performance and financial strength of Tesco
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EVALUATE THE PERFORMANCE AND FINANCIAL STRENGTH OF TESCO WITH A PUBLISHED BALANCE SHEET
THE IMPORTANCE OF ANALYSING FINANCIAL CONTEXT
The purpose of this paper is to evaluate the performance and financial strength of Tesco, with reference to its balance sheet. However, before this area is focused on, the idea of the balance in a wider financial context will be set. As Vause (2005) observed that to provide an understanding of how to analyse and assess the performance of a listed company is the main purpose of evaluating a financial statement. The financial strength of a company can be examined through the inspection of a company's annual reports: the income statement or profit and loss account, and the cash flow statement. Both of them provide the basis for a full analysis of a company. However, a published balance sheet can still be used to assess to prove the financial strength of a company.
THE CRITERIA OF INTERNATIONAL FINANCIAL STATEMENTS
The criteria of financial statements are broadly defined as they are dependent on different organisations and economies. As noted by Van Greuning (2006), International Financial Reporting Standard (IFRS) aims to build the scope of the standard, including comparable information that to be provided. There are two key concepts, the reporting date and the transition date, which should both be highlighted. The former one is the balance sheet date of the first financial statement that clearly state that they comply with IFRS (For example, August 29, 2009). The latter one is the date of the opening balance sheet for the prior year relative financial (For example, January 1, 2007, if the reporting data is December 31, 2008). Another important presentation of financial statement is the standard of IAS 1, which means financial statements should have a standard minimum content, and the bases on which should be explained (Tiffin, 2004).
THE DEFINITION OF A BALANCE SHEET
Reference to Mott (2005) reveals that a widely accepted definition of balance sheet describes it looks like a photograph recording in a particular time. There are two main parts it contains. On the one hand, the value of assets owned by the business is presented; on the other hand, it shows the values of liabilities and equity. As it can be clearly understood that the two different aspects of a balance sheet are by the equation (assets are equal to the sum of equity and liabilities). Also, Lerner and Cashin (1998) point out that a far more detail about a published balance sheet, including the followings: the total assets consist of Current Assets and Non-Current assets; the total liabilities the total liabilities including Current Liabilities and Non-Current Liabilities.
THE HISTORY OF TESCO
Historically, Tesco, the largest and most famous supermarket in the UK, started life in 1919 in London. Approximately 30 years later, in 1947, Tesco Store (Holdings) Ltd. floated on the London Stock Exchange. From the London Stock Exchange, the published balance sheet of TESCO PLC is shown (Appendix 1). It is presented in a form that became normal practice, following the standards of IFRS and IAS 1 as the past definition mentioned.
THE MAIN STAGES OF EVALUATING A PUBLISHED BALANCE SHEET
The opinion of Perks (2007) is that a published balance sheet of a listed company provides useful indications, which relates to several aspects of a company, especially comparing one base with another through different years and industries. Following this, the evaluation of Tesco will be presented in three different main stages-namely, size and growth, liquidity ratios and solvency.
SIZE AND GROWTH
Firstly, one of the most common ways to evaluate a company's size and growth is to look for their book value. To quote from Pratt et al (2000), the book value is based on a company's common stock equity as it appears on a balance sheet. In illustration 1.1, the book value of Tesco increased from ￡8,600 million in February 2005 to
￡12,995 million in February 2009, with an increase of 51.1 per cent.
(￡M) 28-Feb-09 26-Feb-05 Total Equity 12,995.00 8,654.00
LIQUIDITY – CURRENT RATIO
Generally, liquidity ratios are used to measure a company's ability to pay its short-term liabilities, also called its liquidity. The two most commonly used ratios are the current ratios and the quick ratios. According to Haber (2003), the current ratio is based on all of the current assets and the current liabilities (The Formula: total current assets divided by total current liabilities). A single rule of thumb is not widely followed because it is flexible in different conditions of various industries (Pratt, Reilly and Schweihs, 2000). Using illustration 1-2, the current ratio of Tesco in 2009 is calculated as following:
0.78: 1 (from 23-Feb-08 to28-Feb-09)
(￡M)
Total Current Assets
Total Current Liabilities
28-Feb-09
14045.00
18040.00
As it is clearly seen that the current ratio is significant lower than the satisfactory ratio as it is usually defined to 2: 1.
LIQUIDITY – QUICK RATIO
Another commonly used ratio to assess liquidity is quick ratio, which also called the acid test ratio, defining as the subtraction of inventory from the current assets and then divided by current liabilities. The ratio excludes inventory because of its difficulty to quickly convert into cash in the short-term. In illustration 1-3, the quick ratio of Tesco in 2009 is calculated as following:
0.63: 1 (from 23-Feb-08 to28-Feb-09)
(￡M)
Total Current assets
Inventory
Total Current liabilities
28-Feb-09
14045.00
2669.00
18040.00
Compared with the general standard (1: 1), the ratio is also considerable lower than the ideal.
