Multinational Running and Risk Management of Qinetiq Group Plc - Case Study Example

Multinational Running and Risk Management Study of Qinetiq Group Plc Contents Contents 2 Introduction 3 Discussion 3 Industry Analysis 3 Financial Trend Analysis for QinetiQ Plc 4 Liquidity Ratios 5 Efficiency Ratios 6 Profitability Ratios 7 Investment 9 Corporate Level Actions 10 Risk Management of QinetiQ Group Plc 10 Exchange Rate Risk Management 11 Country and Political Risk Management 12 Conclusion 14 Reference List 15 Bibliography 17 Introduction In this era of global competitiveness, most of the organizations strive for global expansion of their businesses in order to exploit cross border business opportunities. Such enterprises control the production and operations of their goods or services in multiple locations expect their home countries. However, as a result of operating in multiple countries, the multinational companies experience certain risk factors associated with their business. Such risk mainly arises due to operating in countries with different exchange rate regime and currency systems (Gia, 2009). In this paper, multinational running and risk management of the British multinational company Qinetiq Group Plc will be analysed. Qinetiq is world’s 52nd biggest defence and aerospace company, in the UK it is 6th largest (ADS, 2014). The paper will concentrate on the how Qinetiq acts in the industry segment in terms of its size, turnover, market share, source of raw material, financial trend, corporate and financial interactions as well as the company’s strategy of managing country based, political and exchange rate risks. Discussion Industry Analysis The Aerospace and Defence industry of the United Kingdom is one of the strongest industry of the country and in the world economy as well. The industry constitutes for more than £22.1 billion in the Gross Domestic Product (GDP) of the UK economy in which QinetiQ’s contribution is £1191.4 million, as per the statistics of 2014 (KPMG, 2015). BAE Systems, Cobham Plc and GNK are some of the most significant domestic competitors of QinetiQ whereas among oversees competitors, Boeing, Airbus Group, GE Aviation Systems and Finmeccanica are noteworthy. In the UK aerospace and defence industry, BAE Systems is the largest with a 38% market share; however, QinetiQ has also been able to secure 18% of market share in this highly competitive industry. Stability and efficiency of this third largest industry in the world has made it capable of becoming the source of huge employment. Whereas the industry as a whole employs more than 3,89,000 people directly and indirectly, QinetiQ alone accounts for the employment of 9000 employees in various technical and administrative departments in 2014 (Deloitte, 2015). Being a company of defence segment, source of raw material is an important consideration for QinetiQ as their whole business as well as a part of safety and security of the United Kingdom relies on the source and quality of raw materials. According to the reports, all the suppliers of QinetiQ should be qualified according to the supplier qualification process as defined by QNA-TSG, recognised under AS9100 Quality Management System (QinetiQ Group Plc, 2015a). US, UK and other foreign governments as well as commercial clients are allowed to send Quality Assurance Representatives (QAR) on a definite interval in order to monitor and evaluate quality of materials supplied and on the basis of the inspection reports, purchase order of the suppliers are renewed or cancelled (QinetiQ Group Plc, 2015a). Financial Trend Analysis for QinetiQ Plc Figure 1: Financial Trend of QinetiQ Group Plc 　 2014 2013 2012 2011 2010 Revenue 1191.4 1327.8 1469.6 1702.6 1625.4 Total Operating Expense 1169.1 1448.2 1111.9 1645.2 1656.9 Operating Profit 22.3 -120.4 357.7 57.4 -31.5 Net Income -12.7 -133.2 246.3 5 -63.3 Current Asset 597.7 554.1 562.4 550.2 582.7 Non-current Asset 439.4 626.7 867.4 933.1 1049.4 Total Asset 1037.1 1180.8 1429.8 1483.3 1632.1 Current Liabilities 437.2 486.6 600.7 587.4 428.9 Non-current Liabilities 221.9 255.8 229.8 438.5 729.6 Total Liabilities 659.1 742.4 830.5 1025.9 1158.5 Total Liquidity 378 438.4 599.3 457.4 473.6 Liquidity Ratios Current Ratio Current ratio of QinetiQ Plc that strikes a balance between current asset and current ratio over the period of five years indicates that the ratio has been sharply increasing from 2012 to 2014, signifying a sound financial health for the company. Moreover, expect from 2011-2012 period, the current ratio of QinetiQ Plc has always been above one which indicates the company’s ability of liquidating all its current assets in the time of requirement. QinetiQ Plc should focus on maintaining such steady current ratios in future