You are on page 1of 13

Economic Downturn and the Role of Financial Management

Table of Contents
1

Introduction...................................................................................................... 2
Part-1: The impact of the current economic downturn and the role and
purpose of the financial management...................................................................3
Impact of the Crisis....................................................................................... 3
The Role of Financial Management................................................................4
Part-2: Analysis of the financial ratio and financial statement of Tesco PLC.....7
Introduction of the company.........................................................................7
Ratio Analysis................................................................................................ 7
Analysis of the Statement of Financial Position...........................................10
Conclusion...................................................................................................... 10
References...................................................................................................... 11

Introduction
The impacts of an economic downturn are changes in their trading activity, changes in sales
figures and net revenue, the profitability and overall performance of the business. The
macroeconomic effects are increase in unemployment rate and exchange rate, decrease in
economic growth and gross domestic product (Colvin, 2012). We have discussed two parts
2

here. The first part discusses about the role and purpose of the financial management and the
impact of the current economic downturn. The second part discusses about the ratio analysis
and analysis of the statement of financial position of worldwide renowned UK based retailer
shop Tesco PLC.

Part-1: The impact of the current economic


downturn and the role and purpose of the
financial management
A slowdown in economic activity is called an economic downturn for a specific period of
time. In an economic downturn, unemployment rises, share price falls, investment decreases
and the financial mangers face a great trouble to survive. Though they cant avoid the risk
totally but all they can do is to minimize the impact of the downturn (Edwards, 2009). The
financial managers can also find new business opportunities in economic downturn.
Reviewing the business plan is an import task to face any situation in the economy. Assessing
the business performance according to the business plan, understanding what is happening
around the business and updating the business plan with respond to the situation help a
financial manager to face economic downturn. The management can follow risk management
plan that includes identifying, assessing and developing new strategies to manage risks.

Impact of the Crisis


The crisis will have an impact on potential output due to low growth rates during the
immediate crisis period. A crisis can reduce potential output in the short and medium term
through its adverse impact on investment. Due to the economic downturn, the unemployment
rate will increase, the number of poor and hungry people will increase as well; national
growth will decrease, economic contraction and Gross Domestic Product (GDP) will decrease
also; the trade balances and balance of payment will be affected negatively; Foreign Direct
Investment (FDI) will decrease; exchange rates will move; budget deficit will grow, tax
revenue will fall, fiscal space will reduce also; price of commodity will increase; remittances
to developing countries will decrease; tourism revenue will decrease sharply; private capital
flows will reverse massively, access to credit financing and trade financing will reduce,
public belief and confidence on financial institutions will reduce, investment in social
3

services like health and education will reduce, infant and maternal mortality will increase;
Housing market will fall down, personal debt level will increase as well. The most immediate
effect of the crisis is t its adverse impact on investment (Hart and Tindall, 2009). The effect
on the stock market can be of two types. Firstly, the reduction in investment rates during the
crisis phase will negatively affect the stock of capital and this will cause a downward shift in
the potential output. Economic theory suggests that higher uncertainty encourages increasing
the risk and that have a negative effect on investment and higher uncertainty increases the
value of delayed investment. Secondly, the rate of depreciation of the capital stock will rise.
A short recession cant affect the pace of growth of labor force and a long and deep recession
may cut down the potential labor force by demotivating the workers from seeking job
(Markovits, Boer and Dick, 2014).

The Role of Financial Management


The past financial and economic crises may give us a guideline to face the economic
downturn. During an economic downturn, a financial manager should follow the following
strategies:
Monitoring the Business Activities
Continuous monitoring of the business activities, business environment and the impact of the
changes during an economic downturn can help a financial manager to minimize risks. This
strategy also includes understanding the business environment and updating the plan to
achieve expected profit from the business.
Managing Cash Flows
This strategy includes managing the debtors and creditors to keep the business financially
stable and make sure the business has the ability to pay bills, wages, taxes and other operating
expenses, assessing receivables and inventory, reviewing accounts payable and business
expenditure, investigating ways to achieve more assets etc. (Mertzanis, 2013).
Managing Stocks

