Management of Financial Resources and Performance Assessment: Tesco and Primark

Introduction:

An organisation is dependent on its stakeholders for its daily business operations. Hence, satisfaction of stakeholders is essential for the long-term growth and sustainability of an enterprise. This needs to be accompanied by sound corporate strategies, effective management of financial and non-financial resources. The present assignment is divided into 3 tasks. Task 1 would evaluate the interest of relevant stakeholders of Primark and management of these stakeholders. Tesco has been selected for task 2 in which the current strategy, resource allocation, performance appraisal, and financial analysis of Tesco would be done. Task 3 would evaluate various investment appraisal techniques for the given alternatives.

1.0 Task 1:

1.1 Stakeholders of an organisation:

Stakeholders are the major parties having an interest in a business enterprise. In the view of Agrawal and Chadha (2008), the principle objective of any corporate governance policy is to satisfy its major stakeholders. Satisfaction of stakeholders determines growth, competitive advantage, and long-term sustainability of the firm. In contrast, Faleye and Olubunmi (2006) argued that interest of the all the stakeholders can never be satisfied, rather a firm needs to focus on balancing these interests in an effective way. Major stakeholders of Primark include investors, employees, suppliers, customers, local people, and the government. A good corporate governance policy aims to deliver highest benefits to its stakeholders against respective contributions of these stakeholders. Co-operation from relevant stakeholders is also vital during adverse situations like economic downturn, financial crisis, and others.

1.2 Interest of stakeholders:

It is important to understand the contribution and interest of each segment of stakeholder. This helps an organisation in meeting the expectations of its stakeholders in a better way.

Shareholders: This section comprises of equity and preference shareholders. While equity shareholders are the owners of a company, preference shareholders do not enjoy ownership rights however dividend to preference shareholders are payable prior to equity shareholders. Shareholders provide necessary capital to the firm in expectation of interests in the form of dividend. Hoshi et. al. (2006) opined that maximisation of shareholders wealth is the most important responsibility of a firm. Generally, shareholders expect better dividend and capital appreciation.

Employees:

The efficiency in the performance level is determined by employees of an organisation. In the view of Bebchuk et. al. (2009), better increment, scope for promotion, and growth prospects are the major expectations of employees. Satisfied employees would result in better performance of the firm.

Creditors:

Creditors are the suppliers from whom a firm procures input materials on credit. Timely clearance of dues and increase in ordering quantity are the principle expectations of creditors. Hence, creditors take considerable interest in knowing the liquidity and profitability position of the enterprise. Satisfied creditors would enable a firm to procure more materials on credit and ensure interrupted production process.

Customers:

Customers are the principle source of revenue to a firm and decide the firm’s ability to reward its internal and external stakeholders. Customers expect high quality products and services at a reasonable price. However, Makadok and Barney (2008) opined that modern customers expect innovation in production from different business entities. Thus, a firm needs to be able to introduce innovation in its products and services to satisfy its customers.

Local people:

Local people expect job opportunities and development of the local areas. In addition, environment friendly behaviour from business enterprises is another major expectation of local communities.

Government:

The quantum of revenue earned by a firm decides the amount of tax payable to the government. Thus, the government is also interested in the performance of an enterprise as tax is one of the major sources of revenues to the government (Hopwood, 2006). In addition, ethical practice by the firms is also expected by the government for the overall benefit of the economy.

1.3 Management of stakeholders:

Shareholders:

The corporate governance policy of Primark is highly focused towards generation of better returns to the shareholders. During the financial year ending on 31st March, 2013, Primark has been able to achieve group revenue of £13.3 bn which is 9% higher than the preceding year. Profit before tax has also been increased by 15% and stood at £876m. Basic earnings per share were 74.8 p, an increase of 6%. While, the adjusted earnings per share increased by 13% and stood at 98.9p. In addition, Primark has paid dividend of 32.0 p, a rise of 12% against the previous year.

