Critical Strategic Analysis of the 2016 Annual Report of Tesco PLC and the Financial Position of Benedict Co PDF

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This report aims at critically analyzing the Annual Report of Tesco PLC and the financial position of Benedict Co, based on the available financial data. ...

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Critical Strategic Analysis of the 2016 Annual Report of Tesco PLC and the Financial Position of Benedict Co.

Summative Assignment on

Strategic Financial Management

Submitted for Grading at The University of South Wales Department of Business and Society

Strategic Financial Management (AF4S31-V2-12302) Tutor: Dr Anna Kochanova

Authored By: John Olumide AGBEDE (MBA Student, ID: 74108206)

15th September, 2019.

Student ID: 74108206

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TABLE OF CONTENTS 1.0.

INTRODUCTION .................................................................................................3

2.0.

Corporate Strategic Financial Analysis of Tesco PLC..........................................3-4 2.1.

Tesco Stakeholder…………………………………………………………….4-5

2.2.

Corporate Governance, and Environmental and Social Review…………5-6 2.2.1. Tesco’s Corporate Responsibilities to Customers………………….6-7 2.2.2. Tesco’s Corporate Responsibilities to Employees…………………7-8

3.0.

Benedict Co. Financial Position Analysis……………………………..……….........8 3.1.

Financial Ratio Categories……….. ...........................................................9 3.1.1. Profitability Ratio……………………………………………………….9-110 3.1.2. Efficient Use of Resources……………………………………………10-12 3.1.3. Liquidity Ratio……………..……………………………………………12-13 3.1.4. Gearing Ratio……………………………………………………...........13-14 3.1.5. Investor Ratio…….……………………………………………………..14

4.0.

Conclusion and Recommendations…………………………………………….........14-15

References: …………………………………………………………………………………….16-18 Appendix: Table 1: Calculation of Benedict Co.’s financial ratios…………………………………….19-20

Student ID: 74108206

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1.0.

INTRODUCTION

This report aims at critically analyzing the Annual Report of Tesco PLC and the financial position of Benedict Co, based on the available financial data. Tesco, a British multinational groceries and general merchandise retailer headquartered in the United Kingdom, is a customer-centric company serving customers from their stores and online (Tesco, 2018), and “as one of the world’s largest retailers with 476,000 colleagues, we serve millions of customers every week in our stores and online” (Tesco, 2016 Annual Report). This report will only focus on Tesco’s stakeholders like customers, suppliers, and employees, and analyze their contributions to the company’s financial performance. Further analysis on how the Environmental and Social Review and the Corporate Governance Report help Tesco demonstrate its performance in terms of its corporate and social responsibilities will also be applied to two of the stakeholders.

However, in the case of Benedict Co., this report will focus on evaluating its financial position, analyzing a range of financial ratios to measure its financial performance. Benedict Co. is a “professional, experienced buyer and reseller of damaged cargo, abandoned freight, casualty losses and more” (Benedict Co., 2018). This report has shown how its very weak profitability increases the company’s liabilities and eventually put strain on its liquidity. 2.0.

Corporate Strategic Financial Analysis of Tesco PLC

The term stakeholder has passed the “tipping point” into common use (Gladwell, 2000) and the notion that key stakeholders must be attended to is an idea “in good currency” (Schon, 1971). Freeman and Reed (1983, p. 93) describe it as individuals, groups or organizations, on which

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an organization depends for survival, in agreement with Bryson (2003) who sees “stakeholders as individuals, groups or organizations that need to be taken into account by business leaders”. Similarly, Bourne, et.al (2008) explains that “stakeholders are the groups and persons who have interest in an organization”. Shawn (2017), however, argues that “although stakeholders have interest in the organization, they are not to be confused with shareholders who have an ownership interest in the company”. Some example of stakeholders, in this broader sense, is customers, creditors, employees, government agencies, shareholders, etc. Tesco, according to its annual report 2016, categorized its stakeholders into internal, external and connected stakeholders. These are customers, suppliers and its colleagues (Tesco, 2016, p.48, 53). Other stakeholders are also referred to as external stakeholders, including shareholders and environmental and social stakeholders (Tesco, 2017, p. 40,126). 2.1.

