Strategic Financial Management

Introduction:

The long-term sustainability of an organization highly depends on its relationship with stakeholders, efficiency in resource utilization, and effectiveness of capital expenditure decisions. Strategic financial management can help to achieve these objectives through the application of various theories, models, techniques, and tools. The current study is divided into 3 tasks. Shareholder interest and shareholder management strategy of Argos are discussed in task 1. Task 2 is concerned with resource utilization, performance appraisal policies, and analysis of financial performance of ‘BT’ group. Popular investment appraisal techniques are presented in brief under task 3 which also presents an investment appraisal of three investment proposals for 123 Ltd.

Task 1

Argos is a retailing company engaged in the market of home and general merchandise. The company is a part of Home Retail group of UK. Argos is a market leader in the concerned industry. At present, the Argos has a product range of 33,000 products. The current customer base of Argos is estimated at 130 million (Argos.co.uk, 2014). The company has 740 stores to serve this huge customer base.

1.1 Key stakeholders of Argos:

Stakeholders refer to the individuals or parties having interest in the business decision making and activities of an organization. As mentioned by Reynolds et al. (2007), the long-term sustainability of a firm depends highly on the satisfaction level of its stakeholders. In contrast, Reynolds et al. (2007) argued that there exist conflicting interests among different stakeholders which can be properly balanced. Two major theories in this regard are Agency and Stakeholder theories. The effectiveness of corporate governance policies and practices of a company is often judged by the benefits derived by the stakeholders. However, stakeholders can be broadly classified into internal and external stakeholders. Internal stakeholders include employees and management whereas external stakeholders include suppliers, customers, local people, and government. Stakeholder satisfaction and long-term relationship with stakeholders helps a firm to withstand adverse situations like recession, liquidity crisis, and economic downturn.

1.2 Interest of key stakeholders of Argos:

Investors:

Investors or shareholders are the owners of a company. Investors provide the required capital to the company. This section of stakeholders mainly includes equity shareholders. In this context, Hull and Rothenberg (2009) observed that capital appreciation and consistency in dividend payout are the key expectations of equity shareholders. Hence, it is the responsibility of a company to focus on maximizing shareholders’ value. In general, shareholders are entitled to the Profit after tax (PAT) remaining after payment of interest to debenture holders, creditors, and preference shareholders.

Customers:

Customers hold immense importance to a company as customers are the direct source of revenues to an organization. In this context, Makadok and Barney (2010) expressed that quality products at reasonable price are the major expectations of customers. However, Vaivio (2008) viewed that customers expect consistent innovation in products and services. Hence, a company needs to have an advanced and dedicated research and development department to develop new products or add new features to the existing products.

Suppliers:

Suppliers provide raw materials and other input materials on short-term credit to companies. Relationship with suppliers is often considered as crucial to meet customer demand and enhance competitive advantage. A company might face loss of sales due to lack of adequate raw materials on time. As mentioned by Lowe and Koh (2009), suppliers are mainly interested in the liquidity position of a company. Hence, current and quick ratios are the key interest areas for suppliers.

Employees:

The degree of competitive advantage enjoyed by a company is also determined by the efficiency of its workforce. Employees are a part of the internal stakeholders of a company. As mentioned by Lowe and Koh (2009), financial rewards and growth opportunities are the major expectations of employees. However, recognition of employee efforts is also considered as a vital motivational factor.

Society:

In the view of Hopwood (2007), employment opportunities, development of standard of living, and environmental sustainability are some of the key interest areas to the members of a society. A company is expected to adhere to legal guidelines and deliver corporate social responsibilities as per expectations.

Government:

Tax is one of the major sources of revenues to the government of a company (Chang and Dasgupta, 2006). Companies are liable to pay a certain percentage of the Profit before Tax (PBT) to the government of the country in which it operates. Hence, government is mainly interested on the fairness and correctness of the financial statements prepared by a company.

