International Finance Issues - Essay Example

Table of Contents Introduction 2 Shareholders wealth generation techniques 3 Inventory valuation method 3 Dividend Payment 3 Human resource as the value driver 4 Corporate social responsibility (CSR) as the value driver 4 Transferring wealth of bond holders to shareholders 5 Proper management 5 Evaluation criterion 6 Right/Bonus/Buyback option 6 Creating cash flow 6 Mergers and Acquisitions (M&A) 7 Depreciation 7 Lease of property 8 Tax heaven 8 Suggestion and recommendation 8 Introduction After liberalization in 1990s, the business entities have started increasing their base of operation from country to country. The MNCs moved across the nations in search of better manpower, newer consumers, wider market share and to increase the profitability. They produced extraordinary products, provide innovative services, give solutions to our problems and earn huge amount of profits and reinvest that. They distribute large chunk of their profit in terms of value generation of its stakeholders. Stakeholders include the investors, people directly or indirectly working for the company or linked to the company in any way. Business entities are incorporated to cater need of some segment. The ultimate goal of any company is earning profits so that in can be further utilized to widen up the scope of that business operations. Any living being is in need to have oxygen for the survival. In the same way, any business entity must be provided with cash for its existence. The major sources of finance for any firm are equity and debt. Debt finance is raised from various financial institutions, with the commitment to repay it back after a horizon with some specific interest rate. To go for equity finance, the company has to enlist its shares in some registered stock exchanges. Fund is raised automatically when people starts buying those shares from the exchange. In exchange of the shares, the shareholders expect returns or benefits from the company under consideration. This is termed as shareholders wealth. In perfect market condition, the performance of any company and so as the shareholders wealth is not effected by any external market forces. As for example, the smaller companies do not change the market forces significantly, so they are into an almost perfect market situation. Shareholder’s wealth is of great importance for imperfect market where market forces are largely determined by competition. Any changes in the form of customer perception, economic condition, performance of the company under consideration, competitors move are largely reflected into the share prices. The rewards of value generation are offered to the shareholders in the form of share price appreciation and dividends. Dividend is the distributed part of profit earned by the firm. Company due course of its operation generates revenue. One way of creating value for the shareholders is directly transfer the revenue amount to the shareholders in the form of dividends without thinking about the contribution of others in the profit. This is an irrelevant technique for value generation. If this policy is employed the company will lose trust from all of its stakeholders other than shareholders. Accounting result of the company Companies announce its performance in the form of quarterly result, half yearly result and annually result. Lots of expectations of the shareholders are attached with these results. If the performance is higher than the market expectation then share price will rise, as a result the shareholders wealth will also go up. Shareholders wealth generation techniques Inventory valuation method The adopted methods for the valuation of inventories are First in first out (FIFO) and Last in last out (LIFO). If the company uses LIFO for the valuation of inventory, the earnings of the company will go down as the valuation of the inventory is done at higher cost. But the cash flow will go up and tax will go up. Lower earning may reflect bad impression towards shareholders, which will devaluate the market capitalization of the firm and also shareholders’ value will go down. FIFO method is generally adopted at the time of unstable market condition. This method allows the firm to evaluate the inventory at lower cost. Here the earnings will go up and so the taxes. Due to better profit the share price is likely to go up and thereby increasing the wealth of shareholders. BOOTH L., [No Date] Dividend Payment Dividend is a channel through which the companies can bypass a part of its earning to the shareholders. Dividend always gets grand welcome from the shareholders. Long term investors always tend to invest into those types of shares which give hefty dividends. Companies, who don’t reward dividends to the investors, invest that amount of profit into some lucrative investment options. If the expected earnings from the invested capital are less than the cost of equity, it will destroy the shareholders value. In that case it is better to distribute that amount of earnings to the shareholders in the form of dividends. BOOTH L., [No Date] Human resource as the value driver If cash is the oxygen for any organization, then human resource is the heart of any organization. Robots are efficient enough to fix the loose parts of space ships but they are not suitable to run any business entity, making strategies regarding the future growth of the organization. Human resources are the most hit in terms of layoffs at the time of weak financial condition of any firm. But only human resources can restrategise the firm back to its normal operation. Skilled employees of any company can help