Changes Impacting Global Markets and Financial Institutions - Assignment Example

Corporate Strategic Management Table of Contents Answer 3 c) 7 d) 10 Answer 2 11 a) 11 b) 14 a) 16 b) 17 References 20 Answer a) Qantas is one of the largest international and domestic airline companies in Australia, which was established in 1920. The company is registered under the name Queensland and Northern Territory Aerial Services Limited (QANTAS), and it is one of the most popular brand names in the country. Qantas has ordered 110 Airbus A320, which has been considered one of the largest single orders in the history of aviation in Australia. This initiative of the company was in compliance to its vision to grow rapidly in the Asian markets. In this regards, the CEO of the company, Alan Joyce also confirmed that they have firm decision of buying 110 A320, and in future, they wish to buy another 194 planes (Qantas, 2011). The final dividend for the 2010 to 2011 was not paid to the shareholders as the company wanted to maintain a credit rating of investment grade. The reason behind such a decision might be because of the business change strategy or program of Qantas, which has been considered since 2009. It has achieved benefits of $533 million during 2009 - 2010, followed by $470 million in 2010- 2011. The management has estimated that A320 aircraft would provide a renewable source of growth to the company in the next 15 to 20 years. The expansion and growth of company in terms of size and revenue is definitely favourable for the shareholders because they are going to receive high dividends in future (Qantas, 2011). Qantas’ decision for restructuring the business model and introducing new cost effective airbuses were mainly due to the threat that were rising due to the growing demand of many low cost airlines such as Tiger, Jetstar, Virgin etc. The market reaction was however, not positive for Qantas. According to The Australian (2011), the restructuring of Qantas with the purchase of 110 A320 airbuses will lead to 1000 job cuts due to cancellation of international routes. Though the CEO of the company claimed that this decision can save the company from losses, and it will take the company ahead of its competitors in the long run, the market considered such an abnormally high value order to be a proof of drastic decision-making (Creedy, 2011). The company plans to stop the unprofitable routes and introduce some new lucrative travel routes in the Asian countries. A320 is a small plane, which fits only 150 passengers in two classes. These airbuses will get filled up faster and assist the company to reap profits quicker. The model that Qantas ordered was called A320 NEO, which was around 8 percent cheaper than the current A320 model. Qantas has ordered 32 A320s and 78 A320 NEOs at a price of $9.5 billion. This model was capable of reducing the fuel cost by 15 percent and engine maintenance cost by 20 percent. This approach of Qantas was a part of their expansion strategy in the Asian markets. They wanted to introduce new premium class airlines for cities like Kuala Lumpur, Vietnam, Singapore etc. Keeping in mind the rising cost of fuel and effect of trailing recession on the aviation industry, the decision taken by the management is viable in the long run (Creedy, 2011). b) Financial management is an essential part of the business strategy in any organisation. Though financial tools or theories are complex but when applied, significant insight of the company’s financial and operating situation can be obtained. The general theories that can be considered in case of Qantas’ decision to buy 110 A320 airbuses would lead to evaluation of the strategies for wealth maximization of shareholders, evaluation of stock prices and market shares, and analyse the relationship between risk and security of the decision. Shareholders are the real owners of any firm, so their authority and significance is a priority, when it comes to decision-making. According to Rappaport (1999), the business strategies in any organization are measured by the economic returns that it is going to generate for the shareholders of the company. These are usually measured in terms of the yearly dividends and share prices of the company. Among the other strategies which create value for the shareholders are the competitive advantages of the firm. As far as the shareholders are concerned in case of Qantas, the company claims that in order to attain financial sustainability it believes in offering superior returns to its shareholders over a long period of time. The corporate governance is strategically designed to protect the rights and interests of the shareholders. Shareholder’s returns checks are considered as important performance indicator of the company’s sustainable result. Even twelve non-executive directors are chosen or elected by the shareholders of Qantas. However, in the year 2011, dividends were not declared for the shareholders to overcome the hurdles of performance and expansion plans of the company. The management of Qantas has introduced a five year profitability plan as an objective behind the huge spending and drastic decision-making. The first is the gateway strategy, which means Qantas