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03/27/2012

MANAGING FINANCIAL PRINCIPLES AND TECHNIQUES


 

MANAGING FINANCIAL PRINCIPLES AND TECHNIQUES

Introduction

            Finance is considered as one of the most important aspects or units of any company. It pertains on the art and science of managing money (Khan & Jain 2007). Currently, due to the different events that have happened in the history of business, including the different unexpected bankruptcy and downfall of different huge companies including Enron, resulted to huge buzz about financial management. As a result, financial management is not just an aspect to be considered inside the organization, but it must also be shown to the community, in order to protect the rights of the stakeholders of a specific company. Based on this financial management is not just about the process to be implemented in order to ensure good performance of the company, but it is also considered as social responsibility and part of corporate governance.

            There are major areas of finance – (a) financial services and (b) managerial finance/corporate finance/financial management. While the financial services pertains on the design of the delivery of advice and financial products to individuals, businesses and governments within the areas of banking and related institutions, personal financial planning, investments, real estate, insurance etc., financial management pertains on the duties of the financial mangers in the business firm. Financial managers focus on managing the financial affairs of any type of business, which include financial and non-financial, private and public, large and small, profit-seeking and non-for-profit. Thus, they are responsible for budgeting, financial forecasting, cash management, credit administration, investment analysis, funds management and so on (Khan & Jain 2007). With this, it is important to take note that the role of financial manager is very important because he or she is the one who’s handling the flow of money inside and out the organization. Practically, without any financial help, or without budget, it will be impossible to implement any plans and strategies, no matter how good they are. Due to this, different companies and organizations are focusing on implementing different managing financial principles and techniques in order to ensure the success of their entire operation.

            Pertaining to financial management, Tesco plc, is considered as one of the companies in the world that have been able to show expertise. It is one of the largest retailers in the world, which operates in more than 2,300 supermarkets and convenience stores and employing 356,000 people. The core business of the company is in Britain, where the company considered as the largest private sector employer and largest food retailer in the United Kingdom, which operates about 1,900 stores. In continental Europe, the company operates in the Czech Republic, Hungary, Poland, the Republic of Ireland, Slovakia, and Turkey. In Asia, the company operates in Japan, Malaysia, South Korea, Taiwan and Thailand. Via Tesco.com, the company ranks as the largest online supermarket in the world. Aside from that, the company also offers different financial services via the Tesco Financial Services with 4.6 customers account (Funding Universe n.d.).

            In 2009, group sales of Tesco, including VAT had increased by 15.1% to £59.4 billion, compare to last year - £51.6 billion. At constant exchange rates, sales had increased by 10.6% (Tesco plc 2009).

Task 1: Forecasting

1.1 Forecasting Techniques

            Forecasting plays a vital role in business planning. The ability to accurately predict the future is considered as fundamental to many decision activities in retail, marketing, production, inventory control, personnel as well as many other business functional areas. Improvement and increased in the forecasting accuracy, can smooth the progress of savings of million dollars to a company, thus it is considered as the major motivation for using formal systematic forecasting methods, as well as investigation of new and better forecasting methods (Zhang 2004). Sales and revenue forecasting is considered as important activities for any company, because it enables them to foresee the movement of the sales and revenue in the company, which will help in order to create focus on strategic decision-making.

            In the case of Tesco, quantitative forecasting method must be used in order to forecast sales and revenue. Quantitative methods relay on numerical data that is connected to the source of revenue and sales. It helps to make explicit assumptions and procedures used in order to generate forecasts (Garrett & Leatherman n.d.). It uses statistical procedures which involve the examination of current and historically seasonally unadjusted data (Sloot 2003). There are two different general types of quantitative forecasting methods: time series and causal techniques. In the case of Tesco, time series will be implemented. Time series technique is defined as:

 

“Time series are sequences, discrete of continuous, of quantitative data assigned to specific moments in time and studies with respect to the statistics of their distribution in time. They may be simple, in which case they consist of a single numerically given observation at each moment of the sequence; or multiple, in which case they consist of a number of separate quantities tabulated according to a time common to all.” (McNabb 2004, p. 288)

            Therefore, it involves statistical analysis which uses only historical data of the variable (Sloot 2003). In using time series techniques, there are different essential concepts that need consideration before the selection of technique (Frank 1993 cited in Garrett & Leatherman n.d.). First is the trend, which pertains on how long a data series is required for the technique to identify any underlying pattern in the data. Another is the cyclicality which pertains on the extent which the revenue source is affected by general business cycles. In connection, seasonality is another cyclic phenomenon that must be considered, which can be observed monthly or quarterly.  Lastly, randomness pertains on the unexpected events that may distort trends that exist over the long-term (Garrett & Leatherman n.d.).

