Task 5 - How to Interpret Financial Documents

Rory Ball-Reeder

Task 5 - How to interpret financial documents

Introduction:

In part one of this report I will be explaining what the profit and loss accounts are for Tesco. Secondly I will go on to explain what the balance sheet is for Tesco.

The Profit and Loss Accounts of Tesco:

Profit and loss accounts are used by companies to work out how much money they have made and spent over the year. Which will then help them to work out whether they have made any profit over the year or whether they have lost money over the year. This can then go on to help banks or loaners to see whether or not it is worth lending money to them.

There are three sections of a profit loss accounts they are:

• Gross Profit – Gross profit shows how much money they have made from their sales over the year, and how much it also cost them to make all that money.
• Net Profit – Net profit shows how much money they have made minus the admin and overheads.
• Retained Profit –Retained profit shows how much money you have left after you minus the tax and dividends from the net profit.

The print screens above came from the following website:

Tesco use a profit and loss account, because it gives Tesco a better understanding of how much money they have made without lots of different things they have to look at. What I mean by this is thata profit and loss account only shows the overall headings of where the money is being spent without going into lots of detail and listing every single thing the money got spent on this only shows the main categories. This will help Tesco to understand where the main percentage of their money got spent, and also gives a greater understanding on how much money they have made after they have subtracted all the money they spent, giving them their overall profit.

The Balance Sheet for Tesco

A balance sheet is a way of business’sshowing everything the business owns and parts of its financials, meaning this will hold every bit of information on it to do with the business liabilities, what they own and basically how much they are worth. This shows people or other businesses which might be interested in buying that business, what debts they will have to pay off, what assets they can sell to make quick money or what might take a long time to sell. This will also help them to work out what they will own or be able to use from that company if they wanted to turn it into their own company.For example, is someone bought the company and they wanted to turn it into a clothes shop they will want to keep the certain assets, e.g. buildings, vehicles, any stock which is clothing etc. The balance sheet will have to be updated frequently,because some things will devalue of time or become worth more, and before someone buys a business they will want to make sure they get an up to date balance sheet.Assets are things that could be useful to someone or could be worth money. Liability is things that you could have to pay back or responsible for by law. Equity is where you have to be fair. What I mean by this is that you will have to be fair when sharing out the money which you might own to shareholders. Tesco use a balance sheet because they can sue this to show them how much money they own to people or people owe to them. Balance sheet can also show you how well you are doing in their net worth which is how well they are doing financially minus the liabilities which they owe. This will be used to show the value of Tesco on other words how much they are worth.

The print screens above came from the following website:

Interpreting Tesco’s Financial Documents

Introduction

Within this part of the report I am going to be interpreting the profit and loss account and balance sheet which was published by Tesco by using ratio analysis. I will make sure that I show all of the formulas I have used and also show all the working out I did to get the answers I got. I will then go on and explain what each answer means to Tesco. Furthermore I will then evaluate the accounting ratios in order to monitor Tesco using examples.

Ratio Analysis:

Profitability Ratios:

-Gross Profit Margin –Gross profit margin is the amount of money a business has made from their sales before tax has been taken away from it. The higher the number that comes out of the formula the better.

Gross ProfitMargin Formula: Gross Profit Margin = (Gross Profit÷Sales Revenue) × 100.

Gross Profit Margin for Tesco: Gross Profit Margin = (5,000 ÷ 65,000) × 100

Gross Profit Margin for Tesco = 7.7% interest

This means for every £1 Tesco made in sales the firm makes 7.7 pence gross profit.

-Net Profit Margin – Net profit margin is the amount of money a business has made from their sales after deductions has been taken away from it. Tesco will be mainly concerned about this ratio, because this is the main ratio which says how much money they have really made overall.This is because you could make a massive amount of money in the gross profit, but the government will take 20% of that which makes a huge difference. Net profit normally includes tax however Tesco don’t include tax in their net profit, because it makes their profit look bigger.

Net Profit Margin Formula: Net Profit Margin = (Net Profit ÷ Sales Revenue) × 100.

Net Profit Margin for Tesco: Net Profit Margin = (2,500 ÷ 65,000) × 100.

Net Profit Margin for Tesco = 3.8% interest

This means for every £1 Tesco made in sales the firm makes 3.8 pence gross profit.

