The Role and Functions of Financial Administration In of Abacus Distribution Plc - Case Study Example

Role and Functions of Financial Management – A Case Study of Abacus Distribution Plc Task Abacus Distribution Plc – A Background Being one of the leading distributors of electronic components in Europe, The Abacus Group has its own directly owned companies in almost all major electronic markets of Europe. The Group was established in the year 1972 and has 11 offices across Europe with staff strength of 1,100 people. “The Abacus Group offers electronic component distribution, own brand product, specialist distribution of displays, embedded computing and wireless communications, and value added services including electromechanical sub contract manufacture.” (Abacus Group Annual Report & Accounts, 2006) The Group has adopted a customer service policy with more personalised local service and a strong technical support. This ensures the company’s performance in providing quality products and support from a strongly motivated workforce. The company has an office in Asia with manufacturing operations extended in the Far East to supply European customers, quality products at competitive prices. Financial Management in Abacus Distribution Plc In general, the objective of a company must be to create value for its shareholders. Value is represented by the market price of the company’s common stock, which in turn is a function of the firm’s investment, financing, and dividend decisions. The basic idea of managing finance in any business venture therefore is to acquire assets and invest in new products and services where expected return exceeds their cost, to finance with those instruments where there is particular advantage, tax or otherwise and to undertake a meaningful dividend policy for stockholders. (Ross et al.) These functions define the scope and role of financial management in any organisation. The financial management function thus concerns the acquisition, financing, and management of assets with the overall organisational goals in mind. In line with the above principles of financial management the company has taken the following actions in the financial discipline. Investments During the year 2004 the company embarked on a major capital expenditure in upgrading the business system of the company scheduled to be completed in the year 2007. The company has adopted a policy of acquiring large properties on a freehold basis. In line with this policy the company has invested in the acquisition of subsidiaries to the extent of £2.1 million, a net investment of £1.1 million in plant, machinery, and equipments, and a small investment of £0.1 million in land and building. There is an investment of £50 million representing the acquisition of Deltron Electronics Group UK having subsidiaries in France and Germany; Axess Technology in France and Realisations et Diffusion pour I’Industries of France. Financing and Capital Structure There was a change in the capital structure of the company with the increase in the called up capital of £1.6 million. The company’s capital structure has changed considerably in the year with the increase in the total non-current financial liabilities of £ 13.3 million and the increase in the liability is to finance the acquisition of the subsidiaries during the year 2006. The loans have been obtained against the security of assets of the Axess Group France. Dividend Though the company has paid a total dividend of 10.5p per share in the year 2004 the company has been following a consistent dividend policy for the years 2005 and 2006. This is evident form the fact that the company has declared and paid an interim dividend of 3.6p for both the years and also a final dividend of another 3.6p as final dividend. Thus the total dividend for the years 2005 and 2006 which is more or less equal to the dividend of 7.0p paid for the year 2004. The company adopