The importance of corporate finance
In this modern era no business can regret the importance of corporate finance. Its main concern of corporate finance is how companies raise finance; allocate these funds for increasing shareholders wealth. However, beyond this function corporate finance has many other functions such as, corporate governance, financial management, risk management, agency theory etc. Shaun Beaney (2005) defines corporate finance in the following words "to describe activities, decisions and techniques that deal with many aspects of a company's finances and capital". In this assignment I am going to discuss the different aspect of corporate finance in Spectrum Manufacturing Company.
The purpose of this assignment is to apply different functions of corporate finance in Spectrum Manufacturing Company. Required information is taken from the scenario and financial reports of 2006, 2007 and 2008. All relevant information of the company is included, moreover references from different books, published journals articles and internet has been used and provided at the end of this research which support my research work.
Financial ratios are used to interpret the company's financial statements and other sources, to analyse the company performance over the number of years. It is also very important to know how to survive in the competitive environment in which a company is operating. Management need to be aware of the external and internal factors that have big impact on the company's performance. Therefore, it is very important for managers to know different financial and non-financial tools and techniques to measure the company's performance. It also helps manager to understand the company's financial position and how the company's performance affects the market place (Brian Watts 1997).
Managers use financial ratio to get required information, in order to make decision for the future. Ratios are a powerful tool which provides an overview of the company's financial position. In order to exploit the full potential of ratios, users must have strong knowledge and skills to understand ratios and why certain changes have occurred in comparison (McLaney and Atrill, 2008). Nevertheless, there are some drawbacks of using financial ratios, such as, all information is historic and does not reflect the present situation of the company. Ratios do not consider the future, so it could lead to wrong decisions. All relevant working and formulas are provided at the end of this assignment in appendix 1.
All companies are concerned with their profitability. One of the most used tools is profitability ratios for analysis and evaluation of the company's financial statements. Profitability ratios are very important for managers and shareholders to measure the efficiency and performance of the company. Profitability ratios are divided into two types of ratios:
- Margins Ratios
- Returns ratios.
Ratios that show margins represent the organisation ability to translate sales (turnover) into profit at different stages of measurement and ratios that show returns represent the organisation's ability to measure the efficiency of the organisation in making returns for its shareholders (Rosemary Peavler 2009).
In case of Spectrum Manufacturing Company, Profitability ratios are used to measure how well Spectrum is producing profits from its equity, assets and revenue. It also shows how well the managers are using the organisation's available resources and controlling costs to maximise shareholders wealth. The profitability ratios of Spectrum are as follows:
Gross Profit Margin
Gross profit ratio tells us the Company ability to control its production costs and increase sales value and volumes. It is normally used to benchmark against competitors to measure own performance. Spectrum gross profit margin ratio is as follows;
Gross profit margin above shows, a big declined in gross profit ratio in 2007 and 2008 compare to base year 2006, and small increase (1.64%) in 2008 compare to 2007. Gross profit ratio 28.05% in 2006 means that from sales activity, company's cost of sales was 71.95%. Sale in 2007 was increased 30.62% compare to 2006 but gross profit is declined 5.37% which indicates that the rate of increase in cost of sales is higher than rate of increase in sales. There could be several reasons of declining gross profit. The material cost is increase almost 55% compare to 2006 which indicate that company could have problems to find cheap suppliers, management was unable to negotiate with them, or material prices increased more than inflation rate due to increase in demand. Another reason of declined in gross profit could be, Spectrum reduced its selling prices of goods to increase market share. Sales in 2008 increased by 4.21% and gross profit decreased by 3.73% compare to the base year 2006. On the other hand Gross profit increased in 2008 compare to previous year (2007), although sales declined over 20%. A small increase in Spectrum gross profit in 2008 was due to massive decreased in labour and overhead costs. Material cost is declined same ratio as sales of the company. Gross profit margin ratios movement are shown in chart below;
Net Profit Margin
