FINANCIAL ANALYSIS: TESCO VS DEBENHAMS
Table of Contents
Most significantly, financial analysis involves selection, assessment, and interpretation of financial data, together with other relevant information, to help in making financial and investment decisions (Fabozz 2009, p. 193). Financial analysis may be undertaken to evaluate the efficiency of operations, potential investments, creditworthiness, credit policies, and financial leverage of the company. Furthermore, the primary source of data for financial analysis includes balance sheet and income statement. Financial analysis employs various ratios to evaluate the performance of a given company in comparison to its competitors (Khan & Jain 2007, p. 6). The financial ratios employed include profitability ratios, liquidity ratios, operational ratios, and leverage ratios.
The main goal of this paper is to evaluate and compare the financial performance of Tesco plc and Debenhams plc through financial ratio analysis encompassing three-year period from 2012 to 2014.
Tesco Plc’s history of development can be traced back in 1919 during the time when Jack Cohen began selling surplus groceries via a stall in London, where he made a profit of one pound from sales of four pounds on the first day (Zentes, Morschett & Schramm-Klein 2011, p. 311). However, the Tesco Brand appeared in the market in 1924 when Cohen purchased a tea shipment from T.E Stockwell. Therefore, the initials of names, T.E Stockwell and Cohen were combined to Tes-co and in 1929, Jack Cohen started to operate a flagship Tesco store that was located in Burnt Oak. As the brand kept on growing, Tesco was incorporated as a private limited company in 1932 and became enlisted in LSE (London Stock Exchange) market in 1947 with a 25 p share price. Furthermore, Tesco exhibited its expansionary zeal by acquiring rival shops and buy 1960, the company had acquired 200 Harrow stores and 70 Williams stores, as well as the Victor Value chain and 97 Charles Philips stores (Fernie & Sparks 2009, p. 162). In 1961, the company entered into the Guinness Book of Records as the Europe’s largest store and in seven years, it opened its fits “Superstore’ in West Sussex, Crawley. In 1987, the company completed a successful hostile takeover of its competitor, Hilards Supermarket for £ 220 m. In an effort to overtake Sainsbury, the company launched the Tesco Clubcard scheme in around 1995 and Tescom.com in 2000 (Palmer, Meek, Parkinson & Meek 2012, p. 204). Unfortunately, the company started declining in 2013 where it reported the first decline in profits in its 20-year history. In 2014, Tesco exhibited worst performance in a 20 –year history, with a 3.7 % decline in sales. In 2014, Sept 22, the company shocked the market where it overstated its semi-annual profit projection by £ 250 m.
Debenhams Plc is among the largest clothing and goods retailers in the United Kingdom (Varley 2014, p. 33). The company’s origin can be traced back to 1778 When William Clark opened a drapers store in London to sell expensive fabrics, parasols, bonnets, and gloves. In 1813, the business becomes Clark & Debenham when William Debenham invested in this business and established the first store away from London City in Cheltenham (Francis, Terry & Steven 2013, p. 281). From 1818, the company started to prosper years later due to Victorian fashion for mourning where the windows and female relatives followed a stringent code of etiquette and clothing. Since then, the company continued to operate as an independent company up to 1980s, when the Bruton Group succeeded it hostile takeover. In 1998, the company regained its autonomous when it “demerged” from the Burton Group and Debenhams changed its company name to Arcadia Group plc. After this de-merger, Debenhams was enlisted into LSE until 2003, but became re-enlisted in 2006. In 2007 and 2009, the company managed to acquire 9 stores from Roches (Ireland) and acquired Magasin du Nord (Denmark).
Essentially, all business ventures cannot exist in the life long without making profit (Duska 2007, p. 167). Therefore, evaluation of profitability levels of a company is very important to management, investors, creditors, and obligors. However, there is no direct formula for determining a firm’s level of profitability. For this reason, several ratios such as gross profit margin, operating profit margin, and net profit margin can be used to evaluate the company’s level of profitability.
