AAF044-6 Accounting and Finance
AAF044-6 Accounting and Finance
Introduction
Tesco is a British multinational grocery and general merchandise retailer whose headquarters are located in Welwyn Garden City. In 2011, they became the third biggest retailer in the world as per their gross revenues. They employed 336,926 employees as per the 2023 report which, however, is 5.02% low as compared to 2033. The company aims to provide maximum satisfaction to customers by serving healthy, sustainable, and affordable food. They serve their customers beyond their stores as they consider a local community. They offer additional services to needy customers through donations, community grants, and food banks. Other than grocery retailers they operate in Tesco Mobile and Dunnhumby, One Stop, Tesco Bank, and Booker (Tesco Plc, 2023). Further, the company offers its services online and in-store. They have around 3712 stores in the UK, 166 stores in Ireland, 187 in the Czech Republic, 152 in Slovakia, and 197 in Hungary. Including all stores, their group sales are 57.7 billion Euros, operating profit is 2630 million Euros, and 2133 million retail free cash flow.
Key resources of Tesco
Employees: Human resources or employees are considered key resources of every company. Tesco also believes and thus, they include them in the decision-making process and every part of their business operation from store team to new product development. Around 85% of employees believe that they can share ideas and give suggestions without fear.
Suppliers: Tesco provide great value and in return get the best quality product for their customer (Chen, 2022). Group supplier satisfaction is around 86.6% which is high as compared to competitors.
Shareholder: The company maintain a strong and transparent balance sheet, invest in growth and development, and deliver high return to its shareholders. In return, they attract high investment and provide a 10.90% dividend to their shareholder which shows their financial strength.
Intellectual property: Tesco’s goodwill stands at 5375 million Euros which increase by 15 million Euros in 2023. It proves that the company’s intellectual property is an important resource.
Challenges faced by Tesco
Economic recession: In 2022 GDP growth in the UK was 4.3% which slipped by 1% in 2023. Ukraine and Russia’s war, Brexit, Covid-19 pandemic, are some of the reasons behind the depression in the economy (Catalão, 2022). It directly impacts supplies in the UK and thus, Tesco’s struggle to maintain its profitability as the disposable income of the citizens is also adversely impacted. The company recently reported a 6.9% decline in their adjusted operating profit in all their businesses for the 2022-2023 year.
Poor quality allegations: Tesco faced allegations of poor customer services, a horsemeat scandal, and an accounting scam creating challenges for the company to regain their customer trust and remove these allegations. It severely affected their profitability and revenue.
High competition: In the UK, there are four big supermarkets, Morrison, Sainsbury, Aldi, and Tesco. It creates high competition in the market which adversely affects their profit margin (ZXhang et. al. 2023). Also, they intensely face price competition from Aldi and Lidl due to discount retailers which also decrease their profit margin and they struggle to meet their market objectives.
Evaluate the financial statements of Tesco Plc
Tesco’s income statement shows that year on year the company’s net income decreased. Income falls 49.70% from 1.48 billion to 745 million even an increment of 7.20% in revenue from 61.34 billion to 657.6 billion (Tesco Plc, 2023). The increase in the cost of goods sold as a percentage of sales from 92.22% to 92.77% was the reason for the decrease in net income despite the increment in revenues.
Regarding cash flow, in 2023 Tesco’s cash reserve decreased by 206 million. However, the company generated 3.72 billion from its operations at a 5.66% cash flow margin (Financial Times, 2023). Additionally, the company invested 706 million and paid 3.19 billion in financing cash flow.
Moreover, year-on-year increments in dividends remained flat while earnings per share excluding additional items decreased by -48.68%. However, as per the measure of five-year annual dividend, Tesco pays high as compared to competitors but earning per share growth is equal to their rivals.
As per the annual report of Tesco 2023, Tesco’s income has increased in the last three years. In 2021 revenue was 57,887 million and in 2023 it is 65,762 million. However, this growth is not sufficient as per the expectations and as compared to competitors due to the crisis in the global supply chain, economic recession, and other internal or external challenges (Naveen et. al. 2022).
Interpretation of ratios
Profitability ratio: The purpose of this ratio is to assess the profitability of the company to earn profits from their business operations. Tesco’s gross profit ratio increased to 7.55% in 2022 from 6.84% in 2021 however, it decreased to 5.56% in 2023. In this result, the company’s operating margin also falls from 4.6% in 2022 to 4% in 2023. This percentage is lower than the operating margin of 60% and 80%. However, the ideal or average ratio depends on the industry and the market where they operate (do Peso Catalão, 2022). Moreover, external challenges faced by the company also cause lower operating ratios, for example, economic recession and low disposable income.
| Years | 2021 | 2022 | 2023 |
| Gross Margin | 6.84 | 7.55 | 5.56 |
| Operating Margin | 3.1% | 4.6% | 4% |
| Return on Capital Employed (ROCE) | 5.4% | 7.8% | 8.6% |
It can be inferred from the return on capital employed that there are increments from 5.4% in 2021 to 7.8% in 2022 and 8.6% in 2023. It shows that the company earns 8.6 GBP on each 100 GBP in employed capital. If ROCE is high or more than 20%, then it is considered an optimistic use of capital.
