Financial Ratio Analysis: A Report On Benedict Co. - An Essay.

Prepare a report for your manager which:

1. Using the Annual Report of Tesco available at the following link:

1. a) Explains the term ‘stakeholder’ and identifies three types of stakeholder of Tesco.

1. b) Analyses how the Environmental and Social Review and the Corporate Governance Report help Tesco demonstrate its performance in terms of its corporate and social responsibilities to two of the stakeholders identified in a) above.

Analyses and evaluates the financial position of Benedict Co. using a range of financial ratios to meet the requirements of potential customers, investors, lenders and suppliers. Your analysis should:

a) Explain the purpose and relevance of the chosen ratios.

b) Include the results for each chosen ratio and reasons for the movement between the two years.

c) Highlight any aspects of the performance of Benedict Co. which would give cause for concern.

d) Critically evaluate the application of financial ratios in interpreting and measuring the performance of a company.

Marks are available for the presentation of your report including structure, style and the presentation of referencing.

Explanation of Financial Ratios

Having attended a workshop purposed mainly for understanding annual reports of a company, it has been required that a report should be prepared to the manager using the annual report of Tesco. This paper gives a summary of such report, which discusses three types of stakeholders of Tesco and analyses how the company’s environmental and social review as well as the corporate governance report helps Tesco in demonstrating performance to two of its main stakeholders. This paper also gives an analysis and an evaluation of financial position of Benedict Co. using a range of financial ratios, aimed at meeting the needs of its potential customers, lenders, investors and suppliers (Kamauff 2009, p. 43).

1. Definition of the Term Stakeholder

The term stakeholder is generally used to refer to any party, individual or group that is directly or indirectly affected by the outcome or results of a business or project. Stakeholders are believed to be significantly interested in success of the project or business. Stakeholders are often concerned about financial performance of the business and they have direct as well as indirect interests in its survival and going concern. They are either involved actively with the operations of the business, or there are gains to enjoy as well as loses to incur depending on the results of the company. Stakeholders are very key in any business or project since they determine if success will be achieved or not. It is believed that for a business to succeed, it must keep its key stakeholders satisfied and happy. If this does not happen, then the business is likely to fail in achieving its mission and objectives due to lack of key support from them (Ward 2012, p. 49).

Stakeholders in any organization are either internal or external. Internal stakeholders are those found within the organization and have a direct relationship with the company. Examples of internal stakeholders include employees and the top management. On the other hand, external stakeholders are those that are not directly involved in carrying out the daily operations of the company, but play a significant role in assisting it achieve its key objectives. Customers, suppliers, government and the general public or community at large are some of the external stakeholders in any business. In TESCO however, the three main types of stakeholders include employees, customers and suppliers. These are considered very important since they determine the success of the company (Kamauff 2009, p. 43). Each of them is discussed further below.

1. Employees

Results and Analysis of Financial Ratios

An employee is an individual who is hired by a business to work for it. Tesco is a mart for shopping which avails essential products to its various customers. Employees in Tesco include managers and subordinate staff, whose main objective is providing excellent service to its customers. The employees in Tesco are involved in assisting the visiting customers in acquiring the various essential products that are offered by the organization. The main interest of employees in Tesco is to get a secure employment and an opportunity to get job promotions as a way of being rewarded by the company. Tesco is highly credible, and thus its employees are much interested in working with it. Employees are also interested in getting their payments in good time in form of wages and salaries. This would enable them in being satisfied in their jobs, which would improve their productivity. Employees are very key in Tesco and any other business since they significantly affect turnover of staff as well as the quality of services offered (Noreen, Brewer and Garrison 2014, p. 67).

1. Customers

In any business, customers are the most important stakeholders. A business cannot exist without customers since there would be no market for selling its goods and services. Since Tesco is a retail business involved in provision of goods, customers serve as one of its key stakeholders. The main of the customers at Tesco is to get products and services of the best quality at the minimum prices possible. Its main customers are shoppers. Shoppers would like getting a satisfying experience while shopping, and would want to get the best value for their money. If customers are satisfied, they would recommend their friends and peers to the company thus making it increase its revenue significantly. Customers at Tesco are highly interested in seeing the company make significant improvements that would enable them enjoy better services. Tesco prioritizes its customers and focusses mainly on serving them in better ways every day (Ross, Jaffe and Westerfield 2008, p. 20).

