Financial Decision Making

This report explores the role of accounting and finance in financial decision making, with a focus on Tesco. It discusses the functions of finance and accounting, and evaluates their critical role in the organization. The report also calculates five different ratios and provides a commentary on the financial performance of Tesco. Get study material and solved assignments on financial decision making at Desklib.

Financial Decision Making

Contents
INTRODUCTION...........................................................................................................................1
TASK 1............................................................................................................................................1
Critically evaluating the role of accounting and finance.............................................................1
TASK 2............................................................................................................................................3
Calculating the five ratios and commenting on the performance of Tesco.................................3
CONCLUSION................................................................................................................................8
REFERENCES..............................................................................................................................10

INTRODUCTION
Financial decision making is a procedure of analysing the financial performance of an
organisation by evaluating its financial information so that reliable decisions can be taken. This
process is related with financial analysis and performance evaluation of an organisation
(Agarwal and Mazumder, 2013). The main aim of this report is to build an understanding about
the financial aspects of an organisation which can help an investor to invest in a company. For
this purpose, a large scale retail organisation is selected which is Tesco. This is one of the best
supermarket retail organisations in United Kingdom established in the year 1919 and has
headquarters in Welwyn Garden City, England.
In this report, the functions of finance and accounting are analysed along with their critical
evaluation in order to explore their role in Tesco. In second task of this report, annual report of
Tesco is considered and then five different ratios are calculated. After the calculation, all these
ratios are used to provide a commentary on the financial performance of selected company from
the perspective of an investor.
TASK 1
Critically evaluating the role of accounting and finance
The term “finance” refers to the concept of analysing every financial transaction which is
conducted and processes by an organisation. Finance is a wider concept which includes
accounting. “Accounting” is a procedure of recording and analysing the transactions which an
organisation conducts in an accounting year.
The concepts of finance and accounting play various roles in an organisation. In context of
the selected organisation that is Tesco, role of these concepts are analysed below:
Budget & Budgetary Control: Budgetary control refers to the process of determination of
actual performance as compared to the standard or the budgeted performance. Budgetary control
is one of the key roles of accounting and finance function (Du and Zhou, 2012). It helps the
organisation to determine whether the business operations are directed towards the achievement
of organisational goals or targets. For example, in context of Tesco Ltd., accounting and finance
department has the responsibility to prepare budgets related to various departments and measure
the actual performance with the budgeted performance.
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Capital budgeting and investment appraisal: Ascertaining the profitability of any
investment opportunity and helping the management to choose the best alternative for capital
investment is another important role of finance department. It is the duty of finance managers of
the company to make sure that the funds of the organisation are being used optimally and all the
investments are made only after a thorough risk analysis.
Preparation of financial statements: One of the most important functions of accounting
and finance department is preparation of financial statements which helps the management to
determine the financial position of the company and examine any shortcomings in the financial
results obtained during any period. Preparation of financial statements helps in using various
tools such as ratio analysis which provide a better picture of the organisational performance. In
Tesco Ltd, various financial statements are analysed to understand the current financial position
of the company and the debt structure as well.
Handling tax issues- Accounting and finance department plays a crucial role in meeting
the tax requirements of the company. Evasion of tax is illegal and any fault in adhering to the tax
rules of the government can result into a huge amount of penalties charged to the organisation by
the tax department. Thus, it is very essential for the finance and accounting department to make
sure that all the tax rules are duly complied with.
Cost control- It is the duty of the finance and accounting managers of any organisation to
make policies and strategies which help in reduction of costs related to production, inventory
management, supply chains, distribution process etcetera (Koropp and et.al., 2014). Finance
department actively engages itself in classification of costs according to the return obtained by
incurring that cost or expenditure. It helps the business to achieve optimum utilisation of
resources. Any expenditure which is not fruitful and doesn’t yield any result for the organisation
is classified as waste expenditure by the finance department to help reducing costs and increasing
profit margin.
Managing cash flow- Working capital is very important for any business organisation to
ensure smooth functioning of its day to day business activities. Accounting and finance
departments make sure that there is enough cash flow within the organisation to meet the
working capital requirements and payment of any current liabilities. It helps the organisation to
execute the activities related to production and manufacturing of goods and services without any
hindrance (Kramer and Weber, 2012). The finance manager of Tesco ltd. makes sure that enough
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working capital flows in the organisation for procurement of materials and meeting fixed
expenses of the company.