Tesco Stakeholders

The following categories of stakeholders are clearly indicated in Tesco’s 2016 Annual Report. 2.1.1. Employees Tesco (2016 Annual Report) categorizes the employees as internal stakeholders under Colleagues; a group of people it has invested in to better serve its teeming customers, who are responsible for the company’s surviving growth. Job satisfaction, enticing remuneration, job security, motivation and self-actualization are some of the factors that attract and retain quality employees in an organization. Tesco currently has 476,000 employees globally, offering very competitive benefits like Employee Share Schemes, additional discounts on merchandises, staff housing, etc, that make Tesco as an employer or choice (Tesco, 2016 Annual Report).

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2.1.2. Customers These are people or entities that buy the company’s products/services, or recommend the company to other shoppers. They are categorized as the company’s external stakeholders whose loyalty is defined by the frequency of shopping and their average weekly spend. “Tesco exists to serve customers – and our business model has customers at its core. We listen to our customers and act on what is important to them to deliver the best shopping trip: price, service, range and availability” (Tesco, 2016 Annual, 2016, p. 11). Suffice to say that good value for money through quality products/services, reliable services, good customer care and fair value, more meaningful connection with other people around them are some of the factors deployed by Tesco to retain the existing and win new customers.

2.1.3. Suppliers Tesco’s key stakeholders that belong to partnerships and are categorized under connected stakeholders. Receiving payments on invoices as at when due, receiving payments on loan amounts and interests earned, company’s credit rating, and timely supply and delivery which are required to solidify buyer-supplier relationship are not in short supply at Tesco PLC. 2.2.

Corporate Governance and, Environmental and Social Review

"The long-term profitability of the corporation generally depends on meeting the fair expectations of [stakeholder] groups" (Vasudev, 2012). Every business that must remain profitable is expected to clearly define its corporate governance rules and be sure to carry out the responsibilities thereto. Corporate governance being the aggregation of mechanism, processes and, relations by which corporations are controlled and operated, Tesco clearly spells out the way to achieve these in what they described as the “Big 6” while setting its KPIs,

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“We aim to serve shoppers a little better every day and have six simple, key business performance measures. On every KPI, we have made good progress. As a team, we are doing a better job for our customers and improving our relationships with our suppliers, whilst creating long-term sustainable value for shareholders” (Tesco, 2016 Annual Report, p.12). In support, the chairman, John Allan, had this to say, “During the past year, there has been a renewed focus on corporate governance and the Board has spent a significant proportion of its time examining and strengthening our processes throughout the Group. Having a solid governance framework is key to rebuilding trust and transparency” (Tesco, 2016 Annual Report, p. 5). However, Strives and Brenna (2017) think that “a central element of many corporate governance codes is the ‘comply-or-explain’ system”. Compliance to every detail of Corporate Governance code is required. On the Environmental and Social front, Tesco came up with the slogan “Every little help makes a big difference – it’s the value we live by to ensure we serve our customers, colleagues and their communities a little better every day” (Tesco, 2016 Annual Report). This approach is aimed at making it easier for both customers and colleagues to make healthier choices of reducing food waste wherever it occurs and tackle food poverty with any surpluses, and work with suppliers to source responsibly and develop sustainable supply chains, while ensuring social and environmental challenges affecting the communities where they operate in and source from are tackled (Tesco, 2016 Annual Report, p.22) 2.2.1. Tesco’s Corporate Responsibilities to Customers Dawkins and Lewis (2003) think that “across a wide range of sample of the public, the most commonly mentioned factors relate to corporate responsibility like treatment of employees,

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community involvement, ethical and, environmental issues”. The following captured in the Annual Report as the responsibility discharged to its customers which informed its performance:

 “Product team structure completely changed to focus on getting the offer right for customers and prioritizing sales and total profit over margin rate.