Liquidity ratio: It is used to determine a company’s ability to pay short-term debt obligations. There are three ratios: current, quick, and cash (Sharmaa et. al. 2022). The current ratio of the company is 0.7295 in 2023 while the quick ratio is 0.5788. Total debt/total equity is 1.30 while total debt/total capital is 0.5646.
As compared to the last three-year ratio, in 2021 it was 0.67, in 2022 0.75, and in 2023 it was 0.71. Falls from 2022 to 2023 can be seen due to supply chain disruption and lack of liquidity. However, the ideal current ratio should be 2:1 and the entire industry average ratio is 1.186. It proves that the company faces a cash crunch and is able to pay only 80% of short-term liabilities.
| Year | Current ratio |
| 2021 | 0.67 |
| 2022 | 0.75 |
| 2023 | 0.71 |
If all the creditors ask for their money back which is around 17721 million Euros in 2023, the company pay only 2465 million Euros. However, it is very unlikely that such a situation will happen but this situation discourages investors from investing in the company (Li, 2023).
Efficiency ratio: It is also called as activity ratio which is used to measure a company’s short-term or current performance. The company’s current assets and current liabilities number used to measure this ratio. Tesco’s efficiency ratio is described below:
| Year | 2021 | 2022 | 2023 |
| Inventory turnover ratio | 26.06 | 24.24 | 24.74 |
| Asset turnover ratio | 1.26 | 1.24 | 1.42 |
| Receivables turnover | 45.83 | 48.57 | 50 |
Inventory turnover ratio, asset turnover ratio, and receivable turnover ratio are evaluated in the above table. It can be inferred that the company can buy inventory by 26.06 days in 2021 which decreased by 24.24 in 2022 and 24.74 in 2023. It increases but very slightly which does not have a significant impact. In terms of receivable turnover from debtors, it was 45.83 in 2021, 48.57 in 2022, and 50 in 2023. It proves that the time to receive from debtors is increased year on year which means Tesco can buy inventory and receive from debtors which provides them sufficient time to pay their liabilities (Adel and Anis, 2022). It improved the company’s liquidity issues and thus they can attract investors.
The asset turnover ratio also shows improvement year on year as in 2021 it was 1.26, in 2022 it was 1.24 and in 2023 it is 1.42. It proves that the company generates revenue by using its assets. However, the ideal asset turnover ratio for the retail industry is 2.5 but Tesco’s asset turnover is around 1.25 which proves that the company cannot generate enough revenue due to holding a large amount of fixed assets. However, with time, the asset turnover ratio increases which is a good indicator as they generate sufficient revenue as compared to assets held.
Above above-discussed financial status of Tesco proves that the company has competitive advantages due to sound financial resources. However, they face a liquidity crunch and their revenue and profitability also decrease (Smith, 2023). There are many internal and external reasons behind such depression. In terms of internal factors, the employee count decreased as compared to last year which is already shown above. The reasons behind employee turnover can be Brexit, economic recession, and competition from other supermarkets. The same reason can be considered as external issues as the company faces supply chain disruption, lack of government aid, high transportation costs, infrastructure costs, increased pressure to meet corporate social responsibility goals, and high cost on sustainability (Mundi et. al. 2022). However, these issues are not only faced by Tesco, but by other competitors as well in the market because these are very common issues.
Compare Tesco’s financial performance with Morrison
Tesco is the third largest supermarket chain in the UK while Morrison is the fifth largest supermarket chain (Tesco Plc, 2023). Morrison has 497 supermarkets across the UK, Wales, Scotland, and Gibraltar. The headquarters of the company is in Bradford, England. The company focused on food and grocery where they source and process half of the fresh food through their own manufacturing facilities and stores and it provides them close control on provenance and quality (Morrison, 2022). As per the 2021 report they employed around 110,000 workers. In the 2023 first quarter, their sales increased by 3.1% due to high investment in customer value paying off. However, as per the 2022 financial report, their profit fell by 15% and reached 828 million Euros. The same situation faced by other supermarket giants in the UK due to economic recession.