            On the other hand, multiplicative model will be applied because of the fact that this model implies that the impact of each factor amplifies the impact of the previous factors (McNabb 2004). Therefore, in addition to trend component T, and seasonal component S, this model assumes that the time series also has an irregular component I. The irregular component pertains on the random impact on the time series that cannot be explained by trend and seasonable components. Using T1, S1 and I1, to identify the trend, seasonal and irregular components at time 1; it is assumed that the actual time series, denoted by Y1, can be described by the multiplicative time series model (Sweeney & Anderson 2009, p. 199):

 

Y1 = T1 x S1 x I1

1.2 Sources of Funds

            Capital investments require a source of funds. For large companies, like Tesco, multiple sources is being applied. It is important to take note that the process of obtaining funds for capital investment is called financing (Turner & Doty 2009). There are two broad sources of financial funding which include debt and equity financing. Debt financing involves borrowing and utilizing money which is to be paid in time (Turner & Doty 2009). Therefore, it involves repayable loans (Pakroo 2008).It is important to take note that debt financing does not create an ownership position for the lender within the borrowing organization. The borrower is just obligated to repay the borrowed funds, plus accrued interest, with accordance to the repayment schedule (Turner & Doty 2009).        

            The second broad source of funding is equity financing. Under the equity financing the lender acquires an ownership or equity position inside the organization of the borrowers. With this, the lender has the right to participate in the financial success of the organization as a whole. The two main sources of equity financing are stocks and retained earnings (Turner & Doty 2009). Equity financing is the process of acquiring new owners who will invest cash in the business (Pakroo 2008).

            Overall, Tesco finances its operations by a combination of retained profits, long and medium-term debt, capital market issues, commercial paper, bank borrowings and leases.
The objective of this is to make sure that the continuity of funding will be implemented. Thus, it enables to smooth the debt maturity profit, at the same time, arrange the funding ahead of requirements and sustain the sufficient undrawn committed bank facilities as well as a strong credit rating so that maturing debt may be refinanced as it falls due. Tesco has a long-term rating of A3 by Moody’s and A- by Standard and Poor’s with a stable look. In 2009, new funding of £5.6 billion was arranged, including a net £0.7 billion from property transactions and £4.9 billion from medium-term notes. At the end of 2009, the net debt as £9.6 billion, compare to £6.2 billion of 2008 (Tesco n.d.).

Task 2: Financial Appraisals and Techniques

2.1 Appraisal Methods

            Investment decision can be defined as one which involves the firm in making a cash outlay that aims to receive, in return, future cash inflows. With this, decisions regarding buying new machine, building a factory, extending a warehouse, improving a delivery service, instituting a staff training scheme or launching a new product line are all considered as instances of investment decisions (Lumby 1988, p. 22). There are two traditional methods that can be used in appraisals – payback period and average annual rate of return.

            In the case of Tesco’s investment activities in India, the payback period method will be applied. This is because, this method is considered as the most tried and trusted of all methods, and its name neatly describes its operation, which refer on how quickly the incremental benefits that accrue to a company from an investment project payback the initial capital invested – the benefits being normally defined in terms of after-tax cash flows (Lumby 1988). This method will help the Tesco to have a first screening method, which will focus on the question: How long will it take to pay back its cost. This will offer different advantages including:

  • a long payback means capital is tied up;
  • focus on early payback can help to enhance and improve liquidity;
  • investment risk is increased if payback is longer;
  • shorter-term forecasts are likely to be more reliable;
  • the calculation is quick and simple; and
  • payback is an easily understood concept (The Institute of Chartered Accountants in England and Wales n.d.).

Therefore, with this, Tesco will be able to rank its projects in India in order of the time taken in order to recoup initial investments, which can help in order to look at the projects with the high degree of risk (Price 1995).

2.2 Financial Information Use in Strategic Decisions on Investment

            Investment decision is the decision to commit the resources, including capital, people, know-how etc. of a firm to a given project with the intention of achieving greater financial and other benefits in the future (Butler 1993).

