British Petroleum Finance Strategy - Case Study Example

Finance Strategy (Students Name) (Institution) (Date) ABSTRACT British Petroleum is one of the world’s leading oil and gas companies. The company whose headquarters is found in London operates nearly in every part of the world. It currently ranks as one of the top oil and gas companies with the highest turnover rates. The performance trends, as well as the financial position of this company, continue to follow a positive trajectory due to the expanded business rate and the growing demands for the products of the company. This paper determined the financial strategies used by the company and also analyzed the current performance trends of the company over the past few years. British Petroleum-BP The following section describes the financial structure and composition of the company as well as its performance over the few past years Strategy for raising funds The capital structure of British Petroleum consists of two major sources of funds. They include the Share capital and the Debt capital. The share capital is the type of funds raised when the shareholders make contributions to the funding of the company by way of buying the company shares. Presently, British Petroleum ranks as one of the oil and gas companies with the highest confidence levels for shareholders. Many people have opted to invest in British Petroleum, therefore, contributing significantly to the funding (Petroleum 2014). Share capital is the largest portion capital structure maintained by the company. The company maintain s both basic shares and diluted share thereby giving a wide range for the potential shareholders to choose their preferred option. British Petroleum operates a dividend payment plan that further boosts the confidence and motivates many people to contribute to the company in the form of buying the shares. Share capital has been one of the initial sources of capital used by British Petroleum due to the little costs associated with raising and making use of the capital. The other source of financing which composes the capital structure of British Petroleum us the debt capital. This is the amount borrowed by the company to aid in financing some of the capital expenditure run in the normal course of the company’s business. The debt capital composes about 20%-25% of the company’s total capital structure every year. Net debt to equity ration usually ranges around 20% of the total capital structure. This represents the gearing or leverage rate to be about 20% on an annual basis. The debt borrowed by British Petroleum are divided into short term debts meant to finance cost of recurrent expenditure as well as long-term debt aimed at financing the capital expenditures. The debt capital is integrated into the main capital structure and used as part of the sources of funds (Petroleum 2014). The two major sources of funds are the main strategies employed by British Petroleum to raise its funds and be able to finance its activities. From the financial statement, the share capital contributions and the consequent dividend meant for the shareholders can easily be read out. Besides, the debt ratio to equity and the outstanding debt after every financial year can equally be seen reflected and captured within the financial statements (Global 2009). These two represent the major sources of funds which are currently used by the company and which help define the capital structure. Firm’s strategy of raising capital The Net Income (NI) Theory The NI theory is one of the theories advanced to explain the capital structured used by companies. It determines the composition of the various components of the capital structure and further determines their weighted averages. This theory seeks to increase the value of the business by lowering the cost of capital. Cost of capital, in this case, represents the amount incurred in acquiring a particular source of funding. Therefore, an optimal capital structure is normally achieved when the cost of capital is at the lowest rate while the value of the firm is greatest. The value of the firm also increased when more debt capital is used while the cost of capital is reduced (Global 2008). The rationale for this theory is usually achieved when the Cost of debt (Kd) is correspondingly lower than the cost of equity (Ke). This rationale is achieved when there are no taxes and when the perception the investors is not changed by the use of debt capital. Whenever the level or amount of debt capital in the structure increased, the Weighted Average Cost of Capital (WACC) reduces. Consequently, the value of the firm increase and this implies a positive trend to the company (Global 2009). British Petroleum employs the NI theory in raising its capital by seeking to raise the value of the firm through lowering the cost of the capital. This can be seen by the limitation of the use sources of capital which have the ability to raise the cost of capital of the company. Therefore, British Petroleum relies majorly on cheap sources of capital and also balanced between debt and equity capital to a level that has no negative implication on the company. The amount of debt capital employed by British Petroleum is much more than the amount of equity capital employed within the firm. This has a considerable reduction on the final cost of capital that exists in the company. The ultimate strategy of British Petroleum is to come up with an optimal structure which results from reduced costs and the same time enhances the value of the firm (Yoo 2006). The considerable use of equity capital to finance most of the operations of the company is intended at reducing the consequent costs of financing and also supporting the positive value of the firm as viewed by the competitors and the shareholders. Firm’s dividend policy British Petroleum relies heavily on equity funding being the money raised by the members through the issuance of shares. The shareholders represent a large section of ownership of the company with massive contributions towards running of the activities of the company. The dividends are paid out depending on the number of shares held by every shareholder. The policy recognizes that different people have a different number of shares held within the company. Therefore, the determination of the shares according to the amount held by every member is intended to grant benefits to members commensurate to their share of ownership in the company (Penman & Penman 2007). One feature of the company’s dividend policy is that it’s subject to regular review by the Board of Management. The review and amendments done on the rates as well as the periods for declaration and payment of the dividends is subject to the decisions made at this senior-most organ of the company. British Petroleum declares and pays its dividend on quarterly basis. The shareholders can access the rates and the amount of dividend payable to them on a quarterly basis. This implies that the declaration is usually made three times within a financial tear. However, the rates payable as dividend usually The policy regarding the amount of dividend paid to every shareholder is subject to the balance of profit which remains after consideration of all the expenditure necessary. The dividends are paid out on the profits of