Net profit margin ratio shows the company ability to make profit before any payment make to company finance providers. It tells us about the company ability to control production, operating, distribution and overheads costs. It also provides clues about the company's cost structure, production efficiency and pricing policy. This ratio is widely used to measure performance against similar companies or industry. Spectrum net profit margin ratio is as follows;
The Spectrum net profit margin result shows that the margin is fairly stable over the period with slight decline in 2007 and improvement in 2008. However, to know how well Spectrum is performing we need to compare these ratios with the competitors or industry average. The main reason of net profit margin declined in 2007 was mainly due to increase in cost of sales and selling expenses. Although sales increased in 2007 with a big margin but due to increase in material, labour and selling costs net profit margin declined. In 2008 Spectrum net profit margin increased mainly due to declined in cost of sales and all operating expenses compare to first two years. Net profit margin ratios are shown in chart below;
Return on Equity (ROE)
ROE is the most important ratio of all profitability ratios to shareholders in the company. Return on equity shows how much profit company actually made on money invested by its shareholders. ROE measures company's efficiency to generate net profit from shareholders funds. It also shows how well company management is using shareholders funds to generate earning growth. This ratio also helps the potential investors to make the investment in that particularly business. . Spectrum ROE ratios are as follows;
Spectrum Manufacturing Company ROE showing a strongly positive and upward trend. It has increased strongly from 22.65% in 2006 to 34.3% in 2008, which mean shareholders earned more dividend or increase in shares value. The main reason of increase in company return on equity is due to increase in profit after tax and decrease in shareholders funds over three years. Why equity shareholders funds decreased over the period is not mentioned in the information given. This could be due to Spectrum re-purchased its shares. Anyhow, existing shareholders should be comfortable with that increase in return on equity. ROE ratio is shown below chart;
Advantages and Disadvantages of Profitability Ratios
The major advantages of profitability ratios is to measure the company profitability by using different profitability ratios and also help managers to get information about the earning capacity of the company. So we can say profitability ratios shows actual performance of the company at the particular period of time. Secondly, profitability ratios are very useful to summarise the whole picture of the company profit and loss statement into percentage form, which is easy to understand. Another advantage of profitability ratio is evaluate the performance of company by using resources employed e.g. capital employed or assets. How management is using these resources effectively to earn profit.
Disadvantages of profitability ratios is they do not tell us what is going right or wrong and invite further questions such as, profitability ratios do not account inflation over the period of time, which is a major factor to make ratios meaningless. Normally managers do not make adjustment for inflation rate change. Secondly, financial statements can be manipulated by the management to increase profit by using different accounting polices. So if financial data used in profitability ratios are not reliable than ratios will be unreliable. Thirdly, profitability ratios only reflect past profit of the company and nothing about future. So it is impossible for managers to forecast future event by using past data.
Return on Capital Employed (ROCE)
ROCE is generally used as the key ratio in a set of management ratios but sometimes it can be used as a method of carrying out a capital investment appraisal (FTC 2004). It tells us what return company has made on the funds available to them before making any payment of interest and tax. Spectrum's Return on Capital employed (ROCE) tells us how much profit it earn from Capital employed by its investors in the business. .Spectrum ROCE ratios are as follows;
Spectrum ROCE shows that the company had effectively used capital employed to generate profits. It increased from 21.24% in 2006 to 40.44% in 2008. It is a positive sign for managers that they are utilising capital employed efficiently and make maximum profit for every pound invested by investors in Spectrum. There are two reasons of ROCE increase in Spectrum, first is company profit before interest and tax has increased over the period and secondly company capital employed (shareholders funds and long term debts) decreased significantly over three years. Due to these reasons ROCE increased almost double over past two years. So increased in ROCE is presented in graphical form shown as below:
Advantages and Disadvantages of ROCE
The major advantage of ROCE is to use to evaluate the project on the basis of percentage rate of return which all management are familiar. It can be compared with the existing ROCE of the industry or company. The second advantage is ROCE is very simple method to calculate and understand the company overall performance. The third advantage is management performance is often measured by shareholders in term of company overall return on capital employed. So the ROCE is the method of measuring company's actual performance.
