Importance Of Financial Statements And Accounting Practices For External Users – Tesco PLC Case Study
Description of the non-management external users
The chosen organisation Tesco PLC is the leader of the grocery retail super market of the UK and holds around 28% share of the market .In every year the organisation release an annual report that represents the major financial statements[income statement, balance sheet cash flow statement] along with other financial reports[changes in share holder’s equity, fund flow statement etc] of the organisation so that the external users of the organisation can gather sufficient information regarding the financial performance as well as the financial position of the organisation(Kantarworldpanel.com, 2018). The financial report that is used some of the major non management are the investors, Trade creditors, Institutional as a well as private investors , Tax Authorities and Regulatory Agencies, Customers, Employees and the labour Unions. The chosen organisation complies with the requirements of the International Accounting Standards (IAS)and the United Kingdom Generally Accepted Accounting Practice[UKGAAP] and the International Financial Reporting Standards(IFRS) regulated by the International Accounting Standards Board (IASB)( Wood et al.,2016).
The major five non-management external users of the organisation that use the annual reports as well as the finacial statements o f the organisation are as follows:
The potential new Investors are the most important external user of the financial reports of Tesco PLC as they may not be the part of the management but they are very much interested in past financial performance of the business or better to say the historical financial performance of the business. This inference regarding the future will help the investors to regulate the investment decisions with respect to the organisation in terms of duration of investment and the ,amount of investment to be made so that maximum return can be generated. The investors study the financial statements that are presented in the accounting reports released by the organisation for the purpose of studying the summary of the performance of the different fund generating activities of the organisation. This study will help the organisation to assess the efficiency of the different revenue generating activities of the organisation. The existing investors on the other hand study the financial report to decide where to hold the investment (which to a large extent depends upon the financial position of the organisation) or it is better to withdraw the investments made for the maximization of the returns(Booth and Hamer, 2009)
Trade Creditors or Suppliers are other non-management external users of the financial statement of the organisation who study the financial report for gathering information regarding the financial situation as well as liquidity position of the organisation to assess the credit repayment capability of the organisation. These are the persons who supplies goods and services and raw material to the chosen organisation TESCO PLC for credit and it is essential for them to understand the credit repayment capability of the organisation to determine the duration of the credit period and the possibility of the credit period and to determine also the volume of goods and services that will be supplied on credit to the organisation. These external users mainly study the liquidity position of the company, the income statement that describes the profit earned by the organisation (in a particular period under consideration) and also the cash flow statement to study the liquidity position of the organisation
How the financial information is fulfilling the requirement of information of the non-management external users
Banks and Other private Lenders will study the financial report of the organisation to assess the debt repayment capability of the organisation. The debt repayment capability of the business to great extent depends upon the sustainability or stability of the organisation that are reflected either a stable cash generation capacity or steadily rising cash generation capacity of the organisation that will gradually strengthen the liquidity position of the organisation by enhancing the volume of free reserves within the organisation that will strengthen the debt repayment capacity of the organisation. Apart from the study of the liquidity position the lenders also look for the different historical ratios that will describe the debt repayment pattern of the organisation and such ratios are the debt equity ratios, debt asset ratio, interest coverage ratio all that describes the importance of debt in the capital structure of the borrowing company and how the debt is managed by the organisation. Beside, the debt equity ratio is specifically studied by the lenders to understand the purpose of borrowing. That is, a lender who is going to lend certain amount to Tesco PLC will deeply study the historical debt-equity ratio of the organisation to study to what extent the debt is taken to utilize the advantage of financial leverage and top whit extent the debt has been taken to finance some investment projects as the organisation has reached to a saturation position with respect to the raising of capital by the issue of shares for a particular period under consideration.
Tax Authorities and Regulatory organization always keep a tap on the financial reporting of the organization Tesco PLC to Understand that to what extent the organization is complying with the regulatory requirements of report presentation and in the method of accounting as per the IFRS so that the correct profit amount is presented as the tax rate will be charged on the profit amount and if the calculation or accounting of the profit amount is not done as per the accounting standard then the tax calculated on the basis of the profit will be wrong and this wrong amount will be paid to the required authority. The regulatory agencies also looks after over the annual report deceleration to track whether the organization has submitted all the required report to the different regulatory agencies and has made all the required disclosure of the financial information as per the accounting standard or not. These regulatory agencies always monitor the activities of the organization in order to protect the interest of the share holders, creditors as well as investors of the company so that everybody can get access on the required information before making any vital decisions regarding the organization.
Customers or the clients often study the financial report of an organisation specifically in case where the customer is a business and is engaged in a Business –to –Business relation with the organisation. The main reason of studying the annual report for a customer to understand the capability as well as efficiency of the organisation with respect to the delivery of a particular raw material or a finished goods that the customer really need to carry on its own operation. For instance, if a cake making agency buys huge amount of floor from nearby TESCO outlets then the organisation may be interested to study the financial report to understand that how long Tesco will be interested to carry on its outlet in the nearby location where the cake maker owns the shop as the business of the cake maker who is a micro business owner and is very much dependent over the flour that the micro business owner buys from the only available big retail grocery outlet of Tesco.
