-
- QUESTION
CASE STUDY 2 – COMPANY FINANCIAL POLICY DECISION-MAKING Your current role is the Manager of the Finance Division of Fortescue Metals Group Limited, and you report directly to the Chief Financial Officer (CFO) of the company. The CFO has requested you to attend a strategic retreat being held by the company to present to the Senior Leadership Group, including the Chief Executive Officer (CEO) and the Board of Directors, on the current financial policy platform of the company, the nature of the linkage or association between these policies adopted by the company, and how they integrate to influence the operating and share performance outcomes for Fortescue Metals Group Limited. Fortescue Metals Group Limited (FMG) is a leading iron ore production and exploration company which operates in the Pilbara region of northern Western Australia. The company is the fourth-largest listed resources company in Australia, behind BHP Billiton Limited, Rio Tinto Limited and Woodside Petroleum Limited, and the largest pure-play iron ore mining company listed in Australia. The company currently has two primary production sites in operation, namely the Chichester Hub located in the Chichester Ranges in the Pilbara region comprising the Cloudbreak and Christmas Creek mining projects, and the Solomon Hub, which is located 120 kilometres west of the Chichester Hub and comprises the Firetail and Kings Valley mines. The company’s current operational objective is to achieve iron ore production of at least 155 million tonnes per annum (Mtpa), and it has undertaken an aggressive expansion program in the last decade in pursuit of this objective. The iron ore produced by the company’s mining operations is transported to their port facilities at Port Hedland and is shipped for spot market or futures contract trading in a number of overseas locations, but predominantly China. The follow table provides a summary of financial and structural information for Fortescue Metals Group Limited for their recent June 30th year ends (All figures, except for per share, issued capital and percentage statistics, are expressed in A$Million): 2012 2013 2014 2015 2016 Key indicators No. of issued shares (Mill.) 3,113.798 3,113.798 3,113.798 3,113.798 3,113.798 Market capitalisation 15,257.610 9,465.946 13,545.021 5,947.354 10,897.023 Share price ($) 4.900 3.040 4.350 1.910 3.500 Price/Earnings ratio (times) 11.086 5.704 4.657 14.470 8.216 Earnings per share ($) 0.442 0.533 0.934 0.132 0.426 Dividends per share ($) 0.080 0.100 0.200 0.050 0.150 Dividend payout ratio (%) 18.100 18.762 21.413 37.879 35.211 Trading Information Iron ore processed (wet metric tonnes) 53.900 76.100 126.000 153.600 167.600 Iron ore shipped (wet metric tonnes) 57.500 80.900 124.200 165.400 169.400 Iron ore price (US$ per Mt) 134.62 114.82 96.26 61.84 52.34 Total revenue 6,558.728 8,686.792 12,325.902 10,924.479 9,354.969 Operating expenses 3,766.068 5,459.838 6,649.681 8,069.010 5,428.225 Earnings before interest and taxes (EBIT) 2,563.045 3,032.884 4,918.259 1,365.885 2,702.666 Profit before tax 2,067.510 2,436.657 4,153.928 546.875 1,823.323 Net profit after tax before abnormals 1,376.704 1,660.377 2,908.704 411.458 1,326.420 Net profit after tax after abnormals 1,529.781 1,882.479 2,908.704 411.458 1,326.420 Net interest expense 495.535 596.226 764.331 819.010 879.342 Income tax expense 690.805 776.280 1,245.223 135.417 496.903 Net operating cash flows 2,755.372 3,238.814 6,632.696 2,652.344 4,070.832 Return on total assets (%) 9.314 7.380 12.074 1.479 5.094 Return on equity (%) 37.294 29.117 36.133 4.193 11.718 Structural information Cash and cash equivalents 2,299.087 2,326.685 2,545.648 3,100.260 2,131.699 Current assets 3,581.592 3,948.248 4,752.654 4,595.052 3,262.860 Property,plant&equipment 10,869.394 18,215.633 18,746.346 22,084.635 21,673.848 Total assets 14,780.689 22,498.113 24,091.295 27,812.500 26,039.590 Current liabilities 2,096.948 1,524.528 3,471.338 2,197.917 2,200.377 Long-term debt 8,063.978 13,461.995 9,981.953 12,257.813 8,992.728 Total liabilities 11,089.196 16,795.687 16,041.401 17,998.700 14,719.903 Share capital 1,268.767 1,391.914 1,368.365 1,684.896 1,751.953 Retained earnings 2,382.494 4,359.030 6,593.418 8,052.083 9,504.444 Total shareholders’ equity 3,691.492 5,702.526 8,049.894 9,813.802 11,319.688 Long-term debt to Total assets (%) 54.558 59.836 41.434 44.073 34.535 Total liabilities to shareholders’ equity (%) 300.399 294.531 199.275 183.402 130.038 Further detailed overall summary, structure, financing and performance information can be obtained from the 2016 Annual Report document for Fortescue Metals Group