The main disadvantage of ROCE is to measure return against the book value of the assets in the business. Depreciation on assets could increase the ROCE even though cash flow of the business remains same. In case of Spectrum, the main reason of declined in ROCE is company bought more fixed assets in 2007 and 2008 and profit declined cause of depreciation. The second disadvantage of ROCE is that the company cash flow is normally affected by inflation but the book value of assets remains same. ROCE only consider accounting profit of the company rather than cash flow. Accounting profit can be manipulated by management to satisfy investors but Cash flow is difficult to change.
Leverage means, a level or degree to which a company is utilizing debt finance. Leverage ratios indicated capital employed of company supported by creditors' funds (debt). The company which is highly leveraged contain high risk of bankruptcy if company is unable to make payment of debts or interest on debts. Debts are not always bad. Companies normally use this practice to maximise shareholders wealth. Debt is usually considered as a cheaper method of financing in a company due to two reasons. The first reason, tax advantages are associated with borrowing cost and secondly if earning on capital employed is greater than the rate of interest on borrowed funds than debts help to increase shareholders wealth. Most widely used leverage ratios are the debt to equity ratio, debt to assets ratio and interest cover ratio (Kaplan 2006).
Debt Ratio or debt to Assets ratio
This ratio is normally used to measure long term ability of the company to meet financial obligations. Debt ratios measure the financial strength of the company by reflecting the percentage of capital which has been financed by debts. Spectrum debt ratio is as follows;
Spectrum debt ratio shows declining trend over three years and debt ratio was 63.12% in 2006, 62.80% in 2007 and 47.41% in 2008. Spectrum debt ratio shows that company is financed by huge amount of debt in first two years more than the actual value of equity and so its means company most assets are used as security for these debts. The main reasons of declining debt ratio are big fall in current liabilities and long term debts. If we analyse current liabilities, accounts payables and accrual expenses are reduced massively and Spectrum paid off bank loan in 2007 as well. Spectrum long term debts are also reduced more than half of there total value in 2008 compare to 2006. On the other side its assets are also declined over three years but less than the debts proportion. Spectrum debt ratio in 2008 shows that, company holds debts almost equal to total assets value. Spectrum debt ratios are shown in graphical form below;
Debt to Equity ratio
This ratio is used to measure company's financial leverage, how company debt finance is covered by shareholders funds. This ratio shows the position of the equity holders and debts holders and also indicates the company policy on capital structure. Debt to equity ratio is calculated as follows;
Spectrum debt to equity ratio shows that company has used more debt finance than money invested by its equity providers in first two years of trade and decreased massively in 2008. The debt to equity ratio in 2006 shows that every £1 of shareholders funds there was £1.71 of debt in Spectrum capital structure, which decreased down in 2008 to £.90 of debt compare to £1 equity. The above ratios indicate that company was aggressively financed (by debts) in first two years. High debt ratio also impact on earning of the company and earning is more volatile than company finance by equity funds. Overall Spectrum debt to equity ratio shows declining trend due to decline in current liabilities and long-term debts over the period. The big declined in 2008 represents, that company paid back its long term debts and in current liabilities, payables declined massively which shows that suppliers reduced their credit period or management prefer to pay cash earlier to suppliers for discount or any other reason. Spectrum other current liabilities are also declined over the period which shows company has good cash in-flow and want to pay suppliers earlier. The declined in debt to equity ratio is shown in graph below;
Interest Cover Ratio
Interest Coverage Ratio is a tool that measures the company ability to meet its interest payments on its debts. A high interest cover ratio means that company is easily able to meet interest liability from operating profit and it also add value to shareholders wealth. Shareholders, directors and managers are also interested in the company ability to meet the fixed interest charges on debt finance. Interest cover ratio is calculated as follows:
Spectrum interest cover was 4.71 times in 2006 and it increased 6.12 times in 2007 and 16.74 times in 2008 respectively. The increase in interest cover was due to big increase in profit before interest and tax and reduction in long term debts and short term loans, which result declined in amount of interest payment. Due to these two reasons, debts holders enjoyed bigger and healthy interest cover in 2007 and 2008. High interest cover ratio means, company is earning higher rate of return on debt finance than paying out to debt holders in the shape of interest, which results increase in shareholders wealth. High interest cover ratio means less financial risk for Spectrum shareholders and debts holders. Spectrum interest cover is shown in below graph;
Advantages and disadvantages of Leverage Ratios
The one of the biggest advantages is that leverage ratios make easier for managers to maintain optimal capital structure. It help company to reduce the overall cost of capital by introducing debt into capital structure, debts are considered cheaper than equity because of tax advantages. The second advantage of leverage as per Modigliani & miller (1963) is help to maximise company's overall value by minimising WACC. The third advantage of leverage is that, it helps to maximise overall profitability of the company compare to equity. The two reasons make debts cheaper, one is security on debts and second interest is allowable expense for tax purpose.