 Adding extra colleague hours on the shop floor to improve customer service;  Offering customers an immediate price match at the till with Brand Guarantee, so they never pay more for their branded shop;

 Launching a range of exclusive new fresh food brands, available at great prices;  Passion and commitment of colleagues in serving the customers have strengthened the progress towards building their trusts in Tesco’s brands

 Investing in 9,000 more customer-facing roles in store and reducing the total number of product lines by 18% to make frequently purchased product more available on the shelf remove inefficiencies in supply chain  Measuring customer satisfaction through the Customer Viewpoint Survey – a weekly measure that captures direct customer feedback in every store” (Tesco, 2016 Annual Report).

2.2.2. Tesco’s Corporate Responsibilities to Colleagues (Employees) Clarkson (1988) thinks “communications with employees; training and development; careerplanning; retirement and termination counseling; lay-offs, redundancies and plant closings; stress and mental health; absenteeism and turnover; health and safety; employment equity and discrimination; women in management; performance appraisal; day care” are some of the

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factors determining how an employee sees an organization. At Tesco, the following are some of the responsibilities discharged to the employees

 “Replacing their defined benefit pension scheme with a defined contribution scheme, thus providing sustainable benefits for colleagues;

 Colleagues are first to know of any transformational changes within the business that will affect them;

 Demonstrating diversity in the ratio of male to female colleagues at year end standing at 57% to female against men’s 43%, and reducing gender pay gap to less than 1%

 Developing risk metrics to assess potential human rights impacts, and a range of tools and KPIs to help it address and, if necessary, remedy any abuses, in close consultation with the Ethical Trading Initiative, NGOs and trade unions;  Introducing more flexible working, enhanced training and growth opportunities” (Tesco, 2016 Annual Report) 3.0.

Benedict Co. Financial Position Analysis

This part of the report involves using a range of financial ratios to analyze and evaluate its financial position in meeting the requirements of intending stakeholders. This takes consideration of data from the given financial statements for the years 20X0 and 20X1 and, literature reviews to help us in calculating and interpreting the financial ratios, their relevance, and demonstrating the overall financial status of the company while highlighting the aspects of performance that raise concerns.

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3.1.

Financial Ratio Categories

“Accounting ratios are considered a group of important metrics used to measure the efficiency and profitability of a company based on its financial reports while expressing the relationship between various financial data points. A ratio represents a relationship between two figures and can be expressed as a fraction (e.g. ½), a proportion (e.g. 0.5), a percentage (e.g. 50%) or as a pure ratio (e.g. 1:2)” (Scicluna, 2019, p.3) 3.1.1. Profitability Ratio Scicluna (2019) describes “Profitability ratios as a measure of profitability of a company in relation to sales or assets”. It is measured through a class of metrics that are used to assess a business's ability to generate earnings relative to its revenue, operating costs, balance sheet assets, and shareholders' equity over time, using data from a specific point in time. A higher profitability ratio relative to a competitor's ratio or relative to the previous period’s ratio is an indicator of an organization doing well financially. The following ratios combine to measure the profitability of a business concern. 3.1.1.1.

Return on Capital Employed ratio (ROCE)

Benedict Co. has a decrease in its profits before tax from $8.7M to $8.3M and an increase in capital employed from $33.9M to $40.0 which translates to a drop from 27.14% in 20X0 to 24% in 20X1, though an increase in sales happened. Nissim and Penman (2001), suggest “this status indicates that a company’s efficiency in using capital to generate profit has reduced”. Suffice to say that this means that the revenue per invested capital has reduced, which is a negative indication. This might be due to new investments into the company that might be expected to improve returns on multi-year term.

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3.1.1.2.

Net Profit Margin

A decrease in profits before taxes and interests has also negatively affected the net profit margin ratio; though an increase in sales by 23.69%, Benedict Co. experienced a drag down in net profit margin from 36.95% to 31.17%. Diacogiannis (1994) suggests that “a decrease in the Net profit Margin implies a reduction in the company’s ability to efficiently use revenues to generate profits”. 3.1.1.3.

Gross Profit

The Gross Margin sees a jump from 41.7% to 48.05% occasioned by a significant increase in sales revenue, but the Net margin declined from 36.9% to 31% as a result of cost of sales increase, thus affecting the revenue. There is an urgent need for the company to review its operating costs, and improve efficiencies of operation significantly. 3.1.1.4.

