Rory Ball-Reeder

Task 5 - How to interpret financial documents

Introduction:

In part one of this report I will be explaining what the profit and loss accounts are for Tesco. Secondly I will go on to explain what the balance sheet is for Tesco.

The Profit and Loss Accounts of Tesco:

Profit and loss accounts are used by companies to work out how much money they have made and spent over the year. Which will then help them to work out whether they have made any profit over the year or whether they have lost money over the year. This can then go on to help banks or loaners to see whether or not it is worth lending money to them.

There are three sections of a profit loss accounts they are:

Gross Profit – Gross profit shows how much money they have made from their sales over the year, and how much it also cost them to make all that money.

Net Profit – Net profit shows how much money they have made minus the admin and overheads.

Retained Profit – Retained profit shows how much money you have left after you minus the tax and dividends from the net profit.

1 | P a g e

In 2013 Tesco made 65,000 million pounds from their sales. Sales is the products that have been sold.

In 2013 Tesco had to spend 60,000 million on cost of sales in order to get the 65,000 million in sales. Cost of sales is the amount of money that would have been spent on advertising of the products, and the buying of the products.

In 2013 Tesco overall after the sales and the cost for sales only made 5,000 million pounds. Gross profit is the amount of profit they made after you have subtracted the cost of sales from the amount of money they made from the sales.

This just means pounds in millions.

Rory Ball-Reeder

2 | P a g e

Tesco is 2013 spent 500 million on admin. Admin is the administration of a business’s organization e.g. the filing of reports, telephone calls, the organisation of meetings etc.

Tesco in 2013 had to pay 2,000 million pounds on overhead. Overhead are things like electricity, water, staffing etc.

Tesco only made 2,500 million pounds net profit in 2013. Net profit is the admin and the overheads deducted from the gross profit.

Tesco in 2013 had to pay 500 million pounds in tax overall. Tax is the money you have to pay to the government for certain reasons e.g. road tax, business tax etc.

Tesco also had to pay out 1,000 million pound to dividends in 2013. Dividends is the amount of money that has to go to the shareholders.

Tesco in 2013 made 1,000 million pounds in retained profit. Retained profit is the overall profit that they have made over the year. This is also the point where the tax and dividends has been taken away from the net profit. A company a big and as well-known as Tesco should be making more than just 1,000 million pounds in a year yes that is a lot of money and still a good point that thy made that much profit but they should be wanting around 10,000-20,000 million pound profit in a year because this will show they are doing the right thing and that they are making good amount of profit 1,000 million pounds to business like Tesco will be seen as nothing.

Earnings per share is for Tesco in 2013 was £12.07. Earnings per share is the dividends divided by the number of shares that a business has or is offering. Which will then work out how much it will cost for one share. However the more shares you own means the bigger percentage of the dividends you will get. Therefore you will also get more money.

Rory Ball-Reeder

The print screens above came from the following website: http://files.the-group.net/library/tesco/annualreport2013/pdfs/tesco_annual_report_2013_financialreview.pdf

Tesco use a profit and loss account, because it gives Tesco a better understanding of how much money they have made without lots of different things they have to look at. What I mean by this is that a profit and loss account only shows the overall headings of where the money is being spent without going into lots of detail and listing every single thing the money got spent on this only shows the main categories. This will help Tesco to understand where the main percentage of their money got spent, and also gives a greater understanding on how much money they have made after they have subtracted all the money they spent, giving them their overall profit.

The Balance Sheet for Tesco

A balance sheet is a way of business’s showing everything the business owns and parts of its financials, meaning this will hold every bit of information on it to do with the business liabilities, what they own and basically how much they are worth. This shows people or other businesses which might be interested in buying that business, what debts they will have to pay off, what assets they can sell to make quick money or what might take a long time to sell. This will also help them to work out what they will own or be able to use from that company if they wanted to turn it into their own company. For example, is someone bought the company and they wanted to turn it into a clothes shop they will want to keep the certain assets, e.g. buildings, vehicles, any stock which is clothing etc. The balance sheet will have to be updated frequently, because some things will devalue of time or become worth more, and before someone buys a business they will want to make sure they get

3 | P a g e

Rory Ball-Reeder

an up to date balance sheet. Assets are things that could be useful to someone or could be worth money. Liability is things that you could have to pay back or responsible for by law. Equity is where you have to be fair. What I mean by this is that you will have to be fair when sharing out the money which you might own to shareholders. Tesco use a balance sheet because they can sue this to show them how much money they own to people or people owe to them. Balance sheet can also show you how well you are doing in their net worth which is how well they are doing financially minus the liabilities which they owe. This will be used to show the value of Tesco on other words how much they are worth.

