Reasons For Next Plc's Consistent Market Performance And Debenhams' Decline

Tesco plc's income statement analysis for the years 2013 and 2014

Explain about the Next plc is a consistent performer in the market but the Debenhams is gradually losing their position?

Tesco plc is one of the largest plc among the retail sectors in UK.  The company incorporated in the year 1919 in a small town of London. It has a large collection of women wear and accessories. The company is now operating almost 12 countries in the world. The following income statement is extracted from the annual report of TESCO for the year 2013 and 2014. The table shows that there is some change in the figures for both the years.

Consolidated income statement of TESCO plc
Particulars	2014( £m)	2013 ( £m)	Change
Continuing operations
Revenue	63,557	63,406	151
Cost of sales	-59,547	-59,252	295
Gross profit	4,010	4,154	-144
Profit and losses arising on property-related items	278	-290	568
Administrative expenses	-1,657	-1,482	175
Operating profit	2,631	2,382	249
Finance income	132	120	12
share of post tax profit of joint venture and associate	60	72	-12
Finance cost	-564	-517	47
Profit before tax	2,259	2,057	202
Taxation	-347	-529	-182
profit for the year from continuing operation	1,912	1,528	384
Discontinued operation
Loss from the discontinued operations	-942	-1,504	-562
Profit of the year	970	24	946
Attributed to
Owners of the parent	974	28	946
Non controlling interest	-4	-4
	970	24	946

Note: here the change of the figures includes both increase and decline. The positive change includes the increase in the figure from the previous year, and the negative change includes the decrease in the figure from the previous year.

Probable reasons for changes

Change in revenue

The revenue has increased by £ 151 m. The reason should be either increase in the selling price of the product or increase in the number of units to be sold. Revenue includes some other incomes apart from the sales. It may increase due to some realization of cash from debtors or any other income that may drive in the particular year (Annual report, 2014).

Change in cost of goods sold

The cost of sales of in the year 2014 has also increased. It indicates that the total cost of producing and selling the product is increased. The reason may be inflation due to which the price increases adoption of new technology in the production process or due to the need of making a quality product in order to compete in the market (Anon, 2013).

Change in gross profit

The gross profit in the year 2014 has declined by £ 144 m. The reason that is visible from the annual report is the increase in the cost of goods sold. Though the revenue has also increased but from the above table it is shown that the increases in the revenue is less than the cost increases, so there is a decline in the gross profit.

Change in profit and loss of property

In the income statement, this change is a positive one, and the change is mainly due to the change in the market price of the assets. If the asset that is sold in the market is very old then its written down value is also very low, and the disposal value create a loss on the sale.

Probable reasons for changes in Tesco plc's income statement

Change in administrative expenses

It is also a positive change. It means the expenses relating to the salary, office maintenance, etc. increases compared to the previous year.

Change in operating profit

The company shows a good sign by increasing the operating profit in spite of declining gross profit. The main reason for increasing the operating profit is that in the year 2014 the company has a profit on the sale of property that offset the reduction in gross profit due to more cost of sales.

Change in financial income

The financial income of the company has increased due to the increase in the interest receivable and the income from cash and cash equivalents.

Change in finance cost

The finance cost for the current year has increased because the company has to pay more amounts of bank interest and net pension financial cost. Moreover, the interest payment on USD bond is also high in the present year (Shim and Siegel, 2008).

Change in PBT

The above table represents a positive trend of profit before tax. The probable reason of increasing PBT is due to the increase in operating profits and increase in finance income.

Change in tax expense

The tax expense is reduced in this year whereas the profit before tax is more. The reason should be a change in the tax rate, or the company may get some rebate or subsidy in this year (Shim, 2009).

Change in net profit

From the income statement, it is found that there is a drastic change in the net profit of the company. In the year 2013 the net profit was only £ 24 m, and it has changed to £ 970 m in the year 2014. The revenue from operation in 2013 is lower than 2014, but the gross profit was high. The main reason for low profit in 2013 is due to heavy loss from its discontinued business. This loss also existed in 2014, but the amount was very high in 2013. Moreover, the taxation expenses were also very high in 2013. These two reasons probably be the main reason for increasing the net profit in 2014 (Zimmerman and Yahya-Zadeh, 2011).

