Financial Management Questions - Essay Example

FINANCIAL MANAGEMENT] Part A Meaning of Terms from a Listed Company’s Point of View i. Types of Investment Managers of listed companies should invest cash in hand on projects that have positive net present values (Asgari and Lahrudi, 2014, p.213). Ordinary shares can be a beneficial investment for listed companies. These are a source of finance that is long-term in nature for such companies. In addition, the companies do not have to incur liabilities pertaining to repayment. This is advantageous because, the credit worthiness of a listed company that has offered equity shares increases. A listed company does not incur any obligation requiring it to pay dividends (Bhat, 2008, p.719). A quoted firm can seek to grow its capital as an investment. Therefore, purchase of other organisations and seeking to produce more products, as well as enlarging the market share falls under this investment. When a listed company purchases another company, it increases its earnings through this investment. Listed private companies engage in this kind of investment because, they do not have to distribute the money back to the limited partners after a specified period of time (Cumming, 2010, p.56). ii. Sources of Finance A listed company that has already offered its shares in, through the stock market, can seek additional capital through a rights issue. Therefore, a listed company offers a rights issue to raise more finance, because its shares are already listed in the stock exchange. Rights issues are regarded by the stock exchange as the fairest activity to existing shareholders. Therefore, a company’s management can decide to allow shareholders to purchase additional stocks in the proportion to their current holdings. When an organisation wants money to expand its operations, it may opt to offer a rights issue. Members who are not willing to take up the rights issue can sell their right in the market so as to avoid losses resulting from dilution. It should be noted that a rights issue leads to an increase in the number of shares of a company, leading to dilution. Listed companies can also offer preference shares as a source of finance. The issue of preference shares enables a company to raise long-term finance. Preference shareholders provide finance to a listed company, while they get shares in return. A fixed dividend is to be earned by any shareholder who owns a preference share in a listed company. It is impossible for these types of stockholders to be engaged in decision making through voting. They do not participate in retained earnings, and this is advantageous to a listed company, because presence of preference shareholders does not threaten management of the company. By ploughing back its income, a listed company can source finance. At the end of every financial year, a company that earns net income sets aside some of this income and retains it. This income is not distributed to shareholders and can be used as a finance source during times of need. Listed companies also use debentures, which are loans secured by a charge, to obtain finance for expansion purposes. Finally, a listed company can seek long-term loans to source capital (Mohana, 2011, p.544). There are several places from which an organisation can obtain loans such as institutions that provide finance on interest. iii. Distribution Decisions A listed company’s directors have the power to decide when distribution of profit should occur, depending on whether the company has made profits or not. A listed company ought to embrace a proactive profit distribution strategy. Distribution dividends and interests should be made in proportion to the number of shares that the listed company holds. Distribution decisions require a listed company to state its cash dividend policy explicitly in the articles of association. This should help shareholders and other stakeholders understand the company’s policy in advance. When a company seeks to distribute its net earnings, it should ensure that this is continuous and constant. As much as the power to approve a listed company’s plan for distribution of profits rests on shareholders, it is only the company’s directors who are responsible for the formulation of the plan. Financial reporting after every fiscal period is mandatory for a company whose shares are quoted. Listed companies can only distribute realised profits after off-setting their unrealised losses with unrealised profits. It should be noted that a profit distribution exercise should not reduce the company’s net assets below the aggregate of its called-up share capital and undistributed reserves. 