Employees:

The corporate governance policy of Primark lays stress on employee engagement in all activities. This enhances motivation and loyalty of employees. The pay package of Primark is at par with the industry standards. In addition, Primark accounts pensions in accordance with IAS 19 to ensure transparency in employee benefit policies (Abf.co.uk, 2014). The defined benefit pension scheme has exceeded employee benefit assets for the year ending 2013. Furthermore, Primark ensures safety of its employees through various safety and accidents prevention measures.

Creditors:

The creditors of the company are effectively managed by Primark. Primark ensures maintaining enough liquidity and strike a proper balance of liquidity and profitability to pay off its creditors on time.

Customers:

Business structure of Primark is highly organised and the company ensures that its businesses are in close proximity to the market and customers. The operational decisions of Primark are made by local managers who have considerable knowledge of local markets and customers. Local managers are granted decision-making power. This helps to understand and serve its customers in a better way. In addition, Primark is consistently engaged with development of new products or innovation in existing products.

Local people:

Currently, Primark has employed around 48000 employees and aims to recruit more employees in coming years. The company focuses on development of local communities in which its businesses operate. Further, the corporate governance policy of the company ensures protection of environment. The company has made considerable investment towards improvement of environment and is focused on reducing energy consumption.

Government:

Primark has been found compliant to all statutory obligations. No fraudulent practice is observed. Tax liabilities are paid on time by the company. In addition, Primark has contributed significantly toward the development of economy by raising the standard of living of local communities in places where it operates.


 

2.0 Task 2:

2.1 Current business position of Tesco UK:

Tesco is a major UK based retailer, operating across UK, Asia, and Europe. Groceries are the major business of Tesco, however, Tesco has a banking division as well. At present, Tesco has employee strength of 313885 in UK while the total number of employees is 530000 across the globe (Tesco.com, 2014). In addition, Tesco has 3146 stores in UK.

Tesco has reported 1.8 % growth in its revenues from operations in UK for the financial year ending 2013. Total revenue of Tesco in UK stood at £43.6 bn. Though total revenue of the entire group has increased from £63916 m in 2012 to £64826 m in 2013 but its operating profit has reduced considerably against 2012. Increase in operating expenses is evidenced. Profit after tax has also fallen sharply. However, sales revenue from Tesco’s online groceries business has increased by 12.8%.

In the view of Makadok and Barney (2008), increase in portfolio of products and services offered by a firm enhances its competitive advantage. The company has also decided to invest in Mobcast, Giraffe, WE7, and others in order to increase its portfolio of business. The strategy is to reduce total risk and increase revenues from sales. In contrast, Chang and Dasgupta (2009) believe that the incremental costs associated with expansion of existing product lines involves considerable market risk that cannot be diversified. However, Tesco aims to arrest its increased operational costs and reduced profit margins by entering into new markets.

2.2 Business planning and current strategy of Tesco:

2.2.1 Optimum utilisation of resources:

Resource allocation refers to the distribution of organisational resources among various processes or departments to achieve pre-determined targets. In the view of Sinha et. al. (2007), optimum utilisation of resources is one of the principle objective of an organisation. Optimum utilisation of resources reduces the marginal cost of production, thereby increasing profit margin of the enterprise. In the opinion of Land and Lang (2010), organisational structure, production deadlines, available resources, benefits or revenues generated by each department are the basic parameters that form the basis for resource allocation. An effective resource allocation strategy needs to ensure optimum utilisation of resources, minimum wastage, minimum per unit and marginal cost of products, meeting production deadline, and complete avoidance of loss of sales.

The resource allocation policy of Tesco is much broader and extends beyond the basic objective of optimum utilisation of resources. Tesco follows a resource allocation policy that focuses on continuous effort to eliminate or minimise food wastage. The company adopts a scientific measure to calculate wastage and further calculates food wastages as a percentage of total sales. In addition, Tesco is engaged in distributing excess or unsold food products to poor people.

As alcohol is one of the major products sold by Tesco, the company has pledged to remove 1 billion units from the market, annually, from 2015 onwards. Instead the focus is to introduce low strength beers. Tesco also prevents sale of alcohol to the under-aged customers. In addition, Tesco has an aim to be a zero carbon business by 2050. The corporate governance policy of Tesco ensures ethical trading, sustainable sourcing, and satisfaction of customers. 

