The Importance of Financial Management to an Organisation - Free Essay Example

Sample details Pages: 6 Words: 1877 Downloads: 1 Date added: 2017/06/26 Category Finance Essay Type Argumentative essay Did you like this example? Credit control is the process of control over payments coming into and going out of the firm. It is mainly concerned with the firms and the firms debtors. Tight credit control is important if a firm wants to avoid cash flow problems (Garrison, Ray. Don’t waste time! Our writers will create an original "The Importance of Financial Management to an Organisation" essay for you Create order H., et al : 2009). According to(Kaplan, Robert. S., Bruns. W, 1987) Cash or finance is considered the life blood for any business. In the current competitive era Granting credit in order to win sales is a fact of life for every business, as is the likelihood that more than 50% of your credit customers will fail to pay on time. Sadly, no matter how good your product or service is and no matter how adapt you are at winning new customers and increasing sales, unless you can convert those sales into cash reasonably quickly, you wont remain in business for long. The solution to this problem is setting up a simple credit control system and injecting a little more discipline into the process of granting credit and recovering cash, your customers will start paying. If we look at the financial report of Wal-Mart, Current liabilities exceeded current assets at January 31, 2010, by $7.2 billion, an increase of $789 million from January 31, 2009. Our ratio of current assets to current liab ilities was 0.9 at January 31, 2010(financial report, 2010 p.10). According to the Wal-Mart officials it is the proof of efficient cash flow management but if we look at the industry average, it is clear that Wal-Marts working capital ratio is critical and they should maintain working capital ratio around 1. Furthermore, the increased provision for doubtful debts which was $298 million and $188 million at January 31, 2010 and 2009, respectively also shows the poor credit control management (five years financial report, 2010 p.17). 1.2 How a company can adjust its fixed and variable cost A fixed cost is that cost which does not vary with the level of activity within a specified range (Garrison, Ray. H., et al, 2009). A variable cost is that cost which varies with the level of activity within a specified range (Garrison, Ray. H., et al, 2009). There are number of ways by which a company can adjust its fixed and variable costs in economic downturns like reducing activity level, downsizing, and decrease in the level of borrowings or investments. Wal-Mart Stores Inc.  acquired a controlling interest in  Distribucion y Servicio DS SA, Chiles largest grocer, completing its biggest acquisition in Latin America on 23 January 2009, and other collaborations with China and Indian firms to open super markets in these particular countries, when Wal-Mart acquired DS, there was too much overstaffing and non-productive debt burden which was paid by Wal-Mart these activities shows the strong financial position of Wal-Mart (Bloomberg, 2009). Wal-Mart is als o reducing its fixed cost like interest by paying off the unproductive debts of DS but due to the new acquisition of DS the overall staff is increased and hence there is an increase in the administrative expenses and variable expenses like labour cost but by downsizing and training the staff these expenses are being removed gradually (five years financial report, 2010 p.40). Reasons For The Companies Need To Raise Finance 2.1 Debt Financing The act of a business raising  operating capital  or other  capital  by  borrowing, most often, this refers to the  issuance  of a  bond,  debenture, or other  debt security (Powell, Gary. N., 2005). Long Term Debt Financing  usually applies to assets your business is purchasing, such as equipment, buildings, land, or machinery. With long term debt financing, the scheduled repayment of the loan and the estimated useful life of the assets extends over more than one year (Sapp, Richard, David. C., Steven. R., 1990 ). Short Term Debt Financing  usually applies to money needed for the day-to-day operations of the business, such as purchasing inventory, supplies, or paying the wages of employees. Short term financing is referred to as an operating loan or short term loan because scheduled repayment takes place in less than one year. A line of credit is an example of short term debt financing (Sapp, Richard, David. C., Steven. R., 1990 ). Short-term borrowings of Wal-Mart consist of commercial paper and lines of credit. Short-term borrowings outstanding at January 31, 2010 and 2009 were $523 million and $1.5 billion, respectively. The company has certain lines of credit totalling $9.0 billion, most of which were undrawn as of January 31, 2010. Of the $9.0 billion in lines of credit, $8.6 billion is committed with 34 financial institutions(five years financial report, 2010 p.24)In long term debts bonds and other certificates consist of $42216 million in 2010 while it was $40960 in 2009 (five years financial report, 2010 p.18) 2.2. Equity financing Equity finance is a way of raising share capital from external investors in return for handing over a share of the business. This may take many forms, including a share of future profits, but is most frequently associated with sharing the ownership of the business to some degree (Sapp, Richard, David. C., Steven. R.,1990 ). A company can raise finance in three different ways by equity financing it can either retain the profits in the business instead of distributing them back to shareholders, it can sell new shares to existing stockholders (rights issue) or it can sell new shares to general public and investing institutions. Wal-Mart has equity portfolio which consists of preferred stock, common stock, retained earnings and premium on the issue of shares which was $70,749 million in 2010 and $ 65,285 million in 2009 (five years financial report, 2010 p.18) As the Wal-Mart is enjoying the good financial position so it can easily increase its capital by seasonal and unseasonal public offerings Options for Companies to invest 3.1 Consideration of a company before making an investment Investors must overcome two considerations before they invest. First, the investor must be convinced their