2. Consequences of High Leverage When a firm uses debt to finance its operations, it is expected that the rate of return on assets will be increased. Profits made by the company can be increased through high financial leverage, because the company can be able to make investments. This is only beneficial if the company can pay its debts when they are due (Dlabay and Burrow, 2007, p.127). Holders of stock are comfortable with a high level of debt ratio because this can lead to augmented earnings. However, creditors do not like high debt ratios because they have fewer claims on assets when the business fails. When a company is highly leveraged, unequal distribution of wealth among participants in financing and in the financial market arises. Fluctuations and instability occur in financial markets (Zhu, et al., p.1). A company whose finances are from debts can earn handsome income, but its propensity to perform negatively in terms of finance is amplified. Therefore, a company should have low risk to benefit shareholders by being highly leveraged (Brigham and Houston, 2012, p.448). High leverage can be advantageous or disadvantageous to a company, depending on risk and how the company mitigates this risk. 3. Sources of Information about a Listed Company’s Types of Investments, Sources of Finance and Distribution Decisions within its Financial Statements and Accounts A company’s income statement appropriates profit for a year to ordinary shareholders or other shareholders. The earning per share recorded in the income statement can be a source of information about a listed company’s types of investments. An income statement reveals whether there is a rights issue. The balance sheet provides information about borrowings, loans, share capital and retained earnings. Other particulars are available from the additional information provided by an organisation in the financial statements. 4. Investments, Finance and Distribution Decisions Ratios The price-to-earnings ratio links a share’s market price to the stock’s earnings per share. The dividend payout shows dividends paid from profit. The stock market price of an organisation is linked to the dividends through the dividend yield (Gibson, 2009, p.343). Creditors know their contribution through the debt ratio. Assets-to-equity ratio shows assets financed by equity. Debt-to-equity ratio measures a firm’s financial leverage. To determine profit, the net profit margin is calculated. Earnings per share ratio show investors’ corporate success (Graham and Smart, 2012). The retention ratio shows the fraction of profits retained. Part B 5. Key Investment, Financing and Distribution Decisions made by Tesco Ltd in 2014 From the analysis of Tesco Plc’s 2014 annual report and financial statements, it has been established that the company made various financing, investment and distribution decisions during the fiscal year. In 2014, Tesco Plc’s stock holders received some dividends within the two sub-periods of the whole fiscal year. The total amount of dividends paid in 2014 was £1,193 (Tesco PLC, 2014, p.52). Therefore, the company made a crucial distribution decision of paying equity owners dividends as a form of profit distribution. Secondly, some investments were made by Tesco Plc during the 2014 fiscal year. For instance, some of the investments categorised as ‘other investments’, were sold and the proceeds amounted to £268. This means that the company had made important investments, which it sold out later. In addition, it has been indicated in the financial statements that Tesco Plc received some dividends from joint ventures and associations, meaning that it engaged in acquisitions. It is only through the purchase of other companies that a company earns dividends from subsidiaries. The company may have engaged in major investments so as to increase its sources of revenue and improve performance in terms of profit realisation. Tesco Plc’s major investments in 2014 included loans receivable and financial assets which were available for sale. It has also been indicated that the company purchased non-controlling interests, because some of the net income available is attributed to non-controlling interests in the income statement. The company may have also invested in a rights issue because; shareholders’ earnings per share are diluted. In terms of disposals, Tesco Plc made important disposals during the 2014 fiscal year because, it has been indicated in the notes to financial statements that the company had made some acquisitions, but it disposed some of these subsidiaries. Finance for Tesco Plc during 2014 was obtained from both internal and external. Evidence of a bank loan to Tesco Plc is shown in the company’s statement of affairs and notes to financial statements. The company also sought money through