Preparation of Financial Decision Making

Question: Discuss about the Preparation of Financial Decision Making. Answer: Introduction Financial management is very much important for an organization to manage all its funds. The financial statements of a company include income statement, cash flow statement and balance sheet. The income statement shows revenues, expenses, profit or loss of the company. The cash flow statement shows the inflow and outflow of cash. Balance sheet shows the assets and liabilities of the company. The main aim of the report is to analyze the financial resources of Woolworths (Atrill, 2006). Woolworths is the largest supermarket chain in Australia and operates more than 950 stores all across the country. The main aim of the company is to provide high quality products to their customers and relies on 121000, team members in support offices, distribution centers and stores in order to provide customers with superior value, range, service and convenience. Vision statement The vision of the Woolworth Company is to improve the stock returns and optimising the efficiency with ensuring the serving for the customers. Mission statement The mission statement of the Woolworth Company helps in the formation of the community with the consideration of best loved retailer. Core values The core values of the company depict the provision of the best values to the shoppers values with bringing variations in the products. The product consists of the suppliers product which is sold at the best prices with providing the best values for the consumers. The management of finance is very much important to plan for future development as well as achieving long term goals. Woolworths is the most innovative and fast growing retailers in Australia. It is important for the company to generate profits in order to provide maximum returns to their shareholders (Woolworths Online, 2016). Capital structure Woolworths has managed its capital structure with the aim of enhancing the long term value of the shareholders through its weighted average capital cost while retaining flexibility to undertake and pursue capital management initiatives. The company has maintained and achieved its strong long standing investment credit ratings grade (Helbk, Lindest and McLellan, 2010). The capital structure should be managed by appropriately utilizing its funds and choosing sources of finance. The company will generate maximum return for their shareholders with the help of appropriate capital structure. The company has long term policy of debt financing that involve: A bias towards the long term debt from capital market in order to match the long term assets Minimizing the risks of re-financing by staggering the debt maturities and utilizing diversified debt sources (Hillier, 2010). Foreign currency exposure and fully hedging rate of interest to provide certainty around the funding costs. The board of directors considered the advantages of increased certainty in funding costs and liquidity to outweigh the benefits of increased exposure to the financial markets. It may result in the weighted average costs of funding at any point being lower or higher than current spot rates of funding. WASS is the return rate that an organization must earn using all its current assets so that the company can be able to satisfy and pay its shareholders (Holton, 2012). The above discussed long term finance should be used by Woolworths. Sources of finance The long term finance refers to requirement of capital for a period more than five to ten years. Woolworth should invest in their fixed assets like land and building, plant and machinery etc. The long term finance sources that can be used by Woolworth are as follows: Equity Shares or Share Capital Equity shares are common finance source for large organizations. It is sharing of rights of ownership and considered as costly in comparison to the debt finance. It also requires los of legal formalities and the investors invest into the company through equity shares (Berk and DeMarzo, 2007). Woolworths should issue equity shares for the shareholders to increase its capital investment. Preference stock Preference share includes both debt and equity stocks. Preference shares have got priority over equity shares in terms of dividend payment and capital at the time of the liquidation. Woolworths should use appropriate mixture of investment by issuing both debt and equity shares. Debentures Debentures are considered as the cheaper source of finance in comparison to equity. The company has to pay interest to the debenture holders and requires legislation while offering to common public (Choi, 2003). Retained Earnings Retained earnings are the amount of earnings that are not paid to the shareholders but retained by the organization to reinvest in its core activities. The retained earnings should be used by Woolworths to increase their capital investment. Loan The nature of loan is very similar to the debentures except it does not involve too much issuing cost as because it is given by financial institutions or bank. It