BMW in Relation to its Financial Strategy - Term Paper Example

BMW and Its Financial Reporting and Management Accounting Introduction The purpose of this paper is to discuss the company BMW in relation with its financial strategy. The company analysis will be performed in relation with the market it operates in and the report covers their accounting policy and the implications of their choice of strategies over the years. The main characteristic of the company’s business strategy is its excellent risk management and hedging strategies which are a standard for other companies in the industry. BMW is an acronym for Bayererische Motoren Werke which is best translated in English as Bavarian Motor Works. The company was established in 1916 as a result of a merger between two Germany based airplane engine manufactures, Rapp Motorenwerke and Otto Werke. From then on the merged company made engines for airplanes and also started planning diversification into other businesses. However after the World War II as per the sanctions by the Versailles Treaty the company was no longer allowed to make aircraft engines for airplanes, due to its Germany nationality. The company therefore decided to modify its aircraft engines to powerful motor vehicle engines for cars and motorcycles. Now BMW has managed to gain significant market share in the market for luxury cars. The main four brands which come under the BMW were acquisitions of other companies. These are in themselves well known brands which have been existent in the automobile market for quite some time. These strategic business units that come under the BMW Group include: British Rolls Royce Motor Cars Limited British Range Rover Group BMW Motors Mini Motors The fist time when the BMW Group ever had to face any form of financial crisis after the World War II was in 1959. However with the success of its new and innovative product the BMW 700 the company was able to from its financial setback. BMW in the Automobile Industry BMW is a leading automobile manufacturer with the business philosophy to “build driving machines that respond faithfully and enjoyably to their driver's commands while also providing the safety, practicality, style, quality, reliability and durability that help make long-term ownership a rewarding experience” (Vintage Motors). The company has managed to practice the unique blend of Japanese efficiency and kaizen techniques with the dynamic and rapidly evolving American business phenomenon. The North American President for the BMW group, Victor Doolan, once said “Our status is our driving pleasure, not our badge.” (Holstein, 1996) The industry in which the company is currently operating has the following trends which can have a significant effect on the operations of BMW Group in the future: The product life cycle is decreasing and as a result the time the company has to respond to the evolutions taking place in the market is becoming very constrained. The price of entry into the market is determined by the quality and the reliability of the vehicle. These characteristics are now a mandatory requirement set by the customers. As a result in order to differentiate the product a car manufacturer has to come up with unique appeals. BMW is currently relying on the passiveness and the active safety of their car as a differentiating factor. The market is becoming customer oriented and the customers want more customizations and personalization in their cars. This requires a lot of variants to come into the market. However BMW does not intend to deviate from its business philosophy. BMW’s business strategy is to provide more value in its products for its customers while striving to keep their own costs for the products low. Previously the potential customer for the company was a man around the age of 40. Now the company has changed its image and is targeting people in all walks of life who want driving excellence. The target market for there customers has now been expanded to include females as well. Financial Strategy: The financial strategy for the company is proactive and takes support from the hedging oriented risk strategies. They have invested in a diverse range of products to minimize their chances of incurring losses. The company’s marketing strategy for the diverging onto diverse markets also supports the company’s financial strategy by establishing a precautionary hedge against competitive pressures and imminent problems. The company is also focusing not to reduce its return on investment on the smaller cars being manufactures under the BMW group enterprise. The company is focusing on keeping its profits high and intact by investing in product differentiation. The chief executive of the company has mentioned in press releases that the company is now focusing towards making small cars as well to cater to the increasing demand in this market segment. However in order to reduce the financial risks involved with this venture the company has kept its return on investment (ROI), consistent with other products even though the target market is likely to be much more profitable specially due to the popularity of the Mini with the consumers. The company is also heavily depended on debt financing as “debt financing offers corporate borrowers an increasing number of very flexible instruments in an increasingly international environment.” (Ballara, 1998) SWOT Analysis The SWOT analysis of the company depicts the position of the company