fiancé leases. These were external sources of finance to Tesco Plc during 2014. The existence of diluted earnings per share indicate that the company offered a rights issue. Tesco’s sources of finance were both short-term and long-term. For instance, borrowings were a form of short-term finances, as well as, deposits from banks and customer deposits. The cash flow statement of Tesco Plc indicates that £1912 was issued for repayment of borrowings (Tesco PLC, 2014). The company, Tesco Plc, indicates its efforts of paying back the money it had obtained from lenders. Tesco also indicates that payment of finance leases back to the owners was undertaken. Dividends paid in by Tesco Plc 2013 were £1,184million in total, amounting to 14.76 pence per share dividend. In 2014, Tesco plc paid a total dividend of £1,189, but the dividend was 14.76 pence (Tesco PLC, 2014). 6. Ratio Analysis From the analysis of relevant ratios that have been calculated from the information provided by Tesco in its financial statement, it has been established that the company’s price-to-earnings ratio is about 16%. This implies that the share market’s price of Tesco is much higher than the earnings that shareholders get on each share that they own. However, the dividend payout shows that the portion of current earnings per common share paid as dividends to shareholders is almost equivalent. This is because; the dividend per share exceeds the earning per share by a small margin, given that the ratio is almost 1. The dividends per share showed high disparity from the market price per share as per the dividend yield. As for the debt ratio, creditors of Tesco Plc do not have to worry because; the fraction of total assets that is financed by creditors is not large. This implies that there is no increased risk on the company’s financial performance. Leverage is not high for Tesco because, the amount of liabilities is half its assets. The assets-to-equity ratio shows that only a small fraction of the company’s assets are financed by Tesco Plc’s equity. Based on the debt-to-equity ratio of Tesco, the company’s financial leverage is not so high. Stock holders should not be alarmed that the company may fail to achieve financial prosperity. The company’s net profit margin shows that the profitability level of Tesco Plc in 2014 was as low as 2%. There are very low earnings per share ratio, indicating low levels of corporate success. Finally, the company retains most of its net earnings, totaling to 99% and leaves about 1% for distribution only. Appendix Calculation of Investments, Finance and Distribution Decisions Ratios Name of Ratio Formula Calculation Ratio Price to Earnings Ratio Market Price Per Share/Earnings Per Share 187/12 15.58% Dividend Payout Ratio Dividend Per Share/Earnings Per Share 14.76/ 12 1.23 Dividend Yield Dividend Per Share/ Market Price Per Share 14.76/187 0.08 Debt Ratio Total Liabilities/Total Assets 35,442/50,164 0.71 Assets to Equity Ratio Total Assets/Common Stock Equity 50,164/8,096 6.20 Debt to Equity Ratio Long Term Debt/ Stockholders Equity 14,043/405 34.67 Net Profit Margin Net Profit/Sales 970/63,557 0.02 Earnings Per Share Earnings Available/Number of Outstanding Shares 974/8,095 £0.12 or 12 p Retention Ratio (Net Income-Dividend) /Net Income (970-0.1476) / 970 0.99 Source: (Bragg, 2012, pp.5-113). References Asgari, M. R. and Lahrudi, R. H., 2014. The Impact of Institutional Ownership on Determining Cash Maintaining Level in Listed Companies in Tehran Stock Exchange. International Journal Of Academic Research, 6 (3), pp.213-221. Bhat, S., 2008. Financial Management. New Delhi: Excel Books Press. Bragg, S. M., 2012. Business Ratios and Formulas: A Comprehensive Guide. Hoboken: Wiley and Sons Press. Brigham, E. and Houston, J., 2012. Fundamentals of Financial Management, Concise Edition. Mason: South-Western Cengage Learning Press. Cumming, D., 2010. Private Equity: Fund Types, Risks and Returns, and Regulation. Hoboken: John Wiley and Sons Press. Dlabay, L. and Burrow, J., 2007. Business Finance. Mason: South Western Cengage Learning Press. Gibson, C., 2009. Financial Reporting and Analysis: Using Financial Accounting Information. Mason: South-Western Cengage Learning Press. Graham, J. and Smart, S., 2012. Introduction to Corporate Finance: What Companies Do. Mason: South-Western Cengage Learning Press. Mohana, R. P., 2011. Financial Statement Analysis and Reporting. New Delhi: PHI Learning Private Limited Press. Tesco PLC., 2014. Tesco PLC: Annual Report and Financial Statements 2014. [pdf] Available at[Accessed 26 November 2014] Zhu, C, et al., 2014. The Leverage Effect on Wealth Distribution in a Controllable Laboratory Stock Market. Plos ONE, 9 (6), pp.1-10. Read More