is considered as one of the most important sources of long term finance (Elliott and Elliott, 2008). Loan is considered as long term finance for Woolworths to increase its capital. Venture capital Venture capital is same as the equity shares. Woolworths can use venture capital in order to invest in new organization and do analysis continuously that will help to take decision for further investment. Gearing Ratio Gearing ratio is the general classification that compares the equity of the owner to funds borrowed by the firm. It measures the financial leverage that shows the degree to which the activities of the company are funded by the owner and creditors (Kieso, Weygandt and Warfield, 2007). Gearing Ratio = Total Liabilities/Total shareholders equity Woolworths Liquidity/Financial Health 2014-06 2015-06 Gearing Ratio 2.36 2.34 The gearing ratio of Woolworths has decreased from 2.36 to 2.34 from the year 2014 to 2015. Higher value indicates that the company has higher leverage degree ad higher degree of risk. The gearing ratio of Woolworths has decreased which means that the leverage degree has decreased (Leonard, 2007). Higher leverage indicates high level of debt in comparison to the equity of the shareholders. Therefore, organizations with higher gearing ratio have higher amount of debts to service. Capital Structure Theories The capital structure theories help in depicting various types of proportions with the consideration of the financial leverages and henceforth the equity, debt and the preferences are described. A capital structure theory focuses on the maximization of shareholders value and thereby the financing mix is created. MM Theory The MM theory is a part of the capital structure theory in which irrelevance proposition is assumed that consists of no taxes and no bankruptcy costs. The weighted average cost of the capital seems to be remaining constant with thereby considering the changes in the capital structure. Pecking Order Theory The Pecking Order Theory is defined on the basis of three sources of funding which are seemed to be available for the firms that are the earnings, debt and the equity. In this part the retained earnings creates no adverse problems and thereby the debt is seemed to be creating a small amount of the selection problem. Trade off Theory The trade off theory refers to the idea that the company chooses how much debt and equity finance is used for balancing the costs and the benefits. It basically helps in entailing the offsetting costs of the debts which is seemed to be created against the benefits. It primarily deals with the two concepts that are the cost of financial distress and the agency costs. Agency Theory The agency theory in terms of finance is defined as the relationship or the bonding created for the management of the organisation or the company. Corporate executes and the shareholders of the company become the main examples for describing the agency theory. It also helps in describing the main challenges revolving round the agency relationships and thereby the personal goals are fixed. Risk Characteristics Woolworths can use long term finance sources in order to increase its finance and investing into its core activities. Equity share can be used for fianc but is more costly in comparison to debt finance and not easy to increase the company as it requires lot of legal formalities (El-Masry, 2007). The risk associated with debenture issue is that the company has to pay fixed interest to shareholders even if the company suffers losses. Taking loan from banks or financial institutions is also considered as fixed liabilities as because the company has to pay interest and principle loan amount. The payment of preference shares can be delayed for some reasons but cannot be ignored as because it has more priority over equity shares (Fischer, 2010). However, Woolworth has to raise its finance with the help of long term finance in order to achieve the future goals. It is important for the finance department to determine and evaluate the sources of finance in order to achieve the companys object ives. The major drawback of the long term debt is that it restricts the monthly flow of cash which also increases the risk for the company. The increase in liabilities imposes major threats to the companies that should be kept in mind while using the long term sources. Liquidity Management The management of liquidity is very much important for a company in order to operate its business without any risks. Managers, lenders investors look into the financial statements busing the liquidity ratios to determine and evaluate the liquidity risk. Liquidity Ratios Liquidity/Financial Health 2014-06 2015-06 Current Ratio 0.95 0.84 Quick Ratio 0.21 0.23 Debt/Equity 0.4 0.28 The current ratio and quick ratio of Woolworths is below one which shows negative sign for the company. The ability of paying off its obligations has decreased in both the year 2014 and 2015. The debt to equity ratio is below one which means that the debt level of the company is not so high. Working Capital Management