• Suppliers

Since Tesco is a shopping mart, it highly depends on suppliers in providing to its customers essential products. Without suppliers, Tesco would be unable to avail such goods and services. The main interest of vendors or suppliers in Tesco is to get stable orders and receive quick payments for the supplies delivered to the company. The suppliers would also like to be represented by a highly credible company that attracts a high number of customers to it in order to increase its inventory turnover. In an effort to improve its relationship with suppliers, Tesco has established a new approach of making payments to them (Kamauff 2009, p. 43).

Aspects of Benedict Co.'s Performance of Concern

• How Tesco Demonstrate Its Performance In Terms Of Its Corporate and Social Responsibilities to Its Stakeholders

On analyzing the Environmental and Social Review as well as the Corporate Governance report of Tesco, it can be concluded that the company demonstrates its performance in terms of corporate and social responsibilities to its key stakeholders. For instance, it is highlighted in its environmental and social review that the company is purposed to serving shoppers much better each day. In an effort to making sure that this is achieved, Tesco has resolved to engage in tackling social as well as environmental challenges that affect societies in which the company operates and sources from. The company has reviewed its third value which is purposed for ensuring that it captures a significant impact and influence on these challenges via its small and useful actions. It is believed that this value would enable all staff of the company make an active contribution in assisting customers to arrive at better choices, reducing wastage of food, tackling food shortages and poverty, working with suppliers in sourcing responsibly as well as establishing sustainable chains of supply (Ross, Westerfield, Jaffe and Jordan 2009, p. 55).

In addition to this, Tesco has been chosen as one of the key signatories in the initiative of United Nations Global Compact, whose main objective is encouraging businesses across the globe to establish and adopt policies which are socially responsible and sustainable as well. This initiative also enables the companies to make reports on the implementation of these policies. It is focused and centered on committing to ten principles concerning labor rights, human rights, anti-corruption and environment as well. By being appointed signatories of this initiative, Tesco demonstrates its commitment and focus on these key areas (Peirson, Brown, Easton and Howard 2014, p. 53).

Furthermore, the company always honors the human rights of its clients and suppliers. It has a high commitment to ensuring that basic human rights are upheld and supporting fully the United Nations Universal Declaration of Human Rights. The company is a pioneer member of the initiative of Ethical Trading. Additionally, it has a team of experts in standards of labor, whose main duties are supporting the company suppliers and working towards full implementation of its base code. In all this, the Tesco seeks to uphold the human rights of every stakeholder, including customers and suppliers, who are considered critical in their business (Ross, Jaffe and Westerfield 2008, p. 20).

In terms of corporate responsibilities, Tesco has a robust and clear framework of governance. It has this framework internally via its board committees and externally by providing critical feedback as well as advice. Tesco’s committees of governance are tasked mainly with considering financial as well as non-financial risks that are associated with the business. The main duty of the company’s committees for corporate social responsibility is particularly considering risks of the company that are related to its policies on human rights. Tesco maintains these risks in its risk register (Zutter and Gitman 2011, p. 23).

Critical Evaluation of Financial Ratio Application

In addition to this, Tesco has a numerous in-house as well as locally based experts in labor standards, who are located all over the world. The main duty of these experts is working with the suppliers of the company daily in getting to the bottom of the challenges and issues in the chains of supply, as well as offering necessary support in addressing the highlighted challenges. Furthermore, the company has established protector lines for its suppliers and customers, in order to escalate any concerns regarding their conduct of business in an efficient and confidential manner (Slack, Chambers and Johnston 2009, p. 78).

There are also other significant actions taken by the company in promoting a positive culture and tackling business practices that are considered unfavorable. Tesco also considered relaunching its new business conduct code in 2015 with a view to promoting ethical as well as responsible behavior in all levels of its business. The company has also made fundamental changes in working with its key suppliers so that trustworthy relationships with them can be built further for purposes of its business. The company is greatly encouraged by the positive viewpoints of suppliers recognized from its impacts in the changes made (Ross, Westerfield, Jaffe and Jordan 2009, p. 55).

1. Purpose and Relevance of the Chosen Ratios

Financial ratios are used for determining how items of financial statements are related. There are various financial ratios that can be used for analyzing and evaluating financial position of a company. For instance, the following ratios have been used in analyzing Benedict Company. These ratios are broadly categorized into efficiency ratios, liquidity ratios, solvency ratios, activity ratios, leverage ratios and profitability ratios (Liu 2010, p. 46).