will form alliance with the Asian airline companies to maximize worldwide membership in the industry. The second strategy is to invest in the services and products that will enhance the experience of the customers. Third is to enhance the presence of Qantas in Asian travel industry, and fourth is an initiative which will include capital expenditure on acquisition, reconfiguration and retirement of the aircrafts. The company expected to maintain a strong balance sheet for a span of five years with their new business model. Figure 1: Stock Price of Qantas from 2011-2012 Source: (Morning Star Inc., 2013) As can be seen in Figure 1, the stock prices of the company fell considerably due to the decision of placing such a huge order because it was expected to cut down employment of 1000 employees because of retiring the older planes. This resulted in considerable decrease in market share, which led to huge financial loss. The cost base of the company is around 20 percent more than that of its competitors, but Alan Joyce, the CEO of the company said that they have a five year plan, which has specific objectives that will again return sustainability and profitability to Qantas. Qantas has been subjected to risk of interest rates, credit risks, fuel prices and foreign currency. The company hedges this risk through derivatives and other non-derivative financial instruments. The risk associated with maintenance that is covered by the third party is included in the maintenance expense, on the basis of the number of hours flown. Risk management involves identification, analysis and mitigation of the uncertainties associated with the investments or investment decisions made by the company. Risk management is taken up by organizations in two stages: firstly, determining the risks that are associated with the decisions or proceedings of the company, and secondly, the measures that the company can undertake to handle those risks (Handlechner, 2008). In this case Qantas was already exposed to a lot of risks due to the effect of recession in the aviation industry. Further, the decision of investing around $9.5 billion for buying around 110 A320 airbuses increased the panic of job loss, which reduced the market share of the company and reduced the stock prices considerably. The companies tried to hedge its risks partly through investment in derivatives, and a five year strategy was introduced in order to not only cover the cost of its huge purchase but also establish a sustainable business model. The financial theories discussed here were mainly related to creation of shareholders value, risk and return, strategic plans and the stock prices and market share of the company. All these are monitored and managed by the financial managers in the company in order to stabilise the company financially. Qantas being in the aviation industry was already facing the heat of recession and stiff competition of the local airline companies, so they went a step forward and re-engineered their business model, which started with an expensive decision-making. The management of Qantas stated their business model and strategies which revealed that the financial theories have been aptly addressed. However, the future is uncertain and claims made by the company related to its decisions are yet to flourish according to the stated plan. c) The airline companies always find a way for cutting down their cost in order to increase their revenue, but have been faced with the barrier of financing the new aircrafts. The airline companies look for innovative ways to finance the aircraft purchase. Buying directly from the manufacturer costs less to the company than when a third party is involved in it. Qantas also decided to buy 110 A320 for around $9.5 billion. There are many lease financing companies like General Electric Capital Aviation Services, etc. Airlines are purchased through various financing source such as cash, operating leasing or lease backs, export credit guarantee loans, manufacturer support, Islamic finance, etc. Qantas had already declared that they did not pay dividend to the shareholders, so this proves that the company must have utilized its retained earnings for the investment activities. Moreover, the additional financial assistance have been acquired from the sources like lease financing or operating lease. In addition, the manufacturer of the airbuses can also provide assistance to the company because this is the largest order in the history of aviation, so Qantas would be able to benefit (Qantas, 2011) The cash flow statement of the company reveals that the cash flow on investing activities has increased in 2011- 2010. In 2010 it was $1645 billion, while in 2011 it increased to $2478 billion. The cash flow reveals that the payment made for the investment activities are more than the receipt, so a negative balance can be seen. In the capital management section of the Annual Report of Qantas, it has it clearly stated that the company has made capital expenditure mainly from the operating cash flows, so as to present an investment grade credit rating in the market for the company. Further debt funding has been also planned as it is not possible to fund such huge order only