1.3 Stakeholder management policy of Argos:

Investors:

Argos recognizes the importance of investor engagement and hence the company conducts quarterly meetings to discuss on current business position and future strategies and possibilities. The company ensures that all relevant financial information is disclosed through its annual reports.

The sales revenue of Argos in 2014 is £5,663m which is an increase of 3% against that of 2013. The cash gross margin of the company has also increased by 2% to £2,034m. The company has also been able to deliver an Earnings Per Share (EPS) of 6.8p for the financial year ending 2013-14. The full year dividend paid by Argos for the financial year 2013-14 is 3.3p which is an increase of 10% against the previous financial year. In addition, final dividend of 2.3p has been recommended for the shareholders.

Customers:

Argos recognizes the importance of customer feedback in enhancing customer satisfaction through its products and services. The company collects customer feedback through its official website, social networking sites, and its retail outlets. Argos empowers its branch managers to take decisions at local levels. Recruitment of local people by Argos is aimed at understanding the actual needs of customers. The strategy is also aimed at improving customer relationship through better communication process. In addition, Argos spends considerable amount of money towards research and development activities to develop new products and services for the customers. The marketing strategy of Argos is focused on developing more product choice for customers and introduces offers that have universal appeal. Recently, the company has introduced audio CD version of its services to help disabled customers shop easily and conveniently. In addition, a customer care helpline number has been developed by Argos which is called ‘Minicom’. This helpdesk is mainly dedicated for helping disabled customers.

Suppliers:

Argos believes in long-term relationship with suppliers. The company has a centralized payment system to clear invoices. The Treasury and Forex department of Argos is under strict instruction to pay-off suppliers within the due date. In addition, the company has an established code of conduct for suppliers to ensure desired quality level of raw materials. Argos has also taken initiatives to conduct periodic training sessions to raise awareness among suppliers on environmental issues. The company also recognizes the importance of supplier engagement in business activities. However, Argos strictly prohibits its employees from acceptance any gift from suppliers.

Employees:

Argos is a performance driven organization. However, the management team of Argos ensures that pressure of performance does not result in job stress of employees. Argos conducts quarterly team parties for its employees. The company also conducts various Management Development Programs (MDPs) for its employees to develop both soft and hard skills of employees. Argos provides growth opportunities to its employees by realizing Internal Job Postings (IJPs). IJPs contain promotional opportunities along with desired criteria. Argos also provides pension to the employees under IAS 19 to offer secured future to its employees.

Society:

Argos recognizes environment protection and development of standard of living as its key responsibilities towards the society in which it operates. Argos aims to ensure proper waste management and energy consumption process. The company is committed towards the reduction of CO2 emissions generated as a result of its business operations. The company ensures recycling of wastes by taking back the waste packaging from the customers. In addition, Argos believes in recruitment of local people to improve the overall standard of living of the local people.

Government:

Adherence to laws and bylaws is a principal focus of the corporate governance policy of Argos. The company has been consistent in paying its tax dues to the government by respective due dates. Argos has a dedicated department to take care of taxation matters. The company has shown strict compliance to the International Accounting Standards (IAS) through the financial statements prepared by it. Till date, Argos has not been held for any sort of manipulation or fraudulent practices as regards to the preparation of financial statements.


 

Task 2

2.1 History and current business position of BT group:

BT group is considered as the oldest communications company in the world. The organization was formed as ‘The Electric Telegraph Company’ in 1846 and developed nationwide communications network.

At present, BT group operates across 170 countries and offers telecommunications services to corporate and government customers across the globe. As mentioned by Brown and Dant (2008), BT consumer services, BT global services, NT business, BT wholesale, and BT open-reach are the major divisions of BT group. Currently, BT group is the leading provider of broadband and voice services to consumers and UK based SMEs. BT group is also Europe’s largest telecom services wholesaler in terms of gross revenue. A growing trend is observed in the underlying revenues for BT group from 2010 to 2014. BT group has also been able to achieve a constant growth in Earnings Per Share (EPS) from 2010 to 2014. The company has been able to reduce its operational costs from £13,363 million in 2012 to £12,171 million in 2014. BT group has also been successful in reducing its quantum of net debt from £9,082 million to 7,028 million in 2014. The market share of BT group has increased from 35% in 2010 to 39% in 2014. The total number of corporate clients served by BT group is 6,500 across 170 countries.