Gross profit margin can be viewed as gross profit expressed as a component percentage of total revenues (Pinson 2008, p. 115). In other words, gross profit margin is the percentage of revenues that is available to meet operating expenses. Therefore, a high gross profit margin is an indication of increased levels of profitability. The gross profit margin of Tesco plc for the year 2012, 2013, and 2013 are 8.44 %, 7.79 % and 6.62 %, respectively; and for the Debenhams plc for 2012, 2013, and 2014 are 13.59 %, 13.13 % and 12.8 %, respectively. These gross profit margins for Tesco imply that the company was able to generate £0.084, £ 0.076, and £ 0.066 of gross profit from every pound of revenues generated by the company in the financial year that ended at 2012, 2013, and 2014 respectively. For Debenhams plc, its gross profit margins imply that it was able to generate £0.135, £ 0.131, and £ 0.121 of gross profit from every pound of revenues generated by the company in the financial year that ended at2012, 2013, and 2014 respectively. From graph 1 below, The Debenhams’ gross profit margin level is higher than that of Tesco, but both companies exhibit a declining growth.
Graph 1: Gross profit margin
Reliability of grow profit margin
No matter how high gross profit margin ratio of company, this metric is still perilous to depend upon due to misconceptions surrounding gross profit margin. Therefore, full complementary of other ratios can be employed to provide a more detailed snapshot of a company’s financial stability and success (Tracy 2012, p. 13).
Operating profit margin is the operating margin expressed as a component percentage of sales revenue (Graham, Smart, & Megginson 2012, p. 45). In other words, operating profit margin indicates the percentage of sales revenues that remains after cost of sales and operating expenses are deducted from total sales revenues. Therefore, a high operating profit margin is an indication of increased level of profitability. The operating profit margin of Tesco plc for the year 2012, 2013, and 2013 are 5.95%, 5.13 % and 4.73 %, respectively; and for the Debenhams plc ‘s operating profit margin 2012, 2013, and 2014 are 7.85 %, 6.70 % and 5.53 %, respectively. These operating profit margins for Tesco imply that the company was able to generate £0.060, £ 0.051, and £ 0.047 of operating profit from every pound of sales revenues generated by the company in the financial year that ended at 2012, 2013, and 2014, respectively. In the case of Debenhams plc, its operating profit margins imply that it was able to generate £0.078 £ 0.067, and £ 0.055 of operating profit from every pound of revenues generated by the company in the financial year that ended at 2012, 2013, and 2014, respectively. From graph 2 below, The Debenhams’ operating profit margin level is higher than that of Tesco, but both companies exhibit a declining growth in profitability.
Graph 2: Operating profit margin
Reliability of operating profit margin
Operating profit margin is beneficial as it shows the percentage of profit generated by the operating activities. However, the operating profit margin does not take account other important items such as financial obligations, tax income, and income from non-operating activities which may have substantial impact on financial performance of a company. Therefore, operating profit alone cannot be relied upon when concluding the profitability level and other profitability ratios are needed for complementary and comparability (Robinson, Henry, Pirie & Broihahn 2015, p. 330).
Net profit margin is often defined as the net profit expressed as a component of sales revenues (Baker & Powell 2005, 62). In other words, it is the residual sales revenues that remain as the bottom-line item of income statement after cost of sales, all expenses, and preference share dividends are deducted from total sales revenue. It is the amount of money that can be attributed to the shareholders and retained earnings. Therefore, a high net profit margin is an indication of increased level of profitability. The net profit margin of Tesco plc for the year 2012, 2013, and 2013 are 4.39%, 0.04 % and 1.54 %, respectively; and for the Debenhams plc ‘s net profit margin 2012, 2013, and 2014 are 5.62 %, 5.08 % and 3.77 %, respectively. These operating profit margins for Tesco imply that the company was able to generate £0.044, £ 0.0004, and £ 0.015 of net profit from every pound of sales revenues generated by the company in the financial year that ended at 2012, 2013, and 2014, respectively. In the case of Debenhams plc, its net profit margins imply that it was able to generate £0.056 £ 0.051, and £ 0.038 of net profit from every pound of revenues generated by the company in the financial year that ended in 2012, 2013, and 2014, respectively. From graph 3 below, The Debenhams’ net profit margin level is higher than that of Tesco, but Debenhams’ exhibits a declining growth in profitability; whereas Tesco’s decreases in 2013 and then increases 2014.
