Analyze Financial Statements: Ratio Analysis of Tesco and Morrison

To prepare financial statements in accordance with Generally Accepted Accounting Principles (GAAP), one should carefully consider the specific items included in the income statement for companies versus partnerships and sole traders. For instance, companies may include various items such as depreciation, amortization, and interest expenses, whereas partnerships and sole traders may only have limited items such as profit sharing among partners or owners. Moreover, ratio analysis is a crucial tool for evaluating firm performance, including metrics like gross profit ratio, net profit ratio, current ratio, quick ratio, creditor turnover ratio, and debtor turnover ratio. By analyzing these ratios, managers can identify areas of improvement, control costs, and make informed business decisions.

MANAGING FINANCIAL
RESOURCES AND DECISIONS

INTRODUCTION
There are number of factors that play an important role in restricting growth of the
business firm. Finance is the one of the main factor that to great extent influences firm
profitability. In the present report sources of finance are discussed in detail. Along with this its
implications are also described briefly. In middle part of the report, appropriate source of
finance is selected for the business firm. along with this, budget is also prepared and its results
are interpreted in proper way. In end of the report, ratio analysis is done and financial
statements are discussed in detail. Along with this viability of the projects are measured and
best one is selected for the company.
TASK 1
ASources of finance available to the business firms
Every business firm wants to expand its business and to do same it needs finance. When
there is a scarcity of the cash in business firms make use of various alternatives to arrange
finance for the business. Some specific sources of finance are explained below.
 Equity: Equity is financial source which is often preferred by the most of the business
firms. This is because heavy amount finance can be raised through this source of finance
(Haugen, 2011). Cost can be adjusted by the company and due to this feature equity is
preferred by most of business firms.
 Debt : Equity cannot be issued excessively by the business firms. Hence, after using
equity most of business firms raise finance from debt. In this regard firms take loan from
banks or they issue debentures in the market. In both cases it needs to pay interest to
creditor.
 Lease: Lease is another financial source which is used to meet long term and short term
finance needs in respect to the specific asset. Rent amount is paid to the owner of the
property. When firm is not able to purchase the asset it makes use of lease to obtain asset.
 Retained earnings: It is the part of the sales that remain after deducting all expenses from
the revenue amount (Tierney and et.al., 2011). This source of finance is used by most
firms because there is finance cost for mentioned source of finance.

B Implications of the source of finance
Sources of
finance
Financial Legal Bankruptcy Dilution of
control
Equity Dividend is paid
to the
shareholders out
of the revenue
amount. It is
not necessary to
pay dividend to
the shareholders
every year
(Mehrling and
Brown, 2011).
In order to issue
shares it is
necessary to
obtain approval
from the
regulatory body.
In case firm get
bankrupt
creditors will
receive debt
amount.
Thereafter,
residual will be
used to make
payment to the
shareholders.
Control diluted
in case shares
are issued in
the market.
Debt Firm needs to
pay interest in
each and every
situation
whatever
amount of the
profit earned by
the firm in the
specific year
does not matter.
Needs to submit
copy of the
financial
statements to the
bank in order to
obtain debt from
the financial
institute.
As mentioned
above.
Control does
not get diluted/
Lease Rent amount is
paid on the
leased asset to
the lessor.
Necessary to
follow all terms
and conditions
that are
mentioned in the
contract which
As mentioned
above
Same as of debt

is signed with
other entity
(Gatti,, 2013).
Retained
earning
There is no cost
of this source of
finance.
No legal
implications.
In case of
bankruptcy
retained earning
is used to make
payment to
creditors.
Same as of
debt.
C Appropriate source of finance for the business
Every business has its own needs in terms of finance. Need of the finance in the business
depends on the size of the business operations and the firm future business plans. Equity is not
best source of finance for the Radisson plc because in current time period market conditions
are unstable. There is high probability that IPO bring by the firm may remain unsubscribe
from side of the investors. In such kind of situation Radisson may failed to raise required
amount of finance from various sources (Greenwood and Scharfstein, 2013). Apart from this
cost of finance is also very high in case of shares then debt. Hence, issue of shares is not
appropriate source of finance for the business firm. Debt is assumed as best source of finance.
This is because in this source of finance control of the existing shareholders on the firm does
not get diluted. Apart from this, cost of debt is lower than equity. However, it is necessary to
pay interest to the bank every year irrespective of profitability. Lease and retained earnings
are best source of finance because by using same short term finance needs of the business can
be meeting easily. Hence, it can be said that apart from equity all other sources of finance are
appropriate for the firm.
TASK 2
A Analyze cost of different sources of finance
Cost of varied financial sources is explained below. Equity: Dividend is paid the owners of the business firm and it is finance cost of the
mentioned source of finance. It is not necessary for the business firms to pay dividend