Limited, which is available from the subject LMS site. Prior year annual report documents and other filings and announcement information relating to the company can be obtained from the Fortescue Metals Group Limited web-site (www.fmgl.com.au) or from the DatAnalysis Premium database available through the Databases link on the University Library web-site. Other relevant information relating to Fortescue Metals Group Limited or the wider corporate sector is as follows: • Assume this analysis is being undertaken as at Monday 10th July 2017. • Fortescue Metals Group Limited’s share price on Monday 10th July 2017 is $5.09 per share, and there are 3,113.798 million issued ordinary shares on this date. • Fortescue Metals Group Limited is part of the Materials Sector based on the Global Industry Classification Standards (GICS), and its GICS Industry is Metals and Mining. • Fortescue Metals Group Limited’s beta coefficient on July 10th 2017 is 0.89, compared to the beta coefficient for the overall industry of 1.04. • The 5-year and 10-year Australian Government Bond yields are 2.258% and 2.784%, respectively, on July 10th 2017. • The 1-year London Interbank Offered Rates (LIBOR) on June 30th 2016 and July 10th 2017 were 1.2302% and 1.465%, respectively. • The S&P/ASX 200 Accumulation Index, including dividend and franking credit components, has provided an average annual return of 8.668% over the most-recent fiveyear calendar period to July 10th 2017. • The Australian dollar to US dollar (AUD/USD) exchange rates on June 30th 2016 and July 10th 2017 were 0.7782 and 0.7602, respectively. • Fortescue Metals Group Limited is subject to a corporate tax rate of 30%. Required: The CFO has requested you to submit two documents in preparation for the strategic retreat – 1) a PowerPoint presentation that will be presented at the retreat and 2) a Background Analytical Report providing supporting calculation and analysis information. The presentation, prepared employing information from the annual report documentation and any other documentation or sources of information considered to be relevant, is required to identify and outline the following aspects of Fortescue Metals Group Limited’s current policy platform and operational activities and performance: • The nature of the firm’s working capital management policies. Focus should be on overall current asset investment and financing policies, rather than the company’s adoption of policies relating to specific current asset categories, such as inventories or receivables. • The determination of the costs of the various sources of costly or interest-bearing financing employed by the firm and, from this, the firm’s overall weighted average cost of capital (WACC). • The nature of the firm’s capital structure determination policy, including identification of specific policy adoption or usage if relevant, whether the firm appears to have target or optimal capital structure ratios, and the determinants of the firm’s capital structure choice. • The nature of the firm’s earnings distribution policy, including the type of dividend policy employed if relevant, whether the firm has a target dividend policy or payout ratio, and the influence of taxation or other relevant elements associated with the firm’s overall earnings management and distribution practices. • The nature of any association or relationship between these various corporate financing policies employed by the firm, and how this may relate to Fortescue Metals Group Limited’s share and/or accounting performance outcomes, and any other key drivers of the firm’s performance outcomes. These presentation documents should be submitted to the CFO by 6.00pm on August 28th 2017, via the FIN3CSF subject LMS site. This case study will represent 20% of the final assessment for this subject. This case study can be submitted either individually or in a group with up to a maximum of four members. The maximum word limit, excluding any figures and calculations is the equivalent of 500 words per team member, so a case study completed by a team of 4 should be a maximum of 2,000 words. The PowerPoint presentation and background documents should be prepared in a professional manner, be informative and interpretable by an audience with reasonable general finance knowledge, and reflect creativity and thought about the most appropriate way to present the information. The PowerPoint presentation should be a maximum of 15-20 slides. The Background Report should provide supporting calculation and analytical information, including any assumptions made, to expand on the information and conclusions provided in the presentation.