Net Asset Turnover

Net Asset Turnover ratio shows how efficiently Benedict Co. capital is used to produce its turnover. An increase of this ratio from 0.73 times to 0.77 represents 5.48% ratio increase, as a result of higher increase in sales than the capital employed. Scicluna (2019) interprets this movement “as the company’s slight improvement in its ability to efficiently generate revenues from the capital”. Though no indication of a problem, operational efficiencies needs to be enhanced to improve the situation substantially. 3.1.2. Efficient Use of Resources “Efficiency ratios are used by investors to measure how efficiently a company uses its shortterm assets and liabilities” (Scicluna, 2019). It combines the ratios below.

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3.1.2.1.

Stock days

Stock Days shows the number of days the company holds its inventory before selling or converting it. For Benedict Co., we see an increase from average of 65 to 118 days, indicating that the selling or conversion process is hindered for some reasons, far from average industry standard of 60 days. This means that Benedict Co. has not been able to “accelerate stock trading and has moved away from the inventory days of its industry” (Edwards, 2003). 3.1.2.2.

Debtor days

An indicator of how many days (average) the debtor use to pay the company. This number increased from 55.7 to 90.06 days. That is, debtors need 34.36 extra days to pay the company, representing an increment by 62.66%. This is showing a delay in revenue collection, which negatively impacts the cash flow; keeping in mind that industry average number of days is 55 days. On-time issuance of invoices and renegotiation of trade receivable days with debtors may be necessary 3.1.2.3.

Creditor days

This is another measure that impacts cash flow. Benedict Co. increased its average period for paying its creditors by 46.89 days from 108.24 days to 155.13 days; this isn’t particularly bad, but the industry standard is 90 days, meaning suppliers may refuse to supply the company due to its long creditor period. A complicated financial position for Benedict Co. that seeks a mutual understanding and resolution between it and the suppliers.

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3.1.2.4.

Cash Conversion Cycle

This ratio gives idea of the length of time it takes the company to generate cash from operations. For Benedict Co., we see an increase from an average of 13days to 54days; indicating extra 41 days will be required to turn stock into cash. This suggests a high level of underperformance that requires urgent corrective action. 3.1.3. Liquidity Ratio “This ratio measures the short-term liquidity or solvency of a company” (Scicluna, 2019, p. 3); an important metrics used to determine if the company can pay off current debt

obligations without raising external capital. This combines the following ratios. 3.1.3.1.

Current ratio:

This ratio sees a decrease from 1.25 in 20X0 to 1.19 in 20X1, representing 4.8% fall, while the industry average stands at 1.6. This movement might be due to lower increase of 100% in the company’s current assets which, compared to its higher increase of 111% in current liability. If

this drop continued over the years, Benedict Co. might not have the capital to meet its short-term obligations, which might lead to significant problems, or even bankruptcy. 3.1.3.2.

Quick ratio

Similar to current ratio, except that it’s a shorter-term measure of liquidity . It sees a decrease by 0.05 times from 0.75 times to 0.70 times, while the industry average is 1.0. This decrease means a higher risk for Benedict Co., suggesting that it may not be able to hedge short-term liabilities from its short-term assets, thus straining its liquidity. Diacogiannis (1994)

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argues that: “the company's ratios in 20X1 and 20X0 were below industry levels ” because, while the industrial quick and current ratios are respectively 1 time and 1.6 times, Benedict Co.’s ratios are far lower, thus confirming the limitation of its liquidity. This situation has the potentiality of discouraging potential investors and existing partners. 3.1.4. Gearing Ratio “A group of ratios that measure the relationships between long-term debt and equity” (Scicluna, 2019, p. 3); a measurement of the company’s financial leverage, which demonstrates the degree to which the company’s activities are funded by shareholders' funds versus creditor's funds. 3.1.4.1.

Capital Gearing Ratio

The Gearing ratio sees an increase from 23.60% to 30.00%, a difference of 6.4%. This is explained by the company’s higher increase in its long-te...