Inventory management – the concepts of accounting and finance helps in keeping a record
of inventory using methods such as FIFO or LIFO. In context of Tesco, this company is a retail
organisation which procures goods from suppliers and then retails them to end consumers. In this
process, it is important for this organisation to effective manage their inventory so that the threat
of theft and damage can be eliminated.
Effective decision making – The concepts of finance and accounting helps in the procedure
of developing financial statements and then analyse them using the methods such as ratio
analysis. By these methods, all stakeholders of Tesco can effective decide about the operations
and functions of the company.
Apart from the all positive roles of accounting and finance, there are few negative roles of
these concepts as well analysed below:
Time consuming – The process of accounting is a complex procedure which involves
various steps such as identifying of transactions, vouching, recording, analysing and exploring.
In order to complete all these steps, ample time is required. Tesco is a large scale organisation
which has huge number of transactions every day and in order to record them all, ample time is
acquired.
Highly skilled employees required – Another negative role which the concepts of
accounting and finance play is that the procedure of accounting requires highly skilled
employees. In order to develop an organisation’s finance statements which are appropriate
aligned with all the financial standards is a complex task which requires skills. Tesco is a large
company which can afford the wages of skilled employees but such employees are difficult to be
found.
From all the points above, it can be said that the concepts of finance and accounting plays an
important role in an organisation. It has been also analysed that along with various positive roles,
there are few negative roles as well which are played by these concepts.
TASK 2
Calculating the five ratios and commenting on the performance of Tesco
RETURN ON CAPITAL EMPLOYED
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This is a financial ratio which helps in measuring the company’s profitability state and
the efficiency which company has while spending its capital (Kubilay and Bayrakdaroglu, 2016).
This ratio is used to by the various stakeholders, especially investors to explore the state of the
company. This ratio is calculated in a percentage form and by comparing total earnings of a
company which they have earned before paying interest and tax and capital employed. In context
of Tesco (Annual report of Tesco 2018-19, 2019), ROCE is calculated below:
(All amount in million pounds)
Formula: Operating profit / capital employed *100
2018 2019
Operating profit 1839 2153
Total Assets 44884 49047
Current liabilities 19,233 20,680
Capital employed 25651 28367
Calculation 1839 / 25651 * 100 2153 / 28367 * 100
Return on capital employed 7.16% 7.58%
Comment: As ROCE is an indicator of profitability; higher this ratio, better the ability of
an organisation to earn profit is (Lichtenberg, Ficker and Rahman-Filipiak, 2016). From the
above computation, it has been observed that ROCE of Tesco is improving by passing time as in
the year ROCE is computed has 7.16% which increased to 7.58% in 2019. There are various
reasons behind this enhancement of ROCE. Due to increasing efficiency, Tesco is successful in
reducing their operating expenses due to which their operating profit has been increased. Also
increase capital employed is also a cause of this improving ratio. Human resource and strategic
team of Tesco has been improved in effectively utilising their capital instead of wasting it all on
their operations.
This ratio will affect the profit making ability of this company. Due to this investors will
consider investing in the stocks of this company that will lead to enhanced brand equity and
sustainable growth.
NET PROFIT MARGIN
This ratio is a financial metric which represents the profit making ability of an
organisation after paying off all the expenses, interest and taxes. This ratio is calculated in the
form of percentage and is computed by divided the total revenue earned by an organisation in an
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accounting year and net profit earned (Lu, Won and Cheng, 2016). It is considered that
increasing net profit margin of a company indicates its ability to earn effective profit. It is
important to calculate NP margin as it is considered as a measure of overall success of an
organisation. Net profit margin using the financials of Tesco of two years is computed below:
(All amount in million pounds)
Formula: Net profit / Net sales *100
2018 2019
Net profit 1,210 1,320
Net sales 57,493 63,911
Calculation 1,210 / 57,493 * 100 1,320 / 63,911 * 100
Net profit margin 2.10% 2.06%
Comment: From the above calculation, it has been observed that Tesco is experiencing
difficulty in improving their net profit margin as a slight reduction has been seen in this ratio. NP
margin in year 2018 is computed as 2.10% which reduced to 2.06% in 2019. It should be
considered that the decrease in the NP margin of both the years is negligible but such small
difference can also cause a huge difference. From the income statement and notes of financial
statement of this company, the reason of reduction has been analysed. It has been observed that
this company has been successfully increased their level of sales revenue but due to increased
taxation and interest, the net profit of this company could not be increased at a level which was
anticipated.