The breakeven point is the point of the output level of a business concern during a certain period at which total sales revenue is exactly equal to the total cost. In other words, it is that point that breaks the total cost and the sales value evenly to show the level of output or sales at which there arises neither profit nor loss (Hoque, 2005). The breakeven point can be better understandable by the following example:

Explanation of the breakeven point

Suppose ABC Limited has manufactured a certain product "M" and the information related to that particular product is as follows

Selling price                                                    $ 20

Variable cost                                                   $ 12

Total fixed cost                                               $ 80000

Present output and sales                                 20000 units

Therefore the breakeven point of the product is = (Fixed cost / PV ratio)

                                                                            = (80000/40%)

                                                                            = $ 200000 (BEP in value)

                                                                            = BEP in value / selling price per unit

                                                                            = 200000/20 = 10000 units

Following is a chart which represents the detail analysis of the BEP

Outputs (units)	Variable cost per unit($)	Total variable cost($)	Total fixed cost($)	Total cost ($)	Selling price per unit($)	Total sales ($)	Total profit($)
0	12	0	80000	80000	20	0	-80000
2000	12	24000	80000	104000	20	40000	-64000
4000	12	48000	80000	128000	20	80000	-48000
6000	12	72000	80000	152000	20	120000	-32000
8000	12	96000	80000	176000	20	160000	-16000
10000	12	120000	80000	200000	20	200000	0
12000	12	144000	80000	224000	20	240000	16000
14000	12	168000	80000	248000	20	280000	32000
16000	12	192000	80000	272000	20	320000	48000
18000	12	216000	80000	296000	20	360000	64000
20000	12	240000	80000	320000	20	400000	80000

From the above table, it is clear that at 10000 units of output the company is having a no profit and no loss situation.  At 10000 units, the contribution is just sufficient to meet the total fixed cost. Again, then both the fixed and variable cost can be recovered exactly from the sales revenue without leaving any surplus or deficit (Shapiro and Sarin, 2009).  Fixed cost is that type of cost which is remaining same at every level of activity even if there is no production. So it is the part of cost that is fixed in total (Hansen and Mowen, 2006). Now at this point of time if the company can produce more output then per unit fixed cost will be reduced and the company will start to generate more profit. On the other hand, the variable part of the cost varies with the change in the production outputs, and if there is no production, there will not be any variable cost. Now if any company cannot be able to earn that much of revenue to recover its cost, then it will face a loss and ultimately tends to the shutdown point. So it is very necessary to produce at least that much of product which can recover its total cost. In the above table, it is observed that before reaching to the breakeven point the company is facing a loss as its total cost cannot be recovered at that much of production and sales. At the breakeven point, the profit and loss are equal to zero because the sales revenue is exactly offset by the total cost of the company (Groot and Selto, 2013). After the breakeven level i.e. after 10000 units the company started to earn a profit and as the number of the unit increases the amount of profit is also increases. The main reason is at 10000 units the company recovers whole of its fixed cost and after that level it has to incur only the variable cost as the variable cost is proportionate to the selling unit, so the profit is also growing.  So the breakeven point helps a company to understand the number of the unit that they must produce in order to continue the business. It gives a bird eye view of the profitability and the other affairs of the product (Drs. Sugijanto, 2013).

Workings

Note 1

Statement showing the contribution and PV ratio

Particulars	Amount ($)
Sales	400000
Less : variable cost	240000
Contribution	160000
Less : fixed cost	80000
Profit	80000

Note 2

PV ratio = (contribution / sales)

Contribution	160000
Sales	400000
PV ratio	40%

Investment appraisal techniques

Investment appraisal technique is nothing but the capital investment decision. The techniques are used to evaluate the investment proposals in fixed assets or any other expansion activities. There are several appraisal techniques which either incorporate the time value of money or does not consider that factor. With the help of those techniques it is possible for the company to judge the feasibility of the investment make (Eun and Resnick, 2007). Following Illustration can help to understand how different investment techniques can help in decision making:

IC Company has $ 200000 to invest. The following proposals are under consideration. The cost of capital for the company is estimated to be 15%.

