Tesco, one of the giant retailers in the UK has 2291 stores around the world and employs 296, 000 people. Tesco plc group sales excluding VAT increased by 11. 3% to 26337m. Therefore, it may seem Tesco performance was good but we will discuss in this report in details about Tesco’s profitability over the last 5 years by benchmarking it against its one of major competitors Sainsbury plc, net asset value ( NAV ) per share for 2003 by explaining why it is different to the market price of the shares and usefulness of performance graph. Profitability ratios satisfy the users of accounts by letting know how much profit a business has made comparing with previous periods. We will discuss Tesco’s profitability by using profitability ratios ( See Appendix 1 for Tesco and 2 for Sainsbury ).
Return On Capital Employed ( ROCE )
ROCE is a fundamental measure of business performance and it is the most important for measuring profitability. Higher ROCE means that management could utilize total assets efficiently to generate profit. ROCE of Tesco has been decreasing from 1999 to 2003 which is 16. 57%, 16. 17%, 16. 06%, 15. 48% and 13. 85%. It means Tesco’s performance may not be effective. Although PBIT has been increasing from 1999 to 2003 that is 932m, 1032m, 1179m because capital employed has been increasing from 1999 to 2003, that is 5624m, 6382m, 7343m, 8747m and 11129m. But we will further discuss why ROCE decreased by analyzing net and gross profit margin and net asset turnover because it shapes ROCE ( ROCE = Net Profit Margin * Asset Turnover ).
Gross Profit Margin ( GPM )
It relates the gross profit for the period to the sales during that period. It decreased slightly from 1999 to 2002, that is 7. 62%, 7. 61%, 7. 57% and 7. 56%. In 2003, it increased to 7. 58%. But along with it, sales have been increasing continuously from 1999 to 2003. Therefore, Tesco can generate sales effectively by maintaining the costs of inventory and purchasing raw materials and both sales prices and goods sold prices are well managed.
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 from 1999 to 2003, which 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.
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 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 a non-foodbusiness and already got a 5% market share. Along with it, spending on 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 the 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 for 5 years.
Capital Employed of Tesco was also higher than Sainsbury. Therefore we can say that Tesco can make a 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 the 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, which 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’s performance was good by comparing with Sainsbury but Tesco should control its expanding programs carefully not to impact long term profitability.