Financial Management in the Jovi plc Company - Case Study Example

FINANCIAL MANAGEMENT Introduction: The Financial Management deals mainly with various areas like determining Financial needs, selecting the sources of funds, financial analysis and interpretation, Cost Volume profit Analysis, Capital Budgeting, Working Capital Management, Profit Planning and control, and dividend policy. When we are considering the financial plan it should focus on a long term view and there should also be liquidity of funds. The funds should be used optimally. The cost of raising the funds should be minimum. It can be ensured by a proper debt-equity ratio. The Problem: The Company Jovi plc which has a mission statement ‘time means money’ is more concerned in the utilization of money in the most effective way. The problem company is facing in the financial area is that there is no proper cash flow, which in turn leading to no funds for further investment as well as to pay dividend. The debt turnover ratio is not depicting a good picture in the credit terms. There is unduly long credit term. Although the sales is good the realization need to be improved substantially. Long duration is taken to receive cash from the sales made. Thus, because of the shortage of funds for new investment, the company is considering 3 options. The three options are: a) Ordinary shares issued at a 10% discount to ensure full subscription b) Irredeemable 8% loan stock issued at par c) Current retention, plus a similar issue of loan stock The Company should choose one of the method which is more favorable for the company’s financial position. Also the problem of cash flow difficulties should be normalized. Financial Analysis Since the company is desperately in need of additional working capital and since external borrowings would attract regular mandatory payment of interest which would become a burden to the future cash flows of the company. It has been decided to augment the working capital through injection of fresh equity capital from the investing public which would bring in Rs. 100 billion as extra funds. These funds would partially be used for meeting payment obligations, partially for creating future assets and also invested in high income low risk ventures for long term purposes of the company including investment in other strong holdings for the future development and financial stability of the company. The question of irredeemable 8 % loan stock is not feasible in the present context since it would involve a further liability of regular interest payment thereby worsening an already bad working capital position. Further since the nature of stock is irredeemable it would be a permanent liability for the company since it cannot be liquidated at a future date and could only be converted into equity stock if necessary. Therefore it has been decided that the best option would be raising equity capital from outside investing public to generate funds for day to day operation and also for investment purposes. It is proposed that the equity would be redeemable nature that could be bought back by the company when its financial position improves and it is a position to redeem the fresh equity share capital. Net Present value is used in evaluating investment proposals. It take time value of money into consideration.. It is based on the principle that a rupee earned today is worth more than the same rupee earned tomorrow. Through NPV the cash inflow and outflow are projected. NPV Technique may implement capital budgeting approach through various steps. The present value of each cash flow is determined by using a constant discount factor. The sum of these discounted cash flow is found out and this is the project’s NPV. If NPV is positive the project should be accepted and if negative, rejected. But still when implemented in Jovi plc the terms and conditions of the sales plays a significant role in determining the cash inflow. The company may be adopting this credit terms due to high competition in the market. But certain steps are further to be taken to reduce this credit term and receive the payment more quickly. For example the company can encourage payment by giving cash discount. The company should review its credit policy enline with increased realization from debtors and reduce the period of credit. Market Value Added (MVA) – “MVA sometimes is defined as the total market value of the company minus the total amount of investor-supplied capital”.(Financial Management Theory and Practice, Eugene F.Brigham, 10th Edition, Page 49). The primary goal of most of the firm is to maximize shareholders wealth. Shareholders wealth is maximized by increasing the difference between market value of firm’s stock and the amount of equity capital. MVA = Market value of stock – Equity capital supplied by shareholders. For example in the cited illustration, assuming that the stocks are valued at 9 billion and equity capital is 7.5 billion the market value of stock would be 9 – 7.5 = 1.5 billion. Economic value added (EVA) – Net Operating Profit After Tax (NOPAT) – After Tax Cost of Capital used to support operation. The concept of EVA focuses on the managerial effectiveness of the enterprise in a given year. From the cited illustration it could be quantified as 3 million and the earnings before interest and tax is 4 million with a tax rate of 25%. So EVA = 3 – 7.5 = -4.5 million. This is a negative EVA. Debtors Turnover Ratio / Receivables Turnover Ratio and Average Collection Period – It mainly implies