1. Current Ratio

This ratio reflects financial strength of a company. It is used for determining how many times the current assets of a company exceed its current liabilities. This indicates the level of the company’s solvency. If a company has a high current ratio, then this is an indication that it is highly liquid and its cash is not easily squeezable. If however the current ratio is too high, this can mean that the company has too much inventory and other assets which are lying idle. On the other hand, a low current ratio may be interpreted to mean that the company is unable to pay off its current liabilities using its current assets when they fall due (Slack, Chambers and Johnston 2009, p. 78).

1. Quick Ratio

This is a liquidity ratio that is used for comparing cash, accounts receivable and marketable securities (short-term) of a company to its current assets. Therefore, this ratio is a modification of the current ratio. In calculating this ratio, inventory is usually excluded from current assets since it takes some time to be converted into cash (Liu 2010, p. 46).

• Debt to Asset Ratio

Presentation of Report

This is a basic ratio of solvency, used to measure the amount of assets of a company that are funded through debt financing. This ratio is given as a percentage. In deriving this ratio, total liabilities are divided by total assets. A huge debt to assets ratio is an indication that the company depending highly on financial leverage in financing its assets. This means that the company faces increased financial risks due to payment of fixed interest charges (Tirole 2010, p. 11).

1. Debt to Capital Ratio

This ratio is used to measure the amount of total capital of a company that is acquired through debt. A high debt to capital ratio demonstrates that a company has a high and unacceptable financial leverage, and faces more financial risks as well (Slack, Chambers and Johnston 2009, p. 78).

1. Debt to Equity Ratio

This ratio is used for measuring the amount of debt capital used by a firm in comparison to the amount of equity capital used. A debt to equity ratio 1 shows that a company has used an equal amount of debt and equity, which can be interpreted to mean that all the assets are claims of creditors and shareholders would therefore have nothing to enjoy in case of liquidation of the company (Liu 2010, p. 46).

1. Interest Coverage Ratio

Also referred to as times interest earned, interest coverage ratio is used for measuring the amount of cash flows generated by a company in comparison to amount of interest payments made. This ratio is derived at by dividing Earnings Before Interest and tax (EBIT) by interest payments made. If this ratio is high for a company, then it indicates that it has a less chance of being unable to meet its obligations of repayment debts. A high ratio is also an indication that the firm is recognizing heavy profits as compared to its obligations of making interest payments (Liu 2010, p. 46).

• Gross Profit Margin

This is a profitability ratio used for reflecting product costs and decisions regarding pricing. It is calculated by dividing gross income of a company by its net revenue or net sales. If a company has a gross profit margin of 20% for instance, then it means that 20% of its revenues is used for paying the cost of goods sold. As competition becomes stiffer, gross profit margin is expected to become lower. A company with a high gross profit margin than other companies in its industry has an opportunity of holding a competitive edge regarding quality, branding or perception (Slack, Chambers and Johnston 2009, p. 78).

• Operating Profit Margin

This ratio is calculated by dividing operating profits by net revenue. Operating profit is given by subtracting operating expense from gross income. This ratio gives an analysis of how sales are related to costs that are controlled by the management. An increasing or high operating profit margin is an indicator of good performance since the firm is either cutting on its expenses or recognizing increased revenues from sales (Ross, Westerfield, Jaffe and Jordan 2009, p. 55).

1. Net Profit Margin

Net profit margin is a financial analysis ratio used for comparing the net profit earned by a company to its net sales revenue. This ratio is a measure of how a company is able to translate sales into shareholder earnings or profits (Liu 2010, p. 29).

1. Inventory Turnover Ratio

This is a measure of the number of times which a company has converted its inventory into sales. It is often used in evaluating the production and purchasing efficiency of the company. It is derived at by dividing cost of goods sold by inventory (Modell, Bisbe and Malagueño 2012, p. 62).

1. Sales to Receivables ratio

This ratio is used for measuring the number of times which a company turns over its accounts receivables during a given period. The higher this ratio, the shorter the period taken for earning sales revenue and collecting cash. It is given by dividing net sales by net receivables (Nixon et al,. 2012, p. 221).

• Trade Receivables Days

This is the number of days taken by a company in collecting its outstanding debts from its debtors. It is calculated by (Accounts receivable/annual revenue) * 365 days. This measures the effectiveness of the company’s efforts in collecting and allowing credit to its customers (Lal 2009, p. 14).

• Trade Payables Days

This is measurement of the number of days taken by a company to pay its creditors. This indicates how quick a company pays its suppliers. This is calculated by [Accounts payable / (Cost of sales/Number of days)].

