Tesco

Executive Summary The theme of this report is to review as to how an organization has to maintain its focus to remain stable in an environment where there is recession. The document examines the different sources of capital and measures as to how to maximise and survive using the loan capital. It is very important for organizations in recession to concentrate as to how to have a financial strategy and strong cash flow management techniques to survive in the short and long run. Further this document examines as to how to maintain confidence in context of share holders and loan providers. Introduction This report focuses on evaluating Tesco’s sources of funds using suitable financial theory. As the first step the report will list and brief the main sources of funds and these would be analysed using relevant financial ratios. In addition Tesco’s financial strategy and corporate strategy also would be evaluated using the corporate life cycle theory. Most of the information would be gathered using secondary data mainly: Annual Report[the recent five years], Investor review report , Research Essays and other sources of information. The main fundamental theme is to evaluate the different sources of finance and the current prevailing financial strategy and recommend a suitable financial strategy that would support and increase the growth in the next few years. Organization Background Tesco started almost around 1920s and the company has expanded in UK and almost around the world where the company trades in China and India. Tesco has established it’s name as the prime retailer in selling food and other consumer products but the company has expanded into other areas like insurance , banking , mobile business and selling electrical and other energy products like solar cells. Currently Tesco wants to maintain it’s growth strategy considering the following key factors: 1) Maintain and establish the brand name as Tesco across UK as the largest retailer 2) Start new ventures in other countries and have a new growth strategy in global retailing.3) Maintain the position in selling food items as well as non food items taking into account the fair trading policies and selling quality items at affordable prices.4) Practice and adopt ethical trading policies .5) Develop into new trading practices introducing customers to E-Commerce or Mobile Commerce thinking into the next generation trading. In order to achieve the above growth strategies Tesco needs to maintain a strong financial strategy and think in terms of future innovative trading practices that would enhance Tesco’s success whilst maintaining the financial stability of the company. Main Findings of Tesco’s Sources of Funds Tesco is a public limited company where the company is mainly funded through shares traded publicly in the stock exchange or any other source. The world ‘limited’ states that the share holders or any officer directly or indirectly cannot be personally held responsible if the company goes into liquidation other than any amount outstanding to be paid for their share investment. In other words Tesco PLC is regarded as a artificial legal person where the company will have it’s own bank account, employ it’s own staff deemed to be employed by Tesco Plc and hence the company would sell shares in need of investments and as well as borrow money in form of collateral for short term loans or debentures or any other forms of long term loan capital. The status of ‘artificial legal entity ‘ generates its own decision to raise it finance in the form of selling shares or debentures in the need of urgent capital. Further Tesco has its own reputation and hence the company could borrow large amount of overdraft facilities to fund for it’s day to day operations and repay through the sales turnover since Tesco is running at profit even at this time of recession. Using Financial Ratios to Analyse Tesco’s Sources of Funds The table below illustrates the key ratios to analyse Tesco’s financial stability |Ratios |2011 |2010 |2009 | |Current Ratio: Current |11869:17731 |11765:16015 |13647:18040 | |Liability |0.67:1 |0.73:1 | | | | | |0.75:1 | |Acid Test Ratio=(Current |11869-3162:17731 |11765-2729:16015 |14045-2669/18040 | |Asset- Stocks): Current | | |0.63:1 | |Liability |0.49:1 |0.56:1 | | |Gearing Ratio 1= |12852/16623 |15327/14681 |15018/12995 | |Long Term Loans/Equity |0.77 |1.044 |1.155 | |Share Holders Funds | | | | | |77% |4.4% |15.5% | |Gearing Ratio2=Long term |12852+16623/16623 |15327+14681/14681 |15018+12995/12995 | |loans/long term loans+ | | | | |equity share holders |1.077 |2.044 |2.155 | |funds | | | | |Return on Fixed Asset= |3811/35337= |3457/34258= |3206/32008 | |Profit before interest |10.78% |10.01% |10.01% | |and tax/ Total Fixed | | | | |Asset | | | | |Return on Working |3811/-5862= |3457/-4250= |3260/-6304=-51% | |Capital= Profit before |-65% |-81% | | |interest and tax/ Working| | | | |Capital(Current Asset- | | | | |Current Liabilities | | | | |Earnings per share |33.10 |29.19 |27.59 | |Turnover |60931 |56910 |53898 | Liquidity Position According to the two ratios calculated the current ratio and acid test ration Tesco is mainly running on loan capital. Where in 2009 Tesco needed to borrow more as it was the peak of recession but during the years of 2010 and 2011 Tesco was able to maintain its gradually improve its liquidity position to 0.73 and 0.67. In addition to current ratio acid test ratio is used to identify how far the company is financially stable or meet the cash position. Comparing to 2010 and 2011 Tesco had more cash flows in 2009 since it had borrowed more loans to fund it working capital requirements. In 2010 and 2011 Tesco paid some of its debts and the cash flow pr working capital was 0.56 and 0.49 in 2010 and 2011. As per current ratio and acid test ratio Tesco has difficulties in meeting its working capital requirements where Tesco needs to solely depend on bank over drafts and short term loans. The main disadvantage is borrowing short term would be where Tesco would need to incur or pay higher interest costs. At the present context it is evident that Tesco is running more on short term loans . Since Tesco has it reputation of a well established company it would be easy for Tesco to obtain finance from banks and other lenders to fund for the company’s survival. Gearing Ratio Tesco had