through operating cash flow. In 2011 the gearing ratio of the company revealed 56 percent. It is one of the airline companies which is rated in ‘investment grade booth’ by Moody’s and Standard and Poors. The cash of the company in December 2011 was around $3342, which revealed a decrease by $154 million from June 2011. The net debt of the company increased from $817 million to $7787 million in 2011, which reflected the financing sources of the company for its order of A320 airbuses (Qantas, 2011) During the 1990s Qantas had the full support of the Australian Government, so they significantly contributed towards the development and progress of the airline. Qantas was considered to be a company which was valuable for the nation, so management and financing of Qantas was also the responsibility of the Australian Government. The government assisted the company to raise funds through overseas equity financing. However, this procedure changed during the 1970s. During 1970s Qantas started raising fund from the market totally on its own name, without the assistance of the Australian Government. Initially it contributed 20 percent from its own funds and the rest it raised through overseas loans. However, during 1973 the government restricted overseas borrowings, so the company started funding its asset purchase totally from its own pockets. Further, as new innovative financing methods were introduced in the aviation industry, Qantas started adopting them according to the economic environment (Gunn, 2010). The good credit rating by both the best credit rating firms is an assurance of the fact that though the company is incurring losses it has future probability of picking up growth pace. Hence, if the company issues right share to the existing shareholders in order to get equity financing for its new venture, it would be a good idea. There is also another reason for supporting this recommendation. Too much of financing from operating cash flow might affect the liquidity position of the company, which would lead to the bankruptcy of the firm. In order to maintain the working capital to fund the operating activities, cash flow has to be adequate, so equity financing should be the first preference when it comes to financing. Moreover, issuing right shares would be preferred because the shares would be bought by those shareholders who believe in the ability of the company, so the company would also have the support of its investors and shareholders (Qantas, 2011) d) This section will include the outcome of Qantas’ decision to place the largest order of A320 airbuses in the history of Australian aviation industry. This decision and its implementation will not reveal results immediately. However, the projection regarding the effect of such transaction on the company can be viewed from both the perspectives, that are from the perspective of the company, which is a positive perspective, and from the perspective of the speculators or market that is a somewhat negative perspective. The CEO of Qantas, Alan Joyce has stated that in order to save Qantas for mainline losses and creates a sustainable financial base for the company in future; the company has to undergo a restructuring. In this plan, decisions to eliminate those routes which are not reaping profits and stop those jumbo planes which generally fly half empty were included. The motive of buying A320 was due to a few significant reasons, which are undeniable. Firstly, the A320 planes are small and they would eliminate the probability of empty flights. Secondly, these planes are cost effective because they will reduce the fuel cost and the cost of maintenance. Thirdly, Qantas would be able to introduce new lucrative routes in the Asian countries to generate higher revenue. These are the significant reasons, and this transaction is also going to affect the sustainability of the company in future. As stated by Joyce, the five year business plan has been laid down based on the revenue generation through this transaction, so if the restricted business model work according to the strategies laid down by the company, the biggest transaction of Qantas can bring back the status of the most sustainable airline company in the near future (Qantas, 2011). However, the negative prediction were due to the immense job loss and closure of old routes increase the probability of insecurity among the shareholders and the investors in the market with respect to Qantas, so the transaction is not accepted by them as an expansion strategy or growth process, rather it is considered as a drastic wrong decision which would lead to indebtedness and downfall (Qantas, 2011). Answer 2 a) Traditionally, the Chief Financial Officer (CFO) is the executive officer of an organization who is entrusted with ensuring whether the company is operating within the financial decorum and discipline, so that it does not exceeds the propriety (Campbell, 2005). The main role of a CFO is to preserve high-quality financial management methods and practices. At the same time it should also construe, evaluate and present finance related information in such a way that it portrays a clear picture of the options and complex problems, so that the problems may be resolved