4 | P a g e

Assets are things that you own. This can also be useful at times. Fixed assets are things that a business owns but is normally quite big and hard to get rid of. They also devalue quite quickly over time. Some examples of fixed assets could be buildings, massive equipment (machinery etc), vehicles etc.

In 2013 Tesco had 20,000 million pounds worth of premises. However because they are fixed assets and, because of how big they are it will take a long time to get all that money back from them. Tesco premises will also devalue over time so they won’t be worth that much money any more. Premises are the building that they own e.g. supermarkets, warehouses, factories etc.

In 2013 Tesco had 10,000 million pounds worth of equipment however they will not be worth that much anymore because of them devaluing. They may also take a long time to sell, because of what they are and how big they are. Tesco will have equipment like e.g. freezers, fridges, shelves, machinery etc.

In 2013 Tesco had 5,000 million pounds of other investments this would be long term investments which will be very hard to get their money back. Some of their investments might not also be worth as much now as what they did then. Other investments means other places where they have spent their money which is ongoing e.g. new building work etc.

In 2013 Tesco had 5,000 million pounds worth of vehicles. Over time however they would have devalued so know they aren’t worth that much. These are another thing which may take a long time to get all that money from them because of their size and what they are used for. Some of the vehicles they would have are; Lorries, cars, forklifts etc.

Rory Ball-Reeder

5 | P a g e

Current assets are assets which Tesco will be able to get the money from very quickly and easily. Tesco in 2013 had 16,500 million pound in current assets. This helps anyone who might be looking at buying Tesco what they can make quick money on if they needed to pay off any debts, or they were looking at turning it into their own business.

Tesco in 2013 had 6,000 million in stock. Stock is what a business sells e.g. clothes, food etc. This may decrease in value over time the reason for this is, because most of Tesco’s stock is things that has dates on. Meaning some of the stock will go out of date or be low on date. If someone who has just bought the company wants to sell the stock for this much money it will be very hard, because the stock that has gone out of date would have to be binned, and any stock with short life on its date might have to have its price reduced. But this will depend on what the new business owner wants to do with Tesco meaning if they want to keep it the same then they won’t need to sell the stock however if they wanted to turn it into a different business then you will want to think about what stock if any could be useful to you or not.

Debtors are people/businesses or countries which owe Tesco money and in 2013 Tesco had 4,500 million pounds of debtors owed to them. This will help them to understand how much money is owed to them which is also might be easy to get hold of.

In 2013 Tesco had 2,000 million pound worth of their money invested in short term investments. Short term investments are investments which only last for a short period of time. However they are also able to take their money back at any time during the investment, although some of their investments depending on what they are might be quite hard to get back straight away and whenever they want them.

Tesco in 2013 had 4,000 million in cash. This is just money that is sorted somewhere e.g. bank. This is also easily accessible to them.

Current liabilities are things that Tesco are liable for e.g. money which they owe to people, businesses, the country, the government etc.

Tesco have 10,000 million pounds which they owe to other businesses or people. This means if someone wanted to buy the company, and then change it into their own company they will have to pay off any money owed to other people/businesses.

Tesco also owe 1,000 million in unpaid taxes. This will mean that before a new owner can turn Tesco into their own company they will have to pay off any debts which are owed to the government (unpaid taxes).

Tesco in 2013 had 5,000 million pounds which they owe to financial liabilities. Financial liabilities is money which Tesco owe to other businesses for lending them someone of their assets e.g. vehicles, equipment etc. It could also be where the business has provided some of their services to Tesco and Tesco haven’t paid them back for it. If someone new was to buy the company they would be the one who is responsible to pay all the financial liabilities back.

In 2013 Tesco had 25,500 million pounds worth of assets employed. Assets employed is the total of current liabilities taken away from the current assets and then that taken away from the total fixed assets.

