Financial management is crucial part of the business, which will show how to find the 200 million (pounds) at a minimum cost, the importance of appropriate investments to maximize shareholder's wealth in order to expand in a secure steady growth, and the need of independency through building cash reserves and retaining profits.
A location would be provided to attract the people in the capital market, Spry PLC's case would be listed in the full market and would be a more suitable market place to buy and sell shares because the average market capitalization of AIM is £30 million, which is a smaller market place for the companies to sell and issue shares. Now a day the market place could be found on the Internet and regional centre to attract the public, brokers, and dealers. This discloses the company's information, history, announcements, and is constantly analyzed and compared by the people on the financial press in order to raise finance through issuing debentures and bonds To raise finance for the projects it would amount to about £200 million and should be done without affecting the success of the business; obviously this is long-term finance because it's a large number to pay off in a short period of time.
Firstly, the agent needs to check how much debt the company is actually in. Whatever step is taken should be considered by the directors and see if it would affect the capital of the business because the market decides if investors would invest in our company. By approaching this process it won't affect the corporate performance, which then leads to attracting investors thus leads to a rise in the share price. The capital market looks at and is influenced by the:
- Public relation
- Quality of management
- Adding value
- Cash flow of the company.
The Efficient Market theory assumes that the Spry PLC stock would reflect on knowledge of all the investors in a perfect market however this is not true because each person interprets the information differently. Next the investors go their own way depending on the level of risk they are willing to take. If the market efficiency were weak then it would be easy to gain capital since everyone is irrational and not reading the information properly. Usually the Market Efficiency is semi-strong making it harder for Arbitrage games because the system is in place to avoid fluctuations in stocks prices and the people waiting to take chances. This is similar to how mathematicians and economists try to take advantage of these undervalued stocks, by analyzing the behavior, and by using probability so as to profit substantially from market share.
Corporate Governance and OFR
By taking a loan of £200 million the company must make sure doing this will not affect the people's willingness to invest; this could lead to preventing trade, which is why we need corporate governance. Operating and financial reviewing is really important to give balance, to give the good and bad and explain in depth where things are wrong. By comparing the decisions made per year for the last 2 years to see how the accounts got affected would help predict consumers' behavior in order to help future financial decisions.
The senior financial manager is constantly looked at by the financial market and analyzes the manager's performance making the senior financial role more vital to make appropriate decisions day by day to continuously attract investors.
There is a need for good stewardship to keep the business going daily in existence and run successfully year after year to add shareholder value. This is done through looking at what risks to take, what opportunities to let go of, as well as not only think about profit and shareholders wealth. They need to however, act upon stakeholders, otherwise you would not be considering the risks involved in each step you take. An example of this is seen in the case of ICELAND (2008) who went bankrupt because directors thought of there own interests that led to manipulating accounts, and not considering the risks upon the stakeholders. This is all part of Corporate Governance and needs to be followed.
By understanding the owner of Spry PLC's mission and vision, it will help set a corporate strategy in place. By having measurable objectives they will help keep and reach the corporate vision in order to beat the competitors. Some strategies used are constant research or development, entering new markets, or increasing the market. By doing so, the corporation needs to act to be the best supplier, through raising funds cheaply, controlling costs, and investing in working capital, fixed capital projects, and in the future. This should not be done by cutting costs or selling assets because the capital market does not care about the profit when looking at the income statement but will see if the company would prove sustainable growth.
Corporate Social Responsibility
To trade shares on the LSE, all companies now legally need to set out a CSR. The steward should also consider the social responsibilities when making decisions and should have good capital structure decisions to balance between the equity and debt. This is one of the things the market analyzes and judges as to how Spry PLC's share price will be valued.
Liquidity vs. Profitability
To finance investment projects you need a good cash flow and balance the current liabilities with your current assets by managing the working capital through investing in appropriate short-term instruments. The director needs to keep track of how fast Spry PLC brings money in and out to avoid chances of being asked to go to court; he also needs to consider how much needs to be kept back for cash flow problems. This makes it vital to balance the idea of liquidity and profitability and grow the working capital.
If the business is very liquid then the organization can use the surplus money to invest. If there are cash flow problems then there might be the need of a new director to properly control the corporation internally by financial reporting and having accounting abilities to promote fairness, accountability, and open communication. Need to manage resources and not make the business work for the bank. Good accounting means having good short-term finance. The surplus cash should be invested in appropriate short-term instruments. These are a few solutions if the business were facing cash flow problems such as:
- Trade creditors Sell debt
- Retained profits If continue to use reserves afterward Spry PLC capital will start to cut bit by bit.