THE PURPOSE OF ASSESSING SOLVENCY
In the final evaluating stage, it can be said that the main purpose of assessing a published balance sheet leverage ratio is to ensure that it is possible to make some quantifiable assessment of the long-term debt of the business. Furthermore, as Pratt et al (2000) wrote, the assessment of leverage ratio is to ensure the ability to solve financial problems and to provide references in their long-term financial strategies. Thus, the two following specific ratios mentioned are the ones that are most widely used for measuring company's ability of solvency.
DEBT-TO-ASSETS RATIO
One of the most popular ratios to measure the long-term adequacy of capital structure of a company is the debt-to-assets ratio (The Formula: total liabilities/total assets). According to Perks (2007), 20 per cent or 30 per cent is widely accepted without problems in a long-term solvency, generally. Moreover, the ratio of no more than 50 percent is considered sensible. It is important to keep the ratio of debt-to-assets ratio at a standard level. In illustration 1-4, the debt-to-assets ratio is calculated as following:
71% (from 23-Feb-08 to28-Feb-09)
(￡M)
Total Current liabilities
Total Non-current Liabilities
Total Assets
28-Feb-09
18040.00
15018.00
46053.00
It is clearly shown that the ratio is around 70%, which seems to provide a high risk in the capital structure of Tesco so that the debt level of Tesco is extremely high.
DEBT-TO-EQUITY RATIO
In long-term adequacy of capital structure, it was Pratt et al (2000) who said that potential creditors and investors may use the debt-to- equity ratio (total liabilities/total equity), comparing the relationship between total liabilities with total equity. In illustration 1-5, the debt-to-equity ratio is calculated as following:
2.54: 1 (from 23-Feb-08 to28-Feb-09)
(￡M)
Total Current liabilities
Total Non-current Liabilities
Total Equity
28-Feb-09
18040.00
15018.00
12,995.00
The recommended debt-to-equity ratio usually considers this ratio acceptable when it is between 1:1 and 3:1, depended on different industries.
EVALUATE THE FINANCIAL STRENGTH OF TESCO
To sum up the brief, despite there has been a significant rise in both current assets and non-current assets of Tesco during the five-year period (2005-2009), with an increase of ￡10,821 million and ￡15,077 million respectively, there are two critical aspects should be seriously concerned for modifying the capital structure of Tesco. The one is to provide a brief that there is enough immediate cash and near cash available to pay the current liabilities, based on an increase of the current ratio. The average current ratio of the industry, supermarket, is 0.6 as supermarkets usually have high inventories (Platt, 2004), comparing with the ratio of Tesco (0.78). The evidence shows that the Tesco's liquidity in the assessment of financial strength is general stronger than the others in the same industry. Another aspect highlighted is quick ratio; the ratio of Tesco is 0.63, compared with the standard 1.0. To increase of the quick ratio for modifying the capital structure is important in the assessment of financial strength of a listed company, if the quick ratio of Tesco is lower than 1.0, it would means that the cash supply of a company in the short-term is weak to afford current liabilities without selling inventory.
THE EVALUATION OF LEVERAGE AND FURTHER SUGGESTIONS
In terms of the debt-to-assets ratio of Tesco, following the result calculated is around 70%, which means its assets more through liabilities rather than equity. Also, the debt-to-equity ratio (254%) of Tesco is to present a high leverage in the assessment of financial strength of a company. Due to this, the solvency is concerned in weakness of the company's ability to continue the operation of Tesco in a long-term. Nevertheless, the further strategies of Tesco may make an increase of profits by improving in its management of inventory and reduce its debt in the long-term liabilities to optimise the leverage ratios for the further operating.
References
Haber, Jeffry R. (2003). Accounting Demystified, 21, P.145-146
Lerner, Joel & Cashin, James A. (1998), Schaum's Outline of Principles of
Accounting I, 2, P.21-25
Mott, Graham (2005), Accounting for Non-Accountants (6th Edition), 4, P.41-44
Perks, R. (2007), Financial accounting: understanding and practice, 1, P.276-278
Platt, Harlan D. (2004), Principles of corporate renewal (2nd Edition), 3, P.94-95
Pratt, Shannon P., Reilly, Robert F. & Schweihs, Robert P. (2000), Valuing a Business : The Analysis and Appraisal of Closely Held Companies (4th Edition), 8, P.132-151
Temte, Andrew (2005), Financial Statement Analysis, 2, P.74-77
Tiffin, Ralph (2004), Complete Guide to International Financial Reporting Standards:
Including IAS and Interpretation, 1, P.7
Vause, Bob (2005), Guide to Analysing Companies, I, P.vi-vii
Van Greuning, Hennie (2006), International Financial Reporting Standards : A
Practical Guide (4th Edition), 2, P.11-13
www.londonstockexchange.com- a published balance sheet about TESCO PLC CO
www.telegraph.co.uk- a history-of-Tesco-The-rise-of-Britain's-biggest-supermarket
