Accounting and Finance for Managers - Financial Statement of the ARM Holdings - Case Study Example

Introduction

In the current business world, most companies have embarked on the development of strategic, and accurate, forward-looking financial statements to enable them to achieve long-term sustainable growth for its clients more so the potential shareholders in that particular company. The statements include the business strategy, financial results- revenues, operating expenses, gross margin and capital expenditures. In most cases, those financial performances presented for every fiscal year involve managers, shareholders, employees and consumers' contribution to the firm. In other words, they express the ability of the enterprise that efficiently protected its welfare and property against infringement and its continued investment in research and design activities. For instance, the strategic report on the financial results of ARM Holdings, the world’s leading semiconductor Intellectual Property (IP) Company, indicated the manufacture of approximately 750 billion silicon chips and those, some 47 billion entailed a processor. The total estimated value of chips with processors sold in 2015 was about 115 billion dollars and that by 2020, the value of that certain market would have grown to 150 billion dollars.

However, with reference to the financial statement of the ARM Holdings, financial data presents information useful in making investment decisions for shareholders. In this report, various ratios are taken into account to assess how financially feasible the company is in attracting investment, surviving financial crises, and competing favorably against other companies within the same industry. The objective of analysing the ARM Holdings financial statement is to evaluate the company attractiveness to shareholders, resource management, and financial stability during the current UK’s economic climate.

Performance Overview

Figure 1: ARM Share performance 2014 and 2015 (Yahoo Finance)

With 32% of its total market share in 2015, ARM recovered its costs from each technology’s license revenues. Over the medium term, the company bought back 9.0 million shares at a value of 92.2 million euros. In addition to that, the proposed full year dividend was 8.78 pence, a 25% increase. After cost accounting, the returns towards the shareholders amounted to 200 million euros (ARM, 2016). The consolidated balance sheet indicated that the total current assets accumulated to 948.3 million euros with accounts receivables of 183.7 million euros and the total non-current assets amounted to 1171.9 million euros, an increase of 870.9 and 966.3 million euros respectively, from the previous year 2014 (ARM, 2016).

Therefore, the total assets for the fiscal year ended 31st December 2015, were 2120.2 million euros. On the other hand, total current and non-current liabilities were 262.5 and 60.1 million euros respectively that amounted to 322.6 million euros. After deductions from the exceeding assets, the net assets settled at 1797.6 million euros hence balanced off the capital and reserves that were attributable to the owners of the company (ARM, 2016). Also, AMR Holdings recorded the accounts receivables of 1.2 million euros of amounts recoverable on contract. In operating activities, the net income before extra-ordinaries summed to 414.8 million dollars where funds from operations rounded up to 447.6 million dollars without deferred taxes and investment tax credit, for the fiscal year ended December 2015 (ARM, 2016).

Also under the investing activities, the total capital expenditures were 41 million dollars where, sale/maturity of investments added up to 6.4 million dollars and, the net investing cash flow 209.1 million dollars. The figures included net assets from acquisitions ($62.3 million), without any sale of fixed assets and businesses, other uses ($105.7 million) and purchase of investments ($6.5 million). The financing activities involved the total cash dividends paid ($107.8 million) of which those were the only ordinary dividends realized (ARM, 2016). The change in capital stock added up to ($82.8 million) where repurchase of the common and preferred stock was ($92.2 million), sale of the common and preferred stock at ($9.4 million) which was equivalent to the proceeds from stock options. The reduction of debt, net amounted to ($5.1 million) that was also the same figure as that of change and reduction in long-term debt. Therefore, the net financing cash flow settled at $195.7 million (ARM, 2016).