The main disadvantage of debts finance is to increase the risk of bankruptcy if company is unable to pay back principal amount of debt and interest to debt holders. The second disadvantage is interest is a legal obligation compare to dividend. Company must have to pay interest either it is making profit or loss. The third disadvantages of using big leverage is companies usually prefer to invest in short term project which help them to keep their liquidity high for repayment of debts obligation. Most of times companies don't consider long term project which are highly profitable.
Current Assets Ratio
The current assets ratio measures that company has enough resources to pay its short term liabilities. The higher the current assets ratio, the company is in better position to pay its obligations. If the current assets ratio is 2 : 1, then this ratio is considered to have good short term financial strength. The main reason of this ratio is to make sure company has enough current assets relative to short term debts, which provide assurance to the payables that company will be able pay their money back (Brian Watts 1997). The Spectrum current assets ratio is as follows:
Spectrum current assets ratio shows an increasing trend on liquidity over three years. In 2006 current ratio was 1.84 : 1, which means company has £1.84 to pay £1 current liability. This is considered to be satisfactory level (2:1). In 2007 and 2008 company current assets ratio increased 2.12 and 2.88 respectively. The big increase in current ratios was due to huge decline in current liabilities in 2007 and 208. Spectrum payables and accruals declined massively and it also paid off bank loan in 2007. On the other side assets are also declined but small proportion than current liabilities. Company most liquid asset is cash, but company has fairly small amount of cash compare to its most liquid liabilities. Receivables are usually collected between one to three months, but it's depending upon company policy or industry. Most liquid assets (cash and receivables) meet the current liabilities holders demand in all three years. So the least liquid current asset inventory, which represent a huge amount of company current assets. But company had no problem with inventory and there was no sign of slow moving inventory.
Advantages and Disadvantages of Current Ratio
The current assets ratio advantage is to measure the company ability to pay its short term debts. So its means current ratio measures weather the company has sufficient current assets to pay current liabilities. The second advantage of current ratio is to measure the company's operating cycle efficiency or its ability to turn its goods into cash.
The main disadvantage of the current assets ratio is that no one knows how liquid receivable and inventory are. It depends upon industry but in case of Spectrum, it has large amount of inventory and receivables in its balance sheet in past three years. Slow moving inventory is itself a question mark to consider as a current asset. The second disadvantage of current ratio, it ignores the timing of both cash received and cash paid out. For example if company payable is due today and cash from receivable are due in next month. Sometimes current ratio is very high but company have short term liquidity problem. So it raises another question in current ratio.
Financial And Non-financial Techniques
The term investor means any person or organisation which provides capital to the organisation. Investor could be the loan provider or shares holder. But here we will discuss those investors who purchase company shares. Investor ratios are another technique to measure the company performance. High growth rate and high profit are the factors that attract investors. In the case of Spectrum, company profit is very healthy and it also planning to grow in future. For this purpose company made strategic plan to acquire and establish business in different countries of the world. To avoid losses, company diversify it business into different sectors. The main ratios that can be used to measure Spectrum manufacturing company financial performance are price earning ratio, earning per share, dividend per share, divided yield, dividend cover etc. however these ratios does not indicate the overvaluation of the company shares due to company high growth.