| Subject | Business | Pages | 11 | Style | APA |
|---|
Answer
Financial Policy Decision Making
Financial decision is a systematic way through which best alternatives for the sake of financial sanity in an organization are formulated and implemented for the benefits of the owners of an organization. The main objective of investors is to maximize profit (Harrison, 2016). For this to be effected, top managers of an organization must ensure that proper financial policies are formulated in a candid manner. According to Kumar (2016), though the role of financial decision making to a great extent lies squarely on the finance department through the leadership of the financial manager, other top managers, departmental heads are also critical in implementation of the policies. This paper therefore focuses on the financial policy decision making for Fortescue Metals Group Limited
Analysis of the Past Financial Reports and the Impacts
Financial reports refers to documents that summarize the performance of an organization annually, quarterly, or semi-annually. According to Harrison (2016), financial reports made at the end of a financial or accounting year are known as final reports. On the other hand, those that are prepared before the end of the years are known as interim reports. Fortescue Metals Group, being a limited company, is required by company statutes to prepare annual financial reports as per the guidelines given by International Financial Reporting Standards (IFRS). This analysis relies on the financial reports between the years 2012 to 2016. During these years, various ratios are sampled. It is, therefore, worth noting that financial ratios are a systematic way through which the relationship between items of the financial reports as well the efficiency of the management are established. The following are the various ratio analyses that will be used in determining the financial health, formulation of policies and decision making for Fortescue Metals Group.
Fortescue Metals Group Limited Financial Ratios
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net profit |
|
|
|
|
|
|
19.11 |
|
23.51 |
3.78 |
14.16 |
|||||
|
margin |
|
0.99 |
|
|
|
|
|
|
|
|
|
|
|
|
||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
EBIT |
|
|
|
|
|
|
34.91 |
|
39.90 |
12.50 |
28.89 |
|||||
|
|
|
|
9.08 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Current |
|
|
1.71 |
|
2.59 |
|
|
1.37 |
|
|
2.09 |
|
1.48 |
|||
|
ratio |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Quick ratio |
|
1.42 |
|
1.91 |
|
|
0.92 |
|
|
1.63 |
|
1.14 |
||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
||||
|
Gearing |
|
200.10 |
|
200.10 |
|
200.10 |
|
200.10 |
|
200.10 |
|
200.10 |
||||
|
ratio |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net Profit Margin and Earning Before Profit (EBIT) Ratio
Net profit and Earning before Profit ratios are used to determine the efficiency levels of the management in generating revenues. From the table above, it is evident that the net profit margin for the company has not been consistent either on the positive or negative in the past five years (Resta, 2016). While in the year 2012 the profit percentage was less than 1%, in the year 2014 it was more than 23%. This was followed by a drop in the year 2015 and an increase in the year 2016. This is the same with the EBIT ratio. While years in 2012 and 2013 the ratios were above 34%, in the year 2015 the percentage falls below 20%. This, therefore, shows that the efficiency of the company in using its assets to generate revenue is not consistent.
Current and Quick Ratios
According to Consigli, Kuhn and Brandimarte (2017), current and quick ratios examine a company’s ability to meet its short term obligations. This is determined through comparing a company’s current assets and current liabilities. The current and quick ratios, therefore, fall within the liquidity ratios in analysis of financial statements. From the table above, the current and quick ratios have never fallen below 1. It is worth noting that the recommended liquidity ratio that guarantees a healthy financial state for the future of the company is about 1:2 which the company lacks throughout the years. Although the ratio is below 1:2, the company’s liquidity ratios is above average hence the company can meet its short term obligations as they fall due. The level of effectiveness and efficiency of doing this will not be as efficient as in a case where the liquidity ratios were above 1:2 (Resta, 2016).
Gearing Ratio
Gearing ratio is a financial analysis that compares a company’s equity (shareholders’ funds) and borrowed capital. High gearing ratio exists in the event the capital employed is more than the borrowed capital, while a low gearing ratio exists in the case where the borrowed capital is less than the capital employed (Resta, 2016). Besides being used to determine the relationship between the company’s capital employed and the borrowed capital, gearing ratio is used in determining the extent to which a company uses the borrowed capital in financing its assets. This ratio is one of the ways through which the going concern of a company can be determined. Gearing ratio can either be expressed in form of ratios or in from of percentage. It is, however, worth to note that the denominator in all cases is capital employed.
From the table above, the gearing ratio is 200:10 during the five years of focus. This is an indication that the borrowed capital in the company is more than the capital employed. This is a clear indication that a greater percentage of the company’s assets are financed using borrowed capital. Based on the fact that the company’s gearing ratio is too low, its going concern is, therefore, under threat. In addition to this, the independence and the ability to exercise its freedom through its operations on a daily basis and strategic policies are limited.