            With this, in the process of strategic decisions on investment, it is important to focus on financial information that are related to the financial strengths of the company including the tangible and intangible assets of the company. This include land, buildings, plant, equipments and inventories; together with the patents, brands, know-how and people (Butler). All of these are important in order for the decision makers to focus on the different assets on hand of the company, which will help in order to assert the capability of the company to handle a given project. In addition, it is also important to focus on financial and statistical information that are related to the environment of the prospect investment. This will focus on the current changes in the demands of a product in a given place, together with the economic conditions.

2.3 Appropriateness of Tesco’s Selected Investment Project Decisions

            Tesco invested £60 million for its opening of 50 stores in Mumbai, at the same time, the company also planned to enter into a franchise agreement with Trent, a retail arm of the Tata group for a fee. The said deal is expected to support the development of the company’s hypermarket business, Star Bazaar with a further 50 stores opening in next five years. This investment project is good for the business, particularly because, many huge businesses of today are focusing on investing in global market, in order to grow and expand. In a competitive environment, survival does require close attention to economically optimal strategies (Whittington 2001). Based on this, the company has been able to see the different financial strength of Tesco, which pertains on good performance of the company on its mother country. At the same time, the company also enables to see the opportunities which can be gained by investing and expanding in a growing market, India. With a franchise agreement with Trent, the company will be able to prevent any problem that is connected with the political and economic aspects in India.

Task 3: Financial Statements

3.1 Financial Viability of Tesco for 2008

            Financial viability pertains on being able to generate sufficient income in order to meet operating payments, debt commitments, and if applicable, allow growth while maintaining service levels. The financial viability can be ascertained a rigorous pro forma financial statement analysis. There are key financial statements – income statement, balance sheet and cash flow statement (Esteban & Buljevich1999).

3.1.1 Financial Ratios

            Financial ratios enable to reveal the overall financial condition of a firm. It enables the analysts and investors to spot if a firm is subject to the risk of insolvency or if it’s doing well.

A. Liquidity Ratios

Measure the ability of the company to meet the current debt service (Esteban & Buljevich 1999).

1. current ratio – ratio of current assets to current liabilities

£6,300m/£10,263m = 0.61

            Current ratio shows the relationship between the value of the current assets and the value of the current liabilities of a business (Bates & Goodman 2005).The generally accepted ratio is 1:1, therefore, a current ratio that is less than 1 is already considered as red flag (Mladjenovic 2005). This can be observed in the case of Tesco. However, it is important to consider that only short-term creditors prefer a high current ration because it can help to reduce risks, but shareholders prefer lower current ratio, because it means that the assets of the company are all working in order grow the business (NetMBA n.d.).

2. quick ratio – ratio of current assets minus inventory to current liabilities

£6,300m – £2430m/£10,263m = 0.377

            Quick ratio is the indicator of the short-term liquidity of the company, which help to measure the ability of the company to meet its short-term obligations with its most liquid assets. The result shows that the quick ratio of Tesco is low, therefore, based on theory, the company in a god position, however, as have explained in the current ratio, it means that all of the assets of the company are all in use for growth and expansion.

 

3. net working capital – measures the efficiency and short-term financial health of the company.

£10,263m – £6,300m = £3963m

            Working capital pertains on the measurements of the capability of the company to pay its current obligations (Gorman 2003). This can help in order to know the working capitals that are needed in connection with the projected sales or receipts (Troy 2009). A positive net working capital shows the capability of the company to pay its obligations, which can be observed in Tesco.

B. Financial Leverage Ratios

Offers an indication of the long-term solvency of the firm, which is concerned with short-term assets and liabilities, financial leverage ratios measure the extent to which the firm is using long term debt.

1. debt ratio – is the total debt divided by total assets.

£11,902m/£18,262m = £0.65

            The debt ratio of Tesco is less than one, meaning the company has more assets than debt. Therefore, the company is attractive to investors, because of lesser risk.

C. Profitability Ratios

Helps to measure the success of the firm at generating profits.

1. gross margin ratio – shows how much a firm has left over after paying its cost of goods sold. It is what pays the operating expenses, financing expenses or interest and profits (Nelson 2005).

£47,298m - £43,668m/£47,298m = 0.077

            Based on the gross margin ratio, it can be said that Tesco had little amount of money on hand, after paying all the necessary payables. This can be because of the global economic crisis being experienced in most of the countries it base.