Project	Initial outlay($)	Annual cash flow($)	Life of the project(Years)
A	100000	25000	10
B	70000	20000	8
C	30000	6000	20
D	50000	15000	10
E	50000	12000	20

Present Value of annuity received is as follows:

8 years	4.6586
10 years	5.179
20 Years	6.3345

Now the above investment proposals can be analyzed by the following techniques

Net Present value & PI

Projects	life of the project( years)	PV factor (15%)	Annual cash inflow (constant)($)	PV cash inflow ($)	Initial outlay ($)	NPV ($)	PI
A	10	5.179	25000	129475	100000	29475	1.29475
B	8	4.6586	20000	93172	70000	23172	1.331029
C	20	6.3345	6000	38007	30000	8007	1.2669
D	10	5.179	15000	77685	50000	27685	1.5537
E	20	6.3345	12000	76014	50000	26014	1.52028

Here Net present value of proposals= PV of cash inflow- Initial investment

Profitability index (PI) = PV of cash inflow/ Initial investment

Post payback profitability

Project	Initial outlay ($)	Annual cash inflow (constant)($)	Payback period (years)	life of the project (years)	post payback period (years)	post pay back profitability ( $)
A	100000	25000	4	10	6	150000
B	70000	20000	3.5	8	4.5	90000
C	30000	6000	5	20	15	90000
D	50000	15000	3.33	10	6.67	100000
E	50000	12000	4.17	20	15.83	190000

Here payback period = (Initial investment / Constant annual cash flow)

Post payback period = life of the project – PB period

Post payback profitability = Constant annual cash inflow * post payback period

Decision making

In investment appraisal process each and every techniques has its own decision making criteria. It may be happened the most viable project under one technique gets second or third rank under another technique. For example in case of above proposals the ranking of the projects are –

Rank	NPV	PI	Post payback Profitability
1	A	D	E
2	D	E	A
3	E	B	D
4	B	A	B & C
5	C	C	-

Under the NPV method the total cash flow from the project is discounted at its present value and then the initial investment of the project is deducted from that present value. If the result is positive then the project will be accepted and if it is negative then the project will be rejected. In the above example all the projects are having positive value so they are ranked according to the highest NPV as it will give highest surplus. As the company is having $ 200000 to invest so it can select project A, D and E (Granlund, Mouritsen and Vaassen, 2013).

The profitability index technique is actually the benefit cost ratio derived from a project. If the PI is more than 1 then the project is accepted. If the proposals are mutually exclusive then the highest positive PI will be given highest rank. In the above example with $ 200000 in hand the company can invest in project D, E, B and a part of project A if the project is divisible (Peterson, Fabozzi and Habegger, 2004).

The post payback profitability is the measurement through which it can be known that what would be the amount of profit earned from a project after recovering its initial outlay. The payback period indicate the time within which the initial investment will be recovered. The more post payback period the more will be the profit. So as per the post payback profitability the company should invest in project E, A and D (RIEDL and SRINIVASAN, 2010).

There are other techniques also which can be used for the measurement, but here the commonly used techniques are considered. As the decision criteria may differ under different techniques a company should fixed one or two standard technique as per the industry standard in order to get a proper result and to avoid confusion (Danthine and Donaldson, 2005).

Accounting ratios are the mathematical measurement through which the financial stability, profitability and the solvency position of the company is ascertained. The ratios are calculated from the information available in the annual report (Hubbard, 2008).  Here two companies from the retail sector of UK is taken into consideration and some useful ratios are calculated for three consecutive years from the data collected from their annual reports.