Working capital management refers to the accounting strategy of a company designed and to utilize and monitor two components of the working capital, current liabilities and current assets to ensure that the company is operating efficiently. The main objective of working capital is to ensure that the form always maintains sufficient flow of cash to meets its short term obligations and short term costs. It involves monitoring of flow of cash, liabilities, and assets through ratio analysis (Moles, 2011). The ratio analysis includes working capital ratio, inventory turnover ratio and collection ratio. It is important for the management department to manage working capital as it helps to improve financial operation of the company and also helps improve the profitability and earnings. The working capital management includes inventory management, account receivable management and account payable management. Therefore, it helps to manage flow of cash, current assets and current liabilities o f the company. The collection ratio estimates how efficiently the organization manages its account receivable. It estimates average number of days that the company takes receive payment or covert its sales into cash (Moretto, 2008). In order to operate with efficiency and maintaining a high working capital level it is important for the company to balance carefully inventories and also meeting the needs of the customers. The capital cost utilized on the working capital should be minimized in order to achieve high profitability. The cost of capital can be minimized by using long term finance in an appropriate mix. The investment return made in the current assets should be more than weighted average capital cost in order to ensure maximum returns for the company (Smart, Megginson and Gitman, 2004). Working Capital Ratio = Current Assets/Current Liabilities Woolworths Liquidity/Financial Health 2014-06 2015-06 Working Capital Ratio 0.95 0.84 The working capital ratio is also known as current ratio that helps to measures the ability of the organization to pay off its obligations with its current assets. It is more important to the creditors as because it shows the level of liquidity of the firm. Current assets helps to pay off the current liabilities efficiently as because it can be easily converted into cash. The working capital ratio of Woolworths has decreased from 0.95 to 0.84 from the year 2014 to 2015. The higher the ratio is more favorable. The ratio below one is considered risky by investors and creditors because it shows that the firm is not operating efficiently and will not be able to cover its debt (Spiceland, Sepe and Nelson, 2011). The working capital ratio below one shows negative performance by the company as it is referred to as the negative working capital. Therefore, the company is not appropriately managing its operations. The company has to manage its short term finance in order to increase its effici ency. The short term finance that should be managed is as follows: Bank overdraft The financial institutions provide bank overdraft facilities in which a company can withdraw amount in excess of their available balance (Stittle and Wearing, 2008). It will help the company to finance its operating activities in short run. Trade Credit Trade credits are provided by the suppliers to their customers. It is referred to as the number of days that the seller would allow before due payment. Lease Woolworth can use assets on lease which means that the company can use the assets without purchasing it (Vance, 2003). The sources of short term finances should managed by the managers of Woolworths in order to operate its activities efficiently and effectively. An efficient management of working capital is very much important for a company to operate its activities efficiently (Wolf, 2008). Key Ratios - Efficiency Ratios Efficiency 2014-06 2015-06 Collection period 35.85 39.91 The collection period is the time period that the company takes to receive payments from the debtors. The collection period of Woolworths was 35.85 in the year 2014 and 39.91 in the year 2015. The management of cash is very much important for a company. It is the process to collect and manage cash which ensures financial stability of the company. It involves not only avoiding the insolvency but decreasing the account receivables, choosing appropriate short term investment and increasing cash to improve position of the company. Dividend Policies Dividend polices plays a vital role in distributing the retained earning obtained from the overall sales and other key activities of the company. Dividend polices is primarily signifies to the explicit and implicit decision of the shareholders related to the retained earning which should have distributed or divided to the shareholder of the organization (Wood and Sangster, 2005). The primary objective of the dividend policy is share the relationship between the organization dividend policy and the overall market value of the basic stock Date Dividends 3/2/2016 0.6286 9/9/2015 1.02857 3/18/2015 0.9571 9/10/2014 1.02857 