Evaluating TESCO's Financial Performance Using Accounting Ratios

This report analyses TESCO's financial performance using accounting ratios and highlights the limitations of accounting ratios. It includes profitability position, operational condition, and liquidity structure of TESCO.

Financial Accounting

TABLE OF CONTENTS
INTRODUCTION...........................................................................................................................3
1. Evaluating TESCO performance using accounting ratios......................................................3
2. Highlighting the limitations of Accounting ratios..................................................................5
CONCLUSION................................................................................................................................5
REFERENCES................................................................................................................................6

INTRODUCTION
Accounting ratios calculated from financial statements and other relevant data are
beneficial for any company to interpret and analyse and interpret the financial position and
performance of company. The present report is based on TESCO plc, a British retail company
dealing in various products and services. Report will examine different ratios for a three-year
period to explain company's efficiency in operations, etc. Further, study will highlight various
limitations that a company faces while interpreting accounting ratios.
1. Evaluating TESCO performance using accounting ratios
Profitability Position:
 Return on shareholders' funds indicates firm's ability to earn adequately in order to repay
its shareholders (Aliu, Akpa and Egwakhe, 2020). Ratio has drastically increased from
2.25% to 12.39% from 2017 to 2018 which shows that TESCO has paid a large part of
profits to shareholders as dividend and retained less. After 2018, ratio has declined to
9.91 in 2020 that depicts company is retaining its profit to put it back in business for
expansion and diversification purpose. This ratio is also used by investors to evaluate
company's efficiency before investing their excess funds in company. Another ratio return on capital employed shows TESCOs capability to generate profits
from the capital employed. Basically, it tells how much profit business is earning from
each pound of capital invested. ROCE has suddenly increased from 0.55% to 5.90% from
2017 to 2019 which describes organization's is favourably using its capital assets to earn
higher profit margins. It then decreased to 3.83% in 2020 which shows for every pound
invested, company generated 3.8 cents in operating income.
 Return on total assets is important ratio to measure productivity of business by stating the
investment potential to generate value (Acosta-González, Fernández-Rodríguez and
Ganga, 2019). Ratio first increased from 2.89% to 3.41% from 2018 to 2019, then
declined to 2.51% in 2020. In other words, every pound invested by TESCO in assets, it
generated £28.9 to £25.1 of income. The profit margin of TESCO is ranging between 2% to 2.62% and on the other hand,
gross profit margin ranges between 5% to 7% from 2017 to 2020. Business entity is
earning good amount of gross profit from its regular selling activities after covering its

direct expenses. However, it is incurring huge indirect expenses which is depicted by the
difference between net profit and gross profit (Poonawala and Nagar, 2019). In order to
earn profit, TESCO is incurring a lot of indirect expenses which needs to curbed. EBIT shows net operating income which does not include tax and interest payment. It
measures company's ability to earn profits only from their operations which is
continuously increasing from 1.82% to 3.89%. TESCO is generating sufficient revenue
either by reducing costs or quoting higher prices for it quality products which is reflected
in its EBIT ratio. Further, EBITDA shows an increase from 2019 to 2020 from 5.62% to
6.06% which exhibits company is having lower operating expenses in comparison to total
revenue. It means TESCO can easily pay its operating costs and still left with good
revenue.
Operational Condition: Fixed asset turnover ratio examining company efficiency in giving rise to sales by
utilizing its fixed assets. This ratio has deteriorated from 1.85 times to 1.65 times from
2018 to 2020. Such decrease in ratio identifies TESCOs inefficiency to use their fixed
assets in the most productive manner to generate sales.
 Stock turnover ratio evaluates how well a company manages its inventory. Ratio is
rotating between 24 to 26 times which illustrates TESCO is promptly converting its
inventory into final sales and demand for company's product is high in market.
Maintaining this ratio at high rate helps TESCO to reduce the storage and warehouse
expenses. TESCOs debtor turnover ratio has decreased from 2018 to 2019 from 123.37 times to
106.67 times and then again escalated to 130.83 times in 2020. Company's higher ratio
shows it is enjoying high quality customer base who pay their debts quickly. Along with
this, firm is following strict credit policy to ensure quick payments.
 Debtors collection days stretches between 2 and 3 days that exhibits TESCO's potential
to quickly collect their dues from debtors. On the other hand, creditors payments ranges
from 31 to 34 days which exhibits company is taking around a month to settle their dues
with creditors. Organization is collecting their dues swiftly and paying their creditors
lately which means it is maintaining sufficient cash in business to carry on business
activities smoothly.