Graph 3: Net profit margin
Reliability of net profit margin
One of the usefulness of net profit margin is price control where a company can use net profit margin to establish the direct correlation between price and profit on a per-unit basis. Unfortunately, profit margin does not assist in determining sales volume and uncovering of true cost efficiency of generating sales revenues.
The liquidity level refers to the extent to which a firm can meet its short-term financial obligations such as trade payable and interest burden at the disposal of total current assets. Liquidity level is often evaluated using current and acid-test ratio.
As a measure of liquidity level, current ratio is often used to determine the degree to which a given company can cover up its short-term financial debt using all of its current assets (Graham, Smart & Megginson 2012, p. 41). Therefore, a current ratio greater than or equal to 1 show that the current assets of a company are sufficient enough to cover up current liabilities. The vice versa is true. However, the current ratios for Tesco plc for the year 2012, 2013 and 2014 are 0.67, 0.69, and 0.73, respectively; whereas Debenhams’ current ratios are 0.63, 0.63 and 0.64 in the same order of years. It is evident that the current assets of the two companies are not sufficient enough to settle current liabilities for the three-year period as depicted in Graph 3 below. However, the ability to settle current liabilities tends to increase for the two companies.
Graph 3: Current ratio
Reliability of current ratio
Most notably, current ratio indicates the cash richness and short-term strength of a firm, as well as the status of the operating cycle. However, current ratio involves illiquid inventory that results in overestimation of company’s liquidity position. Inventory is vulnerable to obsolete and damage (through fire, floods, and accidents).
As a measure of liquidity level, acid-test ratio is often used to determine the degree to which a given company can cover up its short-term financial debt using all of its liquid assets in cases where inventory become obsolete or damage (Graham, Smart & Megginson 2012, p. 41). Therefore, an acid-test ratio greater than or equal to 1 show that the liquid assets of a company are sufficient enough to cover up current liabilities. The vice versa is true. However, the acid-test ratios for Tesco plc for the year 2012, 2013 and 2014 are 0.48, 0.49, and 0.56, respectively; whereas Debenhams’ currents ratios are 0.17, 0.15 and 0.19 in the same order of years. It is evident that the liquid assets of the two companies are not sufficient to settle current liabilities for the three-year period as depicted in Graph 4 below. However, the ability to settle current liabilities tends to increase for the two companies.
Graph 4: Acid-test ratio
Reliability of Acid-test ratio
Most importantly, acid-test ratio eliminates the illiquid components (inventory) from the equation giving the better snapshot of the company’s liquidity position. Collapsing companies have high level of inventory and acid-test can be much of help in uncovering such situations. However, acid-test ratio ignores the timing of cash flows and this alone cannot be used to assess liquidity of the company.
Efficiency ratios are used to evaluate the company’s efficiency in management of assets such as inventory, account receivables and total assets. Therefore, company’s efficiency can be evaluated using efficiency ratios such as asset turnover, account receivable turnover, and inventory turnover.
Asset turnover ratio is used to indicate the amount of sales revenues in pounds generated by one pound of assets acquired by the company (Ryan 2004, p. 218). A high asset turnover implies that the company is using fewer assets to generate more sales, which is a sign of efficiency. The asset turnover of Tesco plc for the year 2012, 2013, and 2013 are 1.26, 1.26 and 1.26 times, respectively; and for the Debenhams plc ‘s asset turnover 2012, 2013, and 2014 are 1.07, 1.07 and 1.08 times, respectively. These asset turnovers for Tesco imply that the company was able to generate £1.26, £ 1.26, and £ 1.26 of sales revenue from every pound of assets acquired by the company in the financial year that ended at 2012, 2013, and 2014 respectively. In the case of Debenhams plc, its asset turnovers imply that it was able to generate £1.07, £ 1.07 and £ 1.08 of sales revenues from every pound of assets acquired in the financial year that ended at 2012, 2013, and 2014 respectively. Graph 5 below indicates that the assets turnovers for the two companies remained relatively stable during the three-year period, but Tesco’s are higher.