Tesco will need to know this because they will want to see whether, or not they are losing out on money or making money. However by putting it in a percentage it will make it easier for them to work out how much money they can make per pound they pay. If Tesco was making 99 pence per £1 they spent then they would be making -1% gross profit which will mean they will end up in bigger debt, because they are not making any money but instead losing. This could cause bigger problems for Tesco, because this will mean they will have to borrow money from other businesses, or the bank in order to pay for things. Which would mean they would have to end up closing down, because they would go bankrupt. However a method which Tesco could use to help them to make a profit would be by putting up the prices on their products. Although in this case Tesco are making a profit of 3.8 pence per £1 meaning that at the moment they will not have to up the prices on their products. However Tesco might still think about this, because a company as big and as well-known as Tesco should be making more, than just 3.8 pence per £1 they should be making a lot more money per £1. Although Tesco might not need to make as big as profit as I might think, because they might not be fused on how much they make per £1 as long as they are making money. What help Tesco to still make a big amount of money in the end is that they sell so many products per day. Which means they might not need to have to make such a big amount of money per £1, because eventually it will all add up. Another thing that might stop Tesco from making a massive net profit margin is its competitors offering better prices. Which in order for Tesco to still have customers is too lower their prices. They could also find a better supplier which offers the same products just cheaper which should help them to make a bigger net profit margin. Tesco can use this information to their advantage what I mean by this is they can use this to see whether or not they should put up their prices next year to make even bigger net profit margin. They can also use this information to see whether they are then able to lower the prices for their products and still make some net profit the reason they might want to do this is because they might want to offer better prices to their customers which should then make their customers happy. The might also want to lower their prices because they will be in competition with their competitors. Whereas if they don’t have a high net profit margin then the might not be able to match their competitors which could bring their reputation down.They might also want to think about negotiating prices with their suppliers in order to make even more net profit next year. By negotiating prices with the supplier/s they might be able to get hold of their stock for lower prices and they keep their prices in their stores stay the same then they should make more money. Whereas if they were to up the prices for the products in their stores they could lose customers or not make as much money is because their customers might not be able to afford it. This isn’t really the best ratio to go by because it doesn’t tell you the exact amount of net profit margin they really made because in order for them to do this they would have to work out how many products they sold and then multiply this by the percentage of interest. Yes I agree I does what it intends to do which is show you the percentage of net profit margin you have but if the owner of Tesco has no idea what this means to the company about how much money they really made then I think it is a little bit pointless this is why I think they should also include a little bit of information about how many products they sold that year and at what kind of prices. So then they can work out how many products they really sold and how much they really made. However to do this you would have to go into a lot of detail and could also take a lot of time and money. The limitations are that is only shows you how much money you are many every £1 and doesn’t go on to show you how much money you have made in £100 or £1000 etc. The reason I think this would be helpful because if the owner of the company isn’t very good at maths that might want showing how much money they are making on other amounts of money/ products prices because not all their products are £1 and they might also want to be shown how much money they are making per £100 of spending etc.

-Return on Capital Employed – This is the amount of money that the business has compared to the net profit. With this the higher the number the better.

Return on Capital Employed Formula: Return on Capital Employed =

Return on Capital Employed for Tesco: Return on Capital Employed = (2,500 ÷ 25,500) × 100.

Return on Capital Employed for Tesco = 9.8%

This means for every £1 that Tesco invest in their selves a firm makes 9.8 pence net profit. This can then be used to compare the performance of the business with the interest from their bank account.

Solvency Ratios:

-Current Ratio – This is a ratio which shows whether or not you are able to pay of any debts which you might have if you were to sell your resources.

Current Ratio Formula: Current Ratio = (Current Assets ÷ Current Liabilities)

Current Ratio for Tesco = (16,500 ÷ 16,000)

Current Ratio for Tesco = 1.03125

This means for every £1 that Tesco owes they have £1.03 of assets which can be sold to pay for it. However the nearest the number is to 2 the better,because it means they have enough assets to pay off the people/businesses if they were to close down.

In this case this is bad because Tesco only just have enough assets to pay off the debt which means, if they were to close down the owner of Tesco won’t be left with that much money they will be left with 3.125 pence per £1. Another problem with this is that, this is before they have also paid all their employees meaning, after they have paid all the employees the owner will be left with even less money per pound. Which might mean that they could potentially walk away with only a couple of thousand pounds. Whereas the owner will be wanted to make a lot more than that, because otherwise they may think that it was just a waste of their time and money. The reason the owner of Tesco will have to pay the employees which they have made redundant is, because they will have to pay them for whatever work they have already done and because they are now making everyone redundant.If business don’t pay their employees then they will be taken to court and then sued for everything they own, because by law you have to pay your employees statutory redundancy pay. Tesco should want at least around £1.50 of assets per £1 of money they owe. The reason they will want this amount of money in assets per £1 of money they owe is because they will want enough money to pay off all the money they owe, as well as to still make a lot of money after the employees wages have been taken away. Tesco might want that kind of ratio per pound on just one of the current assets that they are able to do without e.g. cash, debtors etc. The reason for this is because that way they are able to pay the businesses/people they owe straight away without having to get rid of things they might need e.g. stock. This is good because that way they will be able to pay off all their debts really quickly without having to use essential to the business which might mean that it will not be able to run as efficiently as they would want. The reason this is good is because that way they are then still able to keep the business open and won’t have to close it down.

The reason Tesco will want to know this is because otherwise they could get their selves into even more debt which could mean they will have to close down. They will also want to know this is because they might want to see whether or not they are able to pay of any debts they might owe to help the company run that little bit smoother. What I mean by this is the owner of the business will be able to run the business a lot easy because they won’t have to deal with all that stress which is being caused by other businesses asking for their money. Also the owner of Tesco will also want to know how big their current ratio is so they can work out how much money they will make. If Tesco have a high current ratio then the owner of the company will be very happy because they will be able to work out that they will make lots of money and they will also have a lot of money to pay off their debts. Tesco will use this information to their advantage what I mean by this is that if Tesco have a high current ratio they might then use as much of that as they can to pay off any debts. What I mean by this is the owner of Tesco might lower the amount of money they will get from the current ratio and instead use it to pay off as much debts as they can. Whereas if they have a low current ratio then they might only pay off as much debts as they can afford instead of as much as they would like to. This ratio isn’t really a good measure of how well the company is doing the reason for this is because this only shows how much profit they make per £1 but this doesn’t show the overall figure e.g. how much they really made. The reason it doesn’t show this is because we don’t know how many products they sold that year meaning we can’t really begin to understand what that means to them. For example if they only sold 1 product that year worth £1 then they only made 3 pence in that year, whereas if they sold 1 billion products worth £1 then they made a total of 30 million pounds in that year. The limits of this is that it doesn’t show you how much you will really have after paying the employees and how much money they will have to make if they want to pay off all their debts all at once.