1. Results for Each Chosen Ratio and Reasons for the Movement between the Two Years
2. Current Ratio

The current ratio of the company decreases from 1.25 in the year 20X0 to 1.19 in 20X1. This drop could be caused by decrease in its current assets due to possible sale of its inventory or an increase in its current liabilities (Liu 2010, p. 29).

1. Quick Ratio

This ratio decreased from 0.75 to 0.70 due to decrease in cash and marketable securities of the company or an increase in the company’s current liabilities (Morden 2016, p. 40)

• Debt to Assets Ratio

This ratio increased from 0.34 in the year 20X0 to 0.45 in the year 20X1 indicating that the company is increasingly using debt financing (Scarborough 2016, p. 48).

1. Debt to Capital Ratio

This ratio increased from 0.21 to 0.24. This could be possibly caused by increase in the total capital of the company due to issuance of more shares of common stock (Levy, Weitz and Grewal 2012, p. 88).

1. Debt to Equity Ratio

Just like the debt to capital ratio, this ratio increased from 0.31 to 0.43 possibly due to issuance of new shares by the company (Hill and Jones 2011, p. 56).

1. Gross Profit Margin

This ratio increased from 0.42 to 0.48. This might have been caused by reduced cost of goods sold by the company due to improved efficiency in production or reductions in cost of inventory.

• Operating Profit Margin

This ratio decreased from 0.37 to 0.31 due to increase in management controlled expenses, which led to significant decrease in the amount of operating profits made by the company (Renz 2016, p. 12).

• Interest Coverage Ratio

This ratio decreased significantly from 18.40 to 7.38 due to potential increase in the finance costs of the company and decrease in its operating profits as well.

1. Net Profit Margin

This ratio decreased from 0.28 to 0.21 due to increased operational expenses of the company.

1. Inventory Turnover

The inventory turnover of Benedict co. decreased from 5.58 to 3.08. This could have been caused by reduced sales which led to a low turnover of inventory.

1. Sales to Receivables Ratio

This ratio decreased from 6.55 to 4.05 due to the increased credit sales by the company, which resulted into increased net receivables (Hill 2008, p. 256).

• Trade Receivables Days

The trade receivables days increased from 56 days to 90 days due to provision of longer credit periods to debtors or failure of the company’s efforts in collecting receivables (Collier 2015, p. 34).

The trade payables days increased from 108 days to 155 days due to more favorable credit terms offered by suppliers to the company, which allowed it longer periods of credit (Gitman, Juchau and Flanagan 2015, p. 12).

Aspects of the Performance of Benedict Co. Which Would Give Cause for Concern

Considering the financial ratios considered above, there are various issues of concern for Benedict Company. For instance, it has a current ratio of 1.19, which is far much below the recommended ratio of 2. This means that the company has no ability of meeting its current obligations or liabilities using the current assets. In addition to this, Benedict Company has a quick ratio of 0.70. Again, this ratio is below the acceptable ratio of 1. This is a clear indication that the company would be unable to meet its current liabilities using its most liquid assets. Furthermore, its net profit margin dropped significantly, indicating that the company is incurring large amount of expenses or it is experiencing reductions in its sales volumes (Cadez and Guilding 2008, p. 24).

Application of Financial Ratios in Interpreting and Measuring the Performance of a Company

Financial ratios are used for denoting past trends of a company, comparing its present performance and indicating its future trends, operations or performance therefore acting as basis for making company policies and plans. Besides, ratios serve an important and a practical role of monitoring a company’s performance. Financial ratio analysis is more useful and relevant if used in comparison with other indices. For instance, a company can use other basis of comparison such as previous year basis, industry comparison and comparison based on management standards (Besley and Brigham 2013, p. 56).

As mentioned above, ratio analysis is a tool for providing management with key information regarding its efficiency in running the company for a specific period. Ratios also help users of financial statements in determining a company’s financial position through evaluating whether or not it is making improvements over a range of time period. Users can also determine the liquidity position of a company through financial ratio analysis. Ratios also help users in determining how profitable a company is, and whether it is making value out of the capital provided by the shareholders with a primary aim of distributing to them portions of such earnings through dividends (Brealey, Myers, Allen and Mohanty 2012, p. 21).

Conclusion

As discussed above, ratio analysis involves determining relationships between items of financial statements. It is a very useful tool in determining financial position of a company through making comparisons to the past years, to the performance standards set by the management and to the entire industry (Brigham and Houston 2012, p. 78).

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