Financial Decision Making and Policy Formulation Based on the above Analysis
As was pointed out earlier, the process of decision making is a systematic way of picking the best alternatives from various alternatives available for the sake of a company’s profit maximization (Kumarm, 2016). The process of decision making involves identifying the problem and objective that is to be achieved, sourcing for various alternatives for solving the problem at hand, picking the best path of action from the various alternatives available, careful implementation of the choices or most preferred course of action and verification of the implemented course of action to prove whether or not it is in line with the pre action set path. Based on the above analysis, the decision that is to be made should be geared towards ensuring the company’s financial policies that guides its operations improve the Return on Equity (ROE) as well as the current and future cash flows (Consigli, Kuhn, & Brandimarte, 2017).
From the analysis, the liquidity ratios in the past five years has never gone beyond 1, implying that the debt policies, unlike credit policies, are not working in favour of the company. The decision on the credit and debt policies should be streamlined so as to ensure that the liquidity of the company moves beyond 1. This can essentially be achieved through lengthening of the credit days and shortening of debt days. This will not only increase the level of efficiency in terms of meeting the short term obligations, but also reduce the chances of the company being insolvent.
Concerning the company’s debt to equity ratio, otherwise known as gearing ratio, the company should purpose to use internal source of capital as opposed to the external sources that has increased drastically the gearing ratios. Based on the fact that the creditors tend to have some level of control on the assets of the company, especially on those that are used as collaterals in acquiring debt, the company’s freedom in decision making will be limited (Consigli, Kuhn, & Brandimarte, 2017). A decision that will lead to formulation of a policy that gives a guideline on the maximum levels beyond which the gearing ratio should not reach should, therefore, be made. One of the ways through which this can be achieved is by ensuring that the levels of reserves are increased. To increase reserve levels, then the declared dividends every year must be reduced so as to increase the percentage of the retained profit. Other than increasing the reserves though earnings per share reduction, the company can increase use of other alternatives in sourcing for capital. These alternatives would include sale and lease back increase in the level of accruals, and share splitting among others (Harrison, 2016).
In order to increase the annual revenue and the net profit margin thereof, then a decision must be made so as to create a paradigm shift in terms of increasing the sales volume. The most fundamental decision that must soon be effected is to formulate an expenditure policy which ensures that expenditure falls within the budget and that it is minimized. Minimization of expenditure leads to an automatic profit maximization. In addition to this, various promotions on the products sold by the company can be intensified so as to boost sales.
Based on the above discussion, it is, therefore, possible to conclusively say that a company’s financial health is fully dependent on the decisions that will be made by the company’s top management and the formulated policies regarding their financial management. Fortescue Metals Group Limited financial status is not in a desperate state being that from the financial statements, it has never made any loss in the past five years despite the low gearing ratio and the low net profit margin. It is, however, worth to note that timeliness is of great essence in making these decisions, formulating the above proposed policies and effecting them thereof for the benefit of the company owners.
References
|
Consigli, G., Kuhn, D., & Brandimarte, P. (2017). Optimal Financial Decision Making Under Uncertainty. Cham: Springer. Harrison, T. (2016). Financial Literacy and the Limits of Financial Decision-Making. New York: Palgrave Macmillan. Kumar, N. (2016). Chronic Regulatory Focus and Financial Decision-Making: Asset and Portfolio Allocation. Singapore: Springer. Resta, M. (2016). Computational Intelligence Paradigms in Economic and Financial Decision Making. Cham:
PPT
Case Study 2: Financial Policy Decision Making Name Institution Date Introduction
Cont…….
Financial Decision Making Process The steps are as follows: Cont….
Financial Policy Formulation Process The process can be as follows: Cont….
Profitability Graph in The past 5 years Liquidity Graph In The Past 5 Years Gearing Level Graph is the past 5 years Conclusion
References Doumpos, M., Zopounidis, C., & Pardalos, P. M. (2012). Financial Decision Making Using Computational Intelligence. New York: Springer. Lucarelli, C., & Brighetti, G. (2011). Risk Tolerance in Financial Decision Making. Basingstoke, Hampshire: Palgrave Macmillan Ziemba, W. T., & MacLean, L. C. (2013). Handbook of the Fundamentals of Financial Decision Making (In 2 Parts). Hackensack, NJ: World Scientific. |