Activity ratios are the financial ratios which use to measure how effectively a company is using and managing its assets. In other words activity ratios measure the company efficiency by using its available resources. Activity ratios are receivable turnover, inventory turnover, assets turnover etc. most companies invest heavily in especially current assets and their activity ratios become more important. Like in Spectrum its current assets are demonstrating over the fixed assets and management need to know why receivables and inventories are the 70% of all assets. Activity ratios are closely linked to liquidity ratios. Spectrum Manufacturing Company can use this ratios to look at financial data form past years and to use these ratios to analyse their performance and compare with its competitors. The main aim of Spectrum management is to measure how effectively company is utilising all assets to generate revenues.
Market share is the percentage of market's total sales that is earned by a company over a specified time period. The measurement normally gives the management an idea of the total market size of the company in the particular market and its competitors. Company' managers and investors always look at the market share and future growth. Here in Spectrum case very limited information is given about company and its competitors. Spectrum has market shares in different countries but no information about how much it have in any market and who are its competitors. From sales point of view, we can say company market share declined in 2008 compare to 2007 due to its sales declined.
Balance score card
Balance scorecard is a performance management tool that focuses on different performance indicators. This tool can be use to measure both financial and non-financial performance of an organisation. It can be use in Spectrum to measure customer perspective, internal business process, growth and financials performance. It is often very difficult for companies to improve overall performance because the collective goals are unclear. Individual are often aware about the aims of their own team but using balance scorecard performance measurement technique, Spectrum management need to focus on few number of measure and important factors that help them to achieve their goals.
Benchmarking is another management technique that was developed in 1970s in response to increase competition. It involves comparing the processes and polices of one organisation with other businesses in same sector or different sector. It is new ways to improve operating efficiencies. It can be used to measure internal and external, financial and non financial performance of an organisation. It has four types and Spectrum Manufacturing Company can use all four types benchmarking to measure its performance. Internal benchmarking can be used between businesses units operate in different countries. In process benchmarking spectrum can measure its different processes with another business in same industry or different industry.
The agency theory describes the relationship between principals and agents. The principals are the normally represent as the ownership of the organisation such as shareholders, partners
And sole trader proprietor and agent are the people who provide their services to run the organisation such as from CEO down to the shop floor employee. Agency theory relationships occur "when one party the principal appoint another party the agent to perform the task on his behalf "(Kaplan 2006). The principals delegate the powers with responsibilities to agents to run the affairs of the company on their behalf and maximise their wealth. The agency theory is concerned with the conflict of interest between both parties.
In case of Spectrum manufacturing Company, the company is operating in different countries. As per the information given, the agents (board of directors) have given fully power to run the organisation and they are performing well. As the limited information given to us there is no sign of any conflict between them but on the other hand there are number of reasons that force directors to take care of shareholders and make all those decisions which help them to maximise Spectrum's their wealth. The first reason could be why directors of Spectrum might do their best to maximise shareholders wealth is that their pay could be related to the size or profitability of the company. So that's why they are trying to expend business globally through diversification, acquisition, establishing new braches and subsidiaries in different countries. The second reason that could stop directors to prefer their own interest is the shareholders have the right to remove directors from acting as their agents. The third reason is that the shareholders believe on the ability, skills and experience of Spectrum's directors. Sometimes conflict arises between them due to different level of risk and risk attitude. But Spectrum shareholders look confident about directors' decision of diversification of business in different sectors and part of the world.
Dividend policy is the policy companies used to decide how much it will pay out dividend to its shareholders. There are number of different dividend policy theories that can be used to select dividend payout policy. Miller and Modigliani's (1961) dividend irrelevance theory says it is the shareholders attitude that will determine whether or not dividends are paid. But company dividend policy is important factor in determining the market value of shares. In current financial environment, where most of the companies ordinary shares owned by institutional investors, and they want to cut propose dividend and consider constant dividend payments from their shares to be very important. Sometimes institutional shareholders have been accused of putting pressure on companies to maintain dividends they can ill afford to pay (Denzil Watson and Antony head 2007).