each year to the shareholders (Chen, 2012). Thus, at its own discretion company can take
decisions in respect to finance cost in equity. Debt: Finance cost of debt is the interest that is paid by the firm to its shareholders.
Finance cost which is interest must be paid by the firm to the creditors every year but its
amount can be fluctuating. In this regard business firm can take debt at floating rate from
the market. However, risk is very high in case of mentioned sort of interest rate. Due to
this reason decision in respect to floating interest rate must be taken cautiously by the
business firm. Lease: Lessor paid rent amount to the lessee and it is finance cost of lease. Amount that
will be paid as lease is determined in the contract that happened between two entities
(McLean, Zhang and Zhao, 2012). Terms and conditions of the contract also determined
the cost of lease. Retained earnings: Opportunity cost is assumed finance cost of retained earnings. It
indicate the benefit that one cannot obtain in case other best use of the asset is not made in
the business. Apart from this there is no other finance cost of retained earnings.
B Importance of financial planning
In current time period most of the business firms are facing similar problem in there is
business which is scarcity of finance. Apart from this second problem in the business is to
make effective use of funds in the day to day operations. In order to solve this problem
financial plan is prepared by the firm for its business. Under financial plan expenditure that
will be made within certain limit are determined. Means that by preparing a financial plan
effective use of cash is done that is already available in the business. Radisson plc can prepare
its own financial plan under which 60% amount can be allocated to the production department
for software development and research (Bachelier, 2011). 20% amount of the entire budget
can be allocated to meet day to day finance needs. Along with this, 20% amount can be
further keep aside for making investment in the safe heavens. By doing so on relevant amount
some appreciation can be made in terms of the value and can be converted in cash when funds
will be required for the business operations. In this way financial plan help Radisson plc in
making effective use of cash in the business.
C Information needs of different decision makers
Different stakeholders of the business firm are explained below.

 Shareholders: Before making an investment everyone intends to confirm that same is
made at the right place. Those who already make an investment remain interested in
knowing whether same will remain worthwhile for future. This is the reason due to which
shareholders needed firm financial statements and annual reports. On the basis of these
statement and reports investors come to know about organization performance and they
make their investment related decisions. Creditors: Creditors needed financial statements because while giving a credit they are
always interested in knowing the days in which firm is paying amount to the other
creditors. Analysis of the financial condition of the business firm further helps creditors in
making prudent decisions. Managers: Managers are those who prepare strategy for the business firm. It is the
financial statement that helps them in identifying weak areas. By working on these weak
points managers improve organization performance. Government: It requires financial statements of the company. This is because firms pay
tax to the government and by using financial statements latter entity ensured that right
amount is paid as tax its department.
D Impact of finance on the financial statements
There are two main sources of finance which are debt and equity. The impact of these
sources of finance on the financial statements is explained below.
 Equity: When shares are issued by the firm shareholder equity enhance in the firm balance
sheet. On other hand, current asset side of the balance sheet also elevate because cash is
received in the business (Ahn, Amiti and Weinstein, 2011). It can be said that due to issue
of shares both assets and liability section of balance sheet increases. When shares are
issued by the firm divided is also paid to the shareholders at end of the year. That dividend
amount is deducted from the revenue. In this way income statement also get affected by
equity.
 Debt: In case of debt also long term loan amount increased in the liability section of the
balance sheet. Similarly, equity side of the balance sheet gets enhanced in terms of
elevation in current assets. On other hand, interest is paid on the debt and due to this
reason profit of the company decline in the income statement.

