Sustainability of Debt Finance Management
Chief Executive of ICAEW proposed the finding that a more sustainable pattern of British companies are to survive the financial management and learning with less debt (Malcolm & Edwards, 1998). But whether this finding is convincing is unknown. Evaluation of the debt finance statement is needed to implement in this essay.
It is apparent for this essay to focus on two aspects of the comment from ICAEW, one is whether the financial management of UK businesses is experiencing a more sustainable situation and the other is the actual debt development and the development situation of UK businesses. And this essay is going to argue this finding with the framework of literature review, assumptions and financial analysis. This essay is going to pick Tesco Plc for subject of analysis.1.1 Literature review
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The importance of the debt management for the corporations
To many entrepreneurial organizations, debt is tempting and is glamorous genre of financing. It is widely accepted that external debt are close companions of external equity, and since the equity is necessary for the entities, debt are indispensable for the companies (Pratt & Morris, 1987). Besides, many advantages are generated from the debt financing of the company. Firstly, debt financing is an efficient leverage tool for shareholders of the companies to produce profits with the help of debt capitals (Ruud, 2012).
Although the debt capitals are used at the price of financial interest or costs, namely that it is possible to reduce earnings before tax, shareholders still take this risk to use the debt leverage financial tool to add more value of their capital amount and keep sufficient internal funds available to take advantage of attractive investment opportunities. What is more, debt financing is helpful in reducing agency costs of free cash flows (Michael, 1986).
Because agency cost is an eternal paradox in the corporate management, shareholders and managers are playing intra beneficial game with each other. Shareholders want to improve value with as small amount of own capitals as possible and mangers would like to use safer capitals from shareholders and boost their bonus. Any failure from misuse or inefficient use of capital from shareholders by managers is agency cost and the positive debt finance is a way to balance this situation.
Risks of debt financing for the entrepreneurs
Even though debt financing is of great advantages and is very important for the entrepreneurs, risks still exist in the debt financing management. The main risk of the debt financing is the high rate of interests from the debt. It is clear that financial costs are mainly from the debt financing and the costs come after the operating interest (Robert, 1974), the number of the costs need to be controlled so that the earnings before tax are positive, namely that the profits are truly generated from proper use of debt.
Furthermore, debt financing will place risk on the cash flow management of the companies (Davis, 1995), because the contradiction of the maturity of loan and fluctuation of the operating, investing or financing situation may lead to the breakage of the cash flows. Finally, the defaults from the debt financing the corporations manage may exacerbate the loss of reputation and integrity (Davis, 1995). This reputational loss will deter the chance for the corporations to borrow money.
The impact factors of debt management
Debt financing management is influenced by different factors. It may be affected by the scale of the corporations. Generally speaking, it is more comment for small businesses to finance debt for operation (Acs, 1999). Because small businesses rather than large scale of businesses have less reputation and competitiveness to attract external equity or equity capital, small entrepreneurs have to turn to help of the financial intermediaries such as commercial banks and lender companies to borrow external capital to back up the operations of the organizations.
On the other hand, large companies have privileges to finance capital by capital funding, shareholder investment and stakeholder investment. What is more, debt financing management is close related to the managerial style, or the governance, of the companies. For risk-averse managers, who are prudent in producing profits with safer and cheaper capital, they will prefer to manage finance by receiving shareholders’ funding rather lenders’ (Amihud & Lev, 1981).
1.2 Assumption and argument for this debt financing findings from ICAEW Based on the literature review, it cannot primarily reach the conclusion about the debt and the survival situation of UK businesses. Before this essay expends the argument of whether the more sustainable model of financial management are currently using by UK business and they are survive with less debt, it is important to set the assumption for the argument. And the assumptions are as follow. The first assumption is that UK businesses discussed in this essay are those running on their track rather the new start-ups or newcomers who are eager in need for external debt or equity.
The second assumption is that the capital structure of the UK businesses discussed is operating at least one kind of debt.
The third assumption is that the debt change (accent or decent) are not caused by the managerial style or the scale of the corporations.
