Your shortcut to understanding company accounts

Company reports and accounts, especially for a large international business like Tesco, can be daunting. Not many private investors have the time, energy and experience to trawl through these modern day tomes.

But don't worry. There are a few short cuts.

Today I want to show you a trick I use to help simplify matters and tease out the stuff that really matters from the accounts. I think you're going to be amazed...

Subscribe to MoneyWeek

Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE

Get 6 issues free

Sign up to Money Morning

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Sign up

First ignore all the guff

First off, you've got to realise that this isn't just a set of accounts. It's a report and accounts. And the report bit is often nothing more than a management sales pitch. It's a load of spiel included to justify their own existence. For management, the temptation is to take the raw data from the accounts, tinker it and then present it in a way that looks better than the real picture.

So unless you want to be hoodwinked, you ignore all the stuff at the start of the accounts. I always start my analysis right at the back of the accounts with the five-year summary.

Not all accounts have this rather helpful summary page, but most do. In the case of Tesco, we're dealing with preliminary accounts (a set of accounts released prior to the full report's publication). That hasn't got the five-year summary, so I've taken it from the 2011 report and updated it with figures from the preliminaries.

The summary is a great place for you to start. It usually includes key figures taken from the profit and loss (p&l) account, balance sheet and cash-flow statement, all on one handy page. And what's more it's got five years' worth of data too...

That's important, because accounts are pretty useless in isolation. What you really need to know is how the figures are changing over time. Is the business growing? Are margins increasing? Is the balance sheet strengthening? All of these things and more you can usually get straight out of the summary and it's presented in an intelligible way that almost anyone can understand.

You should find that the summary alerts you to what's going on with the business and any issues you need to investigate. And again, the answers to those questions are nearly always at the back of the accounts, in the notes to the accounts.

Investorswho read the accounts from the start will mostly give up by the time they reach the notes. That's a serious mistake.

I've transposed some of the key data from the summary here. Let's take a look...

Tesco five-year summary

First, let's look at revenue. Every year, revenue has gone up by some £1.5m to £2bn. And this year was no exception. I haven't included it here, but the summary also breaks down revenue into geographic regions. Again this is very useful if you want to get a clearer picture about where Tesco is plying its trade.

So far, so good. But what's equally important are margins. That is how much profit we make on this turnover. As you can see, margins have been fairly consistent over the years, somewhere between 5.9% and 6.2%... right up until this year, that is!

The latest preliminary accounts show that margins have slipped back to 5.77%. And that's what has got investors so nervous today. And it's certainly an issue that we need to get a handle on. I'll be looking at that in thethird part of this mini-series on Tesco's accounts. To read the first part, click here.

But first, let's see if there are some further clues in this five-year summary that shed some light on what's going on.

The underlying profit figure is interesting. It gives us two options... one including payment protection insurance (PPI) mis-selling, and another ex PPI. As I'm sure you're aware, Tesco has a retail bank. And like most of the others, it's been caught up in the PPI scandal. And in 2012 alone, they've put in a near £100m charge against it.

Now, if we include the PPI charge, then clearly we've got problems. Until this year, profits have been increasing by some £200m to £300m a year. But for 2012, profits are only up about £100m (from £3,813m to £3,915m)... that's a concern. We need to look into this.

The big problem with Tesco

So, let's recap. Revenues are looking okay. BUT margins are down, profit growth is down, and we've got some banking issues.

Let's look a little closer.

Not only does the five-year summary include key data from the statutory accounts, it also includes stuff that would more normally be referred to as management accounts'. That is some handy indicators that management use to guide their day-to-day decisions.

In this case, I've included the average store size and weekly sales per square foot. In fact, there's plenty more that I haven't included here. Stuff like revenue per employee (about £200,000, if you're interested) and even profit generated by each employee, which has gradually grown from about £11,000 to over £15,000. Shelf stackers take note if you're asking for a pay rise!

The average store size has increased from around 34,000 sq ft, to nearer 36,000 sq ft. And up until a couple of years ago, this was all well and good for Tesco. As you can see from the sales per sq ft figure, they were consistently generating over £25.

Clearly all that new square footage was adding to profits. But last year, the figure dropped below £25. And though we won't have a figure for 2012 until the full accounts are released, I suspect that they've fallen again.

Basically Tesco's strategy of creating big out-of-town superstores has started to come unstuck. They've given considerable retail space over to non-food' items. And over the last couple of years, non-food has been hit hard.

It's that old devil, the internet. Yes, the online movement has been eating away at Tesco's non-food sales and of course margins on this stuff too. Clothes, electrics and electronicsare now all available online at fantastic prices.

Again, it's something we're going to have to delve into deeper. Can Tesco adapt its strategy? I'll deal with that on Friday. For now, let's just take a quick look at one more figure in the five-year summary. One that I know will interest you the dividend.

As you can see, Tesco has been growing its dividend very consistently over the years. It's been going up by about a penny a year since 2007. Now that's not bad. Remember, these have been tough, recessionary years. And in 2010, the dividend went up nearly 1.5p!

Now, I bet the new CEO Phil Clarke wishes they hadn't done that! Why? Because this yearhe has had to scale back the increase... the dividend is up by only half a penny. He'd have much rather increased it 1p this year, and 1p the year before. It's all about consistency.

But with 2011's bumper pay-out, management have now pulled back on the reins. Many investors are concerned. We'll need to find out what this means for the future.

Now wasn't that fantastic... all the stuff you can glean from just one page in the company accounts!

This article is taken from the free investment email The Right side. Sign up to The Right Side here.

Important Information

Your capital is at risk when you invest in shares - you can lose some or all of your money, so never risk more than you can afford to lose. Always seek personal advice if you are unsure about the suitability of any investment. Past performance and forecasts are not reliable indicators of future results. Commissions, fees and other charges can reduce returns from investments. Profits from share dealing are a form of income and subject to taxation. Tax treatment depends on individual circumstances and may be subject to change in the future. Please note that there will be no follow up to recommendations in The Right Side.

Managing Editor: Frank Hemsley. The Right Side is a regulated product issued by Fleet Street Publications Ltd.

Fleet Street Publications Ltd is authorised and regulated by the Financial Services Authority. FSA No 115234. https://www.fsa.gov.uk/register/home.do