in the market relative to its competitors. This specific analysis is highlighting the financial attributes as well as environmental, economical and social factors which are affecting the company. The BMW Group holds the largest markets share in Germany with the second strongest market base in the United States of America. The company holds a strategic advantage over other companies in the small car and sports car segment. Strengths Over the years the company has been able to achieve growth in all the markets around the world. Since 2000 the company has attained 5% growth in Germany, 22% in USA, 31% in China and 26% in the Asia Pacific region The company has a very strong brand name and it has managed to achieve a unique perspective in the minds of the consumers. It has managed to achieve a unique perspective in the minds of the consumers. The brand is very recognizable amongst the target market which helps the company launch new products with much ease The company has been able to expand its product portfolio to include the significantly strong brands such as Rolls Royce, Mini, Range Rover and the BMW itself. Weaknesses The company has been undergoing extensive product and brand launches in the past few years. This entails that the company will have to spend more funds in handling and maintaining these accounts and marketing these products. The company has also expanded its target market to include the customers in Asia and the South Pacific region as well. As trade with these countries can turn out to be expensive with the trade regulations and the tariffs. As a result the company will have to struggle to keep its costs at a low to have the comparative advantage to its competitors. Although the company maintains that they do not want to deviate from their core operations the company has actually in reality managed to go into diversified niche segments which do not hold long term scope for growth. The company is also very dependent on the brand name. This is entirely not a bad thing but if the company does not innovate and update its brand image the dependence on the brand name can prove to be successful only so long. However the good thing is that the company does provide the customers with the best quality of motor vehicles. Opportunities: The company has a chance to increase is stagnant sales levels like the ones in 2003-2004 by expanding on its product offering which is in line with its business philosophy. The company has a good chance of better growth by developing on the X3 and the 6-series Coupe models. The company can also explore alternative fuel development. It has already managed to launch the hydrogen fueled car which hit the market in 2005 and more in-depth research and product development will give the company a competitive edge and scope for future evolution and growth The company has already started developing the MINI brand in the market. This brand can significantly boost BMW’s image and sales due to its dynamic looks and functionality. Threats: The target market for luxury and sports car is getting saturated and as a result the future forecasted growth in the industry is not up to par for BMW’s operation. The company will have to make changes to its target market and as a result the company is going to have trouble in the coming future to compete with brands which provide fuel efficient and cost efficient cars like Nissan and Toyota. Competition in the luxury car market is also increasing with the emergence of Lincoln and Lexus. The current market leader like Mercedes and Audi are also facing problem of the same nature due to the changing market dynamic The fuel prices are increasing which has lead to customers focusing towards fuel efficient cars to fit in their budgets. Also the increased level of taxation by the government on the corporations also threatens to drive their costs up. Although BMW started off as an airplane manufacturer now “BMW’s core products revolve around its range of 3-, 5-, and 7-Series saloons, meanwhile the company is also successfully established in the small car, sports car, and motorcycle markets.” (Datamonitor, 2003) Evaluation of the Financial Statements For 2003 the Income Statement for the BMW Group showed the following: The net profit for the company was Euro 1,947 million, a decrease of 3.4% from 2002. The decrease was attributed to the low exchange rate for the US for the year. The group had achieved a growth of 4.2% when adjusted for the exchange rate The revenue brought in from the MINI and the Rolls Royce cars was at a stagnate level from 2002 The revues for the motor cycle fell by 6.6% compared to 2002 The revues for the financial services fell by 6.6% compared to 2002 There was over all revenue growth in all geographic regions The gross profit for 2003 also fell by 2.1% compared to that of 2002 Even with the increase in the expansion the sales and administration costs rose by only 1.3% in 2003 The net financial result for 2003 had improved by 28.8% when compared against 2002. this was primarily due to the gains achieved in the financial derivative markets For 2003 the Cash Flow statement for the BMW Group showed the following: An increase in the cash flow from operation in 2003 to 7,871mill euros compared with 2002 The cash flow from investing activities increased by 1,516 mill euros from 2002 to 2003 The cash flow from the financing activities increased to 2,768 mill euros which was used for sales financing activities The