For example, under sales/revenue generated, the sales growth rounded up to 22%, and cost of goods sold increase to 8%. The gross income recorded as ($910 million) expressed a significant increase of 22.77% whereas the sale of property and assets expense summed to ($516.8 million) with a growth rate of 21.63%. Even though, other expenses incurred while on the sale of goods and property were accounted to ($248.5 million) where the unusual expenses figured at ($4 million). The EBIT from unexpected expense ($397.2 million), non-operating income/expense ($8.9 million), and non-operating interest income ($12.1 million). The interest expense was at $300,000 without any possible percentage growth thus similarly recorded as the gross interest expense (Robert, 2016).

For instance, the pretax income also amounted to ($417.9 million) with a pretax income growth of 30.59% and a pretax margin of 43.16%. The total revenue tax included under the pretax statement levelled at ($75.1 million), equality in affiliates ($3.1 million) and hence, the consolidated net income summed up to ($339.7 million). The ratios of the consolidated net income had achieved a net income growth of 33.01% throughout the financial year, with both EPS core and EPS diluted growth at 32.42% and 32.78% respectively. The outstanding diluted shares were worth ($1.42 billion) and in addition to that, EBITDA amounted to ($435.2 million) with a growth rate at 23.67%.

Financial Statement Analysis

Another major section of interest to the owners of the company more so, the shareholders would be the analysis of annual ratios mentioned above and their implementation through decision-making. They included the net income growth, net operating cash flows both sales and growth, capital expenditures after sales and growth, net investing cash flow for sales and growth and, net financing cash flows on sales and the coincidental growth. The ratios summarised to a free cash flow growth at 7.65% (ARM, 2016). Hence, the shareholders would be able to make better decisions for future excellence considering the growth rate ratios. For instance, rates can be divided into four categories namely profitability analysis, operational efficiency, liquidity and leverage. The profitability analysis entails the sales growth where a percentage increase in sales would be an account of a corresponding increase in overall costs and inflation in the firm (Jeremy, 2016).

Also, the reliance on resource revenue would enable businesses to determine long and short-term trends in line with strategic funding goals e.g. a move towards self-sufficiency and minimising reliance on external financing. Return on equity would indicate the rate of return on investment by shareholders and hence they would ensure the organisation would make enough profits to compensate the risk of involvement in business. The operational efficiency ratio would create a charming atmosphere only when the expense ratio would decrease to increase efficiency. In inventory turnover, a high rate would that indicate stocks sold quickly and their little-unused inventory was left stored. In liquidity ratios, shareholders consider the working capital ratio where if the rate is high, would mean the presence of excess cash that would possibly get invested elsewhere in the business. Usually, a ratio between 1.2 and 2.0 would be sufficient. The leverage ratio entails debt to equity where lenders would have priority over equity investors (shareholders) on a firm's assets. The shareholders would want to get leverage on their investment to boost profits (RASS, 2016).

For instance, the company would operate efficiently with an aim to create returns for the shareholders through investing in long-term growth opportunities. Therefore, financial statistics show that ARM performed strongly in 2015 considering a 15% increase in group dollar sales and a 5.2% increase from £25 to £32.5 in dilute share earnings (ARM, 2016). During the year, the company also approved the buyback of 9.0 million shares. The company would continue to generate revenue for the support of long-term investment in growth through consistency with their current approach and by the board to ensure the level of cash would be under continuous review.

ARM’s commitment would maintain a net cash balance in the medium term. The continued commitment to investment ensures that ARM would retain the flexibility to move more quickly and decisively in the fast moving industry where opportunities lay available to increase growth. In 2015 ARM returned 107.8 million euros by a result of the ordinary dividend. Also, the organisation would continue to repurchase shares to offset the dilution from share-based compensation. Hence, without the financial statements, ARM's managers' and shareholders' would find it tough to run the business or making decisions regarding the firm. The best measure of a company's growth would consider its profitability. An increase in profits would indicate that the corporation would pay dividends and that the share cost would trend upward and hence, investors would risk their money at a cheaper rate to a successful business than to an expensive one. Consequently, ARM Holdings would use leverage to increase stockholders' equity even more (Anaja & Emmanuel, 2015).

