BP Groupss Financial Strategy - Case Study Example

Abstract This paper analyzes the financial strategy of BP with regard to capital structure and dividend policy being adopted by the business. The same has been supported by different theories and mechanism which helps to understand the manner in which the business will improve as recommendations based on the study has been provided. It is seen that BP has adopted an appropriate capital formation and dividend declaration policies. BP needs to continue with similar policies in relation to capital structure and dividend declaration with the only concern being fluctuating EPS and payout ratio. Apart from it the business has to look at achieving an optimal mix of dividend declaration and internal financing through surplus and reserves so that the overall business situation improves. Table of Contents Introduction 3 BP Capital Structure Strategy 3 Use of theory to understand the capital strategy 4 BP Dividend Policy 6 Use of theory to understand the dividend policy 7 Future Financial Strategy 8 Conclusion 9 References 10 Introduction Capital structure of the business determines its ability to deal with the financial needs and the manner the business looks to carry out its activities in the future. This paper looks at analyzing the manner in which financial strategy is adopted by BP. It will look at evaluating the capital structure strategy which has been adopted by BP and will be backed by different theory to understand the significance it has on business performance. This will then be followed by evaluating the dividend and share repurchase strategy adopted by BP and will be backed by different theories so that its significance can be identified. Finally, the paper will look to chalk out the future financial strategies which the business should adopt so that long term prospect and growth can be achieved. BP Capital Structure Strategy BP capital structure strategy has been predominantly shaped by the business filed where they work. BP has looked towards having a mix of different sources of funds which includes debentures, long term debts, equity share capital, reserves and surplus. The short term debt financing has been kept out of purview as otherwise the capital structure would convert into financial structure. The capital structure strategy adopted by BP has been such that they have ensured relative proportion of different sources of financing. If BP had not followed a policy where representation of different sources of financing was available it could have been lethal for the business (Osmundsen, Asche, Misund and Mohn, 2006). For example, if BP had a higher concentration of equity capital and relatively little or no long term debt than the benefits associated with trading on equity would not have been achieved and the returns for the shareholders would not have been maximized. BP has thereby adopted a capital structure which they deem fit. It should also be noted that there is no determined capital structure which is best but it depends on the circumstances and the nature the business is carried out. A look at the financial ratios associated with financing will reveal the manner in which the business has worked and is as follows The above ratios show that BP has looked at adopting a strategy where they have a mix of both debt and equity. This has helped BP to save both on taxes through interest payment and have been able to maximize the returns to the shareholders. It is also seen that the long term debt and equity both forms nearly 50% of the total capital component which has provided the opportunity where the business can look at further adopting a strategy where more finance can be raised either through debt or equity financing. Thus, the strategy which the business has adopted looks appropriate which will be further understood by the different theories. Use of theory to understand the capital strategy Different mechanism and theories have been propounded to identify whether the capital structure strategy adopted is appropriate or not. One such theory is the Trade-Off Theory which looks at whether businesses have the required targeted debt. This is analyzed through the financial flexibility, credit rating and cash flow volatility (Zeitun and Tian, 2008). It is seen that BP has a high credit rating which states that the business has been capable of meeting the interest and other needs. In addition to it the business has financial flexibility and has been able to maintain appropriate liquidity as seen from the current ratio. This denotes the fact that the business has an appropriate debt. As a result the theory strengthens the fact that the business has adopted a model where they have been able to determine the appropriate mechanism of financing which will help the business over due course. Another theory the Pecking Order Theory looks at the manner in which the business finances its operations. It looks at whether internal funds were used by the business to carry out their activities; whether equity financing was used when debt financing was not available; situations where different forms of financing are used (Quirin, Berry and O'Bryan, 2000). It is quite evident from the financials of BP that internal financing is used as a mechanism to finance its business. BP has both reserves and surplus which is used by the business as a mode of internal financing. Apart from it depending on different situations BP resorted towards a mix of different sources of financing. This has helped the business to achieve the financial strength which the business was looking for and has thereby ensured that the business is more viable financially. It is further seen that BP has looked towards internal mode of financing where they use their reserves and surplus for financing first. This is then followed by a financing through financial debt where it raises money in the form of debt and finally the organization resorts towards equity financing. BP has followed the same and is consistent with the requirements of the Pecking Order Theory. This will thereby provide the required financial modelling through which the business will be able to ensure better financing. The theories suggest that BP has been able to determine the appropriate capital structure which will help them over a long period of time and will provide the financial strength and stability which the business requires. BP Dividend Policy BP looks at paying its shareholders dividend every quarter so that the shareholders can be compensated appropriately for the risk taken in the business. It is seen that it is a policy which has been adopted by BP over many decades. The financial condition of BP in recent time has gone down due to decrease in the price of oil. The business has still persisted with the policy of declaring dividend which could mean that the business might have to sell out some assets so that the shareholders can