overall cash flow from 2002to 2003 increased unfavorably by over 400 mill euros for the company. This was attributed largely to the purchase of marketable securities For 2003 the Balance Sheet statement for the BMW Group showed the following: The balance sheet total for 2003 increased by 10.7% to result in 61,475 euros The increase in the assets was due to increased receivable from financing, property, plant and equipment The equity in the balance sheet column increased by 16.4 percent with a 16.9 percent increase in the provision. The debt also increased by 4.5 percent to result in tax deferrals of 67.6 percent The ratio analysis for BMW group for 2003 showed the following Ratio 2003 % 2002 % Gross Margin % 22.7 22.8* 22.7 22.8 EBTIDA Margin 13.8 13.3 EBIT Margin 8.1 8.3 Pre Tax Return on Sales 7.7 7.8 Post Tax Return on Sales 4.7 4.8 Pre-Tax Return on Equity 23.1 30.6 Post- Tax Return on Equity 14.0 18.8 Equity Ratio – Group 26.3 25.0 Equity Ratio – Industrial Operations 45.4 43.1 Equity Ratio – Financial Operations 9.8 9.4 Equity as a percentage of Current Assets 119.5 117.4 Equity as a percentage of Non Current Assets 79.9 73.7 These figures are taken from the 2003 financial reports for the BMW Group Almost all the ratios were in decrease aside form the equity ratios. This suggests that the company falls short of short term financing for its operations. This could mean that the company is facing losses in the short run. However note should be taken that “in 2003, economic conditions prevailing on some of the world’s automobile markets were difficult. At the beginning of 2003, the global economy was still experiencing low growth rates. Although the situation picked up during the course of the year, the overall growth rate for the full year was still only modest.” (‘Annual Report 2003 - Developing Power’, 2003) The only country which did face a commendable boost in the automobile industry was the United States of America. Risk Management at BMW Group: The company extensively makes use of hedging to avoid and minimize risk in its operations. The company has two treasury buildings departments in Munich and New York which are responsible for managing the interest rate effect on the company for the Europe and American regions. The Asia region is covered by the Japanese office. The company manages its automobile and motorcycle business solely from cash flow as a result the debt financing is used for funding the financial service provided by the company. The purpose of this business is to support the sale of the automobiles and motorcycles produced by the company. Joachim Herr the head of risk management at BMW mentioned in an interview that “The overall policy at BMW is to match assets with liabilities and not to take any interest rate risk -- Herr's team does not act as a profit centre.”We're very conservative in choosing the instruments we use -- 95% are just vanilla swaps -- and our main task is to turn our interest rate exposure in to a position which is not sensitive to interest-rate exposure. Taking on speculative risk, furthermore, is not in Herr's remit. BMW has the ability to use trigger swaps, says Herr, but this adds a further layer of complexity and means there isn't 100% hedging because of the trigger mechanisms.” (Pink, 2004) The Board of Management and the Supervisory Board are regularly informed are routinely informed about potential risks. The following depict the different tools for risk management in place at BMW. The group uses a comprehensive risk management system that depicts affects of BMW’s exposure to the varying interest rates, foreign exchange rates and provides for value at risk. In-depth project analysis is conducted for business decisions Mitigation procedures are defined and mapped out proactively All decision makers are kept up to date with the risk management system The risk management is the responsibility of the group and is therefore supervised by the controlling department for the group “The internally developed foreign exchange model shows the equilibrium rate for each currency and that gives BMW an indication of whether major currencies in which it is active are currently over or undervalued. Every treasury center reviews its exposure on a weekly basis and sends a report to central control. At the center, overall exposures are calculated and a committee decides on further measures to be taken. The goal is an average hedge of around 36 months within a six-year period. The company currently handles all commodities through long-term contracts purchasing department” (Neville, 2003) In order to avoid unpredicted risks the BMW Company also arranges meeting with key associate to discuss the status of the economy and the industry and what possible risks arise in the future or as a result of certain action on the company’s part Financial Implications: The company makes use of multiple tools and alternatives for carrying outs its strategy, the company has been able to shift its focus quickly and effectively to respond to the changing financial conditions in the market. The biggest problem faced by the group is the unstable nature of the currencies it deals in. As a result the company uses different vehicles to fund the targets set by the company. This form of debt financing has proven to be good for the company as the chaining dynamics with the currency and the inflation have resulted in the deals being in favor f the company. However in order top maintain