Graph 5: Asset turnover
Receivable collection period is used to indicate the number of days through which the company is able to collect cash its debtors. Fewer days indicate that the company’s management is efficient in managing account receivables. Account receivable period is calculated from account receivable turnover. The Tesco’s account receivable periods are 12.81 days, 12.19 days, and 10. 89 days in 2012, 2013 and 2014 respectively; whereas Debenhams’s receivable collection periods are 3.8 days, 3.34 days and 4.32 days in the same order of years. As can be noticed, Tesco has higher receivable collection period.
Payables payment period is the number of days taken by the company to settle its account payable (Ryan 2004, p. 219). High number of days indicate inefficiency of company’s management in managing the accounts payable. Furthermore, the payables payment period is determined from payable turnover. The Tesco’s Payables periods are 37.46 days, 35.53 days, and 34.34 days in 2012, 2013 and 2014, respectively; whereas Debenhams’s payables payment periods are 51.41 days, 53.80 days and 50.05 days in the same order of years. As can be noticed, Debenhams plc has higher payables payment period.
Inventory turnover period shows the number of days in which inventory stays on store shelves before turned into cost of sales or sales revenues (Ryan 2004, p. 219). Less number of days indicates management efficiency in converting inventory into cost of goods sold. Inventory turnover period is determined from inventory turnover. The Tesco’s inventory periods are 22.44 days, 23.32 days, and 22.26 days in 2012, 2013 and 2014 respectively; whereas Debenhams’s inventory periods are 62.93 days, 65.89 days and 62.05 days in the same order of years. As can be noticed, Debenhams plc has higher inventory turnover period.
The gearing ratio determines the proportion of borrowed money (debt) to its equity. The gearing depicts the financial obligation to which a company y is subjected, since beyond debt can result in financial difficulties. A very high gearing ratio implies a high debt proportion to equity. Examples of gearing ratio include Interest cover, financial gearing and equity gearing.
Interest coverage is a ratio that indicates the extent to which EBIT is capable of covering interest obligations for short-term and long-term debts (Glynn 2008, p. 410). The interest coverage ratios of Tesco plc are12.80, 10.53 and 9.46 times in 2012, 2013 and 2014 respectively, and Debenhams’ interest coverage ratios are 11.99, 12.97, and 9.01 times in order of the same years. Interest coverage ratios for the two companies tend to decrease indicating an increasing debt burden as indicated by Graph 6.
Graph 6: Interest coverage ratio
It is also known as debt ratio. Financial leverage is used to indicate the proportion of debt financing the company’s assets. When financial leverage is high, the risk of the business also goes high since the company has more debt burdens that may increase chances of default (Glynn 2008, p. 410). Financial leverage is determined by dividing total debt by total assets. According to Graph 7 below, the financial leverage of Tesco plc is increasing while that of Debenhams is decreasing. This implies that the Tesco’s business is more risky than Debenhams’.
Equity gearing is also known as debt-to-equity ratio. This ratio is used to indicate how the company’s capital is structured. A high equity gearing ratio indicates that the company’s debt is more than the equity and depicts a high risk of the business. Graph 8 indicates that Tesco’s equity gearing is increasing while Debenhams’s equity gearing is tending to decrease (Glynn 2008, p. 410). This indicates that Tesco’s debt is increasing more than equity making its business more risky when compared to that of Debenhams’.