It is important for the director to have a governance structure for long term competitiveness by considering the problems Spry PLC faced in the past and could face in the future such as making losses, inflation, growth, seasonal factors, and significant expenditures. By considering this, it will help focus on building up the reserves. The bigger the reserves, the less chance of Spry PLC going bankrupt because the balance in liquid and profit are rising meaning the ordinary share price goes up. The shareholders are also happy due to the build up in reserves and could invest without any dependency on other sources of finance.
Agency Problem and Shareholder Responsibility
It is the agent's duty to apply the constant objective of maximizing shareholders' wealth in their line of work, making it vital to keep building assets. The shareholders should and could help Spry PLC's long-term competitiveness, make better investments, and prevent the company from going bankrupt by just understanding the fact that stewards don't always make the right decision. If the shareholders do their part by working hard, attending the AGM, and question the agent's strategy, they can then make sure the directors are balancing the liquidity and profitability of the company.
A cheaper way to solve this would be for the owners to make a contract of maximum 3 years to directors, full disclosure of directors' pension and share option, and set an audit committee including 3 non-executives for conducting the code of best practices. A company sometimes needs to be in debt in order to grow; but there is a cost to doing so. Even though being in debt with financial institutions is easier and less expensive, it is more risky because of the need to generate constant cash flow. In comparison however, equity finance is more expensive yet less risky in which the company must continuously build capital gain. The market and investors analyze how much the company is in debt because it is easier to obtain than cash. First, debt payments are made before dividend payments and failure to do so will end up in bankruptcy, which is why it's important for the director to take action according to the company's debt and the capital market.
The way to gain from the market is by calculating the cost of capital to discount future cash flows; this would be the Net Present Value. Put procedures in place to see exactly why you want to invest in the projects and how much you can afford. You need to go through investment appraisals such as:
- Accounting Rate of Return
- Discounted Cash Flow Examined by (Net Present Value or Internal Rate of Return)
To show good management and for the manager to establish rate of return you adopt the NPV to get a return that is above the cost of the projects.
Value Based Management
The main goal is to increase the value of the business to the shareholders. As a senior financial manager it is easy to know what to work towards. As a manager you can work to increase shareholder value by either cash dividends or influence the capital market through capital gains. There are 7 drivers that could cause the shareholder value to rise or fall. They are categorized into 3 areas, Operating, Investing, and Financing. Through this model you can see the importance of corporate governance and show the market and investors that Spry PLC can sustain growth by showing exactly what drives the shareholder value.
Field research found out that when gathering information from observation, companies like to give out dividend believing the market would punish them if they cut dividends. There is no obligation by law to set a dividend policy. The pay out would depend on how risky investing in the company is in order to know how much they want as a premium.
Different types of Dividends are:
- Cash Dividend
- Scrip Dividend (Offer more stock, more equity instead of cash) needs to be agreed on the AGM
- Stock Issue (Issue the same to all holding shares with more stocks)
It would be a strategic decision if the company sets a dividend policy because the market assumes that if Spry PLC does not give share dividends then it has low cash flow and it's a bad company. If the dividend is shared then the market will have a more positive view of Spry PLC. Capital market expects to know the level of returns to declare how much the company is willing to pay out. This shows that the board of directors understands the constant objective of adding shareholder value and good management team performance. If Spry PL gives a good dividend then they would also get a good credit rating making it easier to raise the necessary funds. They also need to be very similar to their rival's dividends. It may be that Spry PLC needs to set a proper dividend policy to not affect the share price on the capital market because the theory is that dividend policy directly affects the share price.
This is important to know because social Norms indicates the market does not like fluctuating dividends; so they need to control cash to pay dividends. This is linked to the working capital and short-term finance. With the balance sheet having to do with the level of cash management it is important to manage short-term finance or short-term debt because it would be shown on the balance sheet. Stocks affect the cash flow of the business so they need to manage cash but have systems and procedures in place such as Stock Control System because the stock affects the cash flow. The inflows should balance the outflows to show good cash management.
Sources of Finance
To raise the £200 million for the projects, they must be done as cost affectively as possible and as we see there are a number of sources to raise external finance and the ones that are most suitable for Spry PLC are:
- Lending from a mix of financial institutions
- Ordinary loan
- Mortgage Loan
- Issue Debentures
- Issue Bonds
- Raise money through Warranty
- Venture Capitalist
- Insurance companies (where the company buy the shares or buy the debts and loans)
- Individuals (could be considered a source of finance)
The company needs to get through debt by issuing debenture at a fixed charge because it's secured, or loan stock. However, there is a need again for good cash flow because banks lend to people who have money other than cash form. Once they issue convertible bonds to financial institutions you need to show good corporate governance. Afterwards the Spry PLC would have the option to get into debt and then offer the banks to convert debt into shares. Once we get out of the recession and during boom times the banks will then most probably be willing to convert.