The strategy of Tesco is to allocate resources on the basis of past performance of the concerned departments, next year’s forecasts, and relevance of respective departments. This ensures that resources are allocated in a way to derive maximum possible benefits. The benefits derived from effective allocation of resources are further invested towards environmental protection and fulfilling corporate social responsibilities.

Tesco has adopted multichannel leadership to pursue international disciplined growth. The company has also decided to continue investing in strong UK business.

2.2.2 Performance analysis:

In the view of Bushman et. al. (2007), planning, monitoring, developing, rating, and rewarding are the basic components of a sound performance analysis. Tesco’s business strategy is focused on deriving more loyalty from customers. Percentage of customers retained, percentage of new customers added, percentage of customers shopping through multiple channels, and percentage of increase in family shopping by customers are the major parameters on which the organisational performance is measured at Tesco. Apart from regular monitoring, corrective measures are taken wherever necessary. However, Vaivio (2008) argued that inclusion of qualitative factors in the performance measurement is necessary to make it more effective.

The performances of individual employees are measured and appraisals are done purely on the basis of individual performance. Tesco assigns more value to current performance than experience as the company believes that being in a retail industry, current performance is what matters the most.

2.2.3 International perspectives:

A firm is exposed to various risks like currency risk, inflation risk, political risk, and economical risk due to its international operations. Tesco has a specialised management team to monitor the changes in the external environment in which it operates. Accordingly, strategies are developed or modified to mitigate or reduce such risks.

2.3 Financial analysis of Tesco UK:

2.3.1 Operating profit margin:

Tesco
Items 2012 (£) 2013 (£)
Operating profit 4182 m 2188 m
Sales revenue 63916 m 64826 m
Operating margin 6.54 3.38

 

 Analysis:

The above calculation reflects inefficiency in operations of Tesco. Operating profit margin measures operating profit against sales revenues generated. In spite of increase in sales revenue, the operating profit margin has fallen sharply. This implies increase in cost of sales that needs immediate control. In the view of Zhang (2000), decrease in operating profits results in decrease in profits after tax and thus have a negative impact on the returns to the shareholders. Hence, Tesco needs to implement stringent cost control mechanism. Cost-benefit analysis and Cost-effectiveness analysis can be help in this regard.

2.3.2 Current and Quick ratio:

Current ratio:

Tesco
Items 2012 (£) 2013 (£)
Current assets 12863 m 13096 m
Current liabilities 19249 m 18985 m
Current ratio 0.67 0.69

 

Quick ratio:

Tesco
Items 2012 (£) 2013 (£)
Current assets 12863 m 13096 m
Inventories 3598 m 3744 m
Quick assets 9265 m 9352 m
Current liabilities 19249 m 18985 m
Quick ratio 0.48 0.49

 

 

Analysis:

Current ratio measures the ability of a business enterprise to pay off its short-term liabilities. It indicates the liquidity position of the firm. Creditors evaluate this ratio before extending credit to a firm. The above analysis shows that the current assets of Tesco have increased in 2013 compared to 2012. While current liabilities have decreased in 2013. In the opinion of Bushman and Smith (2009), a current ratio under 1 implies lack of liquidity and capability to pay back short-term obligations. Hence, current ratio of Tesco indicates lack of liquidity. This needs to be controlled else the firm might face problem in obtaining credits in future.

In the view of Fich et. al. (2007), Quick ratio is a more stringent indicator of the firm’s ability to pay off its short-term liabilities because while calculating this ratio inventories are excluded from current assets. Though the Quick ratio has increased in 2013 but the increase is very little. Quick ratio below 1 indicates chances of bankrupt and little capability to pay back short-term dues.

2.3.3 Inventory Turnover:

Tesco
Items 2012 2013
Sales revenue 63916 64826
Inventories 3598 3744
Inventory turnover ratio 17.76 17.31

 

 

 

Analysis:

Inventory turnover ratio indicates the number of times inventories are sold and replaced by a firm. In the view of Flannery and Rangan (2006), high inventory turnover ratio indicates ineffective buying or investment with zero rate of return. In contrast, a low inventory turnover ratio implies higher inventories and poor sales. As in case of Tesco, Inventory turnover ratio has fallen in 2013 compared to 2012. As Tesco sells perishable items hence immediate corrective measures are required.