This reduced net profit margin can affect the financial position of Tesco. From an
investor point of view, reduced NP margin is an early sign of deficiency of surplus. But by
exploring the current business environment of Tesco, it can also be said that due to the economic
policy of BREXIT, the NP margin of Tesco has been decreased as this company now has to pay
higher interest and taxation while procuring products for retail purpose from Europe.
CURRENT RATIO
This ratio is a part of liquidity ratios which helps in analysing the liquidity position of a
company. Current ratio acts as a financial metric which represents the ability of a company to
pay their short term debt obligations (MacLean and Ziemba, 2013). This ratio is calculated by
dividing current assets with current liabilities. This ratio tells investors that the company is
capable enough to provide them returns after paying off all the current liabilities or not. For the
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retail supermarket industry, the ideal current ratio is considered as 2:1 which says an
organisation has enough current assets to pay off their current liabilities (Tang and et.al., 2014).
Using the balance sheet of Tesco of 2018-19, current ratio is computed below:
(All amount in million pounds)
Formula: Current assets / current liabilities
2018 2019
Current assets 13,749 12,668
Current liabilities 19,233 20,680
Calculation 13,749 / 19,233 12,668 / 20,680
Current ratio 0.71:1 0.61:1
Comment: From the above financial analysis of current ratio, it has been observed that
the current ratio of Tesco is continuously decreasing that is from 0.71:1 in 2018 to 0.61:1 in
2019. As the ideal current ratio of Tesco is 2:1, the situation of this company must be aligned
with enhancing current ratio and not the decreasing ratio. There are various causes of this
reduction in current ratio which are identified from balance sheet of this company and the
director’s report. It has been seen that Tesco is unable to procure cash from the customers who
were given credit due to which the amount of net receivables has been reduced which is the
major reason behind low current assets and low current ratio. Another ratio analysed is the
current dynamic industry of United Kingdom in which debtors are facing issues while repaying
their amount. In this situation Tesco is unable to procure amount from its debtors, ue to which
they are experiencing low funds situation due to which they are unable to further pay their short
term obligations.
From an investor point of view, current ratio may or may not have an impact as investors
are provided returns from the profits and they are not counted as current debt obligations. But
due to this reduction in CR, brand image of this company may get impacted.
AVERAGE RECEIVABLE DAYS/ DEBTORS COLLECTION PERIOD
This ratio helps in analysing the ways in which an organisation is capable of collecting
the amount which they have provided to be their debtors (Nga and Yien, 2013). In the case of
Tesco, the debtors are the customers who were allowed to purchase products of this company on
credit basis due to which it is expected that the debtor’s collection period will be short as no
company will allow their customers to purchase goods on credit for a longer time period. It is
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considered then less this ratio is, effective company’s position in market is. Using the sales
revenue procured from income statement and trade debtors procured from balance sheet, this
ratio is calculated below:
(All amount in million pounds)
Formula: trade debtors / revenue * 365
2018 2019
Trade debtors 1,504 1,640
Revenue 57,493 63,911
Calculation 1,504 / 57,493 * 365 1,640 / 63,911 * 365
Debtors collection period 9.54 days 9.36 days
Comment: From the above financial analysis of this ratio, it has been analysed that
financial performance of Tesco is improving. The debtor’s collection period which is computed
above represents that in year 2018, Tesco was able to procure their amount from their debtors in
9.54 days which reduced in 2019 as 9.36 days. As a day cannot be divided in decimals but it this
exact calculation presents that the ability of collecting the amount is improving. There are
various causes of this improvements; one of the major cause is change in the policies of Tesco
which state that as the revenue of this company is improving, the policies must be reviewed
again.
This improved ratio will have the impact on its brand image and equity by which
investors will be satisfied to invest in this company. From the perspective of an investor,
investors will think that Tesco is capable of procuring their debt amount effectively which means
they can provide returns on time.