Ratio analysis
Next Plc							Debenhams Plc
2014		2013	2012				2014		2013	2012
Liquidity Ratios
Current assets	1468.1	1207.8	1139.9				486.3		470.5	459.5
Current liabilities	834.5	816	742.4				758		741.9	727
Current Ratio	1.75925704	1.480147	1.5354256				0.6416		0.6342	0.63205
Quick assets	1082.5	876	768				140.6		112.6	127.2
Quick Liabilities	831.9	810.6	734.8				534.2		506	563.6
Quick Ratio	1.30123813	1.080681	1.0451824				0.2632		0.2225	0.225692
Efficiency ratio
Total asset	2144.6	1893.6	1854.2					2148.4	2132.8	2091.2
Revenue	3740	3562	3441.1					2312.7	2282.2	2229.8
Asset Turnover Ratio	1.74391495	1.881073	1.8558408					1.0765	1.07	1.066278
Receivables	808	718.1	699.1					74.7	78.3	75.4
Revenue	3740	3562	3441.1					2312.7	2282.2	2229.8
Receivable turnover	4.62871287	4.960312	4.9221857					30.96	29.147	29.57294
Receivable collection period	78.855615	73.58408	74.15405					11.789	12.523	12.34236
payables	594	537.2	545					529.3	545.8	525.4
Cost of goods sold	2499.9	2437	2395.8					2033.4	1982.6	1927.5
Payable payment turnover	4.20858586	4.536485	4.3959633					3.8417	3.6325	3.668633
Payable payment period	86.7274691	80.45876	83.03072					95.011	100.48	99.49209
Inventories	385.6	331.8	371.9					345.7	357.9	332.3
Cost of goods sold	2499.9	2437	2395.8					2033.4	1982.6	1927.5
Inventory turnover	6.48314315	7.344786	6.4420543					5.882	5.5395	5.800481
Inventory Turnover period	56.299852	49.69512	56.658945					62.054	65.89	62.92581
EBIT	720.5	690.9	604.7					118.8	149.9	170.1
Interest	25.3	24.4	25.2					13	10.9	11.8
Interest Coverage Ratio	28.4782609	28.31557	23.996032					9.1385	13.752	14.41525
Debt	1023.9	792	889.1					623	646.5	703.2
Equity	286.2	285.6	16623					767.4	744.4	661
Financial Gearing ratio	3.57756813	2.773109	0.0534861					0.8118	0.8685	1.063843
Equity	286.2	285.6	222.7					764.4	744.4	661
Total asset	2144.6	1893.6	1854.2					2148.4	2132.8	2091.2
Equity Gearing ratio	0.13345146	0.150824	0.1201057					0.3558	0.349	0.316086

Profitability Ratios
Gross Profit	1240	1125	1045.3			279.3	299.6	302.3
Revenue	3740	3562.8	3441.1			2312.7	2282.2	2229.8
Gross profit ratio	33.2%	31.6%	30.4%			12.1%	13.1%	13.6%
Operating profit	722.8	695.1	601.8			128.6	155.4	175
Revenue	3740	3562.8	3441.1			2312.7	2282.2	2229.8
Operating Profit Ratio	19.3%	19.5%	17.5%			5.6%	6.8%	7.8%
Net Profit	553.2	508.6	474.8			87.2	115.9	125.3
Revenue	3740	3562.8	3441.1			2312.7	2282.2	2229.8
Net Profit Ratio	14.79%	14.28%	13.80%			3.8%	5.1%	5.6%

(Nextplc.co.uk, 2014)

From the above ratio analysis following points can be discussed

Liquidity ratio indicates the liquidity position of a firm. Liquidity means the ability to pay cash and cash equivalents when it is required. Liquidity is necessary for smooth running of a business. Poor liquidity position hampers the credit policy of the firm as they may not be able to pay their creditors due in time. On the other side the firm may able to capture new market opportunities if its liquidity position is high. Current ratio and quick ratio are the two important ratios measure the liquidity position (Magiera, 2010).

In next plc the current asset ratio is more than 1 but not as much as it should be. It is also in the increasing trend from which it may be predicted that very soon they may reach to the ideal form. In case of current ratio also the Debenhams Company produces a negative image as the current ratio fall below 1. It means the company has more current liabilities to pay than its available current assets (CHEN, MITTENDORF and ZHANG, 2010).

Quick ratio as the name indicates is the proportion between the quick assets and quick liabilities. Next plc has moderate quick ratio which is also more than 1. In Debenhams the quick ratio is too low almost 0.22. This clearly indicates that the company is suffering by liquidity crunch (Nextplc.co.uk, 2012).

Debenhams Company has a good receivable and payable management policy (Annualreports.com, 2014).

The overall condition of the Debenhams is deteriorating as all the ratios are below the standard (Annualreports.com, 2012).

The quick ratio of both companies are very low because they have blocked a large amount in inventories they have bank overdraft balances which is also a financial burden (Annualreports.com, 2013).

The liquidity, solvency and profitability position of the Next Plc is better than the other one (Nextplc.co.uk, 2013).

So from the total discussion made it can be concluded that Next plc is a consistent performer in the market but the Debenhams is gradually losing their position,   So they need to focus more on their activities. Lastly it should be remembered that ratio is one of the tools of performance analysis but it is not the only tool, so the other factors should also be considered before giving any final decision.

References

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