to launch new innovative products, materialization the strategies undertaken, providing satisfactory customer service. Human resources are highly intangible and unquantifiable in nature. Human resource is not even reflected in the balance sheet of the company. Fig: Shareholders value creation process Employee skills get directly embodied into the organizational value and are reflected in the form of profitability. Thus, better human resource capability of a business entity will raise the market value of the company. This will intensify the wealth of share holders. Becker B., [1997] Corporate social responsibility (CSR) as the value driver CSR is the responsibility of an organization to some of its indirect stakeholders, and the relevance of them is increasing day by day. CSR is the tool through which firm can show its respect for the society, environment and stakeholders. If these are not taken care of well it may be threat to the firm which has the capability to erode the value of the firm t great extent. It includes people, contribution to development, corporate governance and ethics an environment. CSR is extremely intangible in nature but certainly carries utmost importance for the shareholders. Company will not be able to charge directly anything from the stakeholders for its social responsibility. But, CSR will positively improve the value or image of the company. In this world of competition, global warming and scarcity of natural resources, CSR is a key considerable point for any firm. At present, people have become more socially and environmentally conscious. This can also be a driving force for the organization. CSR will also create a better image about the organization to the stakeholders. With the rise in value and image of the firm, the company’s performance will certainly improve. This improvement will eventually lead to the value creation for the shareholders. Sherman D., [July 22-23, 2003] Transferring wealth of bond holders to shareholders Bond holders indicating the sources from which company has taken loan to fulfill its short term and long term goals. Cost of equity is always more than the cost of debt. During the financial distress condition of the company, often organizations fail to repay its loan amount. It gradually becomes a burden for the company. Without liquidity it won’t be possible for the company to run its business. This type of stress situation dries out the value of the company. So, company can convert the bond holders into equity holders by paying them equivalent amount of equities. Thus the company will be out of the unstable financial situation and will be able to rework on its operations and strategies. With proper restructuring process company will be able to regains its market value. This will create wealth for the shareholders in the long run. Proper management Management is the driver of any company. Wrong decisions made by them may lead to losses for the organization. On the contrary, due course of good management only companies like Apple Inc. still making profits in this worldwide economic downturn. Business is always affected by various kinds of risks like market risk, credit risk, business risk etc. Proper risk management techniques are extremely important for the survival of risk. If the risks are not properly minimized or diversified then the company will incur huge amount of losses. So by proper risk management, company will be able to maintain its value in the market. In turn it will create shareholders wealth in the form rising trend of share price. Chapman R., [n.d.] Evaluation criterion The employees who are working for the welfare of the company are the real human assets for any organization. There should be a proper measurement techniques through which it gets clear who are those real assets are. Evaluation scale should not be based only upon the job responsibility but also upon the value they are creating for the organization. Proper performance appraisal and facilities should be provided to them as per their contribution. This kind of evaluation scale will help raising the organizational value. It will benefit the shareholders in term of their wealth. Right/Bonus/Buyback option MNCs can offer right option or bonus shares time to time for the shareholders. In these techniques shareholders are issued with additional amount of equities against their existent shareholding. Shareholders can earn more as the share base for the investors will increase without paying extra for the additional shares they are being offered. This will also increase the involvement and loyalty of the shareholders towards the company. When the share of any company is not performing well in the share market, company can decide to buyback certain portion of its equity through open price. Open price is always more than the prevailing market of the shares. This extra price is offered just to create the shareholders value. Less number of outstanding shares will lead to lowering the volatility of share. Creating cash flow Free cash flow available with the company determines the operation ability of any firm. The key factors involved here revenue, operating cost, tax, investment and working capital. Company can adopt various techniques to check the value of operating cost, tax rate, investment and working capital. LIFO and FIFO techniques for the valuation of inventory can make a difference in operating cost. Company can shift some of its operation where the tax rate is very minimal. Setting up units in Special Economic Zones as offered by some countries will reduce the tax liability of the company to a great extent. Company should invest