as well (Bloomberg, 2015). Quick Ratio The quick ratio indicates liquidity of business and measures a company’s ability to pay its short term obligations by en-cashing all its cash, cash equivalents and marketable securities. Again a quick ratio of more than 1 in all the years except in 2011-12, indicates that experiencing a small deviation of the ratio in those years, QinetiQ has taken corrective actions in order to improve such ratio. Such effort of the company enabled them to achieve a sound financial position in terms of liquidity (QinetiQ Group Plc, 2015b). Efficiency Ratios Asset Turnover Ratio A company is said to be efficient if it can generate more sales by using less assets. Hence, higher the asset turnover ratio is, the company is said to be more efficient. The Asset Turnover trend of QinetiQ has been substantially improved in the last five years of period which indicates that QinetiQ is continuously struggling to revive its financial position (Bloomberg, 2015). Receivables Turnover Ratio A elevated receivable turnover ratio is always favoured by a company. QinetiQ has always maintained a ratio above 3 during the last five years which indicates that the company has been able to collect receivable within a frequency of at least 4 months per year (QinetiQ Group Plc, 2015b). Profitability Ratios Net Profit Margin Net profit margin that is expressed as the percentage of revenue, after payment of all interest, tax and operating expenses. The net profit margin has been highly fluctuating over the last 5 years. The profit margin reached its peak in 2012 and dragged to a 10% negative in 2013. Such volatility aided an alarming situation for QinetiQ Plc (Bloomberg, 2015). Return on Asset A higher return on asset is always favourable for any company as it shows the company’s ability to generate more profit by exploiting its assets. The ROA of QinetiQ Plc has sharply increased from 2010 to 2012. After 2012, the group experienced a total crash in its ratio due to the company’s decision to sell off its obsolate resources in order to generate fresh capital. However, the ratio has been improved in the next financial year, during 2013-2014 (QinetiQ Group Plc, 2015b). Investment Earnings per Share A high earning per share is also preferable for a company and a decent as well as incrementing trend of EPS ensures shareholders’ faith on the current business activities and future prospects of QinetiQ Group Plc (Bloomberg, 2015). Divident per Share Dividend per share indicates a company’s ability to pay its shareholders a percentage of its profit. Continuous increase in dividend per share indicates sound revenue generation and profitability of the firm. However, a higher dividend payment tends to reduce QinetiQ’s net profit that in turn decreased the investment opportunities of the firm and consequently, QinetiQ had to liquidate its assets in order to meet the requirement of fresh capital for further business expansion (QinetiQ Group Plc, 2015b). Corporate Level Actions Reviewing the QinetiQ Group Plc, one thing is prominent that four years ago in 2010 the group faced significant challenge when the company’s sales drastically decreased. This is reflected in the financial ratios as well. Since then, the management has taken initiatives to strengthen the foundation of the group and to make the capital structure debt free in order to reduce riskiness of the business. The corporate is also giving emphasis in identifying its core capabilities and accordingly improving the quality of customer deliverables, keeping in mind the defence budget of 2014. The corporate level has created a “Value Pipeline” to convert its capabilities in such a way that these can create value propositions in the business operations. Investments are channelized only if such requirements meet three distinct criteria: Maturity i.e. whether the market is matured enough for their business expansion, possible size of the profits to be incurred and cost of investment (Lazar, 2010). In February, 2007, QinetiQ had acquired ITS Corporation, IT solutions and services provider of US government and other public and private agencies. In 2008, the research house MoD sold their remaining holding of 18.9% to QinetiQ Plc at 206p per share. These are some of the examples of corporate restructuring initiatives, taken from the corporate level of the company (QinetiQ Group Plc, 2015b). Risk Management of QinetiQ Group Plc QinetiQ operates in multiple countries of 3 continents i.e. Europe, North America and Australia. Hence, QinetiQ Group Plc experiences considerable amount of systematic and unsystematic risks as a result of differences in geo-political regulations, currencies and economic deliberation in these countries. Market risk, purchasing power risk and