Financial Performance Analysis: Tesco, ASDA, and Working Capital

This report provides a detailed financial analysis of Tesco and ASDA, two major companies. It begins by analyzing their financial statements and conducting ratio analysis to assess profitability, liquidity, solvency, and investment performance. The report then compares the capital structures of both companies and calculates their Weighted Average Cost of Capital (WACC). Furthermore, it explores the nature of the working capital cycle, identifying key factors for effective management, including inventory, receivables, and payables. The report also comments on the sources of finance and share issues, followed by an analysis of the companies' budget plans using Bloomberg economic forecast information. Finally, it provides insights into the future financial performance of both companies based on the analysis of the data. The report utilizes financial data from 2015 to 2017 to support its findings and conclusions.

ACCOUNTING AND
FINANCE FOR MANAGERS

TABLE OF CONTENTS
INTRODUCTION...........................................................................................................................1
1. Analysing financial statements of organisations and conducting ratio analysis................1
2. Comparing capital structure of companies and calculating WACC...................................4
3. Nature of working capital cycle and factors needed to be considered while managing
element of working capital.....................................................................................................7
4. Commenting on sources of finance or share issues in recent years...................................7
5. Commenting on budget plan of two companies and making arguments on budget plan...8
6. Analysing future of companies in 2018 financial year.......................................................8
CONCLUSION................................................................................................................................8
REFERENCES................................................................................................................................9

INTRODUCTION
Accounting and finance is an important department which plays an essential role in the
management of the business. By properly accounting company's income and expenses, it will
help to manage the cash flow within the company. The main function of accounting is to help the
organization to accumulate and prepare a report on financial information about the performance,
financial position of a business. This report will explain various topics like working capital cycle
(WCC), the various factors which can be taken into account in managing each element of
working capital. Difference sources of finance for i.e. internal and external of WCC is also
explained in this report. Two peer companies Tesco and ASDA are taken and future activities are
analysed. It also includes Bloomberg economic forecast information technique to understand the
budget plan of the company.
1. Analysing financial statements of organisations and conducting ratio analysis
The financial ratios for the three years are computed for both companies in effective
manner. It can be analysed that profitability ratio such as gross profit ratio of Tesco was 3.39 %
in 2015, which increased to 5.24 % in next year and further decreased to 5.19 % in 2017. It can
be interpreted that company is performing well as profit margin is increased in the best possible
manner. On the other hand, gross profit of ASDA was 24.8 % in 2015, maximised to 25.1 % in
2016 and increased to 25.6 % in 2017. This shows that firm is performing good as earnings are
maximised. The net profit margin of Tesco was -9.2 % in 2015, 0.3 % in 2016 and again become
negative in 2017 to -0.1 %. It clearly shows that firm is not able to initiate control upon expenses
and as such, net profit is not earned in recent years. While, ASDA has consistent profits as it was
3.4 % in 2015, 3 % in next year and 2.8 % in 2017. This means that net profit of ASDA is good
as compared to Tesco.
Liquidity ratios have been computed for two organisations for 2015, 2016 and 2017.
Current ratio of Tesco was 0.60 in 2015, 0.75 and 0.79 in next two years respectively. It can be
said that organisation will be able to pay off short-term liabilities within one year only.
Moreover, ASDA had current ratio of 0.97 in 2015, 0.93 in next year and decreased to 0.86 in
2017. The ideal ratio as recommended by market experts is 2 : 1. It can be analysed that ASDA
has overall good ratio than Tesco. On the other side, quick ratio of ASDA was 0.24 in 2015, 0.22
1

in 2016 and 0.19 in 2017. It shows that liquid ratio is not good as it will face difficulty in paying
obligations by using extreme liquid assets (Parker, 2012). The quick ratio of Tesco was 0.44 in
2015, 0.61 in 2016 and 0.68 in 2017 which indicates that organisation has good ratio and will be
able to pay-off liabilities with liquid assets.
Solvency ratio is computed which shows that how company is effectively using debt and
equity for financing activities in the best possible manner. It can be said that this ratio shows that
company should use 40 % of debt in relation to 60 % of equity. The ratio of ASDA was 0.50 in
2015, 0.47 in 2016 and 0.46 in 2017. Furthermore, debt-equity ratio of Tesco was 1.49 in 2015,
1.23 in 2016 and 1.45 in 2017. It shows that organisation is heavily relying on debt as ratio is
more than 0.4. It is not good for the company as burden to repay debt along with interest accrued
on the same increases and solvency position of firm reduces (Gitman, Juchau and Flanagan,
2015). Thus, it is required that equity should be used in more quantum by the organisation to
minimise debt financing up to a high extent. Hence, solvency position of ASDA is good as it is
around 0.40 which is the safest finance form for firm because firm is able to use both debt and
equity in its capital structure.
Investment ratios are computed showing how company has position in the market related
to objective of wealth of shareholders maximisation. It can be interpreted that from the EPS
(Earnings Per Share) of ASDA that in 2015, figure was 15.15, decreased to 13.71 in next year
and further minimised to 13.14 in 2017. However, Tesco had EPS of -0.71 in 2015, 0.02 in 2016,
while, in 2017 no EPS was there. Thus, company has not good position as earnings on share are
very low while, its competitor has good position. On the other hand, Dividends per share was
0.11 in 2015 of Tesco and of ASDA was 0.64. After that, no dividends are paid to shareholders
in next two years. Furthermore, efficiency ratios are being calculated. Fixed turnover ratio means
that how effectively company is using fixed assets in generating sales quite effectually (Cheng,
Ioannou and Serafeim, 2014). The ratio was 1.86 in 2015, 1.78 in next period and 1.88 in 2017 of
Tesco. While, ASDA had 3.42 in 2015, 3.45 in 2016 and 3.46 in 2017 which shows that fixed
assets are effectively used by ASDA.
Total assets turnover ratio of Tesco was 1.32, 1.24, 1.25 in last three consecutive years.
On the other side, ASDA had ratio in 2015 was 2.38 in 2015, 2.39 in 2016 and increased to 2.44.
Thus, it can be said that ASDA has good ratio as assets are utilised to generate sales in the best
2

