The UK Hardwood Industry and Global Furniture Corporation - Essay Example

?International finance: Case study analysis report Table of Contents Table of Contents 2 Introduction: The UK hardwood industry and Global Furniture Corporation 3 Answer 1 3 Answer 2 4 Answer 3 6 Answer 4 8 Conclusion 9 References 10 Introduction: The UK hardwood industry and Global Furniture Corporation The United Kingdom (UK) is one of the major importers of tropical hardwood (Forestry Commission, 2007). 52 percent of Brazil’s mahogany hardwood is imported in UK. The UK hardwood processing companies generates very little profit from this industry (Lambert and Halliwell, 2004). This is a major concern for the UK hardwood processing companies. According to the information provided by the department of forestry the import of woods in UK has surpassed the domestic production. In the year 2010, the companies in UK had imported 5.7 million cubic meters of sawnwood and had produced only 3.1 million cubic meters of sawnwood (Forestry Commission, 2011). Global Furniture Corporation (GFC) which is a 200 year old company is situated in UK and still remains one of the leading hardwood processing companies of the country. The longevity of the company determines the company’s efficiency and effective resource utilization capacity. There were various contributing factors to the success of the company which are loyalty of the employees, high quality products, efficient supply chain and management. GFC has been able to adapt to the changing marketing trends and technological developments. The flexibility of the company to adapt to the internal and external changes is one of the key reasons for the success of the company. The company imports hardwood from South American and Asian countries and processes the hardwood into finished products like Hardwood flooring, panelling and decorative strip wood. GFC also owns a subsidiary company known as Real Furniture Company (RFC) which processes imported hardwood into readymade furniture meant for domestic purposes. The operations of RFC are carried out in the overseas locations of the company. Answer 1 The practice of financial management concepts varies from company to company. Financial management helps the managers of the company to formulate various financial strategies for effective utilization of funds. Financial management decisions include investment, dividend and financing decisions (Brigham, 1985). GFC has also adopted various accounting and financial practices over the years. Currently, the company follows the new accounting regulations and principles. GFC pays the supplier of the company in the home currency of the company which is British pounds. The sales is converted into British pounds and then deposited into the company’s UK bank account. The fluctuations in the home currency are of paramount importance to the GFC and other companies who import most of the raw materials from abroad. For example if the home currency of GFC appreciates against the suppliers home currency then GFC will gain however, if the home currency of GFC depreciates against the suppliers home currency then GFC will bear losses (Conklin, 2006). This is because under the appreciation of the home currency, GFC has to pay fewer units of its home currency to buy the equivalent amount of inputs in foreign currency. Problem arises when the home currency of GFC depreciates then the company has to pay excessive amount of money against the suppliers home currency units. The cost management issues also depend on the relationship between the suppliers and the company. If the suppliers of the company share a long term and stable relationship with the company then the ability of the company to insulate its cost from the impact of the currency movements will be high or vice versa. This indicates that the company’s ability to reduce losses while the company’s home currency depreciates depends upon the nature of contracting with its suppliers (Conklin, 2006). Therefore, one can say that currently GFC is not following a very practical approach it should adopt a flexible approach which can help the company to blend with the current economic situation. The strength of the British pound is not as strong as it used to be fifty years ago. GFC should create an appropriate liability in the foreign currency. If the future of the foreign currency is strong then the company should take long term financing in that currency. GFC can either list its stock in the foreign country or issue foreign currency debt capital. The company can also pay its suppliers by undertaking foreign currency swaps rather because of its longer maturities (Chatterji and Gangopadhyay, 2005). Answer 2 The government of different supplier countries has approached GFC and offered incentives to source majority of their hardwood from their country. The government of different supplier countries have also stated that most of the manufacturing, processing and finishing of hardwood would be carried out in the units of their countries. The management team should carefully analyze and evaluate the government’s proposal from the company’s and government’s perspective. The governments of different countries have approached GFC because it expects that there would be inflow of foreign currency through taxation (Hines, 2007). Foreign Direct Investment (FDI) has become a key element for corporations and government. FDI is implemented to increase the economic