STRATEGIC FINANCIAL MANAGEMENT AF4S31-V1-13590
MODULE ASSESSMENT 1
Course: MBA – Master of Business Administration – V1
Teacher: Muhammad Almezweq
Student ID: R1607D1662592
Date of submission: 13 October 2019
Introduction
This report will be discussed in two parts. The first part of the discussion looks at the Annual report of Tesco for the year 2016 with the aim to identify key stakeholders and then analysing the Environmental and social review report to demonstrate the corporate social responsibilities to this three chosen stakeholders. The choice of stakeholders will be based entirely on their influence both on financial and non financial outlooks on Tesco business.
The second part of this report will analyse and evaluate the financial position of Benedict Co. using financial ratios calculated from the supplied income statement and statement of financial position for two years, 20X0 and 20X1 and the relevance of the ratios to its stakeholders. Overall financial performance of Benedict Co when compared with its competitors, it was concluded that the business was not a successful one and company may not last for longer and therefore as a purchase manager I will not consider Benedict Co.
Company background
Tesco PLC (2019) is a British retail company operating in the UK, Republic of Ireland and internationally in Czech Republic, Slovakia, Poland, Hungary, Malaysia, Thailand, India and China. The company was founded in 1919 by Jack Cohen. Tesco was born in 1924 when Jack Cohen came together with his tea supplier, T.E. Stockwell. The name TESCO comes from the combination of initials of the two guys’ first name and surname. It‘s headquarters are located in Hertfordshire, England. The business is engaged in retailing and its related activities, retail banking and insurance services. Tesco is listed on the London Stock Exchange and Financial Stock Time Exchange 100 index. Tesco is the fourth largest world retailers with 476 000 employees that serves a million customers every week in store and online (Tesco PLC, 2019). Tesco brought a new face of retail of self service in 1946 which was unusual culture in British shopping at the time. Tesco store was floated on share stock with a price of 25 pence in 1947. About 500 stores were opened in the 1950s in different locations. Tesco applied different strategies founded on Cohen’s philosophy of ‘pile it up and sell it cheap’ from collecting green stamps on their branded items and exchanging them for Green shield value goods, selling food and non food items and opening new superstores. In 1973 Tesco continued to expand their business wings by introducing petrol stations in their major sites to attract even more customers. Tesco became first British retailer in 1995 to launch club cards which drew nearly five million customers in the first year. Tesco shares overtook Sainsbury as a result. Tesco sought to close the gap of other segments of customers and satisfying their interest as seen in their move into finance in 1997 and launching Tesco Finest for their upmarket clients. Year 2000, Tesco went online in an effort to bring services closer to customers. This growth can be seen even today with quality and fresh produce giving customers options for healthier eating. In the last eighteen years Tesco has been actively involved in supporting local communities, schools, funding researches aimed at prevention of major health diseases.
STAKEHOLDER THEORY AND CORPORATE SOCIAL RESPONSIBILITY PERSPECTIVE
Stakeholder is defined as “any group or individual who can affect or is affected by the achievement of the firm’s objectives” (Freeman, 1984). Stakeholders can be internal or external groups or organisations. Stakeholders include employees, customers, suppliers, shareholders, regulatory bodies, general public and various other individuals depending on the type of the firm and its industry. The corporate social responsibility of stakeholders focuses on supporting the firm’s corporate strategic goals in order to realise them. Social responsibility can be defined as practices undertaken by businesses that contribute positively to the society. Stakeholder model diverts resources away from profit maximising behaviours such as through donations, charity causes, etc. Stakeholder theory maintains that business has responsibility to make profits and satisfy interests of multiple stakeholders. These stakeholders represent the individuals or groups that have an interest in the actions and behaviour of the business. It is important that the management need to maintain a positive relationship with society and the environment to operate effectively. Stakeholders do not have the same influence on the business, so they are categorised into primary and secondary stakeholders. Primary stakeholders have a greater influence on the organisations. They include business customers, suppliers, employees, government agencies and local community. These groups are of utmost importance because the business relies on them for long term survival. Management should spend more time with them in order to satisfy various interests of these groups. Although secondary stakeholders are not critical as primary stakeholders they can influence public perception of the business, they include special interest groups and media. Secondary stakeholders do not have frequent interaction with the business but can play a significant role on transmitting information about the business. Roberts (1992) in his standpoint suggests that managers should consider stakeholder conflicting interests when planning corporate strategy. Shareholder model on the other hand believes that the business of the business is business, that is to say the only social responsibility of the business to maximize profits according to the established laws. The objectives and nature of the business as well as the size of the business will help determine the model that businesses can follow in terms of corporate social responsibilities. Tesco follows the stakeholder model to demonstrate its social responsibility through tackling challenges that affect the communities they operate in.
