Evaluating Tesco Plc's Financial Strategy: A Critical Analysis

" Evaluate Tesco Plc’s Financial Strategy "

Description of the assignment:

This report will require students to critically evaluate the "financial strategy" of the given company. The report will be based on real life cases. Arguments based on using appropriate theories and reading of academic articles will provide the theoretical foundations for the discussion.

Required

Your report to the Directors should cover the following lines of investigation :

• Tesco’s strategy for raising funds:This should include an explanation of the firm’s strategy for raising funds / capital structure. How are they financed?  
• Analyse and evaluate Tesco’s strategy for raising funds:Use relevant corporate finance theories to evaluate Tesco plc’s financial strategy for raising funds.
• Tesco’s strategy on distribution of funds:This should include an explanation of the firm’s strategy on the distribution of funds, such as investments, interest payments, dividends etc.

Strategy of the firm to raise funds

In case of Tesco the company has raised funds from various sources that includes debt, issue of shares and retained profits. The company maintain a low debt ratio so that their credit position is viable. Debt also helps them n dispersing the shareholders by management (Covaleski, et al., 2003). These policies made by the company have an impact on the overall capital structure of the company. The company has also indulged in mergers and acquisition and that is also an important part of the policy management of the company. The company in the past have acquired poor run businesses and converted them into profitable units based on its resources and knowledge. These acquisitions by companies have an impact on the overall capital structure and the flow of resources also. The company also has clear diversification strategies, they acquired Giraffe a chain family restaurant so that they could enter that family business (Charles H, et al., 2015). This helped in creating great synergies for Tesco as a company and it will also help in generating more revenue for the company in many ways. Thus, we see that Tesco as a company has indulged in many diverse techniques of raising finances that has helped them in being the company that they are now.

Tesco as a company has diversified their sources of finance and have invested in such sources that has helped in keeping their level of liquidity stable and accurate. It can also be seen that as a company Tesco has invested both in funds that included debts and equity but they have never escaped from taking risks on their part. Risk management is an important part of any business and keeping finances at a level where the company can pay of their debts at a particular time with their given funds is the most important aspect of it. Money should be used to make money and diversification and mergers are great ideas to outgrow the inefficiencies that are present in a particular system of a poor unit and changed the same and used it for its growth and expansion overall and converted it into a profitable unit. So we see that mergers and acquisition are great methods by which companies can employ their resources and also diversification has helped them in trying new business methods and ideas that has helped them in growing as a big multinational company (Abdullah & Said, 2017).

The company has invested in both shares and debts and has also invested in various related parties that has helped in managing the funds of the company and making it feasible for the company to take risks by indulging in various hedge transcations that are related to securities at a large. The company has indulged in transcations that includes hedge funds and options that are transcated over the counter and these financial instruments have helped the company in gaining lot of revenues (Belton, 2017). The company has also indulged in buy back of shares and have issued the same to its employees which helps in keeping the debt equity ratio stable for the company in many ways. It has indulged in mergers and accqusiition and diversification of business units that has helped it in earning money through other sources and investing in such units which are profitable to the company. So we see that there are various ways in which the company has distributed their funds and an analysis of the same is given below (Boghossian, 2017).

Evaluation of the Strategy of the firm to raise funds

The overall strategy of the firm to distribute their funds can be studied by analyzing the financial position of the company with the help of ratios. The ratio analysis is one of the analytical measures to check on the performance of the company if the same is progressing and growth or are there any shortcomings. Therefore, the ratio analysis has been done for last 3 years from 2016 to 2018.

As per the above ratio analysis, we can see that the company has progressed in terms of all the 3 major profitability ratios. The gross margin has improved from 5.24% in 2016 to 5.83% in 2018, similarly the net margin has improved from 0.3% in 2016 to 2.26% in 2018. The company is one of the leaders and pioneer company’s in the industry but the same is still below the industry trend which is around 4-5% annually. The major reason for the same is increasing competition within the industry, entrants by small producers and manufacturers and heavy price competition. Thus, the company needs to take appropriate steps and improve on the profitability of the company (Grundy, et al., 2017).