            With all of these ratios, it can be said that even though, there are some explanations on the low ratio in some part, particularly current ratio, it can be said that Tesco is somehow “struggling” in its financial performance. This is primarily, because of the different economic changes in the world. However, because of the experience and knowledge of the management of the company, it had been able to maintain its good financial performance. This can cause some problems for the possible debtors, but it can also help in order to attract possible investors.

            With this, it is important for Tesco to focus on investing more on some of the developing and emerging markets, particularly in Asia. This can help in order to improve and expand the market of the company.

Conclusion and Recommendation

            Tesco is one of the most successful companies in the history. It had been able to show consistent good performance, in terms of financial and non-financial aspect of operation. Based on the analysis of this paper, Tesco is facing different problems that are related to financial aspect of the company, focusing on the result of different financial ratios done. However, this can be solved by improving the expansion programs, by investing into a new market, and even having partnership with different companies and organizations in different parts of the globe.

            This can be done by further focusing on the source of funds, by attracting more investors and debtors. With this, the company can implement different programs and strategies that will help in order to prevent or at least, lessen the impact of financial problems towards the company.

            It will be helpful if Tesco will continue and even improve its effort in finance aspect of the company, particularly regarding forecasting. This will help in order to ensure that all of the strategies and decisions to be implemented by the company will be successful in helping the company to survive the global financial crisis and improve its position in the global market.

 

Reference and Bibliography

 

Bates, B, Goodman, S Ladzani, W, de Vries, C & Botha, S 2005, Business Management: Fresh Perspective, Pearson South Africa

 

Butler, R 1993, Strategic Investment Decisions: Theory, Practice and Processes, Taylor & Francis.

 

Esteban, C, Buljevich, E & Park, Y 1999, Project Financing and the International Financial Markets, Springer.

 

Khan & Jain 2007, Financial Management,  Tata McGraw-Hill.

 

Funding Universe, Tesco plc, http://www.fundinguniverse.com/company-histories/Tesco-plc-Company-History.html [Accessed 25 January 2010]

 

Garrett, T & Leatherman, J, An Introduction to State and Local Public Finance, http://www.rri.wvu.edu/WebBook/Garrett/chapterfour.htm [Accessed 26 February 2010]

 

Gorma, T 2003, The Complete Idiot’s Guide to MBA Basics, Alpha Books.

 

Lumby, S 1988, Investment Appraisal and Financing Decisions, Taylor & Francis.

 

McNabb, D 2004, Research Methods for Political Science: Quantitative and Qualitative Methods, M.E. Sharpe.

 

Mladjenovic, P 2005, Stock Investing For Dummies, For Dummies

 

NetMBA, Financial Ratios, http://www.netmba.com/finance/financial/ratios/ [Accessed 26 February 2010].

 

Pakroo, P 2008, The Small Business Start-Up Kit, Nolo.

 

Price, A D F 1995, International Project Accounting, International Labor Organization.

 

Sloot, P 2003, Computational Science – ICCS 2003: International Conference, Melbourne, Australia and St. Petersburg, Russia, June 2 – 4, 2003: Proceedings, Part 4, Springer.

 

Sweeney, D, Anderson, D, Williams, T, Camm, J & Martin, R K 2009, Quantitative Methods for Business, Cengage Learning.

 

Tesco plc, Tesco, http://www.tescoplc.com/a [Accessed 25 January 2010].

 

The Institute of Chartered Accountants in England and Wales, Investment Appraisal Techniques, http://docs.google.com/viewer?a=v&q=cache:tC9M4Qfr2Y8J:financial.kaplan.co.uk/Documents/ICAEW/MI_Ch3_p.pdf+investment+appraisal+methods&hl=en&gl=ph&pid=bl&srcid=ADGEESj6a70JPBjZ5JMnTGie_BISt3jd2OYjDn-3TDeFl_pcBc9czBdA5BLbLfcGiPpy6zHhGHwWpZSC7fmb72CkaRICGZ27mkBNs3eSn1cEJOUIm_AfeLQrn7OCpkktvzdcvw9rMKZv&sig=AHIEtbRfgRTNyubVQDd2ZDV894Q-gXuT9Q [Accessed 25 January 2010].

 

Troy, L 2009, Almanac of Business and Industrial Financial Ratios, CCH.

 

Turner, W & Doty, S 2009, Energy Management Handbook, The Fairmont Press, Inc.

 

Whittington, R 2001, What is Strategy, and Does it Matter?, Cengage Learning EMEA.

 

Zhang, P 2004, Neural Networks in Business Forecasting, Idea Group Inc. (IGI).

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