Accountancy An Analysis Of The Performance Of Tesco

Accountancy 1

ACCOUNTANCY: AN ANALYSIS OF THE PERFORMANCE OF TESCO

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Accountancy 2

Accountancy: An Analysis of the Performance of Tesco

The Performance, Liquidity, and Financial Structure of Tesco PLC

Profitability/Performance Ratios

From the ratio analysis, Tesco PLC’s gross profit margin has improved over the three

years under investigation. The Gross profit margin for 2015 was (3.39) % indicating that the

company’s costs were more than its revenues. The negative profitability of the company may

have been caused by factors both internal factors such as inefficient production methods or

external factors like the increase in the prices of raw materials. However, the ratio improved

for 2016 and 2017 to 5.19 % and 5.24% respectively due to the company’s efforts to restore

customers’ trust following the insecurity issues that had affected customers’ accounts (Tesco

PLC, 2017). The company’s return on assets (ROA) and return on capital employed (ROCE)

also show a similar trend, with a negative record in 2015 and positive improvements in 2016

and 2017. The low yields may be due to the high administration and production costs and low

prices.

Liquidity

From the results of the ratio analysis, Tesco PLC can pay off its short-term

obligations since its liquidity and current ratios are less than one for the three years under

analysis. The stock turnover rate also improved from 2015 to 2016, and this can be attributed

to the increase in sales revenue over the years.

Financial Structure/Ratio

Tesco’s gearing ratio has been lower and relatively constant in 2015 and 2016

compared to 2017. The high gearing ratio in 2017 indicates that the company has more debts

than equity. The high gearing ratio in 2017 may be as a result of the merger between Tesco

PLC and Booker Group; hence increasing the value of equity.

Accountancy 3

Limitations of Using Ratios

In as much as ratios can be used to measure the performance of a company over a

given period or relative to other organizations in the industry, they also have some

limitations. For example, inflation may affect the figures in the financial statements. Since

ratios are usually derived from the financial statements, variations in the calculations may not

depict an improvement in the organizational performance. Secondly, a company with

subsidiaries in different regions such as Tesco PLC may have different accounting practices

in each store, hence making it difficult to compare the performance of subsidiaries or

divisions within the same company. Finally, the application of accounting practices may also

differ across firms within the same industry, thereby making it impossible to conduct a cross-

sectional analysis and to gauge the performance of a business compared to its competitors.

Other Factors affecting Tesco in 2017

Apart from the low prices and the high operation costs, the performance of Tesco

PLC in 2017 was also influenced by other external factors. For instance, Tesco merged with

Booker Group to increase its presence in the UK market and enhance the growth of the

company’s revenue and profitability (Tesco PLC, 2018). Additionally, the company launched

its corporate social responsibility strategy known as the Little Helps Plan with the aim of

tackling the issue of food waste and promoting the health of communities, thereby increasing

the customer in the UK market.

Part two

The evaluation of investment options, such as in the case of Tesco Ltd, is necessary as t helps

in determining the attractiveness of the project regarding recovery of funds used in the project

and the profits earned. Below is a discussion of the appraisal techniques that can be applied to

the two projects.

Accountancy 4

Payback

Payback period refers to the duration taken to recover the initial investment from the

annual cash inflows generated by a project. Companies using this type of appraisal usually set

a predetermined duration and compare the calculated payback period, and the time the project

is expected to recover the cash outflows (Bierman &Smidt, 2012). Using this approach, the

investment option selected for funding is usually the one with a shorter payback period

compared to the set timeline.

The main advantage of the payback appraisal method is that it is easy to compute and

is less time-consuming. However, being an undiscounted technique, the payback approach

does not include the time value of money. As a result, it may be challenging to select projects

with same payback period but the different distribution of the cash flows. Secondly, the

approach does not include the cash inflows after the payback period, which may be higher,

compared to the initial years. Therefore, an organization may end up rejecting a project that

has the potential of generating high returns in later years.

Accounting Rate of Return

The accounting rate of return is the amount of profit that an organization expects to

get from an investment (Bierman &Smidt, 2012). When using this method, a company selects

the project with an ARR higher than the required rate of return. However, in the case of

mutually exclusive projects, the one with the highest ARR is usually considered first. Like

the payback approach, the ARR is undiscounted and hence it is easy to compute. However,

the disadvantage of the appraisal technique is that it does not consider the time value of

money.