borrowed long terms loans in 2009 and 2010 where the ratio was very high where it was 115.5% in 2009 and 104.4% in 2010 than the share capital. Tesco paid some of its loans in 2011 and hence the gearing was almost 77%. In 2009 and 2010 Tesco’s survival was in great danger since it had more loan capital and a threat of facing a danger of creditor’s liquidating the company . In 2011 Tesco was able to pay most of its loans and hence the danger of creditor’s voluntary liquidation was avoided. Though Tesco had large amounts of long terms loans there was constant increase and hence some of the loan amounts were repaid during the year of 2011. As per the second calculation of Gearing ratio most of the capital was financed in terms of loans where it was very high in 2009 around 215% and 204% in 2010 this is evident Tesco was able to survive with loan capital and faced a greater chance of liquidation through creditors action. In 2011 this improved where some of the loans were paid but still there is a chance of high liquidation. As per the gearing ratio Tesco had two key challenges maintaining the investor confidence and as well as maintaining the creditors confidence. During the years 2009 and 2010 there was large amounts of fluctuations in the share market which is evident that there was greater challenge that Tesco has to maintain a steady share price. Since the constant price fluctuations in 2009 Tesco needed to pay dividend as well as high interest rates. During the years of 2011 Tesco reissued some shares where there were new investments made and this increased the sales potential of Tesco and resulted in paying a higher amount of dividends. Most of the sales are cash sales and hence this gives Tesco the ability to generate cash and pay off the loans and maintain the investor confidence which guaranteed the continuity of Tesco during the recession time. Return on Fixed Asset Return of fixed asset measures as to how much profit generated as to the amount being invested. During the years of 2009-2011 there is no significant increase since there was no significant increase on turn over. Tesco is maintaining a return worth of 10% of the fixed asset being invested to ensure it’s survival as an organization. Return on Working Capital This measure as to how much profit is generated comparing to working capital. In 2009 Tesco generated a-51% return since there was more short term loans than any current asset and this increased -81% and reduced to -65% in 2011. Tesco has maximised it’s operation to generate a profit for all three years ensuring continuity and survival . The main drawback could be Tesco is generating most of it’s operating profit from short term loans . Depending on short term loans could be risky since if Tesco did not get the required amounts of loans this could lead to liquidation. Corporate Life Cycle Theory [pic] Lecture 3 Powerpoint Slide As per the above diagram there are four stages for any organization according to corporate life cycle theory they are : Introduction, growth, maturity decline. In case of Tesco which started around 1920 has grown to a larger level in the current trend and faces maturity and as well as decline. Tesco as a whole is not in a declining position but some of the operations are being declined and new operations and functions are being introduced. Introduction Tesco is on the process of introducing the new online sales facility where people could order online and products is being delivered to the door step via with the sales concept Tesco direct. Further Tesco is introducing the new concept of mobile ordering as well as ordering via the telephone for people who cannot operate online or any mobile phones. Growth Tesco has installed self scanned machines in most of the stores where people do not have to wait in rows and purchase the products this has grown to a larger extent. Maturity and Decline Traditional sales and purchase methods are at maturity or decline stage where at the present trend people are moving to online /mobile / machine purchase. According to the corporate life cycle Tesco needs to reinvest more on researching E-Commerce and M-Commerce sales where these are still at the introductory stage. The next generation is more on the trend where they would like virtual shopping and online ordering. A suitable Financial Strategy for Tesco According to Lintner’s theory the longer the stability firms prefer to pay dividends but if in case of recession managers are reluctant to pay dividends. As for this policy Tesco is paying dividends to satisfy its investors which is an essential factor for future growth and success. With the new changes in the industry Tesco needs to change its financial and corporate policies in order to ensure survival. At the present context it is important for Tesco to focus on pricing policies and quality to ensure it attracts more customers in order for the survival where there is bigger competition from other retailers. Further Tesco has to ensure that it starts selling more organic products which is a growing demand at present. In addition Tesco should adopt and focus more on cash flow and loan management which is very crucial at the current trend for future growth and survival. Comparing both the sources of finance at the present context it seems that Tesco is more better off running in loan capital to meet the short term debt crisis . Further it is better for Tesco to start concentrating to better deals with suppliers which would ensure better credit terms and other discount facilities. As Tesco is into other forms of sales it is better for Tesco to start concentrating on selling energy products and as well as selling starting up a commercial bank which would be a new source of revenue for Tesco to be on the business. Hence it is important for Tesco to reshape its corporate and operational strategy to survive in the long term. Bibliography 1)The importance of liquidity in today’s Economy – W.Villagico, Dr Surprise April 2008- Accessed via[http://agencyroundtable.com/uploaded/articles/MW_April_supp.pdf] 2) Business Accounting 2 5th Edition- Frank Wood and Alan Sangster 2005 Publication 3) Tesco Financial Statements – Accessed via[http://www.tescoplc.com/media/417/tesco_annual_report_2011_final.pdf 4) Lecture 2 University of Hertfordshire – Business School and Accounting Finance Group –Lintner’s Theory