In case of Tesco, stakeholders that have significant impact on the business include its employees, customers, shareholders and suppliers.
Tesco exist to put their customers’ needs first in every action they make (Tesco, 2016). This is reflected in their values of “Every little help makes a big difference’, ‘No one tries harder for customers’ and ‘We treat people how they want to be treated” (Tesco, 2016). Tesco embarked on improving availability of products, adding more ranges and more choice of products under one roof whilst offering excellent customer service. In October 2015 Tesco became the first British retailer to introduce price match at the checkout in an effort to regain competitiveness and stable prices. With the advancement in modern technology, Tesco continues to innovate and deliver excellent customer experience and growing customer loyalty in the process. Tesco measure customer satisfaction through surveys on weekly basis and the feedback has been a positive one. It is unsurprising that more customers are recommending to shop at Tesco stores, an increase of 1.2 % customer loyalty and this has added more value into business and creating a stronger financial position.
Employees or colleagues as they are referred to on the annual report, Tesco provide its staff with the right skills and training opportunities in order to serve customers a little better every day. Tesco has a strong and consistent people policy that makes it the best place to work at. Tesco drives an open and transparent business model where colleagues are free to express their concerns without fear or favour. Everyone at Tesco is paid fairly according to their work. In 2016 Tesco became a signatory of United Nations Global Compact Initiative which requires them to report on their implementation of human rights. Tesco promotes diversity through monitoring gap pay. Consequently this business strategy approaches increase their reputation in the market place and society hence the according to the survey, 81% of colleagues recommended Tesco as the best place to work. Introduction of the benefit pension scheme for colleagues providing sustainable benefits and future cash certainty led to better discount rates and therefore reducing long term liabilities.
Tesco need suppliers that can produce great value products that are sourced in a safe and responsible way. Partnerships are very crucial in Tesco business as shown in the KPIs to build stronger relationships so as to conduct a business that is commercially successful and socially responsible. Supplier surveys recorded a 70% group supplier satisfaction which further gives Tesco stores a competitive edge among its competitors. Tesco is committed to uphold and respect for human rights, labour rights and anti corruption as expected member of the UN Declaration of human rights and ILO. Tesco founded Ethical Trading initiative, an initiative that engages its members to develop and integrate a corporate code that encompasses working condition in global supply chains (Annual report, 2016). Tesco runs a programme that ensures surplus food is not wasted but delivered to underprivileged societies. Tesco Chief executive, Dave Lewis chairs a coalition of leaders from different institutions that is dedicated to accelerating progress towards UN SDGs Food Waste Target 12.3. This leadership position gives Tesco market presence through networking and collaborations.
Tesco has demonstrated strategic use of CSR in developing and defining procedures and policies that integrate social, environmental, and ethical and human rights into their business strategies. Companies that invest in their stakeholders social and environmental issues achieve a positive impact in the society while maximising profits and creating long-term value for shareholders. This is reflected by improvement in profitability, in the year 2016 Tesco delivered a group operating profit of £944m reduction of total indebtedness by £6.2bn. Tesco continue to demonstrate its commitment through operations and staying true to their values. Their business strategies were built with these key stakeholders in mind to help achieve a balance of financial and non financial objectives. Tesco corporate strategies are reaffirmed in their actions through regaining competiveness, strengthening the balance sheet and regaining trust in their business. As a result of corporate social responsibility, Tesco have global penetration as evidenced by the company’s footprints internationally, increase in customer loyalty, improved bottom lines, retained talent, value to shareholders as well as brand imaging.
BENEDICT CO. FINANCIAL ANALYSIS
Profitability ratios
| Ratios | 20X1 | 20X0 | Difference |
| ROCE % | 24 | 27,1386431 | -3,1386431 |
| Gross profit margin % | 48,052 | 41,767 | 6,285 |
| Net profit margin % | 31,1688312 | 36,9477912 | -5,77896 |
| Net asset turnover (times) | 0,77 | 0,73451327 | 0,03548673 |
Return on capital employed, ROCE shows how much profit is generated from operations. It compares profit with capital invested (Scicluna, 2016).