 Another ratio which measure the operational performance of company is interest
coverage which has accelerated from 1.17 times to 4.12 times from 2017 to 2019 which
displays TESCO is making enough money to settle its interest obligations and is less
risky for its investors. Ratio showed a downward trend in 2020 i.e. 2.06 times that
exhibits inability of firm to make interest payments on time.
Liquidity structure: Basic ratio to evaluate liquidity position is calculated by current ratio which is less than 1
in case of TESCO. It is fluctuating between 0.61 & 0.79 and portrays inability of TESCO
to maintain enough current assets to pay their current liabilities on time. For every one
pound of current liability, firm has only 0.73 pound of current assets and 27% of it has to
be financed externally. Liquidity ratio is more important ratio to measure the capacity to meet short term dues
without taking inventory levels into consideration (Whelan and et.al., 2021). TESCO's
liquid ratio vary between 0.49 and 0.68 that is very less and depicts firm's incompetency
to settle their short-term dues in a particular period. Organization needs to enhance their
investment in current assets which can be used productively in order to maintain current
ratio at 2:1. Asset cover ratio is running between 3 times & 5 times that displays TESCO can easily
sell their fixed assets and repay their long term loans and advances. Business is
considered to be less risky because it is maintaining enough assets to pay their debts on
time. Gearing ratio examines the portion of external funds compared to owner's funds to
identify financial risk because higher debt portion will increase financial issues
(Kariyawasam, 2019). TESCOs gearing ratio has declined significantly from 2017 to
2020 from 454.71 to 222.91. Company was using high external funds earlier to support
business operations and is now financing it with equity funds. Profit per employee determine the amount of profit earned from each employee in a time
frame and it is decreasing from 2018 to 2020 from 3958 to 3108 units. TESCO is an
established company which can increase this ratio by investing in better technologies and
organizing training and skill development programs for employees. However, applying
the latest technologies, company can also reduce the no. of employees needed.

 Salaries to turnover ratio evaluates how efficiently business is utilizing its employees or
labour to generate income. Ratio of TESCO is decreasing from 2017 to 2020 from 13.17
to 11.42 which expresses company's potential to optimally utilize workforce to earn
revenue.
2. Highlighting the limitations of Accounting ratios
Limitation Description
 Window Dressing TESCO can make certain manipulative changes in
financial statements in order to showcase a better
picture of company's financial position. This in turn,
directly affect ratio calculation and interpretation and
depicts wrong picture of firm's performance which
becomes a limitation.
 No consideration for price level
changes
Accounting ratios are calculated on the basis of past
data and financial decisions are taken on basis of
historical information (Csikosova, Janoskova and
Culkova, 2019). It ignores the concept of price level
changes due to inflation & economic conditions which
does not reflect right business condition of TESCO.
 Ignores qualitative data Financial ratios are computed based on quantitative
information available through final accounts and does
not take into account qualitative aspect like customer
satisfaction, relationship with vendors, etc.
 Lacks standard definitions Different firms uses different formulas for calculating a
particular ratio. TESCO may not consider bank OD at
the time of calculating current liabilities in current
ratio, while other firms may be considering it.
 Lacks comparison TESCO cannot compare its inventory turnover
performance with other firms in same industry if it is

following a LIFO method and other firms are
following FIFO method. It leads to baseless
comparison because of different accounting methods
adopted.
 Identifies problem not a
solution
Ratio indicates just the problem or issues in financial
performance and does not provide any solution to it
(Limitations of ratio analysis, 2021). TESCO's poor
net profit margin shows that there is a problem in
conducting business operations but doest not give any
solution to rectify it. Expert management team has to
find out means to resolve this issue.
CONCLUSION
From the above report, it can be summarized that TESCO Plc financial performance for a
three-year period starting from 2017 to 2020 is not up to the mark. The difference between gross
margin and net margin shows that company is incurring huge indirect expenses. On the other
hand, it can also be said that firm's debtor turnover ratio is increasing which shows it is providing
quality goods at reasonable rates. Further, study analysed various limitation that company faces
while interpreting ratios like window dressing, no consideration for qualitative factors, etc.

REFERENCES
Books and Journals
Acosta-González, E., Fernández-Rodríguez, F. and Ganga, H., 2019. Predicting corporate
financial failure using macroeconomic variables and accounting data. Computational
Economics. 53(1). pp.227-257.
Aliu, F. O., Akpa, V. O. and Egwakhe, A. J., 2020. Executive Compensation Packages and
Return to Shareholders at Selected Deposit Money Banks in Lagos State, Nigeria. IOSR
Journal of Business and Management. 22(3). pp.1-8.
Csikosova, A., Janoskova, M. and Culkova, K., 2019. Limitation of financial health prediction in
companies from post-communist countries. Journal of Risk and Financial Management.
12(1). p.15.
Kariyawasam, H. N., 2019. Analysing the Impact of Financial Ratios on a Company’s Financial
Performance. International Journal of Management Excellence. 13(1). pp.1898-1903.
Poonawala, S. H. and Nagar, N., 2019. Gross profit manipulation through classification
shifting. Journal of Business Research. 94. pp.81-88.
Whelan, G. and et.al., 2021. Impact on Firm Liquidity Arising from Outsourcing Decisions as
Evidenced by Off-Balance-Sheet Disclosures. International Advances in Economic
Research. 27(1). pp.17-27.
Online
Limitations of ratio analysis. 2021. [Online]. Available through:
<https://www.accountingtools.com/articles/what-are-the-limitations-of-ratio-
analysis.html>