Performance Measures

Profitability measures that investors are interested in involve the comparison of sales with profits, analysis of net profit margin, ROA, and ROE. Even though, publication of financial statements by a firm like ARM Holdings would provide a way to present its financial position or otherwise to shareholders, creditors and to potential investors, to enable them to make rational investment decisions. On the other hand, the statements reveal the strength of ARM as well as the potential profit of investing in the company. However, an actual or potential investor would analyse the income statements to know the business's expense income and profit/loss over a specified duration. In other words, cash flow analysis would purpose to estimate the value of money an investor would acquire from an investment, based on free cash-flow projections for the company.

Besides, investment bankers would also rely on financial statements when they need to ascertain the sustainability of corporate business. For instance, the sale or purchase of ARM Holdings would depend on determining an agreed-up on valuation, and therefore, they help bankers establish an appropriate price for transactions. Moreover, corporate organizations owe the responsibility to disclose their operations sufficiently to aid investors in making investment decisions so as to predict future rates of returns. The results from the ratio analysis indicated that investors depended on the credibility of expert financial approval of financial documents in making investment decisions. Therefore, ARM Holdings should maintain an adequate care and due diligence in preparing future financial statements to avoid risky decisions that would lead to loss of funds and possible litigations (William, 2011).

Additionally, ARM Holdings describe its ideal shareholder as one who would have a long-term investment horizon. The organisation would want long-term shareholders in particular since it would enable them implement their corporate strategy and more so, make long-term investments without distraction and short-term performance pressures that would arise from active traders. ARM Holdings' managers, if left to their own devices, would tend to increase their benefits of control rather than the value of the firm's stakeholders' stake. At the same time, managers might make myopic investment decisions as a result of imperfectly informed market participants. Indeed, most managers would admit to the fact that they would willingly sacrifice long-term shareholder value for short-term gains. However, if long-term investors would exert a positive influence on managers, then internal governance would improve, for instance, in the quality of the board of directors.

Moreover, regarding investment, financing and payout decisions, the predictions of theory would not help regarding managerial horizons and corporate investment. Even though, from a dominant view on manager-shareholder conflicts, poorly monitored managers would destroy shareholder value by overinvesting. Another view would hold that managers would underinvest, under certain situations, thereby would also demolish shareholder value. In other words, if ARM Holdings managers would overinvest, they would build up too much financing and even if they underinvest, they would raise too little for the company. Additionally, other than just ARM Holdings, accounting and finance for managers, on the whole, would need greater monitoring so as to increase shareholder value, whether as a result of higher profitability or lower risk (Jarrad, et al. 2015).

According to Abdullah Z.I.B. (2015), accounting and finance for managers would contribute both positively and negatively towards the society and the country at large. An active view, for example, increasing the cash flow for the state where transparency in financial statements would promote more investors to spend their money investing in their preferred company. They might not choose one corporation rather a multi-company to spend their inventory. For instance, when investors from ARM Holdings gain the income or profit from the investment, they would use it to invest again in the same firm and other companies too. Another benefit, reducing the unemployment rate when investors keep investing money into an organisation then many opportunities for employment would arise. When investors in ARM gain profits from their investment, they would contribute significant amounts and hence, more projects and job opportunities are open to the public. The previous fiscal years before 2015, ARM Holdings had an increased number of employees in every year in the different branches located worldwide.

Influence of Information on Decision-Making

On the other hand, corporations make decisions consistently at every level, especially after the release of annual financial results during their annual general meeting. The annual report determines the range of decision making from, strategic decisions through to managerial decisions and routine operational decisions. The decision-making process in business relies on selecting choices or compromises to meet business objectives. However, a decision would only be termed as a good intention until when the organisation degenerates it into work or action. For instance, global markets give ARM Holdings access to similar resources and competition causes its operations to converge on similar standards. Hence, decision making would offer the only possible basis of competitive advantage that would generate superior returns for its shareholders. The financial ratios would, therefore, dictate ARM's path on taking opportunities offered through developments in systems and globalisation, to change their finance and accounting roles in future. Moreover, the 2015 ratios would enable ARM Holdings to operate more efficiently and more effectively in how it supports decision making across the firm.