2.3.4 Debt-to-Equity ratio:

Tesco
Items 2012 (£) 2013 (£)
Non-current liabilities 13731 14483
Current liabilities 19249 18985
Total debts 32980 33468
Share capital 402 403
Share premium 4964 5020
All other reserves 245 685
Retained earnings 12164 10535
Shareholders’ equity 17775 16643
Debt-to-Equity ratio 1.86 2.01

 

 

Analysis:

Debt-to-Equity ratio reflects the composition of debt and equity in the capital structure of a firm. Alti (2006) opined that Debt-to-Equity ratio is a measure of financial leverage of a firm and indicates the degree of debt used by the firm in financing its activities. Increase in Debt-to-Equity ratio of Tesco in 2013 is a good symbol of the financial health of Tesco. However, there has been an increase in debt in 2013 as compared to 2012. Chang and Dasgupta (2009) opined that the benefits from debt financing need to be more than the costs associated with debts.

2.3.5 Assets-Turnover ratio:

Tesco
Items 2012 (£) 2013 (£)
Sales revenue 63916 64826
Non-current assets 37918 37033
Current assets 12863 13096
Total assets 50781 50129
Assets / Turnover ratio 0.79 0.77

 

Analysis:

Assets-Turnover ratio indicates revenues generated per GBP of assets. Stickney and Weil (2006) mentioned that assets-turnover ratio measures the efficiency in deployment of assets. Higher this ratio, better it is for a firm. However, there has been a marginal fall in this ratio in 2013 as compared to 2012. Reduction in total assets in 2013 also needs to be considered here. The management of Tesco need to focus on increasing its revenue without further increase in cost of assets.

3.0 Task 3:

3.1 Investment appraisal techniques:

3.1.1 Payback period:

Payback period is the easiest method to judge suitability of a project. The method considers the number of years taken to recover initial investments made on a project. A project is accepted on the basis of the length of time required to recover initial investments. Generally, project with the shortest payback period is selected. However, Quattrone (2009) argued that payback period method ignores the importance of projects because projects with longer payback period are not accepted even if such projects are vital for the long-run sustainability of the firm.

3.1.2 Accounting Rate of Return (ARR):

ARR represents the ratio between expected average profit from a project and initial investment on the project. ARR method suggests that a project can be accepted only if its ARR is higher or at least equal to the cost of capital (Lowe and Koh, 2007). This method assumes that more quickly cash flows are generated from a project; more quickly such cash flows can be invested to earn returns.

3.1.3 Internal Rate of Return (IRR):

IRR is the rate at which NPV is zero. Put it differently, it is the rate that equalises present value of cash inflows and cash outflows. Stickney and Weil (2006) opined that a project is accepted if IRR is more than or equal to the cost of capital.

3.1.4 Net Present Value (NPV):

Net present value is the difference between the present value of the inflow and outflow of cash arising from undertaking a project. In this method, initial investment is deducted from the cash inflows from the project, including scrap value, if any. In the opinion of Alti (2006), NPV ensures accuracy in the capital budgeting decision by including time value of money in the calculation process. In contrast, Flannery and Rangan (2006) argued that NPV is based on expected future cash flows however the same can differ with actual cash flows.

3.2 Investment appraisal of 123 limited:

123 Limited is a 10 years old UK based cloth manufacturer. Currently, the company wants to expand its operations internationally and that it needs to decide the country in which business expansion would be most profitable. Among the investment appraisal techniques, NPV method has been applied for investment appraisal of the given projects as NPV is considered as the most accurate method in capital budgeting process. Detailed calculations regarding the net cash flows and NPV have been carried out and the same is attached in the appendix.