TASK 3
A Cash budgets and sales budget for business firm
Table 1 Computation of cash budget
December January February March April May
Opening balance 10000 43500 85100 135200 188800
Sales 50000 55000 65000 75000 80000 85000
Total 50000 65000 108500 160100 215200 273800
Expense
Purchase 5000 5200 5700 5900 6000 6200
Salary 12000 13000 14000 15000 16000 17000
CAPEX 20000 0 0 0 0 0
Creditors 3000 3300 3700 4000 4400 4700
Total 40000 21500 23400 24900 26400 27900
Net balance 10000 43500 85100 135200 188800 245900
Interpretation
Budget is the statement in which cash inflow and outflow are determined by the
manager. There is a great importance of the budget because by using same firm can maintain
stiff control on its expenses. Moreover, on the basis of budget targets are set of the entire
workforce. This thing motivates employees to work hard for business. There is a great
importance of the budget variance because it reflects the extent to which firm perform well or
bad. Areas where company needs to make improvement are easily identified by using budget.
Hence, budget have due importance for the firms.
B Calculation of unit cost
Table 2 Computation of unit cost
Fixed cost 50000
Variable cost 90000
Total cost 140000
Number of units 500
Per unit cost 280
Mark up percentage 30%
Sales price 364
Interpretation

Unit cost is computed by following a specific approach. Under this fixed and variable
cost are added and divided by the number of units produced at the workplace. By doing so per
unit cost is computed. Cost plus margin method is used to compute product sales price. Under
this margin percentage is added to the per unit cost. In this way sales price is calculated.
C Project evaluation method
Table 3 Calculation of payback period
Project A Project
B
Initial
investment
-
160000
-
160000
1 50000 -
110000 55000 -
105000
2 53000 -57000 63000 -42000
3 60000 3000 73000 31000
4 67000 70000 77000 108000
5 77000 147000 83000 191000
6 87000 234000 88000 279000
Interpretation
This method is commonly used by project management experts in order to find out
days in terms of years that can be taken by the project to cover cost (Wells, 2013). Both
projects cover investment in 2 years. Hence, none of them is assumed viable for the firm
Table 4 Calculation of ARR
Project A Project
B
Initial
investment 160000 160000
1 50000 55000
2 53000 63000
3 60000 73000
4 67000 77000
5 77000 83000
6 87000 88000

Total 394000 439000
Average 65666.6667 73166.
7
ARR 41% 46%
Interpretation
In order to select most profitable project it is necessary to identify to estimate average
gain that can be earned on the project. ARR of project B is high and due to this reason it is
assumed profitable for the firm.
Table 5 Calculation of NPV
Project A Pv
@10%
Present
value
Project
B
PV
@10%
Present
value
Initial
investment 160000 160000
1 50000 0.909 45450 55000 0.909 49995
2 53000 0.909 48177 63000 0.909 57267
3 60000 0.909 54540 73000 0.909 66357
4 67000 0.909 60903 77000 0.909 69993
5 77000 0.909 69993 83000 0.909 75447
6 87000 0.909 79083 88000 0.909 79992
Total 358146 399051
NPV 198146 239051
Interpretation
NPV is the method that is most popular among the project managers. In this method
value of the project is computed which remains after subtracting cash outlay from the present
value of the cash inflows. NPV reflects net value of the project and in present case its value is
high in case of project B (Finance and Zwerman, 2015). Hence, mentioned project is assumed
profitable for the firm.
Table 6 Computation of IRR
Project A Project
B

Initial
investment -160000 -
160000
1 50000 55000
2 53000 63000
3 60000 73000
4 67000 77000
5 77000 83000
6 87000 88000
IRR 29.83% 35.35%
Interpretation
This method help project manager on computing actual return that can be gained on
the project. IRR of project B is high in terms of actual return. Hence, project B is assumed
viable for the firm.
Way in which project evaluation methods are used to determine whether project must be
accepted or rejected.
 Payback period: Number of years taken by the project to cover investment amount out
of entire life of project is considered by the project managers to accept or reject
specific project.
 Average rate of return: In case of ARR firm compare average return of two projects.
In case there is a single project then standard ARR is compared to compute ARR and
on the basis of results of comparison specific project is selected by the project
managers.
 NPV: NPV of both alternatives are compared to select any project on the basis of
NPV. Firm can also use standard value of NPV to select project.
 IRR: In this case firm determine the actual rate of return that it intends to earn on the
project. If IRR which is calculated is higher than determined value of IRR project is
selected or vise verse.
TASK4
A Financial statements of the business firms
Financial statements that are prepared by the most business firms are given below.