AVERAGE PAYABLE DAYS/ CREDITORS COLLECTION PERIOD
This ratio represents the time period in which Tesco is able to pay off their creditors. In
the context of Tesco, the creditors are the suppliers from which goods are procured by Tesco for
smooth functioning (Patel and et.al., 2012). According to the Tesco policies analysed from their
annual report, Tesco pay off their suppliers when most of their goods are sold due to which the
creditor’s collection period is greater than debtor’s collection period. Using the trade payables
from balance sheet and cost of sales from income statement, this ratio is calculated below:
(All amount in million pounds)
Formula: trade payables / cost of sales * 365
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2018 2019
Trade payables 8,994 9,354
Cost of sales 54,141 59,767
Calculation 8,994 / 54,141 * 365 9,354 / 59,767 * 365
Creditors collection period 60 days 57 days
Comment: From the above analysis, it has been observed that according to creditor’s
collection period, the financial performance of this company is improving. As it can be seen in
2018, the creditor’s collection period was 60 days which decreased to 57 days in 2019. This
reduction of this ratio is portraying the effectiveness of this company in paying of their creditors.
There are various reasons of this improvement. As the cost of sales of this company is
increasing, it is responsibility of this company to pay off their creditors faster.
This improvement can have a positive impact on this company. When suppliers in retail
industry will come to know that this company is more effective in paying back their credited
amount then they all will pitch to supply their goods to Tesco will which provide them a
competitive edge (Seshan and Yang, 2014). This competitive advantage will further help in
enhancing brand image and profitability of this company. All these effects are positive signs for
an investor to invest in this company.
The above financial analysis was conducted for the purpose of analysing the financial
performance of Tesco. From the above analysis it can be said from an investor’s point of view
that this company is suitable to be invested in long run as they are capable of earning high profits
and also capable of effectively utilising their employed capital. This company is facing few
issues while paying of their current debts, but these will not impact its suitability of an
appropriate organisation for investments.
CONCLUSION
From the above report, it has been concluded that the functions of accounting and finance
are vital for an organisation as it helps in analysing their financial performed. It has been found
from this report that the most important role of these functions is that they help in capital
budgeting and assists in the procedure of handling taxation. From the financial analysing using
ratios, it has been summarised that this company is appropriate for investment purposes as they
are able to earn high operating profit and also effective use their capital employed. Few issues
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gained from this analysis are the difficulties which this company face due to current business
environment of United Kingdom.
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REFERENCES
Books and Journals
Agarwal, S. and Mazumder, B., 2013. Cognitive abilities and household financial decision
making. American Economic Journal: Applied Economics. 5(1). pp.193-207.
Du, J. and Zhou, L., 2012. Improving financial data quality using ontologies. Decision Support
Systems. 54(1). pp.76-86.
Koropp, C. and et.al., 2014. Financial decision making in family firms: An adaptation of the
theory of planned behavior. Family Business Review. 27(4). pp.307-327.
Kramer, L.A. and Weber, J.M., 2012. This is your portfolio on winter: seasonal affective
disorder and risk aversion in financial decision making. Social Psychological and
Personality Science. 3(2). pp.193-199.
Kubilay, B. and Bayrakdaroglu, A., 2016. An empirical research on investor biases in financial
decision-making, financial risk tolerance and financial personality. International Journal
of Financial Research. 7(2). pp.171-182.
Lichtenberg, P.A., Ficker, L.J. and Rahman-Filipiak, A., 2016. Financial decision-making
abilities and financial exploitation in older African Americans: Preliminary validity
evidence for the Lichtenberg Financial Decision Rating Scale (LFDRS). Journal of elder
abuse & neglect. 28(1). pp.14-33.
Lu, Q., Won, J. and Cheng, J.C., 2016. A financial decision making framework for construction
projects based on 5D Building Information Modeling (BIM). International Journal of
Project Management. 34(1). pp.3-21.
MacLean, L.C. and Ziemba, W.T., 2013. Handbook of the fundamentals of financial decision
making (Vol. 4). World Scientific.
Nga, J.K. and Yien, L.K., 2013. The influence of personality trait and demographics on financial
decision making among Generation Y. Young Consumers.
Patel, S.R. and et.al., 2012. Single-neuron responses in the human nucleus accumbens during a
financial decision-making task. Journal of Neuroscience. 32(21). pp.7311-7315.
Seshan, G. and Yang, D., 2014. Motivating migrants: A field experiment on financial decision-
making in transnational households. Journal of Development Economics. 108. pp.119-
127.
Tang, F. and et.al., 2014. The effects of visualization and interactivity on calibration in financial
decision-making. Behavioral Research in Accounting. 26(1). pp.25-58.
Online
Annual report of Tesco 2018-19. 2019. [Online]. Available through:
<https://www.tescoplc.com/media/476422/tesco_ara2019_full_report_web.pdf>
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