Importantly, in the context of ARM Holdings and its strategic position, decision making is a proposal considered by the decision makers, more so, the shareholders. Alternatives, risks and potential outcomes that might arise from the ratios presented would get taken into account before reaching a decision. Usually, decisions are subject to human error as the shareholders and managers, in general, have personalities, prejudices and a self-interest bias. For instance, the ratios of financial statement analysis in the fiscal year ending 2015 for ARM Holdings, would affect liquidity and financial stability of the organisation, and therefore, business decisions would rate the significant presumptions shareholders would make (Mahmood, 2012).

Meanwhile, companies need to make forward-looking financial decisions so as to achieve their primary goals. ARM Holdings as a private corporation has a direct relationship between decisions made by its shareholders and its financial performance. Therefore, various financial ratios that would come to the forefront in decisions made would also have an impact on the future financial performance of the company and from the 2015 rates, ARM would have the ability to determine the extent of 2016 successes or failures of its activities. Parameters affecting the performance are also important for all financial actors in the market, of which the parameters are either the indicators originated by the firm itself or the macroeconomic indicators influencing the organisation. Conclusively the ratios are important guiding indicators for the actors in the market.

According to the financial ratios presented by ARM for the year ended December 2015, among-profitability, liquidity, capital structure and operating ratios, it was observed that liquidity ratio is vital in decision making for the business performance. Accordingly, investors who would invest in the firm should pay attention to cash dividend payout rate, earnings per share and return on assets in assessing the continuous future performance of ARM. In other words, businesses need to make decisions that would further improve their financial performance in the following period by evaluating the current position and determining their positive and negative aspects. For ARM’s instance, it should consider the obligations and liabilities to investors and lenders and make decisions by interpreting the financial ratios correctly. Therefore, ARM to explain the ratios that enable evaluating the current financial situation is proposed when making fundamental decisions reflected its performance (Eda, Murat & Vesile, 2015).

ARM has made significant progress across its established markets more so, making substantial in-roads in servers and smart embedded applications, after a strong licensing performance in 2015. Even though, the quarterly results in 2014 fluctuated significantly and became unpredictable which adversely affected the market price of ARM ordinary shares. Moreover, normal economic conditions may reduce ARM's income and harm its business since it depends mostly on a small percentage of customers and products. ARM's failure to achieve the performance under a license or consumer's inability to pay would materially impact its revenues. Therefore, ARM made decisions that ensured it would grow its operations significantly in the year 2015 onwards, and ARM's business would affect adversely if the management of those decisions is not successful.

Furthermore, the growing power of decision models has opened up new pathways for improving corporate performance. Hence, models would often make very accurate predictions or guiding complex optimisation processes and, in the process, would help a firm to avoid some of the usual biases that at times undermine manager's choices. For example, ARM should adopt decision models to enable it to gather real-time information about consumer behaviour by monitoring preferences and spending patterns as retrieved from the financial ratios. For instance, banks approve loans, and insurance corporations increase coverage, basing their decisions on models that are progressively updated to make the best decisions. Thus, from the ratios and their analysis, ARM should rely on using decision models to gauge their customers’ demands as the models weigh all data objectively and evenly and therefore, promoting future sales for the company (Phil, 2014).

Decision making is a critical role to the directors or managers in an organisation. However, shareholder's approval of the director decisions is required by the company's constitution. For example, the ratio results for ARM's financial year ended December 2015, provide a basis for ad hoc decision making for its shareholders where they would authorise the company to join a particular transaction on a one-off basis. Even though, it is not provided for in the Act or the company's constitution. Besides, in respect of share issues, a unanimous shareholder approval means none of the board resolutions and decisions is required. Some duties are not readily applied to shareholders, though when ratifying management decisions by a provision in the firm’s constitution, they possess the full range of director duties.