In 2013 Tesco had 15,000 million pounds which they owed in long term liabilities. Long term liabilities are liabilities which they will have to pay back after a couple of years. For example; loans, bank loans, debentures etc. Meaning if someone else bought the company they will have to make sure they pay it back.

Tesco in 2013 had 500 million pounds working capital (net current assets). Working capital is the money which gets used to pay for the day to day trading. Tesco would have calculated this by subtracting the current liabilities from the current assets.

Rory Ball-Reeder

The print screens above came from the following website: http://files.the-group.net/library/tesco/annualreport2013/pdfs/tesco_annual_report_2013_financialreview.pdf.

Interpreting Tesco’s Financial Documents

Introduction

6 | P a g e

In 2013 Tesco had 10,000 million pounds worth of share capital. Which is the amount of money which the company/business owes to the shareholders.

In 2013 Tesco made 15,000 million pounds worth in retained profit. Retained profit is money which the percentage amount of money which a business will not be putting into dividends but instead it will be reinvested in other things for the company or used to pay back any debts the business has.

In 2013 Tesco had 500 million pounds in other reserves. Other reserves is the amount of money which is put to one side for long term capital investments.

In 2013 Tesco had 25,500 in capital employed. Capital employed is just the other reserves, retained profit and share capital added together.

Rory Ball-Reeder

Within this part of the report I am going to be interpreting the profit and loss account and balance sheet which was published by Tesco by using ratio analysis. I will make sure that I show all of the formulas I have used and also show all the working out I did to get the answers I got. I will then go on and explain what each answer means to Tesco. Furthermore I will then evaluate the accounting ratios in order to monitor Tesco using examples.

Ratio Analysis:

Profitability Ratios:

- Gross Profit Margin – Gross profit margin is the amount of money a business has made from their sales before tax has been taken away from it. The higher the number that comes out of the formula the better.

Gross Profit Margin Formula: Gross Profit Margin = (Gross Profit ÷ Sales Revenue) × 100.

Gross Profit Margin for Tesco: Gross Profit Margin = (5,000 ÷ 65,000) × 100 Gross Profit Margin for Tesco = 7.7% interestThis means for every £1 Tesco made in sales the firm makes 7.7 pence gross profit.

- Net Profit Margin – Net profit margin is the amount of money a business has made from their sales after deductions has been taken away from it. Tesco will be mainly concerned about this ratio, because this is the main ratio which says how much money they have really made overall. This is because you could make a massive amount of money in the gross profit, but the government will take 20% of that which makes a huge difference. Net profit normally includes tax however Tesco don’t include tax in their net profit, because it makes their profit look bigger.

Net Profit Margin Formula: Net Profit Margin = (Net Profit ÷ Sales Revenue) × 100.

Net Profit Margin for Tesco: Net Profit Margin = (2,500 ÷ 65,000) × 100.Net Profit Margin for Tesco = 3.8% interestThis means for every £1 Tesco made in sales the firm makes 3.8 pence gross profit.

Tesco will need to know this because they will want to see whether, or not they are losing out on money or making money. However by putting it in a percentage it will make it easier for them to work out how much money they can make per pound they pay. If Tesco was making 99 pence per £1 they spent then they would be making -1% gross profit which will mean they will end up in bigger debt, because they are not making any money but instead losing. This could cause bigger problems for Tesco, because this will mean they will have to borrow money from other businesses, or the bank in order to pay for things. Which would mean they would have to end up closing down, because they would go bankrupt. However a method which Tesco could use to help them to make a profit would be by putting up the prices on their products. Although in this case Tesco are making a profit of 3.8 pence per £1 meaning that at the moment they will not have to up the prices on their products. However Tesco might still think about this, because a company as big and as well-known as Tesco should be making more, than just 3.8 pence per £1 they should be making a lot more money per £1. Although Tesco might not need to make as big as profit as I might think, because they might not be fused on how much they make per £1 as long as they are making money. What help Tesco to still make a big amount of money in the end is that they sell so many products per day. Which means they might not need to have to make such a big amount of money per £1, because eventually it will all add up. Another thing that might stop Tesco from making a massive net profit margin is its competitors offering better prices. Which in order for Tesco to still have customers is too lower their