interest rate risks are the systematic risks that leads to affect investment and business decisions of QinetiQ whereas unsystematic risk arises when the company cannot predict the credit risk, suppliers’ insolvency etc. well in advance (Chew, 2013). Exchange Rate Risk Management As a result of operating in a large number of countries, QinetiQ experiences differences in the value of currencies and exchange rates. Hence, while drafting financial statements and consolidating balance sheet, the company goes through serious difficulties in terms of translating all the attributes of financial statements in their home currency pound sterling, although it is an unavoidable task for the company in order to arrive at the net profit or loss it has gained in their global business operations. Clearly, the group is largely exposed to risk of volatility in exchange rate in their international operations (Sweeting, 2011). As the main area of operations for QinetiQ Group Plc is UK and US, transaction exposure is limited for the company as the revenue and concerned costs are borne mostly in pound sterling or the US dollars. Hence, more than 50% of the total revenue is contracted in pound sterling, 40% in the US dollar and rest 3% in euros. The hedge accounting of QinetiQ Group Plc shows that the group actively participates in hedging activities in order to minimise the foreign exchange risk associated with medium term volatility in cash flow as well as in marginal earnings. In order to mitigate the risk associated with weakening dollar value in 2014 as against strong pound sterling, the company has protected its balance sheet and foreign exchange reserve by financing the acquisitions of North America through US dollar denominated borrowings. Hence, now the company will use the US dollar earnings to repay the US dollar denominated debt without hampering the foreign exchange reserves. In general, QinetiQ Group Plc adopts a four step process for dealing with foreign exchange risks: Identification of risk factors, evaluation of the extent of risks, plan action for mitigating such risk as well as monitoring of risk over a specified interval. Risk identification includes financial and non-financial risks involved in the business projects. Analyzing risks are the calculative part of risk management that helps the company to take decision regarding the acceptability of the project depending on the degree of risk association and viability of the project. When a project has been taken, QinetiQ Group Plc makes a parallel plan of mitigating the identified risk factors. Finally, periodical evaluation of the project is also taken into account in order to monitor whether the project is progressing according to the plan of action (Homaifar, 2004). Foreign currency risk also arises from a number of merger and acquisition activities i.e. sale-purchase of business in other countries with currencies other than the functional currency of QinetiQ, pound sterling. As per the policy of the group, when a cross-border sale or purchase is confirmed, the net foreign exposure is hedged by the company by using the forward contract. In order to evaluate effectiveness of the hedge activities, hedge accounting documents are periodically reviewed by the finance department of the group (Clark and Ghosh, 2004). Country and Political Risk Management Political and country specific risk is inevitable for any multinational corporation operating in a number of countries across world. Changes in political and economic structure and decisions of the host countries tend to influence the global performance of QinetiQ Plc as well. Country specific risks instigates from micro and macro level of the economy. Changes in legislations, international trade regulations and barriers, modification of corporate tax structure in home as well as host countries constitute for the reasons behind macro level risks. Micro level risks occur depending upon the level of internal corruption, practices of bribery in different levels of business, unethical trade practices. Non- practice of stringent anti-bribery and anti-corruption laws lead to amplify the degree of such potential risk to a great extent (Wagner, 2012). Country Based Country level and political risks are unavoidable as the political framework of any country is bound to change overtime. In order to ensure successful business operations, companies must be able to cope up with the possibilities of such risk by complying with the changes in policy regulations (Wagner, 2012). The group is liable to pay taxes mainly in the UK and US. Hence, a change in tax regulations adversely affects the profitability of the company. For instance, R&D Expenditure Credits in the UK was introduced in April, 2013. Hence, the company had to