Benedict Co made a ROCE of 27.14% in 20X0 and 24% in 20X1. A decline (-3.14%) can be explained by an increase in profit before interest and tax and capital employed in 20X1.
Gross profit margin measures the percentage of gross profit generated from revenue.
Benedict made a gross profit margin of 41.77% and 48.05% from 20X0 and 20X1 making a positive growth of 6.28%. It is observed that the company made more sales (+19.16%) than the previous year subsequently increasing the gross profit from 10.4million to 14.8million.
Net profit margin is represented as a percentage of the company’s profit after operating costs (admin and distribution costs) are deducted.
Net profit margin for Benedict Co was 36.95% in 20X0 and 31.17% in 20X1 indicating a decrease (-5.78%). This can be attributed to company’s inefficiency to utilise the sales to make profit therefore attracting higher interest charges.
Net asset turnover measures the how efficient the capital employed is generates turnover.
In case of Benedict Co, 0.73 times in 20X0 and 0.77 times in 20X1 to generate $1 sale. This slight increase (+5.19%) can be explained by company’s ability to utilise capital employed to generate cash.
Liquidity ratios
| Ratios | 20X1 | 20X0 | Difference |
| current ratio | 1,18518519 | 1,25490196 | -0,069716776 |
| Quick ratio | 0,7037037 | 0,74509804 | -0,041394336 |
Current ratio can be defined as a liquidity ratio that measures the company’s ability to pay short term obligations. Current ratio tells us the number of times assets can be converted to cash over 12 months period.
Current Ratio = current assets ÷ current liabilities
Benedict company current ratio is 1.25 for year 20X0 and 1.19 for year 20X1. This slight decrease (-5%) can be explained by an increase in the non-current liabilities (+50%) and overdraft probably to acquire more current assets (+100%) for the respective years. This is not healthy for the business as current assets like inventory can take longer to sell and also customers take a longer time to pay. The cash tied to inventory may also end up salvaged due to damages, expiries and or obsolete items. Generally speaking, a higher current ratio is desirable as it indicates the liquidity of the business. Competing companies show a better current ratio therefore can meet the short term obligations quicker.
Quick (or acid-test) ratio is similar to current ratio except that inventory is excluded from current assets. The ratio is also termed short term solvency, as sometimes inventory can be slow moving products making it impossible to cover day to day obligations.
Quick ratio = current assets – inventory ÷ current liabilities.
Benedict Co quick ratio declined (-7%) from 0.75 for year 20X0 to 0.70 for year 20X1. This quick ratio tells us that the company does not have sufficient cash available to meet its current liabilities. Consequently this puts the company at a disadvantage in securing trade credits from suppliers or borrowing a loan to continue business.
A quick ratio of 1 and above is good as it means all short term obligations will be met in less than 12 months by its competitors.
Use of resources
| Ratios | 20X1 | 20X0 | Difference |
| Stock days | 118,625 | 65,4482759 | 53,17672414 |
| Debtor days | 90,0649351 | 55,7028112 | 34,36212382 |
| Creditor days | 155,125 | 108,241379 | 46,88362069 |
| Cash conversion cycle | 53,5649351 | 12,9097078 | 40,65522727 |
Trade receivable days show the average number of days it takes the debtors to collect outstanding payments from customers in a year.
Trade receivable days = trade receivable ÷ credit sales x 365
Benedict Co took an average of 56 days in 20X0 and 90 days in 20X1 to collect those sales, an increase (+60%) in average collection period which puts the business at a disadvantage compared with competitors who take a considerable shorter time to receive payments.
Inventory days show the average number of days’ worth of stock sold and replaced by the company over a year.
Inventory days = inventory ÷ cost of goods sold x 365
It took Benedict an average 65 days in 20X0 and 119 days in 20X1 before it turned stock into cash while the competing companies take an average of 60 days. Inventory days should be kept as low as possible as longer days may incur more costs from storage and destruction.