The question asked, does dividend policy matter? And I would say it's depend upon, as conventional finance theory says dividends policy is implemented by the companies to attract more and more investors buy company shares. But from shareholders point of view it makes no difference for them either company pays a dividend or reinvest the retain earning which means high share prices. Dividends are normally paid out in the form of cash or shares (script dividend). In Spectrum there are numbers of reasons where company Board of directors need to think about the dividends payment, how much they need to pay and the method of dividends payment to its shareholders. First situation is, Spectrum is newly incorporated company in the stock market, it face rapid growth and need money to cope with growth. So, firstly company needs to retain high amount of profit for future growth. For shareholders satisfaction it need to pay a constant small amount of dividends in the shape of cash or script dividend. This will improve company liquidity and help it to achieve bigger market share by reinvesting retain earning. The second situation is company planning to expand business in different countries in near future. For this reason company need finance for acquisition and set up of new branches. Spectrum need to adopt zero dividend policy or pay a small fixed percentage of dividends and use this retain earning for reinvestment because investors only bother about the total returns. So, spectrum dividend policy should be to reinvest retain earning now, it will grow with the growth of the business and can pay higher dividends to its shareholders in the future. The third situation is company was highly geared in 2006 and 2007 and debt to equity ratio was almost double than equity. Which means investment in company was very risky from investment point of view. In this situation board of directors need to capitalised retained earning, which help them to reduce debt to equity ratio and also help them to reduce amount of risk for current shareholders. The instructional shareholders are another situation for company. As a said above those institutional shareholders always demand constant amount of dividend from company. In spectrum company has many institutional shareholders son it needs to pay a constant dividend policy.
Debt financing vs. Equity financing
Most of us are agree with the statement that debt financing is often encouraged relative to equity financing in companies. Debt financing is normally considered to be a cheaper source of finance in business, especially when compared to equity finance, which involves giving up the ownership of the company (William h. Payne 2009). But I would say it's depending upon company existing gearing and rating. There are several advantages of debt financing compared to equity finance, which support this statement. Some of them I am going to discuss in brief. Through debt financing company can get finance without diluting the existing shareholders ownership. Debt holders are only entitled to claim back principal amount plus interest and have no right to claim company's future profits. Furthermore debts are paid back on time can enhance company credit rating and make easier for company to obtain cheaper debt finance in future. Interest on debt is allowable expense for tax purpose. So it's mean it helps company in the way of lowering the tax liability and cost of capital. Finally debt financing is also easy to administer in term of reporting requirements. There are no hard and fast rules for debt finance provider compare to equity holders.
Unfortunately, there are some drawbacks of debt financing. First of all, it is very difficult to calculate that up to what point debt finance is cheaper than equity. What is the optimised capital structure, which can give company a minimal cost of capital? Debt finance providers need securities on loans. So its means obtaining debt finance is to be limited based on company assets. On the other hand interest is a fixed cost for the company and has to pay in any case if it is making profit or loss. Sometimes companies experience shortages in cash flow to make regular interest payments.
Which method of financing is best; debt or equity financing? I would say it does depend upon the situation. For example in Spectrum Manufacturing Company, company had very high leverage ratio in first two years. High leverage means high risk, do current Spectrum equity holders want to take more risk by putting extra debt finance in company. If company wants to increase its leverage than what would be the cost of capital and what securities company will provide in return of debt finance and if debts are unsecured than what rate of interest they demand for extra risk. I would say debt finance is not always cheaper but up to some extent it is cheaper than equity and that is the optimised capital structure for the company.
Sources of Financing for Public Company
For all business, the main issue is about where to get finance from for starting up, development and expansion. It is very crucial for the success of the any business. Therefore, we need to understand the various sources of finance which are available to businesses. For public limited company there are different sources of internal and external finance available, e.g. internal resources are retained profit, sales of assets, working capital etc. and external sources of finance are share capital (Ordinary & Preference shares), debentures, overdraft facilities, venture capital, leasing, hire purchase, mortgages, franchising, government grants, factoring debts, trade creditors and loans form banks. My aim is to discuss only three main sources of finance which are available to public companies such as Spectrum Manufacturing Company. These sources are as follows;
Debentures or Loan Stock
Loan stock or debenture is medium to long term debt capital normally raised by public companies. Companies have to pay a normally fixed rate of interest on debentures at pre determined date and interest is a charge against profit in the financial statements of the company. Holders of these loan stocks are considered long term creditors of the company. Debentures are freely transferable and holders have no voting rights. In some countries of the world debentures are not secured but in United Kingdom they are usually secured with fixed or floating charges with them against company's assets. Debenture holders have the right to receive interest on debentures before any dividend payment to shareholders. But most important thing about debentures is that company has to pay interest on debenture even if it makes a loss. Debentures have two types' convertible debentures and non convertible debentures. Debentures are usually redeemable and issued for the fixed period of time. At the end of period or maturity, they become redeemable. There are number of advantages and disadvantages are associated with debentures. As for as public companies are concerned, debt financing is an attractive source of finance because interest is tax allowable expense.