and opportunities can be utilized. It is important that the CFOs effectively converses the financial issue, provides high quality leadership and effective negotiation and management skills. The ability of the CFOs to effectively deliver its duties depends upon his position in the organizational structure of the company. The CFOs should have a sufficient level of contribution towards the effective strategic initiation, promote a framework that would ensure internal control and provide financial advice to the organization. However, this level depends upon the organization size and the complexities in handling the responsibilities and activities (Auditor General Victoria, 2004). The Chief Financial Executive is responsible for handling both strategic and operational aspects of financial planning and management of an organization. Apart from this CFOs are also responsible for corporate level strategic planning. Business Leadership: The CFO evaluates and analyzes the strategic and operational performance of the organization and based on that it frames the policies, programs and outcomes. This includes both prospective and perspective information, and a structure for constant corporate development, projection and cost reporting. The CFO of an organization should not be seen as an “intra-organization financial control” (Auditor General Victoria, 2004, p. 4), but should assist the program managers in implementing the new initiatives and develop the effective financial approach that would provide optimum service. Business Management: This role provides a more extensive service to the program managers by providing them with the refined analytical techniques that helps in investigating internal financial information and resources in providing advice and support on new policy schemes and benchmarking the performance of the organisation against world paramount practice (Auditor General Victoria, 2004). Performance Management: The responsibilities of the CFO are not confined to the traditional role that mainly deals in ensuring that the financial guidelines and policies are properly followed along with maintaining the quality of financial information and reports. The role of the CFOs now includes creation and support of performance management system that provides the linkage to the qualitative and quantitative indicators of performance (Auditor General Victoria, 2004). The constant changing environment of the business and the increasing demand and expectation of earning within the investors have made the CFO under pressure to ‘cook the books’ in order to make them appear attractive and better than before. This places the CFOs in two conflicting roles. Firstly the traditional role, where the Chief Financial Officers are required to ensure integrity and precision of accounts and the financial statements of the company. On the other hand it requires compliance with the contemporary roles that demands the periodical earnings of the business to look at its level best, yet at times supporting this outcome by remedy the of some ‘creative’ accounting. The conflict in roles of the CFO further leads to the conflict in the interest that has a tendency to interfere in exercising the fiduciary duties of the Chief Financial Officer, which mainly refers to the duties of ensuring accuracy and integrity of the financial statement of the organization. These duties has been bestowed on the CFOs by the shareholders and the panel of Directors as well as the potential investors who looks for true and reasonable financial statement on the basis of which their well-versed investment decisions are made. Today, if the CFO thinks about the future responsibilities of profitably running the organization then they will find that their roles are expanding and are gaining more significance in the corporate life. CFOs have now become tactical planners and consultants to the Chief Executive Officer (CEO). According to Robert C. Lowes, CFOs are now seen as “assistant business managers” (Alter, 1990, p. 54) who are proactively involved in the whole business, sits at the top and watches them from the perspective of a CEO. Therefore, to ensure a healthy financial condition along with a stable growth of the organization, it is required by the CFO to perform both traditional as well as contemporary roles. The Chief Financial Officers are under pressure and scrutiny, no matter whether the company is big or small. CFOs always face the demands from the both the external and internal stakeholders of the company that includes “CEOs and boards, activist investors, regulators, customers, business managers and functional managers” (CFO Research Service and SAP, 2007, p. 2). The understanding by the stakeholder about the performance of the company, business strategy and creation of the value depends upon the CFO. Therefore, an ideal CFO acts as a “strategic business counsellor, steward of performance and decision-support information, cost controller and trusted adviser to the CEO” (CFO Research Service and SAP, 2007, p. 2). The activities of the CFO do not have any boundary. They participate in the management of the company and also optimise the utilization of resources whether human or capital. Though their