how financial leverage may effect the risk and return. It indicates the velocity of debt collection of the firm. It is calculated by applying the following formula Debtors turnover Ratio = Net Credit Annual Sales/Average Trade Debtors. Average Trade Debtors = Opening Debtors + Closing Debtors / 2. The average debtors for the period would be 320 + 480 / 2 = 400. Therefore the debtors turnover ratio will be 1600 / 400 = 4. Working Capital Ratios – Working Capital is adequate amount required for meeting day to day expenses. The main working capital ratios are Current Ratio – that is Current Asset / Current Liabilities. The Current asset are 320 (Debtors) + 160 (Stock) = 480 The Current Liabilities are 160 (Creditors). Therefore the working capital ratio is 480 / 160 = 3 times. We find that the working capital of the company is 3 times which indicates that the current ratio is much below the average for its industry. So its liquidity position is relatively weak. But since the company is planning to go for a public issue of Equity shares at 10 % discount at the market price the cash flow to the company would increase to that level. Assuming that the public issue yields 200 billion the new working capital would be 320 + 160 + 200 / 160 = 680 / 160 = 4.25 Billion. With this current ratio the company could make additional investment and also pay off the critical liabilities. At the start of the Balance sheet analysis the net assets stood at 1.5. However we find that in the year 2014 the net asset stood at (480 – 160 = 320). Therefore it is seen that surplus funds are park in current assets which do not yield any income. It may be hypothetically stated that a better debtors realization or a quicker conversion of finished goods into cash has resulted to this situation. Again we see that in the year 2015 the net asset is 720 – 195 = 525. This may also be because of Debtors turnover. However now since there is a high Debtors turnover ratio the situation needs to be immediately remedied. We also find debtors are taking 73 and 87 days to pay (compared with creditor turnover ratios of 61 and 55 days) which suggests that the period of credit taken by customers is at the root of the liquidity problem. Therefore the discount and credit policy needs to be reviewed and the credit sales needs to be increased and the credit period may be extended. Also cash purchases may be made to absorb the excess ideal funds. If possible the company may also buy back a certain proportion of the equity shares floated so that the excess funds may be mopped up. It is believed that excess funds may also be invested judiciously to generate more income for the company and also to built reserves for tackling any unforeseen contingencies that may arise in future. The present situation is that the current assets are far more than the current liabilities which means there are ideal funds which are not properly utilized. This ideal funds may be in the form of slow moving or obsolete inventories or abnormally heavy cash or bank balance. To remedy this situation it is necessary to first identify the nature of asset which is idle and make it workable of the company. If it relates to inventories an immediate review of all inventories have to be done and excess inventories either scraped or pruned out. Inventories which carry no value should be written off and the inventory should only carry its true values. Similarly the idle cash should be invested in profitable areas and excess bank balances should be utilized for profitable measures. Even after all these measures the current assets exceed current liabilities the company should consider the options in converting its surplus funds into loans or paying of its trade creditors with the lower credit days to mop up surplus funds. It may also allocate excess funds into sinking funds for extinguishing future liabilities or to meet future contingent obligations. Conclusion: From the above it is seen that initially the problem facing Jovi plc was the tardy realization from debtors due to longer credit period. As a direct consequence of this the debtors turnover ratio was 3 / 7.4. Thus necessary steps were initiated to remedy this debtors turnover ratio by pumping funds through equity share issue thereby improving the liquidity of the company. However due to beneficial terms of sales to the customer the realizations overtook the payments made to creditors or suppliers. Thus a situation arouse that the current asset far exceeded the current liabilities thereby generating idle funds. In order to rectify the situation the discount policy to customers has now been made conservative and the terms less appealing to the customers in order to offset the surplus position. It is hoped the situation would stand remediate and the desired ratio of debtors would be achieved. In financial practices it is very important to exert effective and immediate control measures to stabilize variations from expected parameters. If the situations are not remedied in time all the time we would be faced with overwhelming situations that is now being seen in the context of Jovi Plc. Since management accounting functions form the back bone of any enterprise it is very important that regular reviews of important accounting data are done and the top management made aware of areas of weaknesses which needs to be addressed immediately in order to bring the company back on the rails. WORK CITED 1. Financial Management Theory and Practice, Eugene F.Brigham, 10th Edition, Page 49 Read More