growth and promote economic development in a country. The concept of FDI had emerged as a suitable foreign investment opportunity after the Asian financial crisis in the year 1997. Apart from cash inflows in a country FDI helps in creation of employment and job opportunities in the host countries. It helps in imparting technical expertise and transferring technological innovations in the host country. FDI also helps the domestic companies of the host country to expand and diversify into various other markets. FDI will benefit the foreign companies operating in the developing countries at macro and micro level. The taxation policies of the host countries can be beneficial or non beneficial for the company. The finance manager of the company should carefully analyze and evaluate the taxation policies of the countries. Apart from the political environment, the management team should also look at the economic environment and banking policies of that country. The banking policies of the host country should be lenient. International investment requires a lot of technical expertise in terms of financial regulation and tax system. Investing overseas would be a good option for GFC as diversification would help in risk reduction and increase its portfolio exposure. An increase in portfolio exposure will help in increasing the consumer base of the company. These will happen only if the GFC selects a country with a good political and economic environment. Apart from that, the customer base of GFC in North America, New Zealand and Australian markets has decreased. This is mainly due to the fact that the company processes most of its hardwood in the UK headquarter and then it is distributed to the customers of UK and the aforementioned countries. The distance between these countries and the UK factory is huge. This has led to an increase in operational and administrative cost. Moreover, the quality of the warehouse facilities has degraded drastically over the years. Most of the wood stored in these warehouses gets damaged due to rain, storm etc. The warehouses of the company are not managed efficiently. There is also a huge communication gap between the employers of GFC working in different countries. This has also led to the practice of different management principles by the same company in different countries. The management of the company should try to improve the operations of its overseas branches and improve the warehousing facilities being provided by these branches etc. Answer 3 There are various kinds of risks involved in the exchange of currency movement (Pricewaterhouse Coopers, 2008). Risk hedging strategy helps in reducing the risks faced by the companies. Risks related to the currency risks are dealt by the treasurer of the company. Exchange rate risk can affect the cash flow of the company. To manage the exchange rate risks a company needs to determine a specific type of current risk exposure, instruments to deal with this currency risk exposure and hedging strategy. The three main types of risks involved in exchange rate movement are: 1) Transaction risks: It deals with the effect of exchange rate movement on transactional account exposure which is related to exports. 2) Translation risk: It is also known as balance sheet exchange rate risks and relates to the exchange rate movement of the subsidiary company. It is measured by the exposure of net assets to potential exchange rate movements. 3) Economic risks: It reflects the risk to the company’s present value of cash inflow. Economic risks affect the effect of exchange rate movement. Economic risks are concerned with the effect of exchange rate changes on revenue. Economic risks associated with a company will arise when the company incurs costs in one currency and sales are generated from the other currency. This affects the competitive position of the Company. Price changes will also affect the company’s economic exposure as it will affect the future cash flows of the company (Chartered Institute of Bankers, 2000). GFC can use the VaR methodology to measure and estimate the riskiness of the foreign exchange rate movement resulting from a company’s activities (Juselius, 2006). The calculation of the methodology depends upon 3 parameters like holding period, confidence level and unit of currency. To calculate the VaR methodology a number of models is used which are as follows 1) Historical simulation which suggests that the company’s currency returns will have the same distribution as they had in the past 2) Variance and covariance model assumes that the currency returns on a company’s total foreign exchange position are normally distributed 3) Monte Carlo Simulation assumes that the future currency returns will be distributed randomly (Lima and Neri, 2007). VaR methodology is one of the easiest methods of calculation as it takes into consideration the company’s current foreign exchange position across a series of historical exchange rate exchanges to yield a distribution of losses in the value of foreign exchange position (Papaioannou, 2006). After identifying the risks associated with the financial transaction and measuring the risk exposure, a company needs to identify whether to hedge the risks or not (Financial Service Authority, 2006). Exchange rate risks can also be neutralized through various financial instruments such as foreign currency debt capital (financial hedge) and exchange rate derivatives. (Dohring, 