7 | P a g e

Rory Ball-Reeder

prices. They could also find a better supplier which offers the same products just cheaper which should help them to make a bigger net profit margin. Tesco can use this information to their advantage what I mean by this is they can use this to see whether or not they should put up their prices next year to make even bigger net profit margin. They can also use this information to see whether they are then able to lower the prices for their products and still make some net profit the reason they might want to do this is because they might want to offer better prices to their customers which should then make their customers happy. The might also want to lower their prices because they will be in competition with their competitors. Whereas if they don’t have a high net profit margin then the might not be able to match their competitors which could bring their reputation down. They might also want to think about negotiating prices with their suppliers in order to make even more net profit next year. By negotiating prices with the supplier/s they might be able to get hold of their stock for lower prices and they keep their prices in their stores stay the same then they should make more money. Whereas if they were to up the prices for the products in their stores they could lose customers or not make as much money is because their customers might not be able to afford it. This isn’t really the best ratio to go by because it doesn’t tell you the exact amount of net profit margin they really made because in order for them to do this they would have to work out how many products they sold and then multiply this by the percentage of interest. Yes I agree I does what it intends to do which is show you the percentage of net profit margin you have but if the owner of Tesco has no idea what this means to the company about how much money they really made then I think it is a little bit pointless this is why I think they should also include a little bit of information about how many products they sold that year and at what kind of prices. So then they can work out how many products they really sold and how much they really made. However to do this you would have to go into a lot of detail and could also take a lot of time and money. The limitations are that is only shows you how much money you are many every £1 and doesn’t go on to show you how much money you have made in £100 or £1000 etc. The reason I think this would be helpful because if the owner of the company isn’t very good at maths that might want showing how much money they are making on other amounts of money/ products prices because not all their products are £1 and they might also want to be shown how much money they are making per £100 of spending etc.

- Return on Capital Employed – This is the amount of money that the business has compared to the net profit. With this the higher the number the better.

Return on Capital Employed Formula: Return on Capital Employed =

Return on Capital Employed for Tesco: Return on Capital Employed = (2,500 ÷ 25,500) × 100.Return on Capital Employed for Tesco = 9.8%This means for every £1 that Tesco invest in their selves a firm makes 9.8 pence net profit. This can then be used to compare the performance of the business with the interest from their bank account.

Solvency Ratios:

- Current Ratio – This is a ratio which shows whether or not you are able to pay of any debts which you might have if you were to sell your resources.

Current Ratio Formula: Current Ratio = (Current Assets ÷ Current Liabilities)

Current Ratio for Tesco = (16,500 ÷ 16,000)

8 | P a g e

(Net Profit before tax ÷ Capital Employed) × 100.

Rory Ball-Reeder

Current Ratio for Tesco = 1.03125This means for every £1 that Tesco owes they have £1.03 of assets which can be sold to pay for it. However the nearest the number is to 2 the better, because it means they have enough assets to pay off the people/businesses if they were to close down.

In this case this is bad because Tesco only just have enough assets to pay off the debt which means, if they were to close down the owner of Tesco won’t be left with that much money they will be left with 3.125 pence per £1. Another problem with this is that, this is before they have also paid all their employees meaning, after they have paid all the employees the owner will be left with even less money per pound. Which might mean that they could potentially walk away with only a couple of thousand pounds. Whereas the owner will be wanted to make a lot more than that, because otherwise they may think that it was just a waste of their time and money. The reason the owner of Tesco will have to pay the employees which they have made redundant is, because they will have to pay them for whatever work they have already done and because they are now making everyone redundant. If business don’t pay their employees then they will be taken to court and then sued for everything they own, because by law you have to pay your employees statutory redundancy pay. Tesco should want at least around £1.50 of assets per £1 of money they owe. The reason they will want this amount of money in assets per £1 of money they owe is because they will want enough money to pay off all the money they owe, as well as to still make a lot of money after the employees wages have been taken away. Tesco might want that kind of ratio per pound on just one of the current assets that they are able to do without e.g. cash, debtors etc. The reason for this is because that way they are able to pay the businesses/people they owe straight away without having to get rid of things they might need e.g. stock. This is good because that way they will be able to pay off all their debts really quickly without having to use essential to the business which might mean that it will not be able to run as efficiently as they would want. The reason this is good is because that way they are then still able to keep the business open and won’t have to close it down.