2.2 Business planning and current strategy of BT group:

2.2.1 Utilisation of organizational resources:

The profitability of a company depends on the efficiency in utilizing its assets and resources (Paramasivan and Subramanian, 2009). Resource allocation can be defined as the process of dividing the total organizational resources among existing departments based on past performances and future business goals. On the other hand, resource utilization refers to the extent to which organizational resources have been utilized by a company. In this context, Gebhardt and William (2009) mentioned that optimum utilization of organizational resources helps in reduction of cost of production. This further increases the profit margin of the company without increasing selling price. Revenues generated by each department, existing resources, production deadlines, organizational structure are the key elements of resource utilization. Roslender and Hart (2010) viewed that resource utilization needs to ensure production deadlines are met at minimum cost and wastages.

BT group has implemented a scientific resource allocation ad resource utilization strategy. The company keeps a continuous check on the percentage of defectives and production wastage. The proportion of wastage to the total production volume is monitored on a continuous basis to ensure optimum resource utilization.

In the view of Lazaridis (2007), resource utilization is dependent on resource allocation. In present context, BT group follows a policy of allocating organization resources among its various divisions based on past performance. Here, past performance implies both financial and on-financial performance. In general, BT group considers revenue as the key parameter for taking decision on resource allocation. In addition, BT group conducts periodic training programs to enhance efficiency of its employees to ensure optimum resource utilization.

2.2.2 Performance analysis of BT group:

The basic elements of performance analysis are mentioned below:

  • Planning
  • Monitoring
  • Developing
  • Rating
  • Rewarding

BT group uses specific parameters to measure and evaluate its performance. Percentage of customer retention, new customer addition, and quantum of use of telecommunication services are the key parameters based on performance is measured by BT group. The company conducts weekly review meetings to discuss on current performance level and take corrective actions for past deviations. In this context, Block (2011) viewed that quantitative and qualitative factors are equally important for successful performance analysis.

BT group has a policy of sending monthly goal sheets to all its employees including managers. These goal sheets are sent at the beginning of each month and contain Key Performance Indicators (KPIs) to be achieved by each individual employee and manager. The performance of employees and managers are evaluated based on actual results achieved against set targets mentioned in the goal sheets. Annual appraisal at BT group is also based on yearly achievements against the goals sheets.

2.2.3 International aspects:

BT group operates across 170 countries and thus the company is exposed to various financial and non-financial risks arising out of international operations. In this context, Yan (2009) observed that credit risk, exchange rate risk, and interest rate risk are the major international risks. Credit risk refers to the risk of default arising out of credit sales made to customers. Exchange rate risks can be defined as the risk of financial losses due to changes in exchange rate. On the other hand, interest rate risk refers to the risk of financial losses due to change in the general interest rate in the economy. BT group has a separate risk management committee responsible for identification and mitigation of various risks.

2.3 Financial analysis of BT group:

Financial analysis refers to the quantitative evaluation of financial performance and position of a concerned company based on financial information available from financial statements of the company. The financial analysis of BT group has been conducted as under:

BT group
Item 2014 2013
£m £m
Revenues 18,287.00 18,103.00
Operating costs (15,142.00) (15,155.00)
Operating profits 3,145.00 2,948.00
Profit before Tax (PBT) 2,312.00 2,315.00
Tax (294.00) (367.00)
Profit after Tax (PAT) 2,018.00 1,948.00
EPS 24.5p 23.7p
Operating margin 17.20 16.28
Net profit margin 11.04 10.76
Current assets 5706 4674
Current liabilities 7687 7604
Current ratio 0.74 0.61
Long-term debts 17803 17537
Equity 17211 17275
Debt-to-equity ratio 103.44 101.52
Assets-turnover ratio 73.45 72.76