its position the company will have to take care of the timing of its operations. In an interview with Euroweek the BMW representative said that a proposed single currency cannot be a long term solution for their problem “On the one hand, we expect that after the introduction of the single currency we will be able to reach new investors in a growing market. But on the other hand, there will also be even more competition among borrowers and that will make credit standing even more important” (Ballara, 1998). Continuing on he also said that the company has “a variety of programs already in place which address different types of investors. We will continue to extend the variety in our funding and adapt our funding to the changing market conditions.” (Ballara, 1998) Finance Management Issues and Recommendations: In order to give a transparent picture of the company to the investors the company should employ the following: Report not only the financial result but also ton the effectiveness of their controls set on their internal operations Reducing the volume and the complexity of the information being shared with the investors. The information should be explained in plain English instead of accounting terms to come up to the investors level of understanding. “Companies should use executive summaries to highlight what's really important” (‘Cooked Books? Not This Time’, 2005) Provide summaries of reports in a comparable format The best method for reconciling the accounts of the company make up of the following key points: Have monthly reconciliation taking place in the business. This makes it accountable and easy to follow the trends. The leads can be followed and any discrepancies can be identified. Using suspense accounts prior to reconciliation is a good strategy as it helps in minimizing errors and does not have the error effective the active accounts directly which difficult to adjust. Any new accounts that are created or deleted should be informed to the customers and the related parties The company should maintain company chart of accounts to record and keep track of all the accounts that are present and being used by the company. “Ideally, companies should prepare a manual describing each account in the chart of accounts with examples. They should update these when accounts are deleted or created, and should keep the manual where all users can access it.” (Abeysekera, ‘Reconciling Accounts’) The chart of accounts should be visited on a periodic basis to check the accounts and their updates Changes in the government regulation: The UK listed companies are now required as of 2005 to provide and OFR as well as an IFR Corporate regulations include the CEO’s and CFOs to certify the financial reports. They can also forfeit any bonuses if the earning is low due to apparent foul play. The Sarbanes-Oxley now has “Increased CEO and CFO penalties for false statements to SEC or failing to certify financial reports to a $5 million fine and a 20- year prison term.” (‘Sarbanes Oxley Act’, 2002) Conclusion: The BMW Group is a multinational company with operations spanning multiple continents. The diverse nature of the company and its markets also requires it to have diverse sourcing for its resources. The company basically is focused on financing its automobile sector operations through its own return on investment and cash flow while the financial service sector is being run on loans and borrowed funds and investment of third parties The degree of debt financing and the currency structure the company operates in requires the company to have a strong risk management strategy in place to support its finance strategy The risk management strategy in place at BMW is that of hedging and managing multiple investors and funding portfolios. This has worked well for the company in past but is proving to be complicated in the current scenario with the single currency of Euro being operational in the EU region. References 1. Vintage Autos, "BMW" Available at: http://www.vintageautos.com/bmw.htm 2. William J. Holstein, (1996), “No time to luxuriate, Can BMW stay on top in a tough luxury-auto market?" US News 3. Dr. Norbert Reithofer, (2007), BMW Corporate Communication: Media Information, Annual Accounts Press Conference Available at http://www.bmwgroup.com 4. Abeysekera, Indra, Tidy Minders - Reconciling accounts 5. (2005), Cooked Books? Not This Time - Kinplinger 6. Dzamba Andrew Ed., (2002), IOMA’s Report on Financial Analysis Planning and Reporting 7. Bulls, Richard, Technical Matters – Financial Ratios 8. Kennedy, Allison., Dugdale David., (1999), Getting Most From Budgeting 9. BMW Group, (2003), Annual Report 2003 - Developing Power 10. Datamonitor, (2003), BAYERISCHE MOTOREN WERKE AG - SWOT Analysis 11. (2002), Provisions of the Sarbanes-Oxley Act 12. Ballara, E., (1998), Corporate(s) Learn Credit Lessons, Euroweek, Issue 572, Facing up to a buyers' market p17, 4p, available at: http://web.ebscohost.com/bsi/detail?vid=1&hid=104&sid=9899455e-1696-4d5b-a44d-a2a1504cc75c%40sessionmgr106 13. Neville, L., (2003), A Natural Pillar, Risk, Vol. 16 Issue 7, pS6-S7, available at: http://web.ebscohost.com/bsi/detail?vid=1&hid=108&sid=f6556876-e036-498a-be37-4dcd8ea91fac%40sessionmgr107 14. Pink, R., (2004), Risk Management's Winners and Losers, Corporate Finance, Issue 232, p26-30, available at: http://web.ebscohost.com/bsi/detail?vid=1&hid=106&sid=6ac4a810-7850-4909-81a9-e74e585f5824%40sessionmgr104 Read More