The reason Tesco will want to know this is because otherwise they could get their selves into even more debt which could mean they will have to close down. They will also want to know this is because they might want to see whether or not they are able to pay of any debts they might owe to help the company run that little bit smoother. What I mean by this is the owner of the business will be able to run the business a lot easy because they won’t have to deal with all that stress which is being caused by other businesses asking for their money. Also the owner of Tesco will also want to know how big their current ratio is so they can work out how much money they will make. If Tesco have a high current ratio then the owner of the company will be very happy because they will be able to work out that they will make lots of money and they will also have a lot of money to pay off their debts. Tesco will use this information to their advantage what I mean by this is that if Tesco have a high current ratio they might then use as much of that as they can to pay off any debts. What I mean by this is the owner of Tesco might lower the amount of money they will get from the current ratio and instead use it to pay off as much debts as they can. Whereas if they have a low current ratio then they might only pay off as much debts as they can afford instead of as much as they would like to. This ratio isn’t really a good measure of how well the company is doing the reason for this is because this only shows how much profit they make per £1 but this doesn’t show the overall figure e.g. how much they really made. The reason it doesn’t show this is because we don’t know how many products they sold that year meaning we can’t really begin to understand what that means to them. For example if they only sold 1 product that year worth £1 then they only made 3 pence in that year, whereas if they sold 1 billion products worth £1 then they made a total of 30 million pounds in that year. The limits of this is that it doesn’t show you how much you will really have after

9 | P a g e

Rory Ball-Reeder

paying the employees and how much money they will have to make if they want to pay off all their debts all at once.

- Acid Ratio – This is here to shows whether or not a business has enough short term assets to pay off the immediate liabilities without them having to sell their inventory.

Acid Ration Formula = ((Current Assets – Stock) ÷ Current Liabilities)

Acid Ratio for Tesco = ((16,500 – 6,000) ÷ 16,000))Acid Ratio for Tesco = (10,500 ÷ 16,000)Acid Ratio for Tesco = 0.65625This means that Tesco have 66 pence of assets which they can sell off really quickly to pay back the money they owe. The reason stock is not put into this set of data is because someone stock might go out of data or might be things that not many other businesses will want or use e.g. fresh fish, washing machines etc. The closer the business is to 1 or more than 1 the better because it means that if they do have to close down then they can pay off a lot of the debts really quickly. Whereas with the stock they might not be able to sell most of it if any because their products have expiry dates and other businesses might not want their products because they either don’t sell that product or don’t have any use for it. If you do include stock and you think you are doing really well because you think you can pay off the debt really easily you might want to think about taking away the stock, because otherwise you could have to end up paying off the debts with your own money because stock can take a lot off your current liabilities as you have seen with Tesco.

Performance Ratios

- Stock Turnover – This is the number of times stock is sold/used in a certain amount of time period, the time period is normally up to a year. This is worked out by the average stock divided by the cost of sales then timed by 365.

Stock Turnover Formula = (Average Stock ÷ Cost of Sales) × 365

Stock Turnover for Tesco = (6,000 ÷ 65,000) × 365Stock Turnover for Tesco = 33.692307 (33.7%)

This means that Tesco only sold/used 33.7% of their stock which they bought in 2013. This means that 66.3% of Tesco stock wasn’t used or they had to get rid of. This is bad because this means that Tesco had nearly 2 thirds of their products going to waste which they would of lost out on. Which means that Tesco might want to look at buying less stock, because otherwise they will keep losing out on a lot of money which they could make if they were to sell nearly all of their stock. Getting less stock will also create a bigger percentage of products sold. However there will still be a bit of stock that will go to waste because some of the stock will go out of date meaning they will have to get rid of it. Even though Tesco did still made a profit from their stock they would make/have even more if they didn’t spend as much in the first place on the products, the only reason they should buy so much products is if someone thing is going really fast or they know a lot of people will be after that particular product e.g. sunscreen in the summer etc. They don’t need to buy more/lots of the same product if it isn’t selling that well or you know a lot of people won’t want it. Another thing they could do is to buy products with longer dates on them to help prevent as much waste.

10 | P a g e

Rory Ball-Reeder

This print screen came from the Business BTEC Level 3 Book.