investment will be safe and that they will eventually recover their capital. Second, the investor wants to know how and whether the return assumptions are reasonable, achievable, and likely( KAPLAN, ROBERT. S., BRUNS. W., 1987). Safety is even more important than ever with the events of recent years so safety is strongly on everyones minds. Overcoming the investment safety issues implies having a very detailed plan that walks the investor through each conceivable downside event and shows clearly and simply how potential pitfalls are overcome. The principals plan should anticipate market devaluation, increased costs, liability issues, unfriendly rate environments, potential inflation, management issues, weaker revenues, weaker revenue growth, vacancy issues, maintenance issues, and facility failures to name a few (Kaplan, Robert. S., Bruns. W., 1987). Apart from these financ ial factors there are several non-financial factors that should be considered some of these are climate issues, staff motivation, customer satisfaction, manpower availability, government regulation etc. Wall-mart must look for opening inaugurating its business in Asia especially in south East Asia as well because the economic conditions of these countries suits Wall-mart and will be proved profitable as the world economy is being transferred to these countries. Wal-Mart already has made collaborations with Chinese and Indian companies as investments in these countries (Bloomberg, 2009) 3.2 Payback ratio The  payback period  is the time necessary to recover the initial outlay on an  investment. Where annual  cash  flows are identical, the  payback period  is equal to:  investment/annual cash  flow.  Payback period  criterion emphasises the  liquidity  of an  investment, but not its value. Payback period  is also called  payback ratio (Garrison, Ray. H., et al : 2009). 3.3 The Pay-out Ratio The dividend pay-out ratio is calculated by dividing the dividend paid by the net income per share. Dividend Paid/Net Income per Share = Dividend Pay-out Ratio 2009= 0.95/3.39= 0.2808 or 28.08% 2010= 1.09/3.71=0.2938 or 29.38% Despite of increase in the cost of production there is increase in the net income available for shareholders, so they have decided to pay more dividend as compare to the previous year 2009(five years financial report, 2010 p.18). Importance of Preparing Reports for Companys Finance 4.1. Overview of income statement and balance sheet 4.1.1 Operating Expenses In fiscal 2010, operating expenses increased 2.7% when compared to fiscal 2009, while net sales increased 1.0% over the same period. Operating expenses grew at a faster rate than net sales due to higher health benefit costs, restructuring charges and higher advertising expenses (five years financial report, 2010 p.5). 4.1.2 Operating Income For fiscal 2010, Wal-Mart met objective of growing operating income at a faster rate than net sales. Operating income increased by 5.1% when compared to fiscal 2009, while net sales increased by 1.0% over the same period (five years financial report, 2010 p.5). 4.1.3 Free Cash Flow Free cash flow is defined as net cash provided by operating activities of continuing operations in a period minus payments for property and equipment made in that period. Wal-Mart generated positive free cash flow of $14.1 billion, $11.6 billion and $5.7 billion for the years ended January 31, 2010, 2009 and 2008, respectively. The increase in free cash flow is primarily the result of improved operating results and inventory management (five years financial report, 2010 p.5). Gross profit, as a percentage of net sales, (gross profit margin) was 24.8%, 24.2% and 24.0% in fiscal 2010, 2009 and 2008, respectively. Wal-Mart U.S. and International segment sales yield higher gross profit margins than Sams Club segment (five years financial report, 2010 p.8). Effective income tax rate was 32.4% for fiscal year 2010 and 34.2% for fiscal years 2009 and 2008. The fiscal 2010 effective tax rate decreased compared to fiscal 2009 due to $372 million in net tax benefits that primarily resu lted from the repatriation of certain non-U.S. earnings that increased utilization of U.S. foreign tax credits (five years financial report, 2010 p.8). There is 0.3% increase in the percentage of operating income to net sales as compare to the previous year. 4.1.4 Common Stock Dividends Wal-Mart paid dividends of $1.09 per share in fiscal 2010, representing a 15% increase over fiscal 2009. The fiscal 2009 dividend of $0.95 per share represented an 8% increase over fiscal 2008 (five years financial report, 2010 p.9). There is 1.26% decrease in the current assets as per last year 2009, but 4.45% increase in total assets shows that company is focusing on capital expenditures rather than revenue expenditures which will ultimately help in improving the stability of the company. The current liabilities are increased this year which shows the better credit policies. 4.2 Advantage of cash flow statement rather than balance sheet Valuation companies prefer to analyse the cash flow statement as compare to the balance sheet because the balance sheet basically shows the assets, liabilities and equity on a particular time but does not show the cash inflow or out flow of the company which is more crucial for valuation because it clears that how much cash inflow will be at the time of debt payment for so that the company will pay the debt. Only the assets and liabilities do not tell the credibility of a company to pay and handle the debt. That is the reason companies prefer cash flow statements rather than the balance sheet (Kaplan, Robert. S., Bruns. W., 1987). Conclusion As we have gone through the financial report of Wal-Mart and we have analysed different ratios and statements it seems that despite the economic downturn Wal-Mart is still carrying on its way to progress and expansion. Although Wal-Mart has acquired the DS which have a huge burden of debts and inefficient employees and there was huge cash outflow but still this year its operating income is increased by 0.3 % which is the proof of efficient credit and finance policies. But the slight unfavourable change in the working capital and debtors and creditors turnover ratio still indicates the room for improvement. Wal-Mart should review its credit control policies and make necessary arrangements to overcome this weakness.