- Equity Finance
- Issuing New shares
- Reselling shares
A director chooses to place shares to financial institutions or the capital market and the shareholders vote at the AGM.
- Internal finance
- Cutting cost this should be done naturally.
- Using retained profits
As a senior financial manager the lowest cost of debt is what should always be headed for. £200 million is a long-term liability that risks the cash flow therefore harder to support the investment plans which reflects negatively to shareholder value. This then shows the effort of the stewards' decision-making and strategy that reflects on their performance and the return on investments. This then shows the standard of corporate governance, which will be analyzed.
Market value of equity plus market value of debt need to be balanced because the market capitalization is constantly analyzed. This is the debt finance, which in financial terms is called leverage. The leverage affects the gearing of the business, which then affects the cash flow of the Spry PLC and by now we know cash is king (Todd Harrison 2008). So the higher the gearing and leverage the market would then ask for a higher premium. This then could affect the capital structure. Cash flow will always be customers concerns, and the current market is going through recession, meaning it might not be such a good idea to issue shares. Instead, it may be that Spry PLC would need to sell their debt or have systems be put in place by having a credit referencing check to make sure all debts are paid. Spry PLC should always have more liquid assets than current liabilities. The target of capital structure is the balance of equity and debt to show good capital structure and good financial management.
Weighted Average Cost of Capital (WACC)
Weighted Average Cost of Capital is to see who has the best portfolio and the relevant risk and cost it carries when appraising the new projects. Debt finance has cost associated with them
This might affect the added value. All long-term debts are included in WACC and it's used to calculate and evaluate the cost of carrying new debt. It is difficult in practice to calculate because the instability of a company's cost of capital continuously changes. The directors should use this to see the opportunities from takeover and merging, which is really done only during boom times. For good strategic management financial manager need to minimize risk by considering the target the capital structure by balancing between equity and debt for a good capital structure. Because when risking the business the capital market will see this and this would surely change the share price.
The theory is to have a bit of both equity and debt to get the necessary fund from a selection of sources because when raising finance there are opportunities to get from everybody and the theory assumes it's a perfect market
Understanding this theory allows you to understand the need of finance because capital is not free. As a fund manager, you must manage the portfolios. The way to distribute the amount from everybody is to have a mix of 40% debts and 60% equity because there is a risk to each source of finance. And then agree and tell the investment plan and the capital market decides if it good.
The market looks at the yield of ROI Buyer looks at and uses two ways to maximize ROI by looking at ratios to either maximize return or minimize investment using portfolio investment. Return is different for different people. Also, the time value of return is different between people, e.g., some people may value a larger return later over a smaller return sooner or vice versa.
Capital Asset Pricing Model (CAPM) is a system used widely to measure the risk it carries. Developed by Markowitz student based on his portfolio theory, a systematic risk for risk management that concludes an expected return. The formula above shows the percentage on the risk of return in leverage in order to not affect the capital structure. When issuing shares, bare in mind that the public and sources of finance would all use CAPM, which is why it is important to show good corporate governance and show that all systems are in place. Shareholders mainly use this formula to evaluate the current price of stock reliability with its return. It evaluates the risk of individual when buying a share, which should show the quality of the strategy.
If the shareholders are inexperienced in how to, or lazy in making sure that the directors are doing their part, they then are not working in the long-term interest of the shareholders. Therefore, there are companies that help corporations achieve their vision like Hermes Investment Management, a business that would monitor the implementation of the proposal and help raise stock price to reach the determined level by making sure that directors are performing strongly. By tackling the internal Spry PLC's performance this solves the agency's problem and the external conflicts.
Miller Theorem (M&M), Miller & Modigliani would disagree and argues that a company's capital structure is irrelevant to the cost of capital. The market value of a firm is determined by its earning power and the risk of its underlying assets, and is independent of the way it chooses to finance its investments or distribute dividends.
BETA as shown above is the only thing that measures the stock, which should be your benchmark to see the market performance on average over a period used to measure a systematic risk. The information is available on Financial Times, broker and dealers. People like Warren Buffet an investor who has earned a substantial return when he pushed himself in investing in financial stocks.
References & Bibliography