The calculations indicate that operating in France and Switzerland, both would fetch negative NPV. It is UK in which the proposed investment is expected to bring positive NPV. Hence, expansion of business operations in USA is advisable. However, various qualitative factors that have a bearing on the long-term sustainability of the firm, need to be included in the decision making process. Factors like intensity of competitors in the proposed market, taste of customers, accessibility to suppliers, and other need due consideration. A PESTEL analysis can be helpful on this.

Conclusion:

Identifying relevant stakeholders and proper balancing of stakeholders is crucial for the long-term sustainability of a firm. In addition, application of sound investment appraisal techniques in the capital budgeting process is vital to ensure maximum benefits from the chosen project.

 

 

References:

Abf.co.uk, (2014). ABF plc – Investors – Annual Report 2013 – Operating review – Retail. [online] Available at: http://www.abf.co.uk/investorrelations/annual_report_2013/operating_review/retail [Accessed 26 May. 2014]

Agrawal, A. and Chadha, S., (2008). “Corporate governance and accounting scandals.” Journal of Law and Economics, 48(18), pp. 371 – 406.

Alti, A. (2006), “How Persistent Is the Impact of Market Timing on Capital Structure?” Journal of Finance, 61(6), PP. 1681–1710.

Bebchuk, Lucian A., Cohen A, and Ferrell A, (2009), “What matters in corporate governance?” Review of Financial Studies, 22(15), pp. 783–827.

Bushman, R. and Smith, A., (2009). “Financial accounting information and corporate governance.” Journal of Accounting and Economics, 32(24), pp. 237 – 333.

Bushman, R., Indejejikian, R. and Smith, A. (2007), “Aggregate performance measures in business unit manager compensation: the role of intra-firm interdependencies.” Journal of Accounting Research, 33(11), pp. 101–128.

Chang, X., and Dasgupta, S. (2009), “Target Behavior and Financing: How Conclusive Is the Evidence?” Journal of Finance, 64(11), pp. 1767–1796.

Faleye and Olubunmi (2006). “Classified Boards, Firm Value, and Managerial Entrenchment.” Journal of Financial Economics, 83(2), pp. 501–529.

Fich,  Eliezer M., and Shivdasani A, (2007). “Financial Fraud, Director Reputation, and Shareholder Wealth.” Journal of Financial Economics, 86(2), pp. 306–336.

Flannery, M. J. and Rangan, K. P. (2006), “Partial Adjustment toward Target Capital Structures.” Journal of Financial Economics, 79(7), pp. 469–506.

Hopwood, A. (2006), “If only there were simple solutions, but there aren’t’: some reflections on Zimmerman’s critique of empirical management accounting research.” European Accounting Review, 11(4), pp. 777–785.

Hoshi, T., Kashyap A., and Scharfstein D. (2006). “Corporate Structure, Liquidity and Investment: Evidence from Japanese Industrial Groups,” Quarterly Journal of Economics, 106(15), pp. 33-60.

Land, J. and Lang, M. (2010), “Empirical evidence on the evolution of international earnings.” The Accounting Review, 77(15), pp. 115- 133.

Lowe, A. and Koh, B. (2007), “Inscribing the organization: Representations in dispute between accounting and production.” Critical Perspectives on Accounting, 18(6), pp. 952-974.

Makadok, R., and Barney, J. B. (2008). “Strategic factor market intelligence: An application of information economics to strategy formulation and competitor intelligence”. Management Science, 47(9), pp. 1621-1638.

Quattrone, P. (2009), “We have never been Post-modern’: On the search of management accounting theory.” European Accounting Review, 18(3), pp. 621–630.

Sinha, P.,  Brown, L., and Das, S. (2007), “A re-examination of financial analysts’ differential earnings forecast accuracy.” Contemporary Accounting Research, 14(10), 1–42.

Stickney, C.P. and Weil R.L. (2006). Financial accounting: An introduction to concepts, methods, and uses. 11th edition. Thomson South-Western.

Tesco.com, (2014). Tesco.com – online shopping; bringing the supermarket to you – Every little helps. [online] Available at: http://www.tesco.com/ [Accessed 26 May. 2014].