2008).The derivatives of the company have become the standard tools for hedging risks which are related to interest rates, exchange rates or commodities prices. Natural hedges are also important ways to reduce exchange rate exposure and are alternatives to forwards and futures. Exchange rate exposure can be reduced by matching foreign currency revenues with revenue expenditures. Operational hedges are less flexible than financial hedges and are used to reduce the long term exposure to economic risks and deals with higher sunk costs (Dohring, 2008). There are other risks like changes in tax rate which can occur during the life of the project and might not be greater than the perceived returns (Maniar, 2010). Risks associated with the tax changes are not inevitable (Stutzman and Popov, 2003). GFC should identify and evaluate the risk management objectives which include survival, stability and continued growth of the company (Stutzman and Popov, 2003). Answer 4 Treasurer and chief accountant have a prominent role in the company. The treasurer should be able to identify the cash needs of a company to ensure sufficient availability of liquid funds for the day to day smooth operations of the company. The treasurer would account for, disburse all payroll and personnel amounts like insurance, retirement, taxes, insurance etc (Material Information Society, n.d.). The treasurer should act as a custodian and administrator between the employees. A treasurer is of great strategic value to the company because they develop marketable skills and their intellectual skills are an added benefit to the company (Jeffery, 2009). They make sure that the company resources are utilized at the optimum level and with the help of technological advancement they will utilize the cash effectively and ensure that the risks are mitigated properly. One of the main tasks of the company treasurer would be to prepare annual financial reports and submit it to the board of directors. The duties of chief accountant would be to check the financial reports prepared by the treasurer and analyze whether the financial reports are adhering to the new accounting concepts and regulations (Republic of Kenya, 1997). The main task of the chief accountant would be to practise internal audit and prepare annual business plans. The chief accountant would also prepare estimated cash flow projection and also give five year projection of the company. He would have to analyze the costs and distribute the overhead costs accordingly (Poway Unified School District, 1996). To handle the day to day accounts and finance operations would be one of the major objectives of chief accountant along with maintaining systems for cost sensitivity analysis. The chief accountant would be performing internal and external financial reporting whereas the treasurer would be responsible for internal financial reporting to the executive committee of GFC. The duties and responsibilities of the chief accountant and treasurer should be clearly defined to them to avoid confusion. Chief accountant and the treasurer of the company need to coordinate their activities with each other because their joint contribution can bring about a significant change in the company. The chief accountant has been associated with GFC for a long time and is familiar with the management practices of the company. He can act as a guide to the treasurer and assist in budget preparation and managing expenses. He can also assist the treasurer in auditing activities by providing relevant information and necessary documentation. A proper synchronisation between both of them can help the management of the company to identify and rectify the errors in their financial accounting system. Conclusion GFC is a leading hardwood processing company because of its effective management process but the company is facing certain challenges at the present situation. One of the major challenges is the current economy of UK which is recovering from an economic slowdown. The British pound is not as strong as it used to be a few years ago. The company is known for its flexibility in adapting to the market changes and trends but the company still pays its supplier in its home currency. Given the present economic condition of UK the company should not be practising this method and adopt a flexible approach which would help the company in saving costs. An extensive financial analysis should be done by the treasurer and chief accountant of the company. The treasurer should analyze the capital market thoroughly and suggest effective methods for the payment to the suppliers. Payment through cash instruments and short term instruments like stocks options, bonds etc should also be considered. References Brigham, E.F., 1985. Financial management: Theory and practice. 4th ed. New Delhi: Atlantic Publishers & Distributors. Chartered Institute of Bankers, 2000. Hedging currency exposures: Currency risk management. Kent: Financial World Publishing. 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The Kenya gazette, [online] Available at :< http://books.google.co.in/books?id=5CAc8129FksC&printsec=frontcover&source=gbs_ge_summary_r&cad=0#v=onepage&q&f=true> [Accessed 04 April 2013]. Stutzman, Y. and Popov, V., 2003. How is foreign exchange risk managed? An empirical study applied to two Swiss companies [pdf] Available at: < http://bbs.cenet.org.cn/UploadImages/200582215562754075.pdf> [Accessed 04 April 2013]. Read More