 

2.3.1 Profitability analysis:

There has been an overall increase in the profitability of BT group in 2014 compared to 2013. The operating margin has increased from 16.28% in 2013 to 17.20% in 2014 (Anon, 2014). The net profit margin of BT group has also increased from 10.76% in 2013 to 11.04% in 2014. This can be explained by both increase in gross revenues and decrease in operating costs of the company. In addition, the taxation expense has also reduced from £367 in 2013 to £294 in 2014. In spite of marginal fall in PBT BT group has been able to achieve higher PAT in 2014 compared to 2013.

2.3.2 Liquidity analysis:

In the view of Preve and Sarria-Allende (2010), 2:1 is the ideal current ratio as it provides a strong shield against short-term debts. In present scenario, the current ratio of BT group has shown considerable rise from 0.61 in 2013 to 0.74 in 2014. This can be explained by sharp rise in the quantum of total current assets. In contrast, increase in current liabilities of the company in 2014 can be considered as marginal.

2.3.3 Debt-to-Equity analysis:

The debt-to-equity ratio of BT group has increased from 101.52 in 2013 to 103.44 in 2014. A slight reduction in total equity is observed in 2014 against that of 2013. In contrast, considerable increase in long-term debts is seen in 2014 compared to 2013. This can be a serious concern for the company. As mentioned by Doss et al. (2012), increase in long-term debts increases the financial leverage of a company. Increase in long-term debts results in rise in interest expenses which further reduces the net profit margin of a company. BT group needs to develop suitable strategy to reduce its debt percentage. This is also important for the long-term growth and sustainability of the company.

2.3.4 Assets-Turnover analysis:

The assets-turnover of BT group has increased from 72.76 in 2013 to 73.45 in 2014. This can be attributed to the increase in both revenues and total assets. This indicates inefficiency in the utilization of assets to generate revenues for the company. The company needs to implement tight internal control procedures to keep a check on the efficiency of assets utilization.

Task 3

3.1 Investment appraisal techniques:

Investment proposals are mainly evaluated based on the financial outcome expected from these projects in future. Cash flows and profitability are the two major forms of financial outcomes that can be generated by a project. Financial managers make use of various tools and techniques to judge the acceptability of a project. These are known as investment appraisal techniques. The most popular investment appraisal techniques are discussed below:

3.1.1 Net Present Value (NPV):

The difference between the present value of cash inflows and cash outflows expected to arise in future from a concerned project is referred to as the NPV of the project. A project needs to generate a positive or at least a zero NPV for the same to be acceptable. Projects with negative NPVs are ignored. In this context, Chang and Dasgupta (2006) mentioned that the greatest benefit of NPV is that it recognizes the time-value of money. However, determination of the discount rate is a tough work. In addition, NPV approach is based on estimated future cash flows which might differ in future against actual results.

3.1.2 Payback period:

Payback is a simple and easy technique used for investment appraisal of projects. This method evaluates suitability of a concerned project on the basis of the length of time needed by a project to recover initial investments. Payback period is the time period required for the recovery of initial investments on a project. In this context, Alti (2009) observed that payback period is not suitable for long-term project as the time value of money is ignored under this approach. Hence, the payback period cannot be considered as an accurate investment appraisal tool as future cash flows are not discounted under this approach. In addition, net cash flows generated after the expiry of payback period are not considered under this approach.

3.1.3 Accounting Rate of Return (ARR):

ARR refers to the ratio of average accounting profits to the initial investments made on a project. Higher ARR indicates higher acceptability of a project. However,  a project can be accepted only if it generates an ARR greater than or at least equal to the cost of capital of the company. As mentioned by Breuer (2011), focus on accounting profit is the key strength of ARR method. Accounting profit can be derived from financial statements of a company and hence no special financial statements are required for this purpose. In contrast, Cosimano and McDonald (2009) argued that inconsistency in calculation and ignoring of time value of money are the major limitations of ARR approach. This technique does not use any discount rate to calculate present value of future profits. In addition, ARR of similar projects can differ due to application of different methods for ARR calculation.