Effective strategic business decisions bring together the right resources to the right markets at the right time. The quality of ARM's decision making would help it gain an advantage over competitors. After every annual report, the financial ratios are used to determine the following year's decisions which reflect ARM's aims, such as to maximise returns for its shareholders. The decisions should also relate to its objectives, such as to be the market leader in developing technology that makes consumer and industrial products smarter, more capable and more energy-efficient. Managers and shareholders from all other businesses use internal information such as a balance sheet and external data like market information to assess effects on the firm and drive better-informed decision making. Conclusively, records of business transactions are used to prepare a company's accounting statements that accountants evaluate and interpret to advise senior managers and hence, play a significant role in managing business performance and improving decision making for future success (Okoli, 2012).

Capital Structure

Figure 2: ARM Balance Sheet (ARMH, 2016)

The analysis of an organization’s capital structure is better defined from the balance sheet. Scholars point that a strong balance sheet is an indicator of a stable capital structure for any given company. However, in order to evaluate this strength, the adequacy of working capital, asset performance, and capital structure which al serve as categories of investment quality measurements. Consequently, a company’s capitalization is the composition of the permanent and capital which takes into account equity and debt. From a shareholders’ perspective, the selection of an organization with a healthy proportion between equity and debt capitals is preferable for investing in. The strategic use of leverage improves the amount of resources a company can have and its ability to expand or grow. As a result, companies that are highly leveraged have the potential of running into risks such as the restriction of their actions by creditors from which profits have a potential of declining as well. Paying high interest cost from debts lowers the company’s financial health. Thus, in order for shareholders to establish a merit for investing with any given company, their assessment takes into account the Debt/Equity ratios which define whether the company can survive through an economic crisis and whether its growth increases shareholder value.

The debt/equity ratio is the comparison component for debt and equity and can be expressed as a ratio or a percentage. The debt ratio takes into account the comparison of total liabilities and assets. From the ARM Holdings balance sheet, the total liabilities are assets for the year ending December 31, 2015 are £322.6m and £2120.2m. The debt ratio of the company is 0.1522 (322.6/2120.2). This ratio indicates that ARM Holdings is not highly leveraged as its liabilities are fewer than the assets. As a result, the company is keen to keep the concept of balancing liabilities and assets. As a result, the company’s capital position is poorly leveraged but at the same time, the ratio also indicates that the company has high opportunities and resources for reinvestment. As a result, the organization is financially stable since its liabilities and assets balance off at only 15.22%. At the current debt ratio, the company is able to buy back some of the shares it has issued in the past. Buy back of shares shows that a company is able to cut back on debt while at the same time taking more risk by accumulating assets and cash.

When considering limitations of Debt/Equity Ratio, it is essential to note that the total liabilities and total equity can be determined in a variety of ways. Nonetheless, industries differ in terms of the D/E ratio that can be considered sustainable. For companies that are not capital intensive, a D/E ratio of 0.5 or lower is considered sustainable while automobiles on the other hand require a D/E ratio of up to 2.0. From ARM balance sheet, the D/E ratio is 0.179 (322.6/1797.6). As it is important for shareholders to compare companies, the D/E ratio helps determine the position of a company within an industry. Thus, with ARM taken into account, the D/E ratio of 17.9% falls within the industries sustainability level of 0.5 since the company makes electronic microchips and is classified under computer manufacturers. In this case, shareholders have the opportunity to conclude that other companies that may be a threat to ARM Holding should have a lower D/E ratio if they were more financially stable. In addition, the capital structure in this case shows that the company does not consider borrowing as a sustainable funding method for its operations and economic ambitions. However, the shareholders also have the ability to assess whether other companies with a bigger D/E ratio can be better positioned within the industry. Nonetheless, companies with a bigger D/E ratio showcase that they a capital structure which may be more capital intensive than ARM’s.

