Financial analysis of Tesco and Morrisons annual reports

Managing Accounting of Tesco and Morrisons

Annual reports give details of financial performances of various companies and are vital assets when making investment decisions about a company. This paper presents an in-depth analysis of several aspects of Tesco and Morrisons; two leading British supermarkets. The paper by using the company reports compares and contrasts the information provided in each of the annual reports selected. The areas covered in this discussion include shareholders and employees among other details.

Important Information from Annual Reports

Shareholders Interest

Shareholders are the strength of any publicly traded corporation; shareholders provide the necessary capital, business objectives as well as strategies vital for daily running of the organization. In the case of Morrisons, the number of shareholders as at January 2012 was 46,410 and the number of shares in issue was 2,532,312,110 (Morrison Supermarkets PLC, 2012). On the other hand, Tesco has 155,600 shareholders; a majority of them owning less than a thousand shares. According to stakeholders, fluctuations in share prices and share issuance periods are of great concern to them. Rising share prices in the firms' annual report may attract more investment from shareholders thus; an annual report indicating rising share prices makes the firms receive more potential investors. As is the case with Tesco, shareholder number is expected to rise over the years given the higher investment returns realized by the company each subsequent year (Tesco PLC, 2012).

In line with this, issuance of attractive dividends by the companies' such as dividends of 7.53p per share is likely to attract more potential shareholders' funds. According to this, the numbers of investors are likely to increase following the increase in the number of proposed shares and investment returns realized. In addition, increasing mergers and acquisitions by the company shows a growth therefore pulling investors towards the firms (Tesco PLC, 2010). From the annual reports, potential investors will examine the firms' sales revenue as well as profit margins to determine whether the firms are profitable or on the brink of collapse. Strong sales and profit net worth figures in the annual reports are indications the firms are financially stable therefore potential shareholders are likely to be attracted to the firm.

Lenders and Suppliers

Tesco sources for its retail products from all over the world just as Morrisons. Tesco's major suppliers come from the Irish market accounting for €705.8 million in Irish food purchased by Tesco from Ireland annually. Additionally, Tesco has a Hong Kong-based plant responsible for supplying the retailer's stores around the world with non-food goods (Hall, 2009). Lenders and suppliers are not merely interested in the firms supply chains but the annual sales volumes as well as revenues achieved by these companies. Tesco and Morrisons realize high net profits each subsequent year a factor likely to attract suppliers and lenders thus developing strong, mutually beneficial, and long-term partnerships with both local and global suppliers.

In addition, this group of stakeholders is likely to examine the organizations' capital investment, including capital expenditure, investments and acquisitions as well. Morrisons' recent acquisition of kiddicare.com Limited, and the purchase of Flower World Limited has increased the firm's capital base; a factor likely to attract more suppliers and lenders. Tesco acquired 100% of ordinary share capital of BzzAgent Inc. And BzzAgent Limited for a cash consideration of £9m which resulted in an influx of suppliers and lenders.

Employees

Without the services of dedicated and highly motivated employees, an organization is unable to achieve high turnover and prosperity as is the case with Tesco and Morrisons. The more than 131,000 workforce at Morrisons (Morrisons Supermarkets PLC, 2011) and 520,000 at Tesco serving millions of clients each week look at several perspectives of the firms' annual reports. Increasing sales volumes and profit margins are motivators to employees who see their efforts paying off to their respective firms. In addition, employees being part of the companies' stakeholders scrutinize the companies' share prices as well as share dividend to estimate the number of shares to make and firms' investment worth.

Information Reliability to Stakeholders

Morrisons' and Tesco's information outlined in their annual results comply with generally accepted accounting conventions and practices. The information provided in the Annual Reports meets the areas of interest that are discussed in the preceding section (The Financial Times, 2011). However, there are possible accounting conventions and practices that may limit the usefulness of the information provided to the stakeholders.

Both Morrisons and Tesco have been reporting their yearly fiscal results according to UK's GAAP until 2005. From 2006 onwards, these firms adapted the use of IFRS. According to this accounting standard, Goodwill is not capitalized and amortized, but is subject to impairment tests conducted yearly; both firms treat goodwill as an asset.