be compensated (Brealey and Myers, 2000). BP has looked towards being generous and has been consistent with their policy of declaring dividend. Despite decrease in the price of barrel of oil BP has been able to meet the capital expenditure and dividend through its operating cash flow. This is a good sign and shows that despite difficult circumstances the business has been able to meet its obligations. In order to understand the dividend policy it is important that the earning per share (EPS) as well as payout ratio is analyzed. It has been shown through the ratios below It is seen that EPS has turned negative primarily due to decrease in profits and the business has not been able to pay the same dividend. The dividend payout has decreased but the business still looks to follow the policy of declaring dividend with whatever profits they have. The payout as a result has also decreased as the bottom line is affected. This brings to an important notion that the business has to gear up towards determining an appropriate mechanism to declare dividend which will be understood by a theory below Use of theory to understand the dividend policy The Lintner Model will help to evaluate the manner in which BP has looked towards the dividend policy. The model is based on four parameters which are (1) firms adopt a long run dividend payout target (2) the focus is on dividend change then on absolute value (3) change in dividend shift is seen over long run and (4) managers don’t prefer dividend changes which have to be reversed (Antill and Amotl, 2000). It is seen that BP follows a stable payout policy which justifies the first parameter. The data shows that the primary focus is on the change in dividend rate but not absolute terms which should be the case. Thirdly, changes in temporary earnings will not have an impact on the dividend policy and lastly managers are looking towards having a stable dividend then a fluctuating dividend. These are consistent with the Lintner Model and shows that BP has looked towards adopting the same in their dividend policy. The analysis further highlights that the high volatility of EPS is having an impact on the payout ratio which needs to be made consistent so that the shareholders can be compensated appropriately. The theory suggest that BP has looked towards following a model where based on different parameters the dividend which the business will offer is determined. This has helped the business to be consistent with their policy of dividend distribution. As a result the focus of the business has been towards garnering a method through which shareholders feel confident and the business has been able to generate adequate operating profits to compensate those. The overall situation turns out to be one where the business has been able to devise a strategy which could strengthen the manner in which they work and would help the business in future endeavours. Future Financial Strategy BP to improve its capital structure and for better performance has to look towards adopting the following strategies Firstly, BP should look towards pursuing the same capital structure strategy where they have an appropriate mix of both debt and equity. This will provide them with the capital leverage and would provide an opportunity through which better performance can be ensured. BP has to further look towards ensuring that they continuously use the internal source of financing through reserves and surplus so that the dependency on external agencies to raise finance is reduced. Apart from it the business has to look towards determining the optimal capital mix which will the best for the business. This has to be done based on the circumstances and nature of business so that business is carried out without any hiccups. In addition to it BP has to further look towards being consistent and while determining the capital mix has to focus towards choosing one which is in the best interest of the organization. Secondly, the business should look towards carrying on with the tradition of declaring dividend as it will help to pacify the shareholders and would help them to get returns for the risk undertaken in the business. The concern for the business here is fluctuating EPS and payout ratio. BP has to look towards being consistent in this regard which can be achieved by ensuring consistency in operations. Apart from it the cash flow from operations has to improve so that the shareholders are provided with more dividends. This will improve the brand image of BP and would provide an imperative solution to the different difficulties which the business is facing. Thirdly, BP has to determine the optimal mix between dividend policy and capital formation. BP should look towards ensuring that while looking to declare dividend they keep the required sum aside in surplus and reserves which would be used for internal financing. This will help to reduce the dependence on external parties and would help BP to formulate a sound financial strategy (Jensen & Mekcling 2006). The entire mechanism should be linked to one another and an appropriate mix of retaining money for future projects and dividend should be identified. Conclusion The paper brings forward the manner in which BP has adopted appropriate capital formation and dividend declaration policies. The different theories highlights that BP has been successful in implementing an appropriate policy based on the nature of the business. The study has shown that the business needs to continue with similar policies in relation to capital structure and dividend declaration. The only concern is fluctuating EPS and payout ratio. Apart from it the business has to look at achieving an optimal mix of dividend declaration and internal financing through surplus and reserves so that the overall business situation improves. This will help the business to take better decisions in relation to capital financing and would help the business to grow. References Antill. N. and Amotl, R. (2000). Valuing oil and gas companies. Cambridge, UK: Woodhead Publishing Ltd. Brealey, R.A. and Myers, S.C. (2000). Principles of Corporate Finance, 6th edition, New York: McGraw- Hill. Jensen M.C., & Mekcling W.H. (2006). Theory of the Firm: Managerial Behavior, Agency Costs & Ownership Structure, Journal of Financial Economics, 3, 305-360 Osmundsen, P., Asche, F., Misund, B. and Mohn, K. (2006). Valuation of International Oil Companies. The Energy Journal, 27 (3) Santimoy, Patra. (2002). Effect of debt financing on capital structure. The Management accountant, September 2002, 35 (9), 691 Quirin. J. J., Berry, K. T. and O'Bryan, D. (2000). A Fundamental Analysis Approach to Oil and Gas Firm Valuation. Journal of Business Finance and Accounting 27 (7), 785-820. Zeitun, R. and Tian, G. 2008. Capital structure and corporate performance: evidence from Jordan. Australasian Accounting Business and Finance Journal, 1, 40-53 Read More