By managing the stocks perfectly and making a proper balance between the costs and the
benefits of the stock, the profits can be increased. Stock management is the decision of the
management about the buying the stock.
Identifying risks that can impact the business
Risk identification is the identification of risks that could impact hardly on the business. Risk
identification also involves reviewing business operations and performance to find out both
the internal and external risks, the impact of the risks and the way to minimize the risks
(Milic, 2013).
Analyzing risks to assess impacts
After the identification of risks, these should be analyzed to measure which risks can be more
dangerous and which can be less. The risks need to be categorized based on their impact on
the business performance.
Evaluating the Risks
When the risks are analyzed, these should be evaluated. In this step, the risks are prioritized
to make a list that requires further action.
Treating the risks
In this step, the risks are treated that means the risks are identified which will be treated
immediately and which will be treated later. This decision is very critical and the priority of
the risks is made based on their impact on the business performance (Mitchell, 2008).
Developing the Risk Management Plan
The Risk Management Plan includes all the strategies for treating the risks. These include
identification of risks, level or standard of risks, strategies against the risks and time period
for the strategies.
Another strategy a financial manager can implement is to strengthen the business because the
more strength the business is the less risk of affecting by the economic downturn (Reynolds,
2004). To strengthen the business, the management can follow the following steps:
5

Reviewing Marketing Strategies


Reviewing marketing strategies will help the management to generate new ideas to increase
sales and profit. During the economic downturn the management should follow low cost
marketing strategies like using the social media as a marketing tool (Rowell, 2009).
Managing Employees and Staffs
The employees and staffs are the asset for a business. In an economic downturn, the
management should take proper steps to keep the employees motivated and dedicated for the
business. Motivational training and counseling can be the effecting strategies to encourage
the human resource and make them involved in business decisions.
Communicating and Networking
Networking and communicating with other businesses will make the management aware
about the economic downturn and the strategies followed by them. It may help the
management to discover new opportunities and make business partners (Smith, 2002).
Developing Innovative Ideas
Developing innovative ideas will help the management to adapt with new conditions and
keep updated. Using technology will help to increase efficiency of the employees and
management, reduce operating costs and make the business more competitive.
After the crisis, the economy needs to be reformed. The financial markets will be stabilized
and the confidence and belief of people on stock market will be restored, short term liquidity
and long term financing will be advantageous for developing countries, long-term debt
sustainability for developing countries will be ensured to create new job opportunities and
social development paths for overall economic development and social gains, open trade and
investment will be promoted, international financial and economic system will be reformed
and strengthened, good governance will be ensured at all levels and human and social
impacts of the economic downturn will be addressed (ZABALEGUI and CABRERA, 2010).

Part-2: Analysis of the financial ratio and


financial statement of Tesco PLC
Introduction of the company
Tesco PLC is the worlds 3 rd largest retailers based on the total revenue that was founded in
1919 by Jack Cohen. Over the years the business has grown and now operating its business in
14 countries around the world, employ over 530,000 people and serve tens of millions of
customers every week. They are committed to provide the best shopping experience to their
customers. They focus on doing the right thing for customers, colleagues and the
communities they serve.

Ratio Analysis
Here we will show the ratio analysis of Tesco PLC shown considering for the year 2011 and
2012.
Profitability Ratio
Profitability ratio measures the profitability position of the company. The investors consider
the profitability of the company before investing in the company (Hansen and Palmer, 1997).
So it provides very critical information to the investors about the company.

Profitability Ratios
Name of the ratios

2011(%)

2012 (%)

Gross profit margin

.48
Net profit margin

.15
4

.39
Operating Profit margin

.35
6

.48
Return on Asset (ROA)

6
.17

1
.30

Return on Equity (ROE)

1
.32

6.96

6.30
7

Tesco PLC has a gross profit of 8 percent where net profit margin is 4.39 percent. The
difference between operating profit margin (6.17 percent) and net profit margin (4.35 percent)
is very high and it says that the company costs more money as operating exchanges. Return
on Asset (ROA) has a very little growth of 0.02 percent in 2012. Return on Equity (ROE) of
16.30 percent shows very good position and the investors focus more on it.
Liquidity Ratio
Liquidity Ratio measures the liquidity position and ability of the company to pay cash to its
short term debt. Liquidity position is very important because the company has to maintain
enough cash balance and avoid the cost of illiquidity (Palmer, 1983).

Liquidity Ratio
Name of the Ratios

2011

2012

Current Ratio

.68
Quick Ratio

.67
0.39

0.37

Tesco PLC has very poor liquidity ratio. Generally a company should have a standard current
ratio of 1:1 to repay its short term debts and other obligations but Tesco PLC has a current
ratio of 0.67 in 2012. This indicates that the current liability is greater than its current asset
and the company is very poor to meet its short term obligations. Current ratio and Quick ratio
are also very poor. This position of current ratio indicates that the company will be unable to
repay its short term debt and other short term obligations.
Activity Ratio
Activity ratio measures the efficiency of the company. After the profitability ratio, activity
ratio has a great importance to the investors. The more efficiently a company can use its
resources, the more easily it will earn profit (Robinson, 2009).