Vaivio, J. (2008), “Qualitative management accounting research: rationale, pitfalls and potential.” Qualitative Research in Accounting & Management, 5(1), pp. 64-86

Zhang, X. (2000). “Conservative Accounting and Earnings Valuation.” Journal of Accounting and Economics, 29(6), pp. 125–149.

 

 

Appendix I: Calculation of Net cash flows:

 

Country USA
Items Annual figures Year 1 Year 2 Year 3 Year 4 Year 5 Year 6
Spot rate 2.10 2.20 2.30 2.10 2.25 2.50
Revenues 700 333.33 318.18 304.35 333.33 311.11 280.00
Residual value of machinery 150.00  
Total revenue 333 318 304 333 461 280
Running expenses 210 210.00 210.00 210.00 210.00 210.00 210.00
Approval fee 22 22.00 22.00 22.00 22.00 22.00 22.00
Total annual cost 232 232.00 232.00 232.00 232.00 232.00 232.00
Net cash flow 101.33 86.18 72.35 101.33 229.11 48.00
Total cash flow 638.31
                 

 

Country France
Items Annual figures Year 1 Year 2 Year 3 Year 4 Year 5 Year 6
Spot rate 1.80 1.90 2.00 2.10 1.95 1.90
Revenues 450 250.00 236.84 225.00 214.29 230.77 236.84
Residual value of machinery 150.00
Total revenue 250.00 236.84 225.00 214.29 380.77 236.84
Running expenses 190 190.00 190.00 190.00 190.00 190.00 190.00
Approval fee 25 25.00 25.00 25.00 25.00 25.00 25.00
Royalty fee 25 25.00 25.00 25.00 25.00 25.00 25.00
Total annual cost 240 240.00 240.00 240.00 240.00 240.00 240.00
Net cash flow 10.00 -3.16 -15.00 -25.71 140.77 -3.16
Total cash flow 103.74

 

Country Switzerland
Items Annual figures Year 1 Year 2 Year 3 Year 4 Year 5 Year 6
Spot rate 10.00 12.00 14.00 12.00 13.00 14.00
Revenues 3800 380.00 316.67 271.43 316.67 292.31 271.43
Residual value of machinery 150.00
Total revenue 380.00 316.67 271.43 316.67 442.31 271.43
Running expenses 200 200.00 200.00 200.00 200.00 200.00 200.00
License fee 30 30.00 30.00 30.00 30.00 30.00 30.00
Inspection fee 23 23.00 23.00 23.00 23.00 23.00 23.00
Total annual cost 253 253.00 253.00 253.00 253.00 253.00 253.00
Net cash flow 127.00 63.67 18.43 63.67 189.31 18.43
Total cash flow 480.50

 

Appendix II: Calculation of Net Present Value (NPV):

 

USA
Items Year
0 1 2 3 4 5 6
Initial investment 450.00
Cash flow 101.33 86.18 72.35 101.33 229.11 48.00
Discounted rate (10%) 1.10 1.21 1.33 1.46 1.61 1.77
Discounted cash flow 92.12 71.22 54.36 69.21 142.26 27.10
Total Present Value (TPV) 456.26
Net Present Value (NPV) = TPV – Initial investment 6.26

 

France
Items Year
0 1 2 3 4 5 6
Initial investment 450.00
Cash flow 10.00 -3.16 -15.00 -25.71 140.77 -3.16
Discounted rate (10%) 1.10 1.21 1.33 1.46 1.61 1.77
Discounted cash flow 9.09 -2.61 -11.28 -17.61 87.43 -1.79
Total Present Value (TPV) 63.24
Net Present Value (NPV) = TPV – Initial investment -386.76

 

 

 

 

Switzerland
Items Year
0 1 2 3 4 5 6
Initial investment 450.00
Cash flow 127.00 63.67 18.43 63.67 189.31 18.43
Discounted rate (10%) 1.10 1.21 1.33 1.46 1.61 1.77
Discounted cash flow 115.45 52.62 13.86 43.61 117.58 10.41
Total Present Value (TPV) 353.54
Net Present Value (NPV) = TPV – Initial investment -96.46

 

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