3.1.4 Internal Rate of Return (IRR):

The rate at which NPV of a particular project is zero is known as IRR. A project is accepted if it generates an IRR which is higher than or at least equal to the cost of capital. This method recognizes time-value of money and considers all cash flows as equally important. Hence, IRR is often used to evaluate long-term projects. In contrast, Elliott and Hanna (2009) expressed that ignoring project life span is a key limitation of the IRR method. This might have an effect on the accuracy of investment decisions made under this approach. In addition, calculation of IRR is a difficult and complicated task.

3.2 Investment appraisal of 123 Limited:

Discounting factors
Country USA FRANCE SWITZERLAND
Discount rate 10% 10% 10%

 

Country Specific Cash Flows (Figure are ‘000 multiple of £) of 123 LTD from different operations
  USA FRANCE SWITZERLAND
Year 1 101.33 10.00 150.00
Year 2 86.18 -3.16 86.87
Year 3 72.35 -15.00 -28.56
Year 4 101.30 -25.71 86.87
Year 5 229.10 140.77 212.31
Year 6 48.00 -3.16 -28.56

 

Net Present Value (NPV)
USA FRANCE SWITZERLAND
£6.26 k £-386.26 k £-96.46k

 

Interpretation:

In the present scenario, 123 Ltd is a manufacturing accompany that produces cloth for its customers. International expansion is the present aim of the company and hence the company wishes to identify the most profitable market through evaluation of 3 different investment proposals. USA, France, and Switzerland are the 3 countries in one of which 123 Limited can invest. Net Present Value (NPV) technique has been applied to the available data to judge the financial suitability of the projects.

The discount rate has been taken as 10% for all the 3 countries. In addition, the given spot rates have also been considered for investment appraisal of the projects.

The results obtained from the investment appraisal of the given projects indicate USA to be the most suitable investment option among the other alternatives.

Investment options in Switzerland or France has generated negative NPVs. In contrast, investment proposal in the USA has fetched a positive NPV which makes the USA more suitable than France and Switzerland. This investment appraisal has considered only financial data but non-financial factors have not been considered in the investment appraisal of the give projects. Therefore, it is advisable for 123 Ltd needs to consider relevant qualitative factors like political conditions, socio-cultural factors, customer demographics, and others.

 

Conclusion:

The present study has been successful in identifying key stakeholders of ‘Argos’ and has also evaluated the stakeholder management practices followed by the company. The study has also conducted a financial evaluation of ‘BT group’ and evaluated current business position and performance evaluation policy of the company. In addition, popular investment appraisal techniques have also been discussed in the study.

References:

Alti, A. (2009), “How Persistent Is the Impact of Market Timing on Capital Structure?” Journal of Finance, 61(6), PP. 1681–1710.

Anon, (2014). [online] Available at: http://www.btplc.com/Sharesandperformance/Annualreportandreview/pdf/2014_BT_Annual_Report.pdf [Accessed 20 Nov. 2014].

Argos.co.uk, (2014). Argos.co.uk for Toys, Home Furnishings, Personal Care & more. [online] Available at: http://www.argos.co.uk/static/Home.htm?sRefURL=http%3A//www.google.co.in/url%3Fsa%3Dt%26rct%3Dj%26q%3D%26esrc%3Ds%26source%3Dweb%26cd%3D1%26cad%3Drja%26uact%3D8%26ved%3D0CCsQFjAA%26url%3Dhttp%253A%252F%252Fwww.argos.co.uk%252F%26ei%3Di-VtVNKzNMvluQTTtIGQDw%26usg%3DAFQjCNHwZPK390oBnNdjYbKxvRT_3WTi1g%26sig2%3DXiDRTBeujp8okmyAmqNAhA%26bvm%3Dbv.80120444%2Cd.c2E [Accessed 20 Nov. 2014].