repay the additional and unplanned tax from their acquired profit which in turn reduced the net profitability of the group. Precautionary actions are also taken in terms of aligning their activities with Competition Acts, while dealing with competitors. Firm Based The group is sensitive to the changes in foreign exchange and interest rates as well. Weakening in sterling on the Group’s financial assets and liabilities has more impact than offset in equity and income on the group’s overseas net assets and earnings. Hence, sensitivity analysis is conducted by the group in order to diminish foreign exchange risk by taking into account certain market conditions that will definitely occur. However, it is nearly impossible to predict all the future occurrences; hence, actual result differs from the projected outcome as a result of fluctuations in global financial market. In order to counter that, hypothetical estimates are taken on the basis of instantaneous fluctuations in interest and exchange rates. In 2014, the estimates for interest rate movement are assumed to be 1% or 100 basis points. Considering exchange rates, 10% weakening or strengthening of pound sterling is estimated against all other foreign currencies, other variables remaining constant (QinetiQ Group Plc, 2015b). At micro level, each and every business operations of QinetiQ Group Plc strictly comply with the documented policies and internal guidelines of the company. Business activities are scrutinized in each and every steps starting from sourcing of raw materials to planning, production and distribution level. Incidents of bribery and corruption are largely discouraged and disciplinary actions are taken in case of any internal stakeholder found to be associated with such activities. Quality inspection is prioritised by the company. Breach of contract, use of internal information for personal gain, inside trading and other similar unethical activities are strictly prohibited by QinetiQ and are apprehended as punishable offence as per the rule of the company itself. In this way, QinetiQ Plc strives to mitigate the scope of political and country based risks (Wilkin, 2004). Hence, QinetiQ Group Plc emphasises on internal control in order to ensure effective application of compliances in each and every steps of business. While signing investment agreements, QinetiQ Group Plc always buys investment insurance while engaging with investment treaties with foreign countries to safeguard the company from potential loss from investment. Such policies taken by the company for identification of risks and efforts to mitigate such risk has aided QinetiQ Plc to operate successfully for such long period of time (Qinetiq.com, 2015a). Global Risk Management Being a multinational company, the risks QinetiQ Plc encounters are unavoidable for the company. QinetiQ Group Plc also strives to cope up with such risks by altering their business decisions aligning with the changes in rules and regulations in the parent country the United Kingdom as well as in other areas of operation of the company. In 2014, £191.4m of the UK tax losses was carried forward by QinetiQ, the amount of which was £202.7m in March, 2013. The company restricts itself from involving in any illegal trade practices for short term gains and always tries to abide by the tax structure of home country as well as of host countries in order to avoid any complications in business operations (Qinetiq.com, 2015b). Conclusion Studying the present situation of the UK defence industry, the financial performance and corporate level actions of QinetiQ, it is clear that during the period of 2010-2011 the group was experiencing a lot of troubles in establishing a sound position in the industry segment. However, ability of the management to revive its financial performances through efficient management of exchange rate, political and country specific risk, resource capability analysis and calculative investments as well as merger-acquisition activities have facilitated QinetiQ Group Plc to ascertain a strong position in global aerospace and defence industry of United Kingdom. Reference List ADS, 2014. Advancing UK Aerospace, Defence, Security & Space Industries, globally. [Online] Retrieved from: [Accessed 11 February 2015]. Chew, D. H., 2013. Corporate Risk Management. Columbia: Columbia University Press. Clark, E. and Ghosh, D., 2004. Arbitrage, Hedging, and Speculation: The Foreign Exchange Market. California: Greenwood Publishing Group. Deloitte, 2015. How the top A&D companies performed in 2013. [Online] Retrieved from: [Accessed 11 February 2015]. Gia, K. P., 2009. International Finance and Risk Management. Munchen: GRIN Verlag. Homaifar, G., 2004. 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