Evaluating Tesco's Financial Strategy

Finances are essential for a business to remain stable in the economy. Moreover, an organization must be in a position to fund its activities appropriately using the available resources. Therefore, it is important for Tesco to effectively manage the money that comes in and out of the organization. Tesco is financed with a combination of retained profits, borrowings from the bank, long term and short term debt, capital market issues and leases. It also receives finances from shareholders who buy shares and are later pay them inform of dividends. In the past five years Tesco has been financed more by debt and less by equity. For instance, in 2007 the organization issued £1213m non-current debt and bought back outstanding debts of £872m (Tesco, 2007).

The business increased their debt which enabled them to fund the capital structure. In addition the company was able to reduce it pension fund deficit as a result of gains from actuaries and foreign exchange contributions. Nevertheless, Tesco increased its cost of sales which facilitated tremendous flow of revenue. This enables the firm to increase its stock through borrowings from the suppliers. Leasing has helped Tesco to get funds for its operations. The ability to release capital from property and leasing back has enabled the company to increase its non-current assets. Tesco’s debt to equity ratio has declined from 0.265 in 2007 to 0.00 in 2011.This is because  the shareholders have been able to increase the number of shares they buy from the company thereby increasing assets which facilitates the growth of the organization.

The strategy of releasing capital from property assets and returning to the shareholder has enabled the organization to manage its capital structure. Furthermore, the company is working on some modalities of changing its debt-equity ratio by increasing their debts in the capital structure. Capital returns to the shareholders enable the business to reduce equity finance and increasing payables.Thus, the shareholders are able to increase their return to equity as the debt increases. It is noted that Tesco has low debt-equity ratio but it is able to retain its financial position through Interest Cover. Tesco should not use unsecured loans to finance its activities because of the higher interest rates charged. Mortgage is the best form of financing a business especially if it expects to expand its operations across the world. In addition, Tesco can get its finance from the internal activities of the business. This can be done when the management liaises with the shareholders in order to increase the prices of share which will eventually reduce the debts of the company.

The dividends to be paid to the shareholders are set by board of directors in the company. However, the shareholders are given an opportunity to approve the dividends to receive in form of ordinary shares or preference shares. Dividends paid depend on the amount of shares traded. Nevertheless, there are legal restrictions that determine the amount of dividends paid to the shareholders (Brealey, 2006). These include the rate of growth of the economy and the stability of earnings in the capital markets. In addition, debt repayment and liquidity of the company also contributes in the determination of the dividends to given to the shareholders. Tesco intends to invest in the economy for its growth and to release capital from property in order to issues ordinary shares to the shareholders. Furthermore the company is looking forward to restructure its capital in order to improve returns from the shareholders. This is aimed at increasing the credit rate of the company to enable it buy back shares and to pay dividends.

Over the last five years dividend growth rate of Tesco has been decreasing due to the inflation rates. It is important to note that annual yield on investment can grow if the company increases the dividend payout. When the company increases the share prices dividend yields may fall and if the share prices fall the dividend yields increase. The dividend payout by Tesco has persistently increased from 0.05 in 2007 to 0.15 in 2011.Nevertheless,the dividend growth rate over the past five years has increased to 10.87%.This is because of the financial stability which has been influenced by the sufficient assets available in the business. Furthermore, the dividend yield has also remained stable at 0.00% from 2007 to 2011.The constant figure has been accredited to consistent cash flow from the increasing number of shareholders in the organization (Tesco,2007). The dividends are paid as share repurchases in open market transaction or as direct offer to the shareholders. Tesco is a big company and should therefore have a low debt-equity ratio which will enable it to increase its tax gains from tangible assets. This will make it easier for the company to pay dividends to the shareholders efficiently.

Tesco can increase its pools of fund if it embraces various ways of sourcing assets and money into the business. With the current economic situation, it is advisable for the company to acquire machineries and other fixed assets through hire purchase. Buying equipment by installments will enable the organization to have a lot of money to for reinvestment and stock turnover. Cooperation with the government and the European Union will enable Tesco to get adequate funds for expanding the business. Trade credit is another option for the company to acquire excess finance for its activities. This will enable the business to operate effectively by earning a lot of money which it can use to settle the debts and remain stable

Tesco’s debt-equity ratio is low at the moment. Therefore, the company should concentrate on improving the return to equity of their shareholders in order to curb stiff competition from other companies. Tesco ought to stop selling its assets in an attempt to attract more shareholders. Instead, the organization should increase its leverage and issue more debts. Furthermore, Tesco needs to adopt this financial strategy of reducing the sale of its properties and to curb the fluctuation of share prices by making use of the tax shield. Nevertheless, they need to ensure that leasers provide favorable terms for investment. Dividend policy used in the company should aim at increasing dividend yields by reducing the share prices.