1.3 Financial ratio analysis for the debt financing situation of the chosen listed company
1.3.1 Debt financing performance
According to the assumption preset above, this essay choose the listed company Tesco Plc in UK to testify the comment of ICAEW. Calculation and explanation of relevant ratios over a five-year period will be presented as follow. Referring to the long-term liabilities, the absolute number of long-term liabilities experiences a big rocket and a fluctuation from 2008 to 2012. Long-term liabilities in 2008 were £5,972 million in 2008 and rose by more than one times to £12,391 in 2009 than in 2008. Although the absolute number of long-term liabilities dropped a little in 2010, they increased to £12,731 in 2012.
When it comes to the short-term and long-term debt, they showed a consecutive up and down from 2008 to 2012 (See appendix two). One of the very important aspects of detecting debt financing situation of a certain company of UK is the average debt/asset ratio (Allen & Gregory, 2003). This ratio of can show the ability of debt to making contribution to adding assets. From appendix one, although a slight rise of 2.36% occurred in 2009, a decent trend of average debt/asset ratio is irresistible from 52.82% in 2008 to 46.23% in 2012. The situation imply the decreasing trend of debt financing in the whole system though the absolute value of the debt is in a growth Another method for evaluating the debt financing is to assess the liquidity ratio of the target company.
This is a method to assess the short-term debt of Tesco Plc (Gombola, 1983). From the liquidity ratios such as current ratio, acid test ratio and operating cash flows to maturing obligations, a lot of insight can be incorporated into the present cash solvency of the firm and the firm’s ability to remain solvent in the event of adversity. Firstly, the current ratio presents the degree of current assets covering the current liabilities. It was interesting to see from 2008 to 2012 the current ratios of Tesco Plc first increased by 29.57% and kept decreasing by 5.97%, 4.55% and 1.23% in the consecutive three years, but the current ratios were in a growth in the whole picture from 0.58 to 0.67. The situation implies that the systematic risks of covering the short-term debt are decreasing.
Acid test ratio illustrates the liquidity excluding inventory. The acid test ratio of Tesco Plc experienced a drop variation trend from 0.35 to 0.48 by an accent of 53.26%.But it cannot disprove the endeavor made by Tesco Plc to decrease acid test ratio consecutively from 2009 to 2012. The other financial ratio for testifying the long-term debt situation is the ratio of financial gearing. Financial Gearing is the ratio presenting the efficiency of using debt to generate profits. Financial Gearing includes debt equity ratio or leverage (D/E), and interest coverage ratio (Harrington, 2004). Debt equity ratio or leverage (D/E) demonstrates the same development details as the liquidity ratios do. Tesco Plc increased from 0.50 to 0.77 by 70.35% (first increased by 90.03% in 2009 then decreased from 2010 to 2012 in a row).
The original soar in D/E may results from the overestimated optimism for the economic environment and over borrow long-term debt, and it takes time to lower the high percentage of debt. On the other hand, interest coverage ratio illustrates the coverage of earnings before interests and taxes to financial interests. From 2008 to 2012, the interest ratio of Tesco Plc dropped from 11.16 to 9.20 and it seems Tesco Plc has less competitive ability to cope with interest costs from debt financing. However, after the two-year decrease in this ratio, interest coverage ratio rise by more than 20% in two consecutive years from 2011 to 2012.
1.3.2 Operation performance
But even the debt financial level is decreasing from the financial analysis above, it is important to evaluate whether Tesco Plc has better survive with less debt. So the assessments of the profitability of profitability, efficiency and shareholders situation of Tesco Plc are necessary (Cunningham, 1995). In the aspect of profitability, ROE of Tesco Plc was experiencing a fluctuation from 2008 to 2012. Tesco Plc decrease from 18.08% in 2008 to 15.85% in 2012 by 12.61%. During the 2010 to 2011 duration, Tesco Plc had risen by 0.93% in the ratio of ROE, however, this increase could not turn around the decent situation. Return on capital employed of Tesco Plc experienced a similar fluctuated decreasing rate (similar with ROE) from 15.69% in 2008 to 12.17% in 2012.
From the perspective of efficiency ratios, they are ratios measurement of the effectiveness of assets performance of the Tesco Plc (Fraser, 2004). Efficiency ratios includes inventory turnover (days) and creditors' turnover (days). Inventory turnover present the efficiency of Tesco Plc to manage the inventory. As can be seen from Appendixes, the numbers of days for Tesco Plc increased from 20.31 days to 22.15 days by a rate of 9.41%, namely that Tesco Plc performed more slowly than before (circulating the same number of stocks with more time). When it comes to another efficiency ratio, debtors’ turnover (days), demonstrates the average number of days for which receivables are outstanding before retrieve.