Graph 9: Equity Gearing
As indicated by the current and acid-test ratio, Tesco’s and Debenhams’ liquidity level is too low, implying that the two have no ability to meet their short-term financial obligations. The companies are likely to experience financial difficulties as creditors and obligors will not be willing to supplier goods on credit and finances due to fear of default. To avoid these circumstances, it is advisable for the two companies to increase their current assets such as cash and cash equivalent through issuance of equity. Furthermore, Debenhams plc has higher profitability level than Tesco plc as indicated by gross profit margin, operating profit margin, and net profit margin. However, the profitability levels of the two companies are decreasing gradually. Tesco plc is more efficient in managing total assets to generate sales revenues when compared to Debenhams. Tesco plc is also efficient in paying due to its creditors as it takes less time to settle payables payment than Debenhams. Additionally, Debenhams is more efficient in debt collection from its customers than Tesco as it has less receivable collection period. Besides, Tesco is more efficient in inventory management as it has low inventory turnover period. On the other hand, as far as gearing ratios are concerned, Tesco’s business is more risky due to decreasing ability to cover its interest obligations, assets are increasingly becoming acquired by debt, and high debt in its capital structure when compared to that of Debenhams. Therefore, the company should try its best to reduce the debt proportion to achieve a balanced capital structured that is stable. High debt proportion increases debt burden, increasing the chance of default and running into bankruptcy.
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|Currency in||As of:||25-Feb||23-Feb||22-Feb|
|Millions of British Pounds||2012||2013||2014|
|Cost Of Goods Sold||58,519.00||58,596.00||58,635.00|
|Selling General & Admin Expenses, Total||1,594.00||1,555.00||
|OTHER OPERATING EXPENSES, TOTAL||1,594.00||1,555.00||1,193.00|
|Interest And Investment Income||114||120||132|
|NET INTEREST EXPENSE||-297||-309||-315|
|Income (Loss) On Equity Investments||91||72||60|
|Other Non-Operating Income (Expenses)||44||-15||-11|
|EBT, EXCLUDING UNUSUAL ITEMS||3,641.00||3,003.00||2,715.00|
|Merger & Restructuring Charges||—||—||—|
|Impairment Of Goodwill||—||-495||—|
|Gain (Loss) On Sale Of Assets||397||-290||180|
|Other Unusual Items, Total||—||-161||-636|
|Other Unusual Items||—||-94||-27|
|EBT, INCLUDING UNUSUAL ITEMS||4,038.00||2,057.00||2,259.00|
|Income Tax Expense||874||529||347|
|Minority Interest In Earnings||-8||4||4|
|Earnings From Continuing Operations||3,164.00||1,528.00||1,912.00|
|EARNINGS FROM DISCOUNTINUED OPERATIONS||-350||-1,504.00||-942|
|NET INCOME TO COMMON INCLUDING EXTRA ITEMS||2,806.00||28||974|
|NET INCOME TO COMMON EXCLUDING EXTRA ITEMS||3,156.00||1,532.00||1,916.00|
|Currency in||As of:||1-Sep||31-Aug||30-Aug|
|Millions of British Pounds||2012||2013||2014|
|Cost Of Goods Sold||1,927.50||1,982.60||2,033.40|
|Selling General & Admin Expenses, Total||127.3||146.6||151.3|
|OTHER OPERATING EXPENSES, TOTAL||127.3||146.6||151.3|
|Interest And Investment Income||0.1||0.4||0.2|
|NET INTEREST EXPENSE||-14.6||-11.8||-14.2|
|Other Non-Operating Income (Expenses)||-2.1||-2.2||-3.5|
|EBT, EXCLUDING UNUSUAL ITEMS||158.3||139||110.3|
|Other Unusual Items, Total||—||—||-4.5|
|Other Unusual Items||—||—||-4.5|
|EBT, INCLUDING UNUSUAL ITEMS||158.3||139||105.8|
|Income Tax Expense||33||23.1||18.6|