3/17/2014 0.928571 9/9/2013 1.01429 3/18/2013 0.885714 9/10/2012 0.957143 3/19/2012 0.842857 9/12/2011 0.928571 3/21/2011 0.814286 9/13/2010 0.885714 3/22/2010 0.757143 9/7/2009 0.8 3/23/2009 0.685714 9/1/2008 0.685714 3/20/2008 0.628571 8/31/2007 0.557143 3/22/2007 0.5 9/4/2006 0.442857 3/27/2006 0.4 9/1/2005 0.385714 3/24/2005 0.342857 8/30/2004 0.342857 3/22/2004 0.3 9/4/2003 0.3 3/27/2003 0.257143 9/4/2002 0.257143 3/27/2002 0.214286 9/6/2001 0.214286 3/29/2001 0.171429 9/8/2000 0.185714 3/30/2000 0.142857 9/9/1999 0.142857 3/30/1999 0.114286 9/7/1998 0.128571 3/26/1998 0.114286 9/11/1997 0.128571 3/25/1997 0.1 10/10/1996 0.114286 3/28/1996 0.1 10/18/1995 0.114286 4/3/1995 0.085714 11/2/1994 0.085714 3/29/1994 0.085714 11/1/1993 0.085714 Graphical representation Dividend is considered to be a significant part of the company retained earning distribution. The board of director of the Woolworth confirmed and assures a final dividend per share of 72c outcome in the overall total dividend of 139c for the financial year 2015 with an average increase of 1.5% on the given fiscal year (Hafer and Hein, 2007). The overall payment of the April 2015 and October 2015 dividends will have the expected return on around 1.8$ billion and $0.8 billion in the overall franking credits to shareholders. Woolworth Limited expected to get a return of around 1.9$billion of franking credit which is available for the key future distribution. Profitability of the company Profitability 2014-06 2015-06 Tax Rate % 30.06 30.33 Net Margin % 4.02 3.53 Asset Turnover (Average) 2.62 2.46 Return on Assets % 10.56 8.66 Financial Leverage (Average) 2.36 2.34 Return on Equity % 25.43 20.35 Return on Invested Capital % 18.79 15.4 Interest Coverage 13.65 13.04 Profitability ratio help to provide a clear and precise idea about the company financial position and huts help to throw light on the company profit and loss margin on the basis of the profit and loss statement. Profitability ratio includes tax rate, net profit margin, asset turnover, return on asset, financial leverage, return on equity, return on invested capital and interest coverage ratio. The profitability ratio of the company is measure and calculated on the basis of the profit and loss statement. The ratio calculated over here is compared with the two year 2014 and 2015. The two financial year ratio which helps to throw light on the profitability aspect of the company is considered (North and Caes, 2012). The tax rate of the Woolworth for the year 2014 and 2015 remained constant with mild increase which helps to throw light that the company is making profit. Net margin of the company is expected to be decreasing as the net profit margin of the company is year 2014 is more comp ared to 2015. Asset turnover ratio helps to provide the clear image of the management of the company in managing its resource effectively. Asset turnover ratio and return on asset both seems to be decreasing with a constant rate. Return on equity, return on invested capital and interest coverage ratio seems to be gradually decreasing at a constant rate which signifies that the company inability to manage its asset and other key resource effectively for the year 2015 which resulted in the decline of the all the key ratio of profitability. Minskey Analysis Minskey analysis of Woolworth describes the financial position of the company. Hedge finance shows the flow of income that is expected to meet the financial obligations in each period. Speculative finance states that the company should roll over the debt because the flow of income is expected to cover oly interest costs (Wolf, 2008). Ponzi finance shows that the flow of income wont even cover the interest cost so that the organization should borrow sell off the assets to service its debts. Recommendations The overall performance of Woolworths has decreased from the year 2014 to 2015. Therefore, it is important for the company to take necessary steps in order to increase efficiency and profitability of the company. The investors can invest into the company as the net profit margin of the company is positive and has built its reputation in the market. Conclusion The financial statements of Woolworths help to calculate financial ratios as well as analyzing the financial health of the company. The working capital ratio of the company shows that the company need to steps in order to increase their efficiency. The profitability ratio also shows the profits earned by the company and financial performance in the year 2014 and 2015. The net profit margin has increased which means that the profit of the company has decreased. The asset turnover has decreased slightly which means the company is not utilizing its assets appropriately. Return on equity and return on invested capital has also been decreased which means that the company was not efficient to generate returns on the invested capital. Therefore, overall the performance of Woolworths has decreased from the 2014 to 2015 which imposes major challenge for the company. 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