the company, and these shareholders are entitled to the dividend paid out after all the necessary deductions and expenditure consideration has been made. For example, the first quarter of 2015 saw dividend amount of 7 cents per share and this further increased to 10cents per share at the last quarter of the year. In 2014, the company paid out a total dividend amounting to $5.9 billion. The figure rose to $6.7billion in 2015 and 2016. The figures are anticipated to increase in 2017 due to the projected positive revenue amounts for the year. One feature of the dividends paid by the company is that they are valued and denominated on the dollar currency. The dividend policy of British Petroleum grants an option to any shareholder to opt for script divided at their disposal. The script dividend would postpone the receipt of monetary value for a certain period which is usually made at the discretion of the shareholders. Presently, the existing shareholders of the company have increased to express their confidence to the non-fixed dividend policy which is witnessed ion the company (Healy & Palepu 2012). This allows the shareholders to benefit immensely during the seasons when the company makes huge profits as opposed to a fixed rate that provides for a fixed rate despite the activities of the company. In addition, the policy aspect which necessitates the company to declare and pay out the dividends on a quarterly basis is seen as progressive and appreciated by the shareholders. As a result, the management continues to have much input in deciding and making decisions regarding the dividend policy seen in British Petroleum. Analysis of firm’s strategy of distribution of funds The residual policy The residual policy is one of the approaches in finance which determines when money is to leave the coffers of the firm. This theory argues that any payments such as payment of dividends is to be made on the money left over after all the valuable investment opportunities have been considered. The residual amount is usually the money which is left over after all the deductions on positive investments have been considered. The company makes and gives priority to investment opportunities first on the amount realized as the profit after which it makes payment decisions. In the case of dividend payment, the shareholders are bound to be paid the dividends from the profits left over after expenditures have been made and investment opportunities considered (Hillier et al. 2011). British Petroleum relies entirely on the use of residual theory which necessitates expenditure to be made on the profits left after considering all positive investment. This is seen in the case of payments of dividends. The company usually declares and pays dividends after catering for all the immediate expenditures and considering investment opportunities with positive assignment. This, therefore, allows the management to have discretion and authority on setting the amount of dividend payable on every quarter. This explains why the dividend policy of British Petroleum keeps on fluctuating depending on the amount of money left over after making consideration of the investment opportunities. Besides, a decision to invest and purchase additional shares by the company is usually done on the amount of money left over after considering priority expenses. The residual approach is used to govern all fund distribution by British Petroleum at all levels. In case a certain financial period witnesses a little amount of residual amount, the distribution of money to be made in such a period will be retracted or reduced to the percentage of the residual amount. The latter decision is usually subordinate and subject to the former since this is purely dictated by the residual value concept. In many cases, the amount remaining for further distribution by the company changes quite often due to the application of this concept. The management makes determination on what investment need to be considered before finally settling on a particular purpose warranting distribution of the company’s funds (Doole & Lowe 2008). Recommendation of the financial strategy British Petroleum operates a financial strategy which depends on its performance within the market. The financial strategy of the company is to come up with a capital structure which is effectively and affordable to the company. Cost reduction is seen as one of the major aspects considered in the financial strategy of British Petroleum. This is seen on the decision by the management to have a larger part of financing done by cheaper source of finance (equity funding) so as to reduce the ultimate cost of finance (Grant 2016). Besides, the decision of the company to adopt the residual theory is aimed at eliminating the fixed distribution strategy which usually fixes amounts for distribution such as kin the case of distribution of dividends. The argument for adopting this policy is to cushion the company in events when it has not made much profit by reducing the distributable amounts. The general approach of the company is base on the need of cost cutting as the major yardstick upon which financial decisions are made. This paper recommends that the company considers other sources of financing such issuance of bonds so as to broaden its scope of risks and gains. The ultimate aim of incorporating a broad capital structure is to cushion the company in the event when the economic conditions turn unfavorably. Presently, British Petroleum is seen as one of the robust companies and its decision to engage in issuance of bonds will be highly adopted within the bond market. In addition, this paper suggests that the company adopts a semi-annual declaration and payment of dividends instead on the quarterly policy. This will be helpful in cutting down the costs and time taken every quarter in coming up with the details of profitability and the issuance of dividends to the many shareholders. Semi-annual basis will ease the time taken and also allow for accumulation of dividends to the shareholders and reduced costs incurred in the issue processes. References Bamberg, J. (2000). British Petroleum and Global Oil 1950-1975: The Challenge of Nationalism (Vol. 3). Cambridge University Press. Doole, I., & Lowe, R. (2008). International marketing strategy: analysis, development and implementation. Cengage Learning EMEA. Global, B. P. (2008). BP Statistical review of world energy June 2010. Global, B. P. (2009). Statistical review of world energy 2009. 2008-7)[2009-07-19]. http://www. bp. com/../statistical_review of world energy_full_review 2008, pdf. Grant, R. M. (2016). Contemporary strategy analysis: Text and cases edition. John Wiley & Sons. Healy, P. M., & Palepu, K. G. (2012). Business analysis valuation: Using financial statements. Cengage Learning. Hillier, D., Grinblatt, M., & Titman, S. (2011). Financial markets and corporate strategy. McGraw Hill. Penman, S. H., & Penman, S. H. (2007). Financial statement analysis and security valuation (p. 476). New York: McGraw-Hill. Petroleum, B. (2014). BP energy outlook 2035. BP stats, Jan. Yoo, S. H. (2006). Oil consumption and economic growth: evidence from Korea. Energy Sources, 1(3), 235-243. http://www.bp.com/content/dam/bp/pdf/investors/bp-annual-report-and-form-20f-2015.pdf Read More