|Earnings From Continuing Operations||125.3||115.9||87.2|
|NET INCOME TO COMMON INCLUDING EXTRA ITEMS||125.3||115.9||87.2|
|NET INCOME TO COMMON EXCLUDING EXTRA ITEMS||125.3||115.9||87.2|
|Currency in||As of:||25-Feb||23-Feb||22-Feb|
|Millions of British Pounds||2012||2013||2014|
|Cash And Equivalents||1,725.00||1,457.00||2,021.00|
|TOTAL CASH AND SHORT TERM INVESTMENTS||2,968.00||1,979.00||3,037.00|
|Finance Division Loans And Leases, Current||2,502.00||3,094.00||3,705.00|
|Finance Division Other Current Assets||580||1,055.00||485|
|Other Current Assets||551||689||2,567.00|
|TOTAL CURRENT ASSETS||12,863.00||13,096.00||15,572.00|
|Gross Property Plant And Equipment||34,772.00||35,643.00||36,585.00|
|NET PROPERTY PLANT AND EQUIPMENT||25,710.00||24,870.00||24,490.00|
|Finance Division Loans And Leases, Long Term||1,901.00||2,465.00||3,210.00|
|Finance Division Other Long-Term Assets||1,526.00||—||—|
|Deferred Tax Assets, Long Term||23||58||73|
|Deferred Charges, Long Term||677||739||885|
|Other Long-Term Assets||3,717.00||3,966.00||1,723.00|
|LIABILITIES & EQUITY|
|Current Portion Of Long-Term Debt/Capital Lease||1,423.00||20||1,064.00|
|Current Portion Of Capital Lease Obligations||32||6||6|
|Finance Division Other Current Liabilities||5,465.00||6,015.00||6,858.00|
|Current Income Taxes Payable||416||519||494|
|Other Current Liabilities, Total||2,947.00||3,341.00||4,342.00|
|TOTAL CURRENT LIABILITIES||19,249.00||18,985.00||21,399.00|
|Pension & Other Post-Retirement Benefits||1,872.00||2,378.00||3,193.00|
|Deferred Tax Liability Non-Current||1,160.00||1,006.00||594|
|Other Non-Current Liabilities||587||1,031.00||953|
|Additional Paid In Capital||4,964.00||5,020.00||5,080.00|
|Comprehensive Income And Other||263||694||-478|
|TOTAL COMMON EQUITY||17,775.00||16,643.00||14,715.00|
|TOTAL LIABILITIES AND EQUITY||50,781.00||50,129.00||50,164.00|
|Currency in||As of:||1-Sep||31-Aug||30-Aug|
|Millions of British Pounds||2012||2013||2014|
|Cash And Equivalents||44||27||64.4|
|TOTAL CASH AND SHORT TERM INVESTMENTS||44||27||64.4|
|Other Current Assets||7.8||7.3||1.5|
|TOTAL CURRENT ASSETS||459.5||470.5||486.3|
|Gross Property Plant And Equipment||1,243.40||1,301.10||1,347.20|
|NET PROPERTY PLANT AND EQUIPMENT||661.6||692.1||689.2|
|Deferred Tax Assets, Long Term||83.2||69.3||51|
|Other Long-Term Assets||20.1||22.6||24.9|
|LIABILITIES & EQUITY|
|Current Portion Of Long-Term Debt/Capital Lease||2.2||2.3||5.4|
|Current Portion Of Capital Lease Obligations||2.2||1.8||3.3|
|Current Income Taxes Payable||55.7||49.7||42.8|
|Other Current Liabilities, Total||67.7||69.6||78.2|
|Unearned Revenue, Current||2.1||4.8||3.9|
|TOTAL CURRENT LIABILITIES||727||741.9||758|
|Pension & Other Post-Retirement Benefits||57.3||24.6||9.3|
|Deferred Tax Liability Non-Current||64.7||59.1||53.4|
|Other Non-Current Liabilities||323.6||323.5||335.3|
|Additional Paid In Capital||682.9||682.9||682.9|
|Comprehensive Income And Other||-12.1||-3.5||-16.3|
|TOTAL COMMON EQUITY||661||744.4||767.4|
|TOTAL LIABILITIES AND EQUITY||2,091.20||2,132.80||2,148.40|
CALCULATIONS AND FORMULAS
Gross Profit Margin
|Gross Profit margin||2012′||2013′||2014′|
Operating Profit Margin
|Operating Profit margin||2012′||2013′||2014′|
Net profit margin
|Net profit margin||2012′||2013′||2014′|
Receivable collection period
|Account receivable turnover||2012′||2013′||2014′|
|Receivable collection period||2012′||2013′||2014′|
Payables payment period
|payable turnover period||2012′||2013′||2014′|
Inventory turnover period
|Inventory turnover period||2012′||2013′||2014′|