The debtors’ turnover for Tesco Plc increased from 10.12 days to 15.03 days by a rate of 42.63%. And it turned out that the debtors’ turnover of Sainsbury Plc was circulated from every 4.22 days in 2008 to 4.68 days in 2012. The situation of Shareholder can be assessed by the dividend per share, dividend payout ratio, earnings per share and operating cash flow per share. Dividend per share presents a different development trend for Tesco Plc. The dividend per share rose from 0.08 in 2008 to 0.10 in 2012 by 29.78%. Similarly, EP of Tesco Plc demonstrated an increase of 27.66% from 0.27 to 0.33 and dividend payout ratio of Tesco increased by 2.41% (0.28 to 0.29).
1.3.3 Systematic debt financing performance
Based on the financial analysis on both debt financing and operations, systematic debt financing is semi-match the opinion of ICAEW. Firstly, the ability of coping with short-term and long-term debt is more competitive even though the total volume of debt is increasing. But this is not “less debt” as the saying goes in the opinion of ICAEW. Secondly, even though the “less debt” refers to more competitive ability to handle debt, the operations of profitability and assets ability are still failed to improve or say few evidence can prove the company with less debt can better survive. Thirdly, the improvement in shareholders situation is one symbol that implies better survival of Tesco Plc but the paradox between profitability and shareholders is need to further explained. In addition, as the forth point, policies are connective with the coping ability with debt. From 2010 to 2012, Tesco Plc procurement policy provides robust and consistent debt selection.
Conclusion
In conclusion, debt financing plays an important part in organizations but it also hide risks when corporations employ this tool. But doubts arise from the opinion that UK businesses can survive with less debt published by ICAEW. After the analysis of financial ratios on debt and operations performance in Tesco Plc among UK businesses from the consecutive five years based on the assumptions, this essay cannot get the conclusive conclusion about the relations of survival and less debt. But if debt financing here refers to the improve ability to cope with debt rather volume of debt, it may be concluded that some of the UK companies at least Tesco had worse-off profitability and efficiency with less debt. And whether the sustainability model of debts financing in UK is sustainable is needed to be further explained.
Question 2
Evaluate the role of finance director in an organization
Introduction
Financial director, as another name of CFO (Chief Financial Officer), is the main character in the organization to control the financial situation. Since
the financial director wears the critical responsibility, it is meaningful to find out what kind of responsibilities or roles are for financial director. This essay focuses on exploring the roles of financial director from aspects of literature review and the scenario (Tesco Plc) comparison between different kinds of job roles, and what kind of sources, or information, or evidence in the financial report can prove the described roles above.
2.1 Literature review of roles of finance director
Financial director is an important role in the system of management in an organization and scholars in the academic or industry has many researches into the topic about financial director. And the framework this essay establishes is a reorganization of the theoretical and practical pinions on financial director.
Compiling financial reports
A competitive financial director is like a doctor who is engaged in safeguarding the healthiness of financial situation of the organizations (Michael, 1999). This safeguard role is quite different from other related financial occupations, since the largest financial burden is laid on the shoulder of finance director. Although financial director lead a team to perform the job about financial reports, he fulfills the solo responsibility of the accuracy of the financial reports (Roles of finance directors, 2013). During the financial work performance, finance director has to manage a financial team as well. And finance director act as the company's treasurer to keep the accuracy of the financial results, because one mistake is a mile in many aspects, such as capital structure, earnings per share or EBIT.
Perform analysis on financial reports
There is too much information in the financial reports and some of the information is hard to understand without translation. Financial director uses financial and non-financial ratios or conclusive and simple information, which other managers, shareholders and stake holders need, to present the key information of the financial situation of the organization (Keith &Falshaw, 1999).
Besides the interpretation of the financial reports, finance director detects problems through the horizontal and vertical analysis on the financial reports in order to figure out approaches to achieve the perfect financial condition and try endeavors to maximize profitability. After the financial analysis on the financial report, financial director proposes an analysis report on historical data, positions the financial goals and objectives, and make the prospective strategy for the organization.