Figure 5 shows that supermarket giants in the country face almost the same conditions. However, Tesco’s market share is comparatively high (Statista, 2023). At the same time, Morrison struggled to stand strongly due to high competition, especially from Sainsbury and Aldi. The following describes Tesco and Morrison’s income statements for better comprehension:
| Tesco | Morrison | |||||
| 2021 | 2022 | 2023 | 2021 | 2022 | 2023 | |
| Revenue | 65620 | 66492 | 67375 | 17733 | 17932 | 18133 |
| Gross profit | 4731 | 4794 | 4858 | 644 | 843 | 1044 |
| Operating profit | 2636 | 2671 | 2706 | 446 | 643 | 842 |
| Profit after tax | 1081 | 1096 | 1110 | 265 | 419 | 574 |
Table 1: Common size income statement of Tesco and Morrison
Common size income statements of Tesco and Morrison indicate that in both companies there are significant differences in profitability and revenue. As per the report of Guardian (2023), Morrison’s market cap is 9310.43 million Dollars while Tesco has 25,346.65 million Dollars. However, Morrison’s revenue, gross, and net profit increase year on year but it is significantly low as compared to Tesco and other market competitors.
As compare to Tesco whose 2023 revenue is 67375 Euros is much higher than Morrison whose 2023 revenue is 18133 million Euros (Financial Prep, 2023). It means that Morrison has invested in several areas and improved their weaknesses to compete against Tesco in the market. Moreover, Morrison executives reveal that they will lose their position as the UK’s fourth largest supermarket to Aldi as their profit decreased by 15% and sales at their stores also down by 4.2%. The reason behind the drop in their revenue is due to food inflation across the industry at 13.3% as per the British Retail Consortium (Maran et. al. 2023). After interest payment, Morrison made a 33 million Euros loss in the first quarter of 2023, narrowing from 121 million Euros in 2021.
Moreover, the company paid out 219 million Euros in liability including 18 million Euros on store closure and 108 million Euros on contracts to buy McColl’s convenience store chain (Butler, 2023). The chief executive, of Morrison, David Potts states that the number of sold goods by the company has decreased due to increment in prices. Consumers of the UK face low disposable income issues due to the COVID-19 pandemic, Brexit, economic recession, high-interest rates, and low supplies also increased prices and it happens due to the Ukraine and Russia wars. Potts further said that the 7 billion Euro debt-fuelled takeover by the American private equity company Clayton Dubilier & Rice in 2021. The following are comparing Tesco and Morrison’s financial ratios:
| Year 2023 | Tesco | Morrison |
| Current ratio | 0.71 | 0.47 |
| Debt/equity ratio | 1.30 | 0.8 |
| Gross margin | 5.56 | 2.51 |
| Return on Capital Employed (ROCE) | 8.6% | 3.41% |
Table 2: Comparative ratio analysis of Tesco and Morrison
Above mentioned ratios of Tesco and Morrison are from 2023 and clear differences can be seen in all of them. Tesco’s financial position is far better than Morrison’s. However, the ideal current ratio should be 1 or more than one and Tesco is nearby but Morrison’s current ratio is very low. Regarding the equity ratio which shows the company’s total liability by their shareholder equity, the ideal ratio should be 2 or 2.5. Tesco has 1.3 and Morrison has 0.8. The gross profit margin of Tesco is 5.56 which is also high as compared to Morrison which is 2.51. Moreover, the ROCE of Tesco is 8.6% and Morrison is 3.41% (Macrotrends, 2023). It proves that Morrison needs to attract more investment and employ their capital in profitable areas to increase their return. Morrison’s high cost of sales proves that Tesco is more efficient in direct production costs. Tesco’s operating profit is high but it increases gradually every year. In contrast to Morrison, their operating profit and even net profit increase rapidly however, it is lower than Tesco but growth rates are high (Li, 2023).
However, both companies’ financial statements prove that the retail industry treated them the same and the external market situation affects both companies’ profitability. As previously said all players in the retail industry face the same challenges but it depends on the strategic management and how well they overcome these issues. As above financial analysis, it can be said that Morrison grew rapidly and they are more efficient in handling these issues but still their financial position is low (vans, 2022).
Conclusion
From the above financial statement analysis of Tesco and comparison with key competitor Morrison it can be inferred that the company has a strong financial position in the retail and grocery market in the UK. However, the growth rate is low and the liquidity ratio also shows depression which may demotivate investors. It can suggest to Tesco that they should invest in profitable ventures, control their production and administration cost, and focus on increasing their profit margin. On the other hand, Morrison’s growth rate is high as in 2021 their net profit was 265 which increased by 564 in 2023 and Tesco’s net profit in 2021 was 1081 which increased to 1110. It shows that Morrison has the potential to earn equal or more profit than Tesco if they are able to control their cost or if Tesco is not able to reduce their costs. However, Tesco’s strong market share and ROCE make them able to sustain in the market and maintain their position. Also, Tesco should consider the economic recession in the country and prepare for uncertain events in order to maintain its competitiveness.
References
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