possible manner. Inventory turnover ratio of Tesco was 19.71, 19.15 in 2015 and 2016. While, it
increased to 22.41 in 2017. ASDA had 8.11 in 2015, 8.06 in 2016 and maximised to 8.26. Thus,
it can be said that ASDA has overall good financial position as compared to Tesco.
The stakeholder perspective with regards to the lenders are quite important in
ascertaining financial position of company. By taking into account annual reports of two
organisations, solvency health is essentially required by them in taking enhanced decisions. The
solvency position is analysed including debt-equity ratio. It can be analysed that ratio of Tesco
was 1.49 in 2015, 1.23 in 2016 and increased to 1.45 in 2017 which means it has more debt in its
capital structure. On the other side, debt-equity ratio of ASDA is around 0.50 which is good in
comparison to firm. Thus, lenders will get their funds within stipulated time as ASDA will pay it
without any difficulty. Lenders would supply finance to ASDA because it has good solvency
position. Hence, Tesco needs to pay debt in order to strengthen its solvency health.
2. Comparing capital structure of companies and calculating WACC
Tesco Plc
Particulars 2015 2016 2017
(in millions)
Market capitalisation (E) 86362 65000 38000
Stock Beta value 0.9 0.7 0.65
Risk Free Rate (Rfr) 1.5 1.5 1.5
(10 year government bonds returns)
3

Market Risk Premium 6 6 6
Cost of equity (Ke) 6.9 5.7 5.4
Cost of debt
Interest expense 400 300 600
Book value of debt 3000 2000 4000
Cost of debt (Kd) 13.33% 15.00% 15.00%
Tax rate applicable 41.71% 41.71% 41.71%
Weights of debt
Listing formula
D / (E + D) 0.0335713167 0.0298507463 0.0952380952
Weights of equity
E / (E + D) 0.9664286833 0.9701492537 0.9047619048
4

WACC
(We*Ke + Wd*Kd*1-Tax rate) 6.26 5.12 4.48
ASDA Company
Particulars 2015 2016 2017
(in millions)
Market capitalisation (E) 236000 248000 249523
Stock Beta value 0.34 0.25 0.22
Risk Free Rate (Rfr) 2 2.8 2.9
(10 year government bonds returns)
Market Risk Premium 6 6 6
Cost of equity (Ke) 4.04 4.3 4.22
5

Cost of debt
Interest expense 2100 2200 2300
Book value of debt 39000 41000 40000
Cost of debt (Kd) 5.38% 5.37% 5.75%
Tax rate applicable 30.09% 30.09% 30.09%
Weights of debt
Listing formula
D / (E + D) 0.1418181818 0.1418685121 0.138158281
Weights of equity
E / (E + D) 0.8581818182 0.8581314879 0.861841719
WACC
(We*Ke + Wd*Kd*1-Tax rate) 3.17 3.40 3.34
Formula of WACC-
We * Ke + Wd * Kd * 1-Tax rate
Where We = Weight of equity
6

Ke = Cost of equity
Wd = Weight of debt
Kd = Cost of debt
Tax rate = Corporate tax applicable in the nation
The WACC has been calculated. Tesco had 6.26 in 2015, 5.12 in 2016 and decreased to
4.48 in 2017. On the other hand, ASDA had 3.17 in 2015, increased to 3.40 in next year and
reduced again in 2017 to 3.34. This is evident from the fact that ASDA has low WACC as cost
of debt is lower which is less risky than other company. While, Tesco relies more on debt and
thus, debt burden is increased and WACC is high, although it is shifting on using equity in recent
years (Wu, Chen and Olson, 2014).
3. Nature of working capital cycle and factors needed to be considered while managing element
of working capital
Working Capital Cycle
The Working Capital Cycle or WCC is the total amount of time company is taking to
convert net working capital into cash. It reflects the ability and efficiency of the company to
manage its short-term liquidity position. If the working capital is shorter, it will help the
company to get back its cash which is being stuck in working capital. The working Capital Cycle
works on 4 key elements of the management i.e. cash, receivables (debtors), payables (creditors)
and inventory (stock). The company should have a complete control over all these 4 factors
(Mathuva, D. 2015).
The cycle consists of Inventory Turnover + Receivables turnover – credit period
Particulars Tesco ASDA
Inventory ratio 22.41 8.26
Receivables Turnover 56.74 84.8
Credit period 30 days 30 days
The credit period taken as 30 days, then formula can be applied. WCC of Tesco is
calculated below-
7