Trade payable days show the average number of days it takes to pay creditors and is computed as follows:
Trade payable days = trade payable ÷ credit purchases x 365
Benedict Co took an average of 108 days in 20X0 and 155 days in 20X1 to pay its creditors. The trade payable days in the industry is 90 days which is shorter than it takes Benedict for two successive years. This risk the chance of trade credits from creditors as payment may be secured against its valuable assets which indicate inefficiency use of resources.
Furthermore, the company takes longer to make payments on credit purchases than it receives payments from debtors, another disadvantage to Benedict Co.
Cash conversion cycle (or net working capital) is the number of times it takes the company to generate cash from operations.
Cash conversion cycle (WCC) = inventory days + trade receivable days – trade payables days
From 20X0 to 20X1, the company’s WCC increased from 13 days to 54 days which is 41 days more, needed by the company to turn assets to cash to meet its short term obligations. Companies in the same industry need only 25 days on average to generate cash from its operations. These results explain a serious problem in the financial status of the business and more work is needed to understand this poor financial position.
Investor ratios
| Ratios | 20X1 | 20X0 | Difference |
| Return on equity % | 23,5714286 | 27,027027 | -3,455598456 |
| Dividend per share | 0,25 | 0,2 | 0,05 |
| Earnings per share | 0,36666667 | 0,38888889 | -0,022222222 |
| Dividend cover | 1,46666667 | 1,94444444 | -0,477777778 |
| Payout ratio % | 68,1818182%
0,68181818 |
51,4285714%
0,51428571 |
16,75324675% |
| Price/earnings ratio | 15,2727273 | 9,25714286 | 6,015584416 |
| Dividend yield % | 4,46428571 | 5,55555556 | -1,091269841 |
| Earnings yield % | 6,54761905 | 10,8024691 | -4,254850088 |
Return on equity, ROE measures corporation profitability by revealing how much profits the company generated with the money shareholders have invested. ROE is calculated as the amount of net income as a percentage of the shareholders equity.
ROE = net income ÷ total equity x 100
Benedict Co. had a ROE of 27.03% in 20X0 and 23.57% in 20X1. A decline (-3.46%) is due to an increase in long term debt that attract higher tax rate.
Return on assets, ROA is a measure of profit per dollar of assets (Ross, et al 2016).
ROA= net income ÷ total assets x 100
In 20X0 and 20X1, ROA for the company was decreased from 17.95% to 13.00% respectively. This indicates that the company is not efficiently utilising its assets to generate cash. The profit that Benedict used to make on assets has declined by 4.95 %.
Dividend per share, DPS is the amount of dividend available to each shareholder is referred to as Dividend per Share. In 20X0 were 0.2 and 0.25 in 20X1, an increase of (+0.05) is due to the increase in the dividends paid from $3.6million in 20X0 to $4.5million in 20X1.
Earning per share, EPS is the amount of profits available to each shareholder. Benedict Co EPS slightly declined from 0.39 in 20X0 to 0.37 in 20X1 suggesting lower earnings.
Dividend cover, from 20X0 to 20X1 reduced from 1.95 to 1.48 respectively due to a lower EPS.
Payout ratio for Benedict Co. increased from 0.51 to 0.68 in respective years. Payout ratio is an inverse of dividend cover.
Price earnings ratio, observed an increase of 9.26 to 15.27 in 20X0 and 20X1 respectively.
Dividend yield, a decline from 5.56% to 4.46% in 20X0 and 20X1 was calculated.
Earnings yield, decreased from 10.80% and 6.55% in successive years.
Gearing ratios
| Ratios | 20X1 | 20X0 | Difference |
| Capital gearing ratio % | 30 | 23,5988201 | 6,401179941 |
| Debt/Equity ratio % | 42,8571429 | 30,8880309 | 11,96911197 |
| Interest Cover | 7,38461538 | 18,4 | -11,01538462 |
Gearing ratios show the level of long-term borrowings (Scicluna, 2016).
Capital gearing ratio is calculated as long-term debt as a percentage of capital employed for management. For Benedict a 23.60% in 20X0 and 30% in 20X1 was observed. The increase is due to an increase in non current liability from $8m to $12m and capital employed as discussed before. A higher ratio may bring negative consequences to the business.
Debt/Equity ratio is a measure of long term debt as a percentage of total equity for share holders. In Benedict Co, a debt/equity of 30.89% in 20X0 and 42.86% in 20X1 was measured. This increase (+12%) indicates a higher risk to shareholders.