 Income statement: This statement is prepared by all sorts of business firms. This is
because it is the statement which depicts the profitability of the business firm (Ross,
2011). In the income statement income and expenses are recorded and by using them
profitability of the business firm is ascertained.
 Balance sheet: This statement is prepared in order to obtain information about the
financial position of the business firm at end of the year. Balance sheet is used in the ratio
analysis which is used to measure firm performance.
 Cash flow statement: It is the statement which is used to find out the way in which
business firm receive cash in its business and spend same (Helleiner, 2010). The cash
inflow and out flow reflected by the cash flow statement is used to formulate cash
management strategy for the business firm.
B Format of the financial statements
Figure 1 Balance sheet of partners
(Source: Hong and Kostovetsky, 2012)

Figure 1 income statement of partners
(Source: Kocherlakota, 2010)
Sole trader
Figure 2 Income statement of sole trader
(Source: Platen and Bruti-Liberati, 2010)

Figure 3 Balance sheet of sole trader
(Source: Visser, 2013)
Company

Figure 4 Income statement of company
(Source: Frieden, 2015)

Figure 5Balance sheet of company
(Source: Ehrhardt and Brigham, 2016)
On comparison of the financial statements of the sole trader, company and partners it
can identify that there is minor difference between same. Some key points are as follows.
 In case of partnership and sole trader financial statements can be prepared without
following GAAP (Baker, Singleton and Veit, 2011). However, in case of company it is
inevitable to follow rules of GAAP while preparing financial statements.
 In case of company so many items are included in the income statement. On other
hand, in case of partnership and sole trader few items are encompassed.

 Profit is not shared in case of sole trader and company. Contrary to this, in case of
partnership profit and less is split among the relevant number of partners.
C Ratio analysis
Table 7 Ratio analysis of Tesco and Morrison
Morrison Tesco
Gross profit 761 -2112
Net sales 16816 62284
Gross profit ratio 5% -3%
Net profit -761 -5741
Net sales 16816 62284
Net profit ratio -5% -9%
Current assets 1144 14828
Current liability 2273 19714
Current ratio 0.5 0.75
Current assets 1144 14828
Stock 658 2957
Prepaid expenses 0 0
Current liability 2273 19714
Quick ratio 0.214 0.602
Purchase 15505 51579
Creditor 1397 4545
Creditor turnover
ratio 11 11.34
Debtor 151 5574
Sales 16816 62284
Debtor turnover ratio 111.364 11.174
Interpretation
 Gross profit ratio: Gross profit ratio is one of the important ratios because it is used to
measure the effectiveness of the firm cost control strategy (Bäuerle and Rieder, 2011). If
gross profit ratio increased then it means that relevant strategy is working out. On other
hand, gross profit ratio decrease then it reflects relevant strategy is not implemented in

proper manner. It can be seen that gross profit ratio of Morrison is higher than Tesco.
Hence, it can be said that Morrison perform better then Tesco.
 Net profit ratio: Net profit ratio is negative in case of both firms. Net profit ratio of Tesco
is -9% and same of Morrison is -5%. Hence, it can be said that Tesco have less control on
its indirect expenses then Morrison. Both firms needs to improve their performance.
 Current ratio: It indicate the firm capacity to pay its current liability by making use of the
relevant items of the business on time (Financial ratio analysis, 2016). Current ratio of
Tesco is 0.75 and same of Morrison is 0.5. Hence, liquidity position is better in case of
Tesco then Morrison.
 Quick ratio: Quick ratio of both firms is below standard value 1:1. Quick ratio of Tesco is
0.602 and same of Morrison is 0.214. Liquidity position of both firms is bad. However,
Tesco is in better condition than Morrison.
 Creditor turnover ratio: Creditor turnover ratio indicate the extent to which firm make
purchase on credit basis. It can be observed that in case of Morrison creditor turnover ratio
is 11 and same in case of Tesco is 11.34. Hence, on this basis it can be said that both firms
give similar performance in their business.
 Debtor turnover ratio: Value of ratio in case of Tesco is 11.17 and same in case of
Morrison is 111.36. This means that former firm is generating less sales in its business on
credit basis. It can be said that Tesco is following good strategy in its business then
Morrison.
CONCLUSION
On the basis of above discussion it is concluded that business firms must carefully
picked up any financial sources in order to do project finance. By doing so finance cost can
be controlled to some extent. It is also concluded that project evaluation techniques must be
employed in order to choose most viable project for the business firm. Finally it is concluded
that ratio analysis method help managers in evaluating firm performance in proper manner.
Hence, it must be used to make business decisions.