Tesco plc has achieved a ROCE of 14.08% in 2008 and then had a sharp decline to 11.33% in 2009 and it grew to 11.52% in 2010. This means for every £100 of capital invested Tesco earned £14.08 in 2008 compared with £11.52 in 2010.

Overall Tesco’ ROCE has fallen over the last three years, as Tesco invested heavily for their expansion but return from their business did not accelerate at the same time. This is due to a sharp rise in Long term debt (used in the acquisition of TPF and Home over of Korea) and also a moderate rise in equity while the operating profit margin remains the same for the last two years. Although Tesco’s increased their revenue significantly but cost of sales was also increased at the same time. Therefore gross profit margin and operating profit margin remains static. Last year long-term debt has almost doubled compare to 2008 to 2010(from (£5972 to £11744) whereas operating profit increased by only 23.8% in the last three financial year.

Comparison with J Sainsbury plc

On the other hand, Sainsbury’s’ ROCE in 2008 was 7.05%, 9.46% in 2009 and 8.80% in 2010. Tesco’s ROCE was almost double in 2008 compare to Sainsbury’s but in 2009 Sainsbury’s reduced this gap significantly this is because Sainsbury’s reduced their debts within this time period but in 2010 Tesco’s ROCE increased from 11.33% to 11.52%, Sainsbury’s ROCE went down from 9.46% to 8.80% this is because slightly increase in debt by 7.6% than the previous year.

Gross Profit Margin

The gross profit is calculated by dividing the gross profit by the revenue produced by the business. The gross profit margin shows the amount of gross profit earned by each £1 of revenue. The gross profit margin earned by a supermarket retail industry is likely to be lower compare to the industries like airlines, restaurant etc.

Tesco earned a gross profit of £3630m in 2008, £4185m in 2009 and further raised to £4607m in 2010 .It can be seen that there was a rising trend from 2008 to 2010 in the gross profits. The gross profit margin in 2008 was 7.67% and 7.76% in 2009 and 8.10% in 2010 which is a good performance. The reason for Gross profit being low in 2008 and 2009 is because of the recessionary climate .another possible reason could be the losses of £142m from US operations which has reduced the profits (numerator).Tesco had to cut down its profit margin by reducing the price to sustain its market share. But in grew up in 2010 because of Tesco’s £540 million productivity savings.

Comparison with J Sainsbury plc

On the other hand Sainsbury earned a gross profit of £1002m in 2008, to £1036m in 2009 and £1082m in 2010.However, the rise in revenue was consistent from 2008 to 2010.

The gross profit margin was 5.62% in 2008, 5.48% in 2009 and 5.42% in 2010.This may be due to lack of control in the cost of sales which resulted in decline of gross profit. The reason for this trend can be assessed as, because of the economic downturn the supermarket retailers had to cut down their product prices hence compromised on their product margin.

4.2.2 WORKING CAPITAL RATIOS:

Payable Days

It is a measure of how long on average it takes a company to pay its creditors. Higher payable days help a business to be more liquid. Usually if the payable days exceed 100 days it is an indication that the business has liquidity problem. Supermarket retailers have a bad reputation of squeezing their suppliers.

Tesco plc has taken 61 days on average to its suppliers in 2008. The payments have become relatively slower in the recent years with 64 and 66 days in 2009 and 2010 respectively. This is due to increasing payable day’s helps in maintaining cash flows and to achieve their objective of international expansion as working capital is available from suppliers.

Comparison with J Sainsbury plc

Sainsbury has improved on payable payment days which are evident from the bar chart. In 2009, it was paying on average 1 day earlier compare to 2008. Tesco is still behind Sainsbury in terms of payment period to their suppliers. In 2010 Sainsbury took 47 days on average which is 19 days lower compare to Tesco, this is due to Tesco have gone slower its payments to suppliers who are largely depended on it as Tesco can use its size to negotiate more payable days.

Inventory Turnover Days

This ratio calculates the length of time finished goods are held between completion or purchase and sale. Usually low ratios are seen as a sign of good management. In general, the shorter the inventory holding period the better working capital management is considered to be.

It seems like Tesco is able to manage its stock quite effectively in 2010 when the turnover period was reduced to 17.5 days as compared to 18.75 days and 18.07 days in 2008 and 2009 respectively. This suggests that Tesco has been able to promote its products quite effectively to its existing as well as potential customers as it seems that stock is been turned over quickly due to the increase in demand.

Comparison with J Sainsbury plc

Sainsbury is better off 5 days compared to Tesco’s inventory days in 2010 this shows that Sainsbury is performing better in this aspect and is turning its inventory into cash more quickly .

4.2.3 RISK RATIOS:

Current Ratio

Current Ratio shows the ability of a company to cover its current liabilities by its available current assets. So that it can operate in near future and continue to trade. it is a measure of liquidity of a company.

Generally if a business has a current ratio of less than 1 it is considered that the business is very weak in meeting its short term debt. However, it is not true for the supermarket retailers like Tesco and Sainsbury. This is because these supermarkets either have no or little trade debtors .Most of their products are sold to the individual customer who pays cash at the time of purchase. Therefore it may be acceptable to have the ratio in between 0.5 to 1.

Tesco has increased current ratio from 2008 to 2009 which has improved by 0.17 times. The increase may be due to increase in short-term investment and cash or cash equivalents. Therefore it is an indication of good working capital management but it decreased slightly in 2010 because of decrease in cash and cash equivalent by £690m.

Comparison with Sainsbury plc

Sainsbury shows an opposite trend i.e. it has declined from 0.66 times in 2008 to 0.55 times in 2009.This may be due to increase in trade payables from £2280m in 2008 to £2488m in 2009. This can be a sign of bad working capital management. But in 2010 Sainsbury has performed better. Its current ratio increased by .10 times to .66 times in 2010.this is because of decrease in payables which has decreased from £2488 in 2009 to £2466 in 2010.

