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Tesco Financial Management
Financial Management Analysis Tesco Plc
1. Introduction
The main purpose of this report is to analyse the financial prospect of Tesco Plc. Accompanying this report, I would like to give some suggestions to my friend - Ravi for investing in shares of Tesco Plc on the London Stock Exchange.
To analyse and evaluate financial management of Tesco Plc in this paper, I have separated the paper into following section. In first section of this paper, Demonstration of current finance theory will provide to build a theoretical framework which can be applied to Tesco Plc, intruding Agency theory, Market efficiency, Investment appraisal, Capital structure and Risk management. next, In the second section, I will continue to discuss how Tesco Plc perform its financial management on above theory base, After analysis and discussion, Findings and recommendations will provide to Ravi for his investment decision.
1.1 Background of Tesco Plc
According on “Tesco at a glance” on Tesco website, Tesco is one of the world's leading international retailers. Since the company first used the trading name of Tesco, in the mid 1920s, the group has expanded into different formats, different markets and different sectors.
At present, Tesco employs over 450,000 people in its businesses around the world and aims to deliver a consistently strong customer offer on every visit and every transaction by focusing on the Group's core purpose: to create value for customers to earn their lifetime loyalty. (Tesco at a glance, accessed 04-12-2007)
The potential of grocery market in the UK still leave large room for development, Farmer weekly (2007) reported Tesco now controls just over 30% of the grocery market in the UK, approximate to the combined market share of its closest rivals, ASDA and Sainsbury's. In 2007, the supermarket chain announced over £2.55 billion in profits.
Currently, The Group's principal activity is the operation of food stores and retailing, purchasing, property investment, property development, personal finance and other activities. The Group operates in 2,365 stores around the world providing a variety of services and products such as Tesco express, Tesco Metro, Tesco Superstore and Tesco Extra (Tesco Plc, accessed 24-12-2007).
2. Theory Review of Finance Management
At the beginning of this section, I will review some important financial management theories that may apply them on Tesco case analysis before moving into analysing and evaluating current financial situation that Tesco locate. These theories can be described in the following:
2.1 Agency and Stakeholders theory
Agency theory main describe the relationship between principals (shareholders) and agents (managers), and that there is a potential conflict of interest between principals and agent if their aims are not aligned. Jensen and Meckling (1976) explained agency theory based upon conflicts of interest between various contracting parties - shareholders, company managers and debt holders.
Donaldson & Davis (1991) stated Agency theory builds on the relationships between principals and agents. Agency theory occurs when the principal and the agent create a delegation, According to Shleifer and Vishny (1997) Agency theory argues that in the modern corporation, in which share ownership is widely held, managerial actions depart from those required to maximize shareholder returns. moreover, in Agency theory terms, the owners are principals and the managers are agents and there is an Agency loss which is the extent to which returns to the residual claimants, the owners, fall below what they would be if the principals, and the owners, exercised direct control of the corporation (Donaldson, & Davis, 1991). In addition,
Stakeholder is defined by Mullins (2002) as “individuals or groups who have an interest in and/or are affected by the goals, operations or activities of the organisation or the behaviour of its members”. We should understand all stakeholder groups have influence throughout the organisation. These influences affect the organisational performance and their existence within its market sector. Such as, Shareholders - they can simply withdraw their investment from the organisation by selling their share. Alternatively shareholders can attend the annual meeting and vote against the organisational suggestions.
2.2 Market efficiency
In finance, The Efficient Market Hypothesis (EMH) can be described as one of the cornerstones of modern financial economics, EMH states that security prices fully reflect all available information at any given time. The implications of the efficient market hypothesis are truly profound. Most individuals that buy and sell securities, do so under the assumption that the securities they are buying are worth more than the price that they are paying, while securities that they are selling are worth less than the selling price.
However, if markets are efficient and current prices fully reflect all information, then buying and selling securities in an attempt to outperform the market will effectively be a game of chance rather than skill. This financial theory has been defined by Fama (1965) on his Ph.D. dissertation, He stated “"An 'efficient' market is defined as a market where there are large numbers of rational, profit-maximizes actively competing, with each trying to predict future market values of individual securities, and where important current information is almost freely available to all participants.
In an efficient market, competition among the many intelligent participants leads to a situation where, at any point in time, actual prices of individual securities already reflect the effects of information based both on events that have already occurred and on events which, as of now, the market expects to take place in the future. In other words, in an efficient market at any point in time the actual price of a security will be a good estimate of its intrinsic value."
2.3 Source of finance
Businesses will have trouble if they fund their activities inappropriately. Finance is essential source for business to go forward for the short-term and the long-term. For example, businesses that try to rely too heavily on short-term sources might run out of cash. Using bank overdrafts, Hire Purchase and leasing to acquire machinery and other fixed assets for too long can raise costs and drain working capital. Similarly, if a business tries to fund rapid growth with short-term sources, it might run out of cash. This is because growth often requires heavy capital expenditure, which might be better funded with long-term sources.