Retained earning is an accounting term, means the portion of net income which has been retained by the company at the end of year after paying dividends to its shareholders. Similarly if company makes a loss and then loss is retained and company can offset against profit when it will make in future. Retained earning is basically reported as shareholders equity in the balance sheet of the company. The major reasons of retaining these earning is to pay dividends when company have not enough profit and the second most important reason is to finance new investment in future internally, rather then raising new finance externally which is time consuming and costly process. The directors of the company promise to shareholders that they will reinvest this retain earning and company will grow and make more money in the future. Company will pay higher dividends in future and it will also help to increase share price.
Equity finance is an important source to obtain capital by issuing shares to the public. Equity finance is a capital investment into the company in return of the ownership of the company. It does not provide or offer any type of guarantee to the investor, so therefore it is seen as a very risky investment in all sources of finance. To compensate for this risk, investors always demand a high rate of return on their investment.
Public companies need finance at different stages; it can be used at set up of the company, for expansion, acquisitions and taking big projects etc. Public companies normally issued two types of shares, ordinary and preference shares. Ordinary shares are very common form of shares in the UK. It give the right to holders to share the company profit in the form of dividends and also give the right to vote at annual general meeting of the company. There are several advantages and disadvantages associated with ordinary shares. The second type of shares is preference shares. They are very different from ordinary shares and behave as long term debts (bounds). .Preference shares usually have fixed rate of dividends and carries no voting right. They also have priority over the ordinary shares in the payments of dividends and on liquidation. Preference shares are usually cumulative and if company make loss this year, than this year dividends will be carried forward to the next year.
The aim of this assignment is to discuss the different aspect of corporate finance in Spectrum Manufacturing Company. From this research work we can conclude that corporate finance is not just for raising finance, using and maximising shareholders wealth but also how to run day to day activates to achieve overall corporate goals. My aim is now to conclude what I have discussed above.
To measure the Spectrum Manufacturing Company financial performance I have used ratio analysis. Taking into account the ratio analysis applied to Spectrum Manufacturing Company, it is concluded that the company had some variation from 2006 to 2008. Profitability ratios and leverage ratios declined or remained stable due to decrease in turnover. However short and long term liabilities, Current Assets Ratio and ROCE increased due to efficient use of capital employed and prompt payment of the current liabilities. Analysing and understanding the performance of Spectrum using key ratios, it looks like Spectrum's overall performance is satisfactory but no information is given about competitors or industry to compare with to see how these ratios compare with competitors. The company management have long term future plan for expansion and growth, so we can expect positive results in future. To achieve these results management have to work hard and make strategies that will help them to deal with competitors and help them to cope with growth.
I have also discussed about agency theory, dividend policy and sources of finance. In agency theory, it is board of directors' legal duty to act in the best interest of Spectrum manufacturing company's shareholders. They also need to make a dividend policy that satisfy all shareholders requirements and also help company to reduce liquidity problem. Debt financing is often encouraged by some organisations. But equity and debt financing are not substitutes for each other. They are very difficult in nature to decide which one is cheaper because companies who use high gearing always prefer to take short term projects. Equity financed companies prefer to invest in long term projects because they have no obligation to pay dividend every year like interest. So Spectrum manufacturing Company need to prefer equity finance for expansion but it need to use optimised capital structure which help management to reduce overall cost of capital and maximise the overall value of the company.
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