Help operating the company and make the prospective strategy for the company
Financial director not just theoretically analyze or improve the financial situation using the historical data from consecutive financial reports (Grant, Roman & Sidney, 2014). He incorporates the financial information into financial operation in the company. Overseeing payroll activity for staff and participants in order to avoid fraud; monitoring the banking activities of the organization to ensure sufficient liquidity to meet daily needs; Investigating cost-effective production approaches in the production line. Besides the internal financial events, he represents the company to meet government in order to control the rhythm of the tax payment or government funding. What is more, he also takes an informative and advice supportive part in marking, operation, financing and investment decision making.
2.2 Roles of finance director of Tesco Plc and comparison of other job advents 2.2.1The evaluation of roles of financial director of Tesco Plc Laurie McIlwee has been taking the position of Chief Financial Officer (Finance director) of Tesco Plc since 27 January 2009. As a Fellow of Chartered Institute of Management Accountants and a member of The Hundred Group of Finance Directors, Laurie McIlwee has experienced years of finance director responsibility in Tesco UK and Pepsico. His horizontal international finance management is impressive. But it is important evaluate whether he meet the roles of the financial director while working in Tesco Plc.
Ordinary Financial engagement
Besides composing the financial statements and financial reports for the board of directors and shareholders, Laurie McIlwee is responsible for utilizing financial and non-financial ratios to analyze the historical data from 2010 to 2012 (Financial Report, 2012) and select key ratios, present then as clear graph and report them in the financial report in order to keep the financial reports usable for the users.
He also monitors any external financial issues, such as relationship with government and tax bureau. And He is responsible for establishing and maintaining a strong working relationship with outside consultants, bank representatives and insurance and bonding representatives. What is more, Laurie McIlwee affects the continued operation of the company by positioning the financial boosting strategy in the foreseeable future. His duties also include managing, maintain and forecasting the company's cash requirements and cash flow. He also reviews and signs all financial reports, tax returns and audit reports.
Financial Team Management
Laurie McIlwee is of course unlikely to cope with the actual receipt of income or the paying of bills in person, he wisely leads a team on all kinds of financial jobs (Financial Report, 2012). The chief finance officer Laurie McIlwee oversees all accounting personnel within the financial team.His mentor and develop the accounting team and manage their tasks and processes, training and performance evaluation He regulations to ensure compliance with current and future Management Accountants Society of practices and procedures to govern the financial director of an appropriate internal control safeguards and requirements Hundred Group Business Development and Strategy Duties
The CFO Laurie McIlwee directs financial strategy, including borrowing and investment strategies (Financial Report, 2012). He also establishes and monitors budget planning and forecasts. He works with CMO, COO and the heads from other department. Finance is expected to incorporate other strategic objectives. In order to meet their specific objectives closely with vice president of information technology, development tools, and the president and providing important financial and operational information systems to CEO.
2.2.2 Other jobs advents for comparison
CEO
Philip Clarke is the CEO of Tesco Plc for more than 3years until today. He is mainly responsible for developing company goals (Financial Report, 2012). He formulated the objectives, designed the progress to achieve these goals. In determining the direction of the company in the process, he defined the specific market, observe competitors and determine how the company will come to the fore.
In addition, Philip Clarke build a competitive team to assist him in the operation of Tesco Plc. Philip Clark uses the best part of the individual team and solve the senior team and the members of the corporate culture differences between a company's values through the establishment. Setting budget is an important role of the CEO, the CEO is only when the budget is set for a certain strategy, CFO or Finance Director may adjust the budget implementation plan. Finally, CEO Philip Clarke have functional public relations. Under many circumstances, it is CEO that pre builds the client relationship before CMO can keep the continuous relationship with the client.