In general, two key sources of finance are internal sources and external sources. Stephen (2000) gave his explanation below:
= Internal sources means money company can raise from within the firm. This may include profit, or perhaps better management of existing resources.
= External sources means raising money from outside the firm. In many cases this will mean turning to the banks, however, It may also be that the firm tries to issue more shares on the stock market or perhaps sells debentures to raise money.
2.4 Risk management
Risk management integrates recognition of risk, risk assessment, developing strategies to manage risk, and mitigation of risk using managerial resources. Charles (2004) explained “the strategies include transferring the risk to another party, avoiding the risk, reducing the negative effect of the risk, and accepting some or all of the consequences of a particular risk”.
Accounting to Lam (2003) Financial risk management is the practice of creating value in a firm by using financial instruments to manage exposure to risk. Similar to general risk management, financial risk management requires identifying the sources of risk, measuring risk, and plans to address them. As a specialization of risk management, financial risk management focuses on when and how to hedge using financial instruments to manage costly exposures to risk.
3.0 Analysis Financial Management of Tesco
3.1 Agency and Stakeholders theory
Concerning about how Tesco Plc take actions to deal with company's stakeholder, through viewing Tesco's financial statement, some information and documents of Tesco, I would like to give my analysis below:
Stakeholder of Tesco's can be categorised into three main groups: Internal stakeholders (Employees and Management ); External stakeholders (Community & environment and Society), and Connected stakeholders (Shareholder and Customers). In my view, As a important part of stakeholders, shareholders of Tesco are playing vital role in company's financial management, because they can simply withdraw their investment from Tesco by selling their share. Alternatively, Shareholders can attend the annual meeting of Tesco's and vote against company's suggestions.
“To create value for customers, to earn their lifetime loyalty” is Tesco's mission statement. At this point, we can see by the statement that Tesco concentrates more on the long-term relationships with its customers. Tesco focused on providing exceptional value and choice for customers to ensure that they continue to grow their market share. Tesco had expanded significantly over the past 10 years, it started in non-food retailing in 1997 and now Tesco is creating value on a wide range of products from grocery to financial services such as personal loan, insurance, credit card, loans, savings, travel, broadband and dial up internet access. From these we can see that Tesco is working very hard to follow its mission statement to achieve its goal.
On the other hand, Combining the agency theory and the stakeholder theory that I have described above, To make any ethical decisions. Tesco always make as much money as possible for the shareholders within the rules of the game, Due to the stakeholder theory defined a business for its stakeholders and its actions should be designed to balance stakeholders' interest, Tesco uses the agency theory to decide its main objectives in order to provide excellent goods and services and to earn their customers loyalty.
This will ensure their existence on the market and to maximise the shareholders' investment. Tesco also uses the stakeholder theory to act on behalf on its stakeholder's interests such as contribution towards the society, care for the environment and responsibility to the supplier chain. Like the statement from Directors of Tesco - “We are committed to the highest standards of corporate governance. We recognise that good governance helps the business to deliver our strategy and safeguard shareholders' long-term interests. We believe that the revised Combined Code provides a useful guide from which to review corporate governance within the Group” (Corporate governance of Tesco's, accessed 12-12-2007)
3.2 Market efficiency
Currently, Tesco is listed on both London Stock Exchange (TSCO) and Irish Stock Exchange (TESCO PLC).
Studying on five year Financial performance of Tesco below, we can see Turnover of Tesco increase 76.9% from 26,337 (£m) in 2003 to 46,600 (£m) in 2007 during five financial year; Company's Profit also increase 100.74% from 946 (£m) in 2003 to 1,899 (£m) in 2007 during five year, moreover, Basic Earning Per share is going up 8.82 (p) from 13.54 (p) in 2003 to 22.36 (p) in 2007, Total increment is 65.1%
In addition, According to Annual report of Tesco(2007), Dividend per share of company has also increased from 6.20p in 2003 to 9.64p in 2007.
The Group's total shareholder return performance (ie. share price movements plus dividends reinvested) over the last five financial years relative to the FTSE 100 index of companies is shown below (See Performance Graph). This index has been selected to provide an established and broad-based comparator group of retail and non-retail companies of similar scale to Tesco, against which the Group's TSR performance can be measured.
Source: FTSE (2007)
3.3 Source of finance
Tesco has to deal with a lot of money coming in and out of the organisation. Through observing financial information on Tescocorporate.com, we can see Tesco's current finances operations by a combination of retained profits, long and medium term debt capital market issues, commercial paper, bank borrowings and leases, with the objective of ensuring continuity of funding. The Group's principal medium to long term funding is 10 £bn, and Short Term Funding is 2 £bn
In the following, I am going to explain all the sources of finance that are used by Tesco and how they are effective to Tesco's. I will analyse the different finances Tesco use and what they could do if they wanted to raise more money to reinvest in stock or the store.