In addition, TESCO and Morrisons use straight line depreciation of definite-lived intangible assets; R&D Expenses, are amortized over project's useful life. Besides, tangible assets like equipment are depreciated by straight line method over time. Inventories at both firms are valued at lower of cost and fair values less cost to sell by using weighted average method.

The first limitation is that the two companies though headquartered in the same country, use different accounting standards which can affect the comparability of the two companies. Some differences may be seen as more problematic because they are likely to result in differences between the information reported for a given reporting period in financial statements of enterprises following IFRS standards and the information reported by those following that would be difficult to compensate for in making comparisons.

The next challenge is measurement differences. In this regard, the companies may have utilized different ways of measurement therefore leading to different amounts for the same item. For example, the method for determining inventory cost (Simms, 2007). One company may prohibit the use of Last in First out (LIFO) method while the other adopts its use. Morrisons uses the LIFO method to value inventory while Tesco has to use the First in First out (FIFO) method. This may lead to different comparisons in the annual reports.

The other possible issue is that differences are likely to arise when one standard allows a company to choose between alternative methods for a transaction but the other standard recognizes only one method (Nash, 2006). In line with this, Morrisons cannot offset an amount due from one party against the amount due to another party. On the other hand, Tesco carries out this transaction if they have a legal set-off agreement with the party involved.

The subsequent problem likely to be witnessed is the lack of guidance. The standards used by one company may not provide guidance for a particular item and the other standard does, therefore several differences are prone to crop up.

Financial Analysis

Tesco

Profitability Ratios

Ratios

Tesco (£ million)

2009-2010

2008-2009

Sales Growth%

((Current year sales/Previous year sales) -- 1)

SG = (56,910 / 53,898) -- 1

= 5.59%

2008's data unavailable

Gross Profit Margin

(Gross Profit / Sales)

GPM = 4,607 / 56,910

= 8.09%

GPM = 4,185 / 53,898

= 7.76%

Operating Profit Margin

(Operating profit / sales)

OPM = 3,457/56,910

= 6.07%

2008's data unavailable

Net Profit Margin

(Net profit after tax / sales)

NPM = 2,336/56,910

= 4.1%

2008's data unavailable

Return on Capital Employed

((Operating profit / Capital Employed)

Capital Employed = (Total Assets -- Current Liabilities))

CE = (34,258+11,765) -- (16,015)

= 30,008

ROCE = 3,457/30,008

= 11.52%

2008's data unavailable

Return on Equity

(Net profit after tax / Shareholder's equity)

ROE = 2,336 / 14,681

= 15.91%

2008's data unavailable

Revenue/Profit per employee

(Operating profit / Number of employees)

3,457 / 0.472

= £7324.15

2008's data unavailable

From the above table, the return on Capital Employed (ROCE) makes a comparison between the firm's earnings with the capital invested by the organization. This is useful in measuring the company's performance over a period of time. As illustrated above, the ROCE of Tesco in 2010 is 11.52%. Tesco's RECO is low; an indication that the organization is gaining from its assets but is losing out because of the high liabilities. In this regard, it is clear from the above results that the Total Liabilities to Sales ratio of Tesco is very high = (16.015 + 15.327) / 56.910 = 0.56.

Return on Equity (ROE) is used in measuring the return rate on shareholder's equity of common stockholders. This outlines how well a particular firm is using invested funds in generating earnings growth; ROE about 15 to 20% is considered desirable by most analysts. From the table above, Tesco's ROE in 2010 is 15.91%. This result is an indicator that Tesco uses investor's equity to generate earnings appropriately. In addition, the ROE has steadily risen over the years to 15.91% in 2007 (The Financial Times, 2011). This is an indicator the company is giving good returns to shareholders and the trend is likely to continue in the coming years. Thus, this indicates that shareholders are willing to invest in the company due to probability of earning high dividends.