Interest cover shows the number of times the profit from operations covers the interest charge on the long term borrowings. In 20X1 the PBIT covers finance costs 7.38 times and in 20X0 it was 18.4 times. A declining interest cover is worrying as ROCE and NPM fell from the previous year but the operating costs increased putting the business in a bad financial space.
In conclusion, the financial ratios of Benedict Co have revealed that the financial performance is far below average than its competitors. Its financial performance continues to plummet over the two years resulting in decrease of profitability. The management has failed to utilise the resources to maximize profits while attracting more long term debts leading to a reduced ROCE and NPM.
The company has failed to take advantage of its longer trade payables and shorter receivables to turn assets or stock into cash much quicker. Due to this, there is an inefficiency of working capital cycle, thus 41 more days are needed to generate cash from operations.
Lower market liquidity ratios suggest that Benedict may end up selling its valuable assets to offset against current liabilities. The business risks being cut off trade credits and placed on cash only basis if it continues with a bad liquidity ratio.
The company gearing ratios are high indicating that the company may face undesirable consequences if they fail to meet long term obligations.
A similar poor financial performance was observed in investor ratios. Benedict management failed to create value for its shareholders due to declining investor ratios.
APPENDIX
|
|||||
| Current ratio | 1.6 | ||||
| Quick Ratio | 1.0 | ||||
| Trade receivable days | 55 | ||||
| Inventory days | 60 | ||||
| Trade payable days | 90 | ||||
| 2. Statement of income for Benedict Co for the year to 31 January | |||||
| 20X1 | 20X0 | % Difference | |||
| $’000 | $’000 | ||||
| Sales | 30 800 | 24 900 | 23,6947791 | ||
| Cost of sales | 16 000 | 14 500 | 10,3448276 | ||
| Gross profit | 14 800 | 10 400 | 42,3076923 | ||
| Admin expenses | 1 700 | 400 | 325 | ||
| Distribution costs | 3 500 | 800 | 337,5 | ||
| Finance costs | 1 300 | 500 | 160 | ||
| Profit before taxation | 8 300 | 8 700 | -4,5977011 | ||
| TAXATION | 1 700 | 1 700 | 0 | ||
| Profit after taxation | 6 600 | 7 000 | -5,7142857 | ||
| Dividends | 4 500 | 3 600 | 25 | ||
| Share price $/share | 5.6 | 3.6 | 55,5555556 | ||
| Share capital | 18 000 000 | 18 000 000 | 0 | ||
| Nominal value | 1 | 1 | 0 | ||
|
3. Statement of financial position for Benedict Co. as at January 20X1 |
|||
|
|
20X1 | 20X0 | % Difference |
| $’000 | $’000 | ||
| Non-current assets | 38000 | 32600 | 16,56441718 |
| Inventory | 5200 | 2600 | 100 |
| trade receivables | 7600 | 3800 | 100 |
| Total current assets | 12800 | 6400 | 100 |
| Total assets | 50800 | 39000 | 30,25641026 |
| share capital | 18000 | 18000 | 0 |
| Reserves | 10000 | 7900 | 26,58227848 |
| Capital and Reserves | 28000 | 25900 | 8,108108108 |
| 6% bonds | 12000 | 8000 | 50 |
| Trade payables | 6800 | 4300 | 58,13953488 |
| Overdraft | 4000 | 800 | 400 |
| Total current liabilities | 10800 | 5100 | 111,7647059 |
| Total liabilities | 50800 | 39000 | 30,25641026 |
| 4. Benedict Co.’s Capital employed | |||
|
|
20X1 | 20X0 | % Difference |
| $’000 | $’000 | ||
| Total assets | 50800 | 39000 | 30,25641026 |
| total current liabilities | 10800 | 5100 | 111,7647059 |
| Capital employed | 40000 | 33900 | 17,99410029 |
- Calculations of Benedict Co. financial ratios