Activity Ratios
Name of the ratios

2011

2012

Receivables Turnover

176.25X

112.25X
8

Inventory Turnover

18.78X

17.54X

Fixed Assets Turnover

2.32X

2.39X

Cash Conversion Cycle

-14.34

- 8.25

Tesco PLC has a very strong receivable turnover of 176.25 times in 2011 and a little poor of
112.25 times in 1012. The inventory turnover was 18.78 in 2011 and quietly decreased in
2012. Tesco PLC has a very good fixed asset turnover of 2.32 times in 2011 and 2.39 times in
2012. The cash conversion cycle was quiet good in 2012. The less time a company takes for
the cash conversion, the more efficient the company is.
Financial Risk Ratios
Financial risk ratio indicates how a company can reduce financial risk through efficiency
(Fridson and Alvarez, 2002).

Financial Risk Ratio


Name of the ratios

2011

2012

Debt to Equity

0.58X

0.56X

Financial Leverage

2.84X

2.85X

Tesco PLCs debt to equity ratio remained same in 2012 that indicates that it has less debt but
more equity. The company focuses more on equity position of the company. The company
has very position by financial leverage also.

Analysis of the Statement of Financial Position


The financial statement of a company gives an overall scenario that helps the investors to
take decision about their investment (Fridson and Alvarez, 2002). Tesco PLC has net
operating profit of 4.39 million in 2011 and 4.35 in 2012. That shows that the profitability of
the company has reduced sharply. The financial position of Tesco PLC shows that it has more
debt in 2012 than of 2011. The financial position of the company was satisfactory that leads
to low risk during the last periods.
9

Conclusion
The current crisis is likely to have a large negative impact on potential output in the short-run
and there is a possibility of slow economic growth as economy needs a prolonged period to
adjust to the post-crisis growth (Mertzanis, 2013). In order to mitigate the losses in potential
output, it is important to implement proper policies.

References
1. Colvin, G. (2012). The upside of the downturn. New York: Portfolio.
2. Edwards, N. (2009). Economic downturn. JRSM, 102(3), pp.86-87.
3. Hart, P. and Tindall, K. (2009). Framing the global economic downturn. Acton, A.C.T.:
ANU E Press.
4. Markovits, Y., Boer, D. and van Dick, R. (2014). Economic crisis and the employee: The
effects of economic crisis on employee job satisfaction, commitment, and selfregulation. European Management Journal, 32(3), pp.413-422.
5. Mertzanis, C. (2013). Risk Management Challenges after the Financial Crisis. Economic
Notes, 42(3), pp.285-320.
6. Milic, T. (2013). Innovation Management in Times of Economic Crisis. ManageFon,
18(66), pp.81-88.
7. Mitchell, S. (2008). Managing IT in a Downturn. Ely: IT Governance Pub.
8. Reynolds, S. (2004). Economic Crisis Management. Journal of Asian Economics, 15(1),
pp.201-203.
9. Rowell, L. (2009). How Will Online Courses Weather the Economic Downturn?. eLearn,
2009(2), p.3.
10. Smith, M. (2002). Government Relations: Economic Downturn Hits the States. Academe,
88(2), p.101.
11. ZABALEGUI, A. and CABRERA, E. (2010). Economic crisis and nursing in
Spain. Journal of Nursing Management, 18(5), pp.505-508.

10

12. Fridson, M. and Alvarez, F. (2002). Financial statement analysis. New York: John Wiley
& Sons.
13. Hansen, B. and Palmer, A. (1997). FRAN, Financial Ratio ANalysis and more. Radnor PA
(5 Radnor Corp CTR Suite 200, Radnor 19087-4585): U.S. Dept. of Agriculture, Forest
Service, Northeastern Forest Experiment Station.
14. Palmer, J. (1983). Financial ratio analysis. New York, N.Y.: American Institute of
Certified Public Accountants.
15. Robinson, T. (2009). International financial statement analysis. Hoboken, N.J.: John
Wiley & Sons.

Appendix
Income Statement of Tesco PLC

11

Balance Sheet of Tesco PLC

12

13