Share Capital - Share capitol is money raised from selling shares. Tesco will use the money raised to re invest into Tesco, in expansion of stores and introduction of more products. If Tesco wanted to introduce a wider variety of stock into the organisation and they didn't have enough liquid cash, then they could sell their shares to raise more money. From Tesco.com, we can see the highest share holder is Barclays Global Investors with only 3.82%, that means that Tesco have still got a large part of the organisation.
Mortgage - Is a long-term loan taken out to buy properties. Tesco will use this if they want to open a new branch. They would go to a loan company with their projected figures and the expected annual income, and based on these figures they will be told if they are accepted to have a loan. They will need to ensure that they can afford the repayments and that they are clearly stated before the store is opened. This is because Tesco need to ensure that they are expected to make enough money to reinvest in stock pay off the mortgage and pay wages of the staff at Tesco.
Unsecured Loan - Is a loan that you do not put security up against. Pay back higher than interest because it is unsecured. This exposes the lender to more risk. Sole traders, partnerships, private and public limited companies, use this. This can be dangerous to Tesco depending on how they go about the situation and the money, which is earned by the company.
Hire Purchase - This is when machinery is hired and then after a certain period of time it becomes yours. It is like buying and expensive item in instalments. This is a good way for Tesco to have machinery and not notice the amount they paid for the item. As Tesco will be paying back a smaller amount a month they will have more money to spend on more important things like reinvestment and stock turnover.
Venture Capitalists - A business that would look to invest in another business as an investment. This could be something that Tesco may consider, although as Tesco is already a well established organisation. And should therefore already be able to raise capital to open a new store or to generate a new or wider range of stock.
Government & EU - Provide money to businesses who they think will be a good investment. This would be always be helpful to Tesco if they were receiving money with the backing of the Government, this is why they should try and set a good example for similar competitors.
Bank overdraft - When you go below zero in you bank account, interest may be charged. Therefore Tesco will need to ensure they have enough cash available if they require it and so that they don't spend money unnecessarily on paying back interest when it could be avoided
Trade Credit - When a creditor has given you things and you pay them back afterwards. This would also be a could be investment for Tesco as they will not be paying a lot of money back initially, although later on once the business becomes more established they will be earning more money and it will be more easier to pay off their debts.
3.4 Internal control and Risk management of Tesco
To achieve Company's objectives, The Board has taken overall responsibility for internal control, including how to mange risk of Tesco. Executive management of Tesco have implemented and maintained the control systems across the Group in accordance with Company 's policies and in line with best practice for identifying, evaluating and managing financial and non-financial risks.
= Identifying Risks
The Board of Tesco always considers and approves the Key Risk Register and the mitigating actions. In addition, They also consider finding out future opportunities and risks lie which helps shape Tesco's corporate strategy in the future. and the key risks are a regular feature of the Board's agenda and further assurance on implementation comes from the reviews by management and internal audit, the Compliance Committee, the Corporate Responsibility Committee and the Finance Committee.
= Internal controls and risk management
Through the Key Risk Register, Tesco can assess the impact and probability of each risk and the effectiveness of the mitigating controls. Methods for monitoring each specific risk are then agreed. Accountabilities for managing these operational risks are clearly assigned to line management. Risk assessments are carried out routinely by management throughout the UK and international businesses. Procedures exist to ensure that significant risks and control failures are escalated to senior management and the Board on a timely basis.
In addition, Tesco have a five-year rolling business plan that focuses on delivering the Group's strategy. Each business unit and support function derives its objectives from the plan and these are cascaded to form individual objectives. The plan covers all the key trading and financial performance measures and targets to deliver the financial returns on the capital employed in the business.
On an annual basis these plans are combined with detailed budgets and also balanced scorecard of Tesco, which unites the Group's resources around our customers, people, operations and finance. This enables the business to be operated and monitored on a balanced basis with due regard for all stakeholders. Financial performance is reviewed weekly and monthly. moreover, all major initiatives require business cases to be prepared, normally covering a minimum period of five years. Post-investment appraisals are also carried out.
Tesco also have a structured programme for internal communication of policies and procedures and performance. This provides employees with a clear definition of the Group's purpose and goals, accountabilities and the scope of permitted activities of companies, executive functions and individual staff. This ensures decision-making takes place at the correct level and that all our people understand what is expected of them and how company have performed.
= Monitoring the controls
The Board of Tesco agrees clear processes for monitoring controls through the Statutory Committees, It include Audit Committee, Nomination Committee and Remuneration Committee. In addition, the Executive Committee monitors controls through three key committees, There are Compliance Committee, Corporate Responsibility Committee and Finance Committee. All of these provide assurance that the business is operating legally, ethically and within approved financial and operational policies.
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