Following the association of debt and equity, shareholders are required to determine the type of liabilities included within the total liabilities section of the balance sheet. For instance, a balance sheet that includes long-term and excludes short-term or long-term debt nearing maturity should be analyzed with these factors taken into account. With reference to ARM’s total liabilities section includes the current and non-current liabilities. These include deferred revenue & tax liabilities, finance lease & accrued other liabilities for the non-current liabilities. For the current liabilities fair value of currency exchange contracts, accounts payable, deferred revenue, and finance lease/deferred tax, and accrued & other liabilities are considered (Largani, Kaviani, and Abdollahpour, 2012).

Based on the D/E ratio, a measure of confidence can be derived from the ratio. Since debt is a consideration for shareholders, it is role is to show how much a shareholder will have left after his/her portion of the debt is serviced per every dollar (Howard, 2013). A high debt indicates that one services the debt poorly and at the same time may suffer from enough resources to cover the debt profitably. This case, ARM D/E ratio indicates that shareholders have about 85% confidence on the company’s financial health. Since the debt only takes 15% of the total equity, a higher confidence level is expected as compared to another company within the industry which may have a D/E ratio of 25%. Thus, given that ARM has sustainable levels of equity to service debts, its financial position is relatively sustainable for investment. With an increase in issued shares, the equity of the company can grow while at the same time prompting for further borrowing if a balance is strategically determined through debt ratio. However, the risk of issuing more shares in order to borrow further is the fact that debt ratio can indicate an unstable financial health of the company. As of the results from the company’s strategic report of 2015, ARM Holdings is sustainably positioned within its industry and can survive a financial crisis which has been developing within the UK and other parts of Europe. However, the current financial climate within the UK shows that inflation and other factors that influence consumer spending and profitability of companies within the UK are moderate and spending on products is slightly affected but steady sales and revenues are generated by organization within the market. These observations showcase that the current financial environment within the UK does not have the severity capable of damaging the leverage of the company.

Shareholder Decision Making

In order for shareholders to ensure that their investments will be beneficial in terms of generating sustainable value, the consideration of how much it would cost them to earn $1 of a company’s profit is determined by the P/E ratio. The P/E ratio determines how much a company is expected to pay for every issued share. Given the difference in growth among companies, a company with a high P/E ratio is likely to incur negative growth as it enters its blue chip status (a highly profitable and large company). With reference to the ARM Holdings PE ratio, it is observed that investors are willing and able to spent £42.96 to realize £1 of the company’s profits. On the other hand, the company’s earnings per share at the current financial year 2016 is 1.04 while share price is 44.59. The two measures in this case indicates that the PE and the EPS show a stable correlation. The difference between the PE and the share price is small and not statistically significant considering that a standard deviations of the respective measures is within acceptable levels.

With reference to shareholder decision making process, the growth rates of a company and the industry are among the factors that shareholders can take into account to determine a better portfolio (Carpenter and Yermack, 2013). Since the comparison of companies through the use of the P/E ratio is not reliable enough, growth rates should be taken into account to determine the best company to invest with. With reference to ARM, the growth rate of the company considering the FY 2014 (1837.2m) and 2015 (2120.2m) is 11.54% taking total assets as a factor to measure the growth. Thus, an 11.54% growth rate and P/E ratio of 42.96 indicates that the company’s financial future can sustainably support shareholder decisions to invest and reinvest into ARM’s stock.

Conclusion

ARM Holdings is a UK-Based publicly traded company. With reference to the company’s strategic report, financial statement, it is observed that the company is financially stable taking in to records the growth rate the company has shown from the year 2014 to 2015, the small debt/equity ratio, sustainable debt ratio, and an impressive future financial position through its PE ratio. To shareholders, the company’s capital structure indicates that the company has a stable financial future which, based on the considered ratios, has cultivated a shareholder confidence. In addition, the company has a small debt which indicates that its major source of funding is equity as compared to debt. On the other hand, the surplus of total assets over total liabilities validates the small D/E ratio and shows the company’s take on debt funding.