Gearing Ratio

Capital structure of a company is made up of equity and debt. Companies should use 50% of both the elements, as it is desirable. This ratio measures to which extent debt is used in capital structure. The bigger the gearing ratio, the more risky is the company.

The gearing ratio of Tesco has increased from 52% in 2008 to 74% in 2009.It shows that in 2009, it has more debt compare to its equity shareholders fund. This may be because they have used long term borrowings for international expansion e.g. to acquire more stores in Asia .Tesco purchased 36 hypermarkets from E-land in south Korea .The long-term borrowing has increased by 107.5% from £5972m in 2008 to £12391m in 2009. This increase in debt borrowing has made them substantially geared and hence, more risky. Tesco’s gearing decreased from 74% in 2009 to 54% in 2010.This is due to the repayment of £1671m debt which includes the repayment of debt acquired for the acquisition of homever of £611m.

Comparing with J Sainsbury

The gearing level of Sainsbury in 2010 is much lower compare to Tesco. The movements from 2008 to 2010 may not be considered as material. Therefore investors of J Sainsbury may not be much concerned.

Interest Cover Ratio

The interest cover ratio helps us to determine how easily a company can pay the finance cost on its outstanding debt. Lower interest cover ratio means that the company is burdened with debt expenses. When a company’s interest cover ratio is 1.5 or less, the ability of the company to pay its finance cost is weak.

Tesco being the largest supermarket retailer is likely to have the strongest interest cover ratio. The ratio in 2008 was strong with an interest cover of 11.16 times and sharply declined to 5.97 times in 2010. This means its ability to pay the interest expense has reduced in the recent years. This is due to its substantial increase in debt borrowings for its expansions overseas which has resulted in high interest expense and therefore reduced the ratio.

Comparing with J Sainsbury

Although Tesco shows a relatively bad interest cover ratio in 2010 compare to 2008 but comparing with the businesses in the same industry like Sainsbury shows it is still a strong interest cover ratio. The best ratio of Sainsbury was in 2010 of 4.8 times which is still lower than the worst ratio of Tesco in 2010 of 5.97 times. The rapid decline of Tesco’s interest cover can be criticised compare to a small decline in the Sainsbury’s ratio.

5.0 Conclusion:

The recession has created a very competitive climate in UK and had made consumers more price sensitive and vigilant, in this environment Tesco has maintained a strong market share and has shown increase in revenue and profits.

However, Tesco’s dependency in the UK market is always in question and the product recalls in 2010 is a major cause of concern. The Venturing of Tesco in the international market and its decision to enter growing economies of Asia are an indication that Tesco is tackling well with its weaknesses. For example in 2009 when Tesco’s gearing went up to 74% it brought it down to 54% by repayment of debt of £1671m in 2010 resulting in less finance cost which will have a positive effect on its profit.

5.1 Recommendation:

1. Tesco is growing internationally but it should avoid classic growth risks such as high borrowing and policy mistakes.

2. Tesco’s should work on improving its product quality, investigate its reason for product recalls in 2009 and eliminate the activities that caused the product recalls.

3. Tesco should improve its profit margin and asset utilisation in order to improve its ROCE which has reduced over the years.

4. In UK the VAT would be increased to 20% from Jan 2011 therefore Tesco should align its UK retailing policies accordingly in order to averse the negative impact of VAT increase on product demands.

6.0 Reference list

Academics books:

F5 Performance Management (Kaplan publishing),

F7-Financial Reporting (Kaplan financial),

F9-Financial Management (Kaplan publishing),

P1-Professional Accountant (Kaplan financial).

P3- Business analysis (Kaplan financial).

‘Cite them right’ which provided in-depth explanation of Harvard referencing system.

The sources for E-news papers, journals and articles used include :

http://www.morningstar.co.uk http://www.ft.com http://www.telegraph.co.uk/ http://money.cnn.com/

www.time.com http://www.businessweek.com/ http://www.nytimes.com/ http://europe.wsj.com

http://www.bbc.co.uk/ http://uk.reuters.com/ http://www.guardian.co.uk/

OTHERS:

http://ar2010.tescoplc.com/downloads.aspx(Tesco Plc annual report for 2008, 2009 and 2010.)

http://www.j-sainsbury.co.uk/index.asp?pageid=20# (J Sainsbury Annual report for 2008, 2009 and 2010.)

http://en.wikipedia.org/wiki/Tesco

http://www.tescoplc.com/

http://www.tescoplc.com/plc/about_us/strategy

http://libguides.library.cofc.edu/primarysources

http://www.somegreymatter.com/primaryvssecondarysources.htm

http://www.maxi-pedia.com/web_files/images/Swot_Matrix.png

http://www.maxi-pedia.com/Five+Forces+model+by+Michael+Porter

http://www.telegraph.co.uk/finance/newsbysector/retailandconsumer/2789827/Tesco-brand-is-UKs-most-valuable.html

http://www.independent.co.uk/news/business/news/tesco-enters-india-with-cashandcarry-891979.html

http://www.thepaypers.com/news/e-commerce/uk-e-commerce-on-the-rise-online-individual-spending-rate-hits-gbp-71-research/741728-25)

http://www.marketresearchworld.net/index.php?option=com_content&task=view&id=1129&Itemid=48

http://www.telegraph.co.uk/finance/financetopics/budget/7852544/Budget-2010-VAT-rise-to-hit-spending-says-Tesco-chief-Terry-Leahy.html

Cite this Business and Financial Analysis of Tesco Plc

Business and Financial Analysis of Tesco Plc. (2017, Dec 21). Retrieved from https://graduateway.com/business-financial-analysis-tesco-plc/

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