The external users that has been discussed here are not part of the management and therefore they are not involved in the decision making process of the organisation but still they are important stake holders of the organisation and makes an in-depth study the financial reports of the organisation(Seaton and Waterson,2013).
Both the existing investors as well as the new investors of the organisation will first and foremost study the “chairman’s report” in order to assess the quality of leadership of the organisation as an efficient leader leads to better fund management and better capability of resource allocation of the organisation which will lead to the maximization of profit of the organisation. In other words the investors will study the annual reports to assess the historical ratios that will define the capability of investment management of the organisation in near future (Tesco,2014).
The study of the above mentioned ratios for the historical period of 2010-2014 reveals the fact for an investor that the gross profit margin of the organisation is more or less stable but the net profit margin of the organisation is showing huge fluctuations and sometimes the organisation has failed to earn any net profit. The study of the above historical ratios indicate for an investor that the operational expense of the organisation is showing a huge fluctuation and this is a huge risk factor(Maynard, 2017).
That why the investors will also study the annual report to study the risk man agent policy (that is described as per the requirement of IFRS) of the organisation to realise that to what extent the organisation is capable to manage such risk and what initiatives are taken by the organisation for managing the fluctuation of the operational expense and to what extent the operational expense done will help the organisation to earn more return over the investments of the company(Iannuzzi, 2017).
However the return on asset of the organisation is stable over years which indicates that the business will be generate good return over the investments, employed in the long run.
The investors will also study the financial reports of TESCO PLC to take a look over the return attained by the organisation over the share holder’s fund in comparison to the major rivals (Sainsbury, M&S, and Morison’s) of the organisation and the study of the historical pattern reveals the fact that TESCO Plc has registered a stable or rising trend so far as return o n share holders fund is concerned with respect to the rest of the major rivals of the organisation(Brannen et al.,2013).
All that study of the historical ratios and returns with respect to Tesco reveals that the investors must study the financial reports and the latest profitability as well as return ratios with respect to capital employed, assets employed along with the risk management policies before investment and on the basis of the same study the exiting investors should decide their timing of withdrawing the investment amount from the organisation (Worthington and Welch, 2011.).
As discussed earlier the creditors of the organisation who supplies goods and services to TESCO plc on credit must study the financial reports a for understand ding the liquidity position and should study the credit report to assess the pattern of dealing of the organisation with creditors and on the basis of the above assessment a creditor who is going to get attached with a credit contract with the organisation must decide the credit period and the volume of goods and services that will be supplied on credit(Schmidlin, 2014).
The study of the historical current ratios of the organisation from 2005-2014 defines that during the period of study the organisation managed to keep the current ratio at 0.5 or above which is a vital information for the creditors(Yoon and Powell, 2012). The information describes that in 2006, when the organisation TESCO PLC is having the lowest liquidity ration of the historical period under study, then also the current asset holding of the organisation was at least 50% of the current liability of the organisation in 2006.On an average during the period of study the organisation managed to maintain a liquidity ratio of 60% during the period of study(Krishnan, 2012)
Looking at the historical pattern of the average settlement period with the creditors it can be seen that for the historical period of study from 2009-2013 the organisation has demonstrated a very stable settlement period compared to the other major rivals of the organisation (Sainsbury, M&S, Morison’s).
Thus from the above discussion it is clear that creditors should study the liquidity position as well as the average creditors period before getting in to accredit contract with the organisation(Mollah, 2014).
Both the banking organisations as well as the private lenders who are looking for sanctioning the loan to the organisation must thoroughly check the pattern of the capital structure as well as the liquidity position of the organisation in order to understand the debt repayment capacity of the organisation and to understand that to what extent the organisation is tilted towards debt financing. The underlying reason is that if an organisation is having a good liquidity position along with heavy burden of debt then also the organisation may fail to service the debt taken(Zentes et al.,2017).
For instance the lenders should study the above ratios such as the current ratios and quick ratios that will tell about the liquidity position of the organisation over years. And the study of the debt to capital ratios for the historical period (2010-2014) of the organisation will describe the proportion of debt that the organisation has maintained over years (Samy et al.,2010).The investors will also study the historical debt to market capitalization ratios in order to understand the portion of the market value of the organisation is covered by debt mover years. The study of this information is required for understanding the importance of debt in the market value of the organisation. The study of the Asset-equity ratio will tell the lenders the scope of the organisation for issuing additional shares for acquiring capital that can be used for servicing the debts taken by the organisation. The study of the gearing ratios will also reveal the nature of dependency of the organisation over long term debts for running its operations. The study of the trade to debtors turnover ratio will help the lenders who are the long term debtors of the organisation to find out the dealing of the organisation with the debtors in the long run.
From the above discussion it can be understood that the non management external users who are not part of the management and hence not involved in the process of decision making for the organisation also have strong interest in the company and in order to get the maximum benefit from the investments made by them those external users should thoroughly study the disclosures of financial information (contained in the different finical statements and financial reports) and ratios to assess the operational pattern as well as efficiency in regulating the financial assets of the organisation so that they can derive maximum return as per their stake in the company. For instance a creditor will be able to develop the most suitable credit contract with Tesco plc once he get an idea regarding the liquidity position as well as the average credit settlement period of the organisation(Jones et al.,2009).
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