core activities are related to the finance of a company involving raising capital, allocating capital, planning, measuring and reporting financial and operational results but the CFOs are also responsible for managing relationship with the shareholders too. A research conducted by the SAP’s Value Engineering Group reveals that an increasing pressure by the stakeholders on increasing the financial performance of the company has lead the CFOs to maximize the value of the shareholders. Thus they perform all the activities that lead to the end result of boosting the performance of the business. b) Below are some of the examples of successful CFOs in the Australian companies. Bendigo Bank Richard Fennell is the Chief Financial officer of the Bendigo Bank. The Bendigo Bank has brought the concept of community bank, by establishing Rosewood Community Bank. This concept of community bank helps in developing and enhancing a community. In the annual report of the community bank for the year 2009 shows that the revenue for the period 2008-09 has increased by 15.5% whereas the profit after tax has reduced by 22.7% and was $43,126. This reduction was due to the global financial situation. There was an increase in the number of accounts and portfolios. The report states that the financial position of the bank was very sound and was operating in profit. They expect a further growth and increase in the profit. Thus highlighting this, director of the bank requested the shareholders and the customers to spread the word of mouth so that more and more customers join this bank and profitability also increases. The shareholders are given huge importance by the bank (Rosewood & District Community Bank Branch, 2009). Newsletters are published in order to communicate with the shareholders. The success and the rewarding venture of the bank were due to the support of the shareholders. In the year 2009 the Community bank participated in grant program and also paid dividend to the shareholders (Rosewood & District Community Bank Branch, 2009). Thus this clearly reveals that the CFO of the bank values the shareholders of the company. Bank of Queensland Ewan Cameron is the Chief Financial Officer of Bank of Queensland. On having a glance over the annual report for the year 2011, it is seen that the bank reports a normalised profit after tax of about $176.6 million and a statutory and underlying profit of about $158.7 million and $447.4 million respectively. There was an overall 18% increase in the profit as compared to the previous year. Though the bank was badly affected by bad debt and other economic conditions but the proper strategy of the CFO like benefits from acquisition and control through expense management has lead to a profitable situation. The bank has also declared to pay dividend to their shareholders at the rate of 28% per share. The bank maintains a strong Tier I capital level that helps the bank in using the growth opportunities productively. The bank also has a well established expense discipline that causes a reduction in the cost-to-income ratio by 44.5%. Thus the CFO of the company not only enhances the performance of the organization by implementing strategies but also values the share holders (Bank of Queensland, 2011). Answer 3 The Global Financial Crisis (GFC) finds its origin in the year 1980 when economic deregulation took place. In order to encourage greater efficiency and innovation government of various countries started withdrawing their regulation from the financial services. Although this directed to “cheaper credit, broad range of credit products and easing in lending standards and tighter lending margins” (Chesters, n.d., p. 2), but the increasing pace of innovation lead to difficulties for the regulators to maintain the solvency and gauge the asset position of the banking institution. In the year 2007, the GFC started when there was a disintegration of confidence around the globe triggered by the enormous default of the borrowers in the “US sub-prime mortgage sector” (Chesters, n.d., p. 1). This reminded the interconnectedness of the economies of the world. Australian banks were not directly exaggerated by the GFC but the lack of confidence on the banking sector and deceleration in the global trade affected the Australian economy. The crash in the share market exaggerated the decline of Australian dollar that in turn lead to the decline in wealth, increased unemployment and a signal of uncertainty on the economy was displayed. a) Westpac is one of the Australia’s oldest banks. They have been serving the community of Australia since the last 200 years including the most difficult and critical periods in the Australian history. They are deeply committed to the citizen of Australia and are playing a major and positive role in the development of the Australian economy. Australia has a very tough, trustworthy and resilient banking system. During the GFC Australian government regulators, regional and major banks and the communities worked together to make sure that they stay strong. Westpac took the crisis seriously and played a significant role for rebuilding the economy. They viewed their obligation towards the community and their customers as