Liquidity Ratios

Ratio

Tesco (£ million)

2009-2010

2008-2009

Current Ratio

(Current Assets / Current Liabilities)

CR = 11,392/16,015

= 0.71

CR = 13,081/17,595

= 0.74

Quick Ratio

(Current Assets -- Inventory) / Current Liabilities)

QR = (11,392-2,729)/16,015

= 0.54

QR = (13,081-2,669)/17,595

= 0.59

Current Ratio is a representation of the organization's capability to meet creditor's demands by offsetting accumulated debts. The table shows that Tesco's CR is 0.71 meaning that for every $1 the firm owes its creditors, it has to repay $0.71. On the other hand, Quick Ratio (QR) is company's ability to clear its current liabilities. Tesco's QR as outlined above is 0.54 meaning the firm is capable of paying off 54% of its current liabilities. In this case, Tesco's assets have gradually risen just like the liabilities. According to this, the company's current assets are incapable of meeting short-term liabilities and the debt / capital ratio stands at 40.24%.

Efficiency Ratios

Ratio

Tesco (£ million)

2009-2010

2008-2009

Net Asset Turnover

(Sales/Net Assets)

NAT = 56,910/14,681

= 3.88

NAT = 53,898/12,906

= 4.18

Net Operating Asset Turnover

(Sales/Capital Employed)

CE = (34,258+11,765) -- (16,015)

= 30,008

NOAT = 56,910/30,008

= 1.90

CE = (32,085+13,479) -- (17,595)

= 27,969

NOAT = 53,898/27,969

= 1.93

Receivables collection period

(Receivables / Sales) * 365

RCP = (1,888/56,910) * 365

= 12.11 days

RCP = (1,820/53,898) * 365

= 12.33 days

Payables Payment period

(Payables / Cost of sales) * 365

PPP = (9,442/52,303) * 365

= 65.9 days

PPP = (8665/49,713) * 365

= 63.62 days

Inventory Holding period

(Inventory / Cost of sales) * 365

IHP = (2,729/52,303) * 365

= 19.05 days

IHP = (2,669/49,713) * 365

= 19.6 days

The Receivables Collection Period (RCP) of Tesco is 12.11 days. In this regard, the time Tesco's customer's take to pay for their services is slightly higher. In addition, Tesco's Payables Payment Period (PPP) is given as 66 days in 2010. This high PPP is good for the company but the firm has to ensure the relationships with suppliers are not put to test. As is the case with Tesco, wrangles with suppliers may occur since Tesco takes more than 2 months to pay them (Potter, 2011). Moreover, the Inventory Holding Period of Tesco is low and efficient at only 19 days. This shows that Tesco only keeps stock for 19 days efficiently rotating accumulated inventory.

Operating Profit and Net Cash Balance

£ million

£ million

Operating Profit

3,457

Net effect of Others including decrease in loans, increase in working capital

1,106

Depreciation and amortisation

1,384

Income from continuing operations after tax

5,947

Interest Paid

(690)

Corporation Tax

(512)

Net cash from operating activities

4,745

Net cash used in financial activities

(3,607)

Net cash used in investing activities

(1,877)

Effect of exchange rates on cash and equivalents

49

Net increase (decrease) in cash and equivalents

4,745 -- 3,607 -- 1,877 + 49

= (690)

Cash and equivalents at beginning of year

3,509

Cash and equivalents at end of year

2,819

Tesco's 2010 operating profit is £3.457 billion, which is £300 million more than during 2009. In line with this, the firm could have had higher operating profit if it efficiently minimized the cost of sales. Tesco's cost of sales increased by £2.26 billion while sales revenue increased by £3.01 billion. In addition, the company's cash reserve dropped by £690 million following adjustments of exchange rates (Tesco PLC, 2010). Furthermore, the firm paid £900 million more than in 2009 to settle borrowings. Besides, Tesco invested approximately £700 million more in short-term investments than in 2009 and sold £1.820 billion worth of property, plant and equipment in 2010, a substantial increase from 2009. The increased operating profit attracted more investors into the company while the repayment of short-term borrowings augured well with the firm's lenders. Outlined below is Tesco's turnover from the year 2007 through 2010 which stakeholders may also critically analyze.