In terms of Efficiency ratios, we can see that the return on assets has increased from 0.31% in 2016 to 2.66% in 2018. This shows that the company has improved in terms of utilization of the assets and has been yearning the returns on the assets. Assets being huge investment of the company needs to be optimally utilized by the company. On the other hand, the return of equity which was negative at -0.53% last year has improved drastically and is at 14.26% in 2018 (Iggers, 2018). This indicates that the company has been improving in terms of returns to shareholders and investors and is thus meeting their expectation. The return on equity is much more than the industry trends and it shows that the shares of the company have been performing well due to improved performance and efficiency of operations (Kaufmann, 2017).

In terms of the turnover ratios, the daily sales outstanding which is the measure of the receivable days and which shows for many days a receivable is overdue and is rolled up in a year, has increased considerably from 1.66 times to 9.39 times and this is an indication that the company has been efficient enough in receiving the sales made and the internal control in this regard has been strong In terms of the solvency ratio which shows the proportion of loan and own capital in the company, the company has done well in the recent past in decreasing the proportion of debt in the capital. The same is evident from the debt equity ratio which has come down from 1.24 times in 2016 to 0.68 times in 2018.

The liquidity ratios is an indicator of the fact that in case the company is required to pay off the short time liabilities on an urgent basis, then the company should be having sufficient current and quick assets and the good operating cash flow to pay off the same (Coate & Mitschow, 2017). The current ratio of the company has depleted from 0.75 times in 2016 to 0.71 times in 2018 as well as the quick ratio (measure of readily convertible liquid assets to current liabilities) has decreased from 0.59 times to 0.55 times in 2018. The same is much below the industry trend of 2 times and 1 time respectively. It is an indication that the company would not be able to meet off its short term liabilities on time if at all there is a requirement to do so. The free cash flow to sales ratio has however improved from 1.1% in 2017 to 2% in 2018 (Vieira, et al., 2017).

Firm's strategy on distribution of funds

After the analytical review based on the above ratio analysis, we can apply financial theories to study the capital structure of the company. Few of the theroies that have been discussed includes the Pecking Order Theory and the Linter and Dividend policy. The pecking order theory considers that the cost of financing will increase along with the assymetrical information. Every company has fund coming from three different sources that includes equity, debt and internal funds. It states that finanes are used based on the basis of preferences and the first preference is given to the internal financing and then the other two sources are used. In case of Tesco also it can be seen that the company has followed the method of financing in which the main focus is given to debt based financing and then equity has been considered. It does not resort to internal financing to fund its operation, rather the company has indulged in raising shares and also taken long term borrowings from relevant sources which forms the bigger part of its operations. The other theories that helps in studying the capital position of the company is the dividend policy which was proposed by Modigliani Miller again as pwe which the value of the company does not change with the distribution of dividend as either ways it belongs to the investor and is either distributed now or is reinvested by the company as is seen in the case of Tesco Plc (Webster, 2017). The Linter Theory discusses how companies set long term targets to comply with the dividend payment options and that is related to the positive NPV of the company. It also mentions that increase in aforesaid earnings is not always sutiable for the company. Thus the dividend policy does not changes alot and the managers often considers the sustainable level of earnings are suatinable or not. It can be seen that in case of Tesco the company has not changed the dividend policy from past three years and also this supports the theory of Linter as the earnings of the company are not sustainable enough to support the high dividends that the company might think to pay off in the future. Thus we see that financial theories helps in studying the indepth part of the capital structure of the company and its various aspects also (Borit & Olsen, 2012).

Conclusion and Recommendations

Based on the overall analysis it can be said that the business aspects and fund raising technqoue of the company is excellent but given that there is so much competition and people are indulging in different ways by which they can increase their finances and invest in sources that can generate income, it becomes imperative that they adopt methods by which they can change their present structure and generate funds through other sources. It is important to take risk as there is no return ithout risk and this should be the basic aim of the company and in case there are situations the liquidity position should be maintained as that is vital. The shareholders should get good return then only they will invest in the company. Hence all with good investing decisions the company should also keep the demands of the shareholders of the company in mind and other stakeholders also.

References

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