paramount and acted accordingly. Speedy and efficient action by “the Federal Government, the RBA and APRA” (Gale, 2012, p. 1), evidently maintained by banks such as Westpac, helped Australia to fight with the extremely serious situation as GFC and protected it from the most terrible effects. Initiatives Adopted by the CFO during GFC During the GFC when other banks pulled out their lending Westpac continued to lend. They provided the most important contribution to ensure a steady supply of credit to the market during the crisis. In the year 2009 they provided new home lending at a rate of nearly 50 percent, in the market. To ensure continuity in the lending process the bank also provided funds to the small lender so that they in turn continue lending. For increasing the support to the customers who were feeling financially distressed Westpac “strengthened Westpac Assist program and launched St.George Assist” (Gale, 2012, p. 2). Westpac provided active support to the small business customers who were badly affected by the crisis. They also invested heavily to their business during the period of crisis by “Westpac Local initiative” (Gale, 2012), which aimed at putting new and senior bank managers and other business bankers into different branches. b) The Global Financial Crisis imposed a profound effect on the Global financial market, which in turn impacted the Australian market too. The two key issues are as follows: Firstly is the increasing rivalry in customer deposit. As the cost of wholesale banking increased the bank was bound to increase the customer deposit and in order to do so they offered a high price. As a result of this the customers started enjoying the competition for deposits. It was the first time in the history of Australian banking business that the banks competed so hard for the customer’s deposit. This situation served as an unequivocally positive competition for the old and retired customers who were savers. Secondly, the volatility in the cost of funding was an important issue. There was an increase in the cost of funding for the Australian consumers and business, which was triggered by the increased withdrawals of deposits and the global market condition. The CFO of Westpac managed these two situations. The whole sale funding which was previously cheap had now become expensive due to the impact of GFC. In order to fight with this situation Westpac improved the quality and security of the funding. At the same time the term of the funds raised from the market was also increased. These funds were available at a higher cost than the short term funds. As told by the CFO of Westpac, Philip Coffey (2010) that Westpac supports strong liquidity requirement. To achieve this they have raised the liquid asset holding by a considerable amount. At the same time the bank is cognizant to the impact of change in their ability to lend (Coffey, 2010). There is a dramatic expansion in the role of the Chief Financial Officer during the Global Financial Crisis that increased the regulation and uncertainty among the financial institutions all around the world. This GFC has taught the financial institutions to devise the sustainable growth strategy to immune and protect the institutions from new and emerging threats. In order to achieve this CFO of the organizations along with the finance departments have planned their efforts in such a way that the business process provides admission to information to facilitate “internal decision-making, risk management, financial reporting and regulatory compliance” (CFO Research Services, 2011, p. 4). A report prepared by Economist Intelligence Unit suggested that after the GFC the companies have increased their risk consideration and metrics significantly in the area of operation and decision making for the last two years. The report of Economist Intelligence Unit also suggested that the financial organizations are now well equipped to face any type of risk or issue caused by any crisis. 45% of the respondents who participated in the survey said that the risk management of the companies are ready to face any other similar crisis like one during 2008-09 (CFO Research Services, 2011). However, some more initiatives are to be taken to identify some more emerging threats. Thus the GFC has helped to realise the role of the CFO in a much broader aspect, which would not have been possible otherwise. References Alter, A.E., 1990. Beyond the Beans. CIO. 3(9), pp. 1-112 Auditor General Victoria., 2004. Chief Finance Officer: Role and responsibilities. [pdf] Available at [Accessed on February 25, 2013]. Bank of Queensland., 2011. Annual Report 2011. [pdf] Available at [Accessed on February 25, 2013]. Campbell, T., 2005. Ethics and auditing. Australia: ANU E Press. CFO Research Service and SAP, 2007. The superstar CFO: Optimising an increasingly complex role. [pdf] Available at [Accessed on February 25, 2013]. CFO Research Services., 2011. Transforming the CFO role in financial institutions towards better alignment of risk, finance and performance management. [pdf] Available at [Accessed on February 25, 2013]. Chesters, J., n.d. The global financial crisis in Australia. 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