Net Profit Margin ( NPM )
It gives the company to measure the net profit for the period to sales during that period. Generally the higher the margin, the better the performance. The net profit margin of Tesco has been increasing since 1999 to 2003, that is 5.43%, 5.49%, 5.62%, 5.72% and 5.85%. It means Tesco can manage well and control finalized overall costs and administration expenses and other general expenses not to affect PBIT to decrease. So the reason why ROCE fell is not because of Net Profit Margin.
Asset Turnover
It measures how effectively the assets of the business are generating sales revenue. The improved asset turnover means each pound of capital employed produces a higher level of sales. It has been decreasing from 1999 to 2003, that is 3.05 times, 2.95 times, 2.86 times, 2.70 times and 2.37 times. As we discussed, Net Profit Margin and Gross Profit Margin did not impact to decrease ROCE. The reason why ROCE fell was because of Net Asset Turnover. Although Sales has been increasing from 1999 to 2003, it could not help to increase net asset turnover. Therefore the only one reason could be because of capital employed as we discussed above. As capital employed increased, it impacted to decrease Asset Turnover in terms of increasing fixed and current assets from 1999 to 2003, again which shape ROCE to decrease.
Therefore, decreasing ROCE was because of asset turnover by making more assets investments. During these years, Tescos opened 62 new stores, acquired 1202 T&S stores ( a leading convenience retailer ), extended 2500 new product lines and launched a fixed line phone. Tesco also extended its market into non-food business and already got 5% market share. Along it with, spending in fixed assets increased from 1999 to 2003, that is £ 7553m, £ 8527m, £ 10,038m, £ 11503m and £ 14061m and debtors also increased £ 151m, £ 252m, £ 322m, £ 454m and £ 662m respectively. Increasing debtors will cause capital employed to be higher and will achieve lower ROCE for Tesco. Internationally, Tesco has also plan to invest more by opening more stores in coming year.
To know whether Tesco’s performance is good, we can benchmark it against Sainsbury. Although ROCE of Tesco has been decreasing from 1999 to 2003, it was still significantly higher than that of Sainsbury, except in 1999. In 1999, Sainsbury’s ROCE was 17.14% and only 0.57% higher than Tesco. In terms of PBIT, Tesco was also significantly higher than those of Sainsbury during 5 years. Capital Employed of Tesco was also higher than Sainsbury. Therefore we can say that Tesco can make profit more than Sainsbury but Tesco should be careful dealings with making much investment. Because in the future, if Tesco’s ROCE has been decreasing, it can get the liquidity problem.
Tesco’s Net Profit Margin and sales were also higher than those of Sainsbury. Only Net Profit Margin of Sainsbury was 0.27% higher than Tesco in 1999. Therefore, we can say Tesco could generate sales more effectively by managing inventory cost, cost of goods sold, overall wages and expenses.
Tesco’s Net Asset Turnover was also higher than those of Sainsbury from 1999 to 2001. Both generated the same asset turnover in 2002, that was 2.70 times but in 2003 Sainsbury was higher 0.03 times than Tesco because Tesco’s capital employed significantly increased from £ 8747m ( 2002 ) to £ 11129m ( 2003 ) by making more investments.
Therefore, overall Tesco performance was good by comparing with Sainsbury but Tesco should control its expanding programs carefully not to impact long term profitability.
( ii )
By comparing NAV per share ( See Appendix 3 ) with the closing share price ( 236.25 pence ) on 31 October, 2003, there were significantly different. There are some reasons. Firstly, NAV is a balance sheet value that is predominantly based on historical costs and it is changing daily. Therefore, it would be difficult to match NAV per share with the current market share price. Secondly, changing market share price depends on the shareholders’/investors’ assessment on company’s performance. NAV per share could not determine the share price. Tesco’s total shareholders’ funds has been increasing continuously from £ 4382m (1999 ) to £ 6516m ( 2003 ), along with increasing fixed assets and current assets value by making new investments. Therefore, existing shareholders were getting more confidence on Tesco’s performance and so there could be more demand of existing and new shareholders to buy Tesco’s shares in the stock market. Besides, Tesco’s underlying earnings per share and dividend per share has been increasing continuously from 1999 to 2003. Therefore, shareholders could think by buying shares from Tesco, they could get big return in the future. Consequently, shareholders bought more shares with high expectations and the market shares price raised up. Generally, market price of shares are more driven by non-accounting values such as state of the economy ( generally ), government pronouncements, tax incentives for the investors/shareholders, quality of management teams, the global market forces, the chances of takeover/merger/amalgamation…but these factors may not impact to NAV per share.
( iii )
According to Tesco’s Total Shareholder Return ( TSR ) performance graph, generally we can say that Tesco performance was good. Because Tesco’s performance was significantly higher than Financial Times Stock Exchange ( FTSE ) 100 index of companies, from February 2000 to February 2003. Only from February 1998 to February 2000 was lower than FTSE. Therefore, performance graph is useful because it expresses generally the performance of Tesco to existing shareholders, outsiders to know whether company is performing well or not and to induce new shareholders. But as FTSE consists of non-retail companies, it may be difficult to say whether Tesco performance was better than its competitors retailers or non-retailers.
We can not say that TSR is a good indicator of company and management performance. Because TSR is described in terms of share price movements plus dividends reinvested. As we discussed in part ( ii ) that share price is shaped by many factors. Therefore, even company’s management and performance is good but TSR can be lesser and lesser because of those shaped factors, especially government’s new regulations, global market changes and competitors’ price changes. At that time, it may be difficult to say TSR is a good indicator to reflect company and management performance.
Conclusion
We have already discussed about Tesco’s performance from financial point of view by using financial ratios. To achieve success financially in the future, Tesco should more focus on ROCE issues.
Appendix 1
Profitability Ratios
1. Return On Capital Employed ( ROCE ) = Profit Before Interest and Taxation / Capital
Employed ( Fixed Assets + Current Assets – Current Liabilities )
2. Gross Profit Margin ( GPM ) = Gross Profit / Turnover or Sales
3. Net Profit Margin ( NPM ) = Profit Before Interest and Taxation / Turnover or Sales
4. Asset Turnover = Turnover or Sales / Capital Employed
Tesco’s Profitability Ratios
£ Million
Table : Tesco
Appendix 2
Sainsbury’s Profitability Ratios
£ Million
Table : Sainsbury
Appendix 3
Net Asset Value ( NAV ) per share = Total Shareholder Funds ( Fixed Assets + Current
Assets + Current Liabilities-Long Term Debts-Minority Interest ) / Number of Shares
NAV per share for 2003 = £ 6516 m / £ 7237.609183 m
= 90.03 pence
Assumption
- Sales or Turnover figures are excluding VAT for both Tesco and Sainsbury.
References
1. Atrill Peter and McLaney Eddie, ( 2004 ), Accounting and Finance for Non-
Specialists, Fourth Edition, Prentice Hall/Financial Times, Pearson Education Limited,
Essex.
2. Dyson J., R., ( 1997 ), Accounting for Non-Accounting Students, Fourth Edition,
Pitman, Great Britain.