- Debtors Collection Period – This is here for businesses to see how quickly they are able to get hold of money that is owed to them by debtors. However in this case the lower the figure the better and this is also measured in days.

Debtors Collection Period Formula = (Debtors ÷ Turnover) × 365

Debtors Collection Period for Tesco = (4,500 ÷ 65,000) × 365Debtors Collection Period for Tesco = 25.2692307 (25 days)

This means that it takes 25 days for the debtors to sort out their bills and then pay Tesco back. This is good because 25 days to get their money back from a debtors is less than a month. However this is only the average amount of day so it may take some businesses longer but I wouldn’t have thought that it would have been that much longer. One of the ways they could improve this even further is by getting even better credit control than they already have, however it isn’t needed because Tesco should be aiming for at the most of 50 days before they get their money back and they have reached that easily. The reason this is, is because a lot of businesses are having to close down because they are becoming in money troubles. Meaning in some cases if Tesco did have businesses that owed them money and couldn’t pay it back in under 100 days that they might not get their money back from the debtors because they are one of the businesses which closed down due to bankrupt therefore showing why Tesco should be aiming for under 50 days to get their money back from that debtor. This is why Tesco would make certain checks like making sure they only lend to businesses that they are certain to get their money back and in short amount of time.

Tesco will want to know this because they will want to know how long before they will be paid back for whatever it is that the debtors owe them for. What they will do with this information is work around it by this I mean they will fit their spending and lending around these time periods. The reason for this is because Tesco might not want to start spending money which they think they might get from the debtors before they get it because otherwise they could end up spending money they don’t have. The reason this might be is because they might think that they have £25,000 coming in, in 25 days but it ends up being late which could cause their whole spending to mess up because of this one delayed payment. This is a good ratio which measures how well the company is doing because it highlight what the average amount of time it will take to get their money from the debtors. For example if they had an average day which they will get their money back from the debtors is high like 100 days this means it will take over 3 months before they get their money back from the debtors which will also mean that there will also be businesses that take even longer to pay them back. Whereas if it was an average of 30 days or less then this will mean that they are able to get most of their money back within a month’s time or less however there will be some businesses that might take slightly longer but I won’t be massively bigger the most I would say it might take a business to pay them back would be 50 days. Therefore meaning they are doing quite well and this gives a great idea of how well the business is doing. The limitations of this is that it only shows you the average amount of time it will take their debtors to pay them back it does show you what the longest is or the shortest amount of time that it will take their debtors to pay them back. This is why I think that you should put the debtors collection period in a box-plot as well as in a ratio.

11 | P a g e

Rory Ball-Reeder

Limitations of ratio analysis:

My thoughts are that you can’t tell how well a business is doing just from the ratios. The reason I think so is because the ratios don’t go into enough detail about how the business is doing it just gives the basics which even then they aren’t that great. I think if you wanted to know how well you are doing you would have to include the balance sheet, profit and loss accounts, ratios, budget and the break even. The reason I think you need all of these is because the breakeven point shows you about whether you are making profit, how much profit, whether you’re making a loss and how many products you need to sell to get to the breakeven point. You will also want the profit and loss accounts to show you where your money is going and where it is coming from. Without the balance sheet you will also not be able to see where you might owe money where money is owed to you and how much the business really is worth. The budget also shows you where you are spending your money and whether or not you are over spending or under spending. All of these with the ratios will give an owner of a business a greater idea on where the business is at financially because with one and without another they will only have some information on that particular area of the company.

Bibliography:

http://en.wikipedia.org/wiki/Liability_(financial_accounting) http://www.investopedia.com/ I used this website to help me with the understanding of some

of these words meanings thought out my work. The information about the statutory redundancy pay under neither the current ratio came

from the following website: http://www.adviceguide.org.uk/scotland/work_s/work_work_comes_to_an_end_s/work_redundancy_s/redundancy_pay.htm#h_what_is_redundancy_pay.

http://www.tesco.com/ I used this website to help me within my work. http://en.wikipedia.org/wiki/Main_Page I used this website to give me information and the

definition of some of the work. http://files.the-group.net/library/tesco/annualreport2013/pdfs/

tesco_annual_report_2013_financialreview.pdf this website is where I got the print screens from for my work.

I also got some of the information from the Business Level 3 Book.

12 | P a g e