CMO
Min Mason is the CMO of Tesco Plc. His job is different from finance director Laurie Mcllwee and CEO Philip Clarke. He launches research and development in order to determine the potential need for a product or service based on current market demand (Financial Report, 2012). Moreover, he cooperate with Lanrie Mcllwee to make an available financial R & D budget. Secondly, Mim Mason is responsible for making promotion strategies by managing the overall marketing and advertising campaign and analyzing effectiveness of a campaign and what types of modifications. For example, the promotion of “Everyday Big sale” in Tesco Plc designed specifically for women and let them feel satisfactory. Min Mason has to manage not only public relations, but also the three aspects mentioned
COO
Kevin Grace is a COO in Tesco. He was the main contact with the other officers of the Board. Kevin Grace manages the daily functions of the company, reporting to the CEO and the board regarding the company needs or performance, make a final decision in many daily problems (Financial Report, 2012). If a company could find a COO like Kevin Grace who is a reliable manager, COO can become into the role of CEO in situations where the board realizes that a current CEO will be retirement. In addition, the role of the COO has been changed. COO need to learn the CEO position. COO becomes an alternate, not a partner. The responsibilities of COO will begin to take on the role of the CEO over time. When Kevin Grace stepped down as South Korea, he was promoted to be the CEO of Poland and UK Property Director.
2.3 Effective evaluation of availability of sources of information All the role information is truly comes from the 2012 Tesco Plc annual report, and it is presented dispersively in the financial report. With the evidence of financial statements, notes of financial statements, clear graph, convincing declarations from the board of directors, the truth and effectiveness can be proven to support the role evaluation of the roles of different directors (Financial Report, 2012). Conclusion
In conclusion, this essay centers on the role evaluation of finance director by demonstrating literature reviewing, citing roles of finance director in Tesco Plc, comparing the roles of finance directors and CEO, CMO and COO in Tesco Plc, and evaluating the effectiveness of evident used to citing examples. Question 3
Evaluation for the usefulness of budgeting and budgetary control in Tesco Plc Introduction
A budgeting control is a mechanism assisting senior managers in setting the adequate spending limits. It is important since risks of expenditure exceeding from the potential budget are what corporation cannot bear and the risks will have an unfavorable impact on corporate profits. So in order to count on the importance to focus on the budgetary control, this essay is going to throw literature control in the budgetary control to see what accomplishment that scholars achieve in this field, and introduce the empirical example of implementing budgetary control in a corporation by citing Tesco Plc.
3.1 Literature review in budgetary control
Scholars in academic field have been doing many researches in the field of budgetary control. They refer the budget control to almost all aspects in the business operation. But after reorganization, this essay reframes the outline of the literature review in budgetary control. Businesses of different kind of scales require different kinds of basic financial concerns and monetary limits in order to keep cost-effective efficiency. Budgetary control is indispensable in the business operation. Cost controlling
The main objective of budget control is to control the cost. Capitals are limited in one organization (Ariratana, Treputtarat & Tang, 2013). Smart and appropriate cost of using is good for cost-effectiveness to save. Through the full use of the capital budget, managers take effective measures to save money. The definition of the budget is a list of intended or expected expenditures of money and proposed to satisfy these expenditures. By presenting the amount of money that will be used for different projects to satisfy different strategy, the managers can handle different assignment with an elastic budget boundary, because decision-makers can see exactly what they are spending their capital on.
Perspective planning
Budgetary control can lead a perspective planning in the business. It is indispensible in the management style of making strategy based on the limited capital or the style of organizing capitals for budget for the decisive planning (Dariya & Klaus, 2013). All businesses have the requirement to balance its short-term expenditures with savings and investments that they can use enough jetton to meet the long-term developmental expand or take advantage of special opportunities. Budgetary management is designed with the changeable need from business opportunities coverage and allows a business to monitor necessary spending along with the capital and earnings in order to generate positive profits. Financial statement compiling
Budgetary control serves a significant practical role by assisting accountants and auditors to compile financial reports for report users. For
the reports in internal use within the organization, budgetary controlling can provide information of costs controlling, strategy positioning and internal operation (David, 1998). For the reports use by publicity such as regulators, industry analysts, stockholders and investors, budget controlling presents the comparison of the original planning of the limited capital and the ability for the business to implement actions to spend money and achieve the original goals. The budget controlling is also important in helping managers to handle the corporate profits and corporate cash flows.