= 22.41 + 56.74 – 30
= 49 days
For ASDA,
= 8.26 + 84.8 – 30
= 63 days
Hence, it can be analysed that Tesco has faster working capital conversion cycle to
transform liquid cash. ASDA has 63 days which is more than compared to Tesco.
Factors Affecting the Working Capital
There are various factors which affects the functioning of working capital of the
company, such as,
 Length of the operating Cycle : Operating cycle in Working Capital Cycle refers to the
time required in the whole process. Amount of working capital directly depends on the
length of their operating cycle. It is very crucial for smooth flow of the system.
 Nature of the Business : In these factors, type of business and firm is involved in the
working capital. Retail shops requires less working capital as their length of operating
capital is small.
 Scale of Operation : Companies operating in large scale requires maintaining more
inventory, debtors, etc. whereas companies working in small scale needs less working
capital (Enqvist, J., Graham, M. and Nikkinen, J. 2014).
 Technology and Production Cycle : This plays an important role in working capital
cycle. For example if the company is using more labor intensive technique then it will
require more working capital to operate effectively because it has to maintain the cash
flow to make payments to the staff. Similarly, if they are using less labor intensive
production they will require less working capital.
 Operating Efficiency : Comping having high degree of operating efficiency needs less
working capital. With high degree of efficiency, there is a less chance of having wastage
and can easily manage with low level of inventory (Baños-Caballero, S., García-Teruel,
P.J. and Martínez-Solano, P. 2014).
 Availability of Raw Material : If the raw material is easily available to the company it
becomes easy for the company to manage with less amount of working capital as they do
not need to maintain any stock of raw materials or they can manage with very less stock.
8

4. Commenting on sources of finance or share issues in recent years
There are various sources by which funds can be raised with much ease. It can be
analysed from annual report of Tesco that borrowings are decreased as it is focusing more on
equity (Annual report – Tesco Plc. 2017). Furthermore, income is generated by selling fixed
assets such as PPE (Property Plant and Equipment) as it was 871 in 2016 and increased to 1205
in next year. Equity is decreased as it was 8616 in 2016 and reduced to 6414 in 2017. On the
other side, ASDA has taken external finance such as borrowings as figure was 38214 in 2016
and reduced to 36015 in next year. Furthermore, income is earned from disposing off property
and equipment to 456 in 2017 while it was 635 in 2016. Thus, both companies have taken
external and internal sources of finance for meeting out operational tasks in effective manner.
5. Commenting on budget plan of two companies and making arguments on budget plan
The budget plan formulated by Tesco Plc is effective. The estimates made by the
company as per analyst's consensus is 58409 of revenue in 2018. The operating profit is likely to
be increased to 1789 in 2018 which was 1564 in 2017. The dividend payout will be increased as
well in the coming year. On the other hand, ASDA has good revenue earning capacity as gross
profit ratio as it will be able to garner profits in the future as well. The overall budget plan of
Tesco should include future strategies and expenditures to be incurred. Thus, it will be beneficial
for company. While, ASDA needs to implement strategies related to dividends and thus,
maximum earnings may be provided to the shareholders. It would be required that Tesco should
implement enhance its capital structure as it is too high and needs to rely on equity as well.
Hence, in the future operational tasks, capital structure need to be balanced. (Caglio and Ditillo,
2012).
6. Analysing future of companies in 2018 financial year
The EDVD function is used for stock splits and historical data is analysed. EE function is
used to give snapshot of Earnings estimates in the future. ANR are analyst recommendation on
equity, GUID displays current and historical earnings of company. EEO function displays
selected equity. DDM is useful for analysing dividend policy. It can be analysed that Tesco will
reach mark of revenue amounting to 58409 in 2018. On the other hand, ASDA will garner 50034
revenue in the financial year. Furthermore, dividends will be paid by both companies in adequate
quantum. Thus, as per historical data and future estimates, Tesco will lead the market (Pais,
9

M.A. and Gama, P.M. 2015). It is clarified from the functions of Bloomberg that Tesco and
ASDA will be able to enhance profitability position.
CONCLUSION
Hereby it can be concluded that finance plays vital role in the company as operational
activities cannot be met without relying on funds. It is clarified that financial ratios are quite
useful for assessing financial health of company in the best possible manner. Furthermore,
WACC is useful assessing highlights of firm's capital structure comprising debt and equity.
Higher WACC, riskier for the business. Moreover, working capital cycle is also useful for the
company so that it may be able to meet daily operational tasks with much ease. Various sources
of finance help firm to effectively attain tasks. Hence, both organisations will be able to achieve
profits in future course of action.
10