Accountancy 5

Net Present Value

The net present value is a discounted investment appraisal technique that measures the

profitability of a project using its annual cash flows (Bierman &Smidt, 2012). The cash flows

are usually higher I the first years of investment and declines as the years go by. The decision

criteria when using the net present value method is to accept projects with a value higher than

one. When the investment funds are limited, an organization can select the project with the

highest net present value. One of the advantages of the net present value approach is that it

acknowledges the differences in the value of money across different periods. The

disadvantage of this approach is that it relies on the estimated cost of capital which may lead

to suboptimal investment choices.

Internal Rate of Return

The internal rate of return is used to decide whether to proceed with an investment by

comparing the calculated rate with the organization’s cost of capital. A project is accepted if

its IRR is higher than the expected rate of return or the internal rate of return. The IRR

approach also considers the time value of money and evaluates a project over its economic

life; hence resulting in accurate analysis of profitability. The downside of this approach is

that it is tedious and also involves the earnings are reinvested at the same rate over the

projects life.

i. Payback

Year

Cash Flow

Net Invested Cash

Super

Deluxe

Super

Deluxe

250000

400000

125000

75000

125000

325000

50000

100000

75000

225000

50000

125000

25000

100000

25000

50000

75000

50000

-75000

50000

125000

-50000

-125000

Accountancy 6

Payback Period: Super= 3+25000/25000= 4years.

Deluxe=4+50000/50000=5 years

The company should invest in super.

ii. Accounting Rate of Return

Annual Depreciation

Super=£(250,000-10,000)/6=40,000

Deluxe=£(400,000-

40,000)/6=60,000,000

Accounting Rate of Return for Super

Year

Cash Inflow

125,00

50,000

25,000

75,000

50,000

Salvage Value

10,000

Depreciation

40,000

Accounting

Income

85,000

10,000

15,000

35,000

20,000

Average Accounting Income=£(85,000+10,000+10,000-

15,000+35,000+20,000)/6=24,166.7

Accounting Rate of Return=(24,166.7/250,000)*100=9.67%

Accounting Rate of Return for Deluxe

Year

Cash Inflow

75,000

100,000

125,00

50,000

125,00

Salvage Value

40,000

Depreciation

60,000

Accounting

Income

15,000

40,000

65,000

10,000

105,00

Average Accounting Income=£(15,000+40,000+65,000-10,000-

10,000+105,000)/6=34,166.7

Accounting Rate of Return=(34,166.7/4000,000)*100=8.54%

The ARR for both projects is higher than the cost of capital.

However, the company should invest in Super since its ARR

Accountancy 7

is higher than Deluxe.

iii. Net Present Value

NPV for Super

PV=125,000/(1+0.08)˄1+50,000/(1+0.08)˄2+50,000/(1+0.08)˄3+25,000/(1+0.08)˄4+75,00

0/(1+0.08)˄5+50,000/(1+0.08)˄6=£299,227.26

NPV=£ (299,227.26-250000)=£49,227.26

NPV for Deluxe

PV=75,000/(1+0.08)˄1+100,000/(1+0.08)˄2+125,000/(1+0.08)˄3+50,000/(1+0.08)˄4+50,0

00/(1+0.08)˄5+125,000/(1+0.08)˄6= £403,959.21

NPV= £ (403,959.21-400,000) =£3,959.21

According to the NPV approach, the company should invest in super since its NPV is higher

than Deluxe.

iv. Internal Rate of Return

IRR: NPV=0

Super

The NPV for super at 8%= £49,227.26

Using the same formula, the NPV at 15% and 16% are £2,577.11 and £-3,012.5 respectively.

Therefore, IRR≈15% since it is closer to zero compared to 16%.

Deluxe

The NPV for super at 8%= £3,959.21

The NPV at 10% and 12% are £-19,503 and £-40,868. Therefore, the IRR for the project is

IRR≈8% since it is closer to Zero.

The company should invest in Super since its IRR is higher than the cost of capital.

Accountancy 8

References

Bierman Jr, H. and Smidt, S. (2012). The capital budgeting decision: economic analysis of

investment projects. Routledge.

Tesco PLC (2018). Understanding Tesco. [online] Tesco plc. Available at:

https://www.tescoplc.com/investors/understanding-tesco/ [Accessed 14 May 2018].

Tesco PLC(2017). Annual Report and Financial Statements. [online] Tescoplc.com.

Available at:

https://www.tescoplc.com/media/392373/68336_tesco_ar_digital_interactive_250417.

pdf [Accessed 14 May 2018].

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