Business success evaluation
Budgetary control gives comprehensive evaluation of the availability of and the success of specific efforts in the businesses (Yanwu & Fei-Yue, 2014). In other words, the link of budget control reflect the input and output in the changing business activities, such as staff training. However, if the future budget show that due to the employees’ mistake, training programs and its cost recovery issues more significant decline would be reasonable. Similarly, if the new forms of consumption can have a negative impression of the future budget, it will be eliminated, maybe it is good to use with similar goals.
3.2 Budgetary control in Tesco Plc
This paragraph is going to evaluate the usefulness of budgeting and budgetary control in Tesco Plc
Use budgetary controlling tools as policy document
Firstly, Tesco Plc smartly uses the budgetary controlling as a policy document to protect important projects. The importance of a budget used as part of policy considerations is to generate enough capital for profitable but vulnerable projects. According to the announcement in early 2012, Tesco Plc plans to substantially increase investment in the shopping trip – particularly in the UK with a limited and special budget.
On the one hand, Tesco Plc anticipate minimal Group trading profit growth for the year 2012, namely that Tesco has considered the possible opportunity costs in the budget when implementing the project. On the other hand, Tesco Plc reduces levels of old capital expenditure when it modifies its policy of expansion. To further protect the project, Tesco Plc establishes another policy that no bonus will be paid to Executives unless performance is greater than budget, representing year-on-year growth in profit.
Financial awareness
Budget Control provides financial awareness of business expenses and income. In the case of Tesco Plc, it needs to take into account tax expenses, thus setting the budget report. When a new tax resolution passed by Congress, which adjust their tax budget accordingly. The budget outline shows the number of business from sales and additional revenue in one month. It shows how much companies spend on operating costs even as revenue. Operational budget should also display a given assets and liabilities Tesco plc in the current time. This reveals whether a company's financial position is positive or negative. Tesco's financial situation reveals the budget showed that the business is profitable or create monthly debt.
Business Opportunities
One advantage of having a financial budget for Tesco Plc is to recognize opportunities that can help market and expand the business. The budget reveals the amount of profit the business can put aside each month. Tesco Plc uses the profit to expand the business and market it in new ways by attending conferences and joining marketing campaigns with larger businesses. Informing the funding available can help the business owner plan ahead and market the business in new and creative ways.
For example, Tesco Plc did researches in 2012 and found out the challenging year for consumers in many of Tesco Plc markets are suffering tight budget in household management by inflation, austerity and high fuel price. That would possibly reduce the enthusiasm of consuming in Tesco Plc. But considering the tight budget Tesco Plc also is facing, Tesco Plc transfers to the international businesses and performed this switch strongly. Thanks for the wise business opportunities, Tesco Plc delivers an 18% increase in profits, which helped to compensate for the reduction in trading profit in the UK.
Communication Tool
Through monthly, half-yearly financial budget statements or reports budgetary control tools communicative acts each year. When held for budgetary control will be discussed from time to time to collect the director, directors can share the latest ideas and mentality, improve the efficiency of the method and the target budget. With the discussing, budget is essentially a communication tool, because it shows how the enterprise works and how the smart money used.
Budgets are discussed in Board, Executive Committee of Tesco Plc regularly and the risk management proposal will be shared in order to improving the efficiency of budgeting. In order to control the budget better, All business sectors in Tesco Plc has stretched the budget based on the Balanced Scorecard and KPI's steering system and performance indicators are monitored on an ongoing and regular basis to the Board
Financial planning
Tesco Plc implements regular review of strategy, risks and financial performance by Board and Executive Committee, with external advice as required and makes consistent operational plans and budgets developed throughout the Group to ensure delivery. What is more, Broad of directors in Tesco Plc approves the budget and long-term plan for the Group. The budget controlling reveals the assets and liabilities in Tesco Plc so that it can have better evaluation of itself when making business decision. Budget controlling can help Tesco Plc create a financial plan as mentioned above so the liabilities can be addressed before the debt becomes uncontrollable.
Conclusion
In conclusion, budgeting control is really important in the aspect of costs controlling, perspective planning, financial statement compiling, and business success evaluation according to the literature reviewing. After citing the example of Tesco Plc, further information about budget controlling containing Use budgetary controlling tools as policy document, financial awareness, business opportunities, communication tool and financial planning.
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Sustainability of Debt Finance Management. (2016, Jul 22). Retrieved from https://phdessay.com/sustainability-of-debt-finance-management/
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