| WORKINGS | |||
| Ratios | Formula | 20X1 | 20X0 |
| Profitability | |||
| ROCE | PBIT ÷ Capital employed x 100 | 8300 + 1300 / 50 800 – 10 800 * 100 | 8700 + 500 / 39 000 – 5100 * 100 |
| GP margin% | gross profit ÷ turnover x 100 | 14 800 / 30 800 * 100 | 10 400 / 24 900 * 100 |
| Net profit margin % | PBIT ÷ turnover x 100 | 8300 + 1300 / 30800 * 100 | 8700 + 500 / 24 900 * 100 |
| Net asset turnover | turnover ÷ capital employed | 30 800 / 50 800 – 10 800 | 24 900 / 39 000 – 5100 |
| Liquidity ratios | |||
| current ratio | current assets ÷ current liabilities | 12 800 / 10 800 | 6400 / 5100 |
| quick ratio | current assets – inventory ÷ current liabilities | 12 800 – 5200 / 10 800 | 6400 – 2600 / 5100 |
| Use of resources | |||
| stock days | inventory ÷ cost of sales x 365 | 5200 / 16 000 * 365 | 2600 / 14 500 * 365 |
| debtor days | trade receivables ÷ sales x 365 | 7600 / 30 800 * 365 | 3800 / 24 900 * 365 |
| creditor days | trade payables ÷ cost of sales x 365 | 6800 / 16 000 * 365 | 4300 / 14 500 * 365 |
| cash conversion cycle | stock days + debtor days -creditor days | 118,625 + 90,065- 155,125 | 65,448 + 55,703 – 108,241 |
| Investor ratios | |||
| ROE % | earnings after tax and preference dividends ÷ ordinary share capital plus reserves x 100 | 6600 / 28 000 * 100 | 7000 / 25 900 * 100 |
| DPS | dividend paid to ordinary shares ÷ number of issued ordinary shares | 4 500 000 / 18 000 000 | 3 600 000 / 18 000 000 |
| EPS | earnings after tax and preference dividends ÷ number of issued ordinary shares | 6 600 000 / 18 000 000 | 7 000 000 /18 000 000 |
| Dividend cover | EPS ÷ DPS | 0,37 / 0,2 | 0,39 / 0,25 |
| Payout ratio % | Dividend paid to ordinary shareholders ÷ earnings after tax and preference dividends x 100 | 4 500 000 /6 600 000 * 100 | 3 600 000 / 7 000 000 * 100 |
| Price/earnings ratio | Market price per share ÷ EPS | 5,6 / 0,3666 | 3,6 / 0,3889 |
| Dividend yield % | DPS ÷ Market price per share x 100 | 0,2 / 5,6 * 100 | 0,25 / 3,6 * 100 |
| Earning yield % | EPS ÷ Market price per share x 100 | 0,37 / 5,6 * 100 | 0,39 / 3,6 * 100 |
| Gearing ratios | |||
| capital gearing ratio % | long term debt ÷ capital employed x 100 | 12 000 / 50 800 – 10 800 * 100 | 8000 / 39 000 – 5100 * 100 |
| debt/equity ratio % | long term debt ÷ total equity x 100 | 12 000 / 28 000 * 100 | 8000 / 25 900 * 100 |
| interest cover | PBIT ÷ finance costs | 8300 + 1300 / 1300 | 8700 + 500 / 500 |
REFERENCES
Freeman, R.E. (1984). Strategic management: A stakeholder approach. Boston: Pitman Publishing Inc.
Roberts, R.W. (1992). Determinants of Corporate Social Responsibility Disclosure: An Application of Stakeholder Theory. Accounting Organizations and Society 17:595-612.
Ross, S.A., Westerfield, R.W., Jordan, B.D. (2016) Essentials of Corporate Finance. Vitalsource 9th edn. [Online]. Available at: https://unicaf.vitalsource.com/#/books/9781308908311/cfi/0!/4/4@0.00:0.00 (Accessed: 13 October 2019).
Sciclunia, C. (2016) Interpretation of Financial Statements [Slides]. Glamorgan: University of South Wales. [Online] Available at: https://vle-usw.unicaf.org/course/view.php?id=1493#section-6 (Accessed: 13 October 2019).
Tesco PLC (2019). Company profile. Available at https://www.tescoplc.com/about/100-years-of-great-value-1/ (Accessed: 13 October 2019).
Tesco PLC [GB] (2016). Annual Reports and Financial Statements 2016 pp. 1-172 [Online] Available at: https://www.tescoplc.com/media/264194/annual-report-2016.pdf (Accessed: 13 October 2019).