into right amount of investment vehicles at right time. So, that the earnings from these investments are high. Diversifying the investments can reduce the investment risk to a great extent. Improper working capital management can lead to loss in terms of opportunity cost or in terms of forgone sales. Innovative techniques like Just In Time for the management of inventories will reduce its carrying cost. All these factors will improve the cash flow for the company. More the cash flow, the more is the financial strength of any company in terms of future operation and growth prospect. Better growth prospect will ultimately give rise to shareholder’s wealth generation. Mergers and Acquisitions (M&A) Mergers and Acquisition is the best way for the organic growth of any company. During the deal, the difference between the price paid for acquisition and true valuation, n of the target company is termed as goodwill for the purchasing company. This goodwill is to be disclosed clearly in the balance sheet. This process leads to increase the confidence among the shareholders and is reflected accordingly in the share price. In M&A activities the bidder companies often offer share premium to the target company. This is a direct extra benefit for the shareholders of the target company. In general, during the prior stage of M&A the share price of the target company often gets appreciated. This is due to the increase confidence of investors into this company. This extra confidence pushes the share price high. The shareholders of the target companies can earn from this also factor also. But when the merger gets executed shareholders of both the companies get benefited from it, if the due diligence is carried out effectively. BOOTH L., [No Date] Depreciation Depreciation is the value erotion of assets due to its use over the use. The two widely accepted method to calculate the depreciation is straight line method and written down method. If the company go for straight line method valuation, the depcrication will be comparatively lower and so the overall asset valuation will go up. This may be a driving factor for some of the shareholders to consider the company as their investment target. But higher asset valuation will lead to higher tax payment for the company. So, the overall profit will come down. This will be cause of value erosion for shareholders. But if the company goes for written down method, the overall profit will go up, as the tax liability will for the company will go down. This will be drive the shareholders value up to many folds. Lease of property Lease payments are entitled to get tax shield benefit. If the company go for leasing rather than buying some properties, it will lowered down the tax liability. Lowering tax will increase the overall profit of the firm. Profit growth is certainly a good factor for the shareholders income or wealth. Tax heaven Diversification is the way to minimize risk associated with the business. The company should diversify or shift more its operations into tax heaven places like Malaysia, Mauritius. These regions have a lean tax rate for the business operations. So Company will gain in two factors namely lowering business risk and low tax liability. Lowering tax will increase the overall profit and also the overall valuation of the company. In this way the shareholders value will intensify. Suggestion and recommendation The shareholders are the real risk taking investors for the companies. So improving their wealth must be the priority for any organization. Actually every initiative taken by the organization for its welfare is more or less linked to the creation of wealth for the shareholders. For that, organization must ensure that right strategies are being adopted at the right time and with proper vision. The company must keep a track of various factors which are responsible for the creation of shareholder’s wealth and priorities them as per their contribution. Steps should be taken as per the performance of each factor for the value creation for the organization and also for the shareholders. If the company is successful in creating value for the shareholders, it is going to be a win-win situation for both the parties. The shareholders will be benefited in terms of capital gain and company will be rewarded in terms of the investment made by the shareholders. The switching cost for equity is low or nil. If the company is failed to increase the wealth of shareholders, then the shareholders will shift their investment focus from other well performing company in the market. References 1. BOOTH L., [No Date], University Of Toronto: Rotman School of Management, [Online], Available at : http://www.rotman.utoronto.ca/~booth/value.pdf, [23rd April, 2009] 2. Sherman D., [July 22-23, 2003], Strengthening the Link Between CSR and Shareholder Value, [online], Available at: http://www.sustainablevaluepartners.com/svp_csr_for_energy.pdf, [25th April] 3. Becker B., [1997], HR As A Source Of Shareholder Value: Research and Recommendation, [online], Available at: http://www.courtenayhr.com/images/HR%20as%20a%20source%20of%20shareholder%20value.pdf 4. Chapman R., [No Date], National Computing Center, [online], Available at: http://www.nccmembership.co.uk/pooled/articles/BF_WEBART/view.asp?Q=BF_WEBART_286539 Bibliography 1. Building and Communicating Shareholder Value, [No Date], Businessintelligence, [online], Available at: http://www.business-intelligence.co.uk/reports/shv/summary.asp 2. Delcoure N., [No Date], Corporate branding and shareholders’ wealth, [Online], Available at: http://programs.business.utsa.edu/swfa2009/PDF/162.pdf Read More