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Appendix:

Exhibit I: Net cash flows

Net cash flows of 123 limited:
Country USA (USD)
Items Annual figures Year 1 Year 2 Year 3 Year 4 Year 5 Year 6
Spot rate 2.10 2.20 2.30 2.10 2.25 2.50
Revenues 700.00 333.33 318.18 304.35 333.33 311.11 280.00
Residual value of machinery 150.00  
Total revenue 333 318 304 333 461 280
Running expenses 210.00 210.00 210.00 210.00 210.00 210.00 210.00
Approval fee 22.00 22.00 22.00 22.00 22.00 22.00 22.00
Total annual cost 232.00 232.00 232.00 232.00 232.00 232.00 232.00
Net cash flow 101.33 86.18 72.35 101.33 229.11 48.00
Total cash flow 638.31

 

Country France (EUR)
Items Annual figures (EUR) Year 1 Year 2 Year 3 Year 4 Year 5 Year 6
Spot rate 1.80 1.90 2.00 2.10 1.95 1.90
Revenues 450.00 250.00 236.84 225.00 214.29 230.77 236.84
Residual value of machinery 150.00  
Total revenue 250.00 236.84 225.00 214.29 380.77 236.84
Running expenses 190.00 190.00 190.00 190.00 190.00 190.00 190.00
Approval fee 25.00 25.00 25.00 25.00 25.00 25.00 25.00
Royalty fee 25.00 25.00 25.00 25.00 25.00 25.00 25.00
Total annual cost 240.00 240.00 240.00 240.00 240.00 240.00 240.00
Net cash flow 10.00 -3.16 -15.00 -25.71 140.77 -3.16
Total cash flow 103.74

 

Country Switzerland (CHF)
Items Annual figures (EUR) Year 1 Year 2 Year 3 Year 4 Year 5 Year 6
Spot rate 10.00 12.00 14.00 12.00 13.00 14.00
Revenues 3800.00 380.00 316.67 271.43 316.67 292.31 271.43
Residual value of machinery 150.00
Total revenue 380.00 316.67 271.43 316.67 442.31 271.43
Running expenses 200.00 200.00 200.00 200.00 200.00 200.00 200.00
License fee 30.00 30.00 30.00 30.00 30.00 30.00 30.00
Inspection fee 23.00 69.99 69.99
Total annual cost 253.00 230.00 230.00 299.99 230.00 230.00 299.99
Net cash flow 150.00 86.67 -28.56 86.67 212.31 -28.56
Total cash flow 478.52

 

 

Exhibit II: Investment appraisal

 

USA
Calculation of NPV Year
0 1 2 3 4 5 6
Initial investment 450.00
Cash flow   101.33 86.18 72.35 101.33 229.11 48.00
Discounted rate (10%)   1.10 1.21 1.33 1.46 1.61 1.77
Discounted cash flow   92.12 71.22 54.36 69.21 142.26 27.10
Total Present Value (TPV)   456.26
Net Present Value (NPV) = TPV – Initial investment 6.26

 

France
Calculation of NPV Year
0 1 2 3 4 5 6
Initial investment 450.00
Cash flow   10.00 -3.16 -15.00 -25.71 140.77 -3.16
Discounted rate (10%)   1.10 1.21 1.33 1.46 1.61 1.77
Discounted cash flow   9.09 -2.61 -11.28 -17.61 87.43 -1.79
Total Present Value (TPV) 63.24
Net Present Value (NPV) = TPV – Initial investment -386.76

 

Switzerland
Calculation of NPV Year
0 1 2 3 4 5 6
Initial investment 450.00
Cash flow   150.00 86.87 -28.56 86.87 212.31 -28.56
Discounted rate (10%)   1.10 1.21 1.33 1.46 1.61 1.77
Discounted cash flow   136.36 71.79 -21.47 59.50 131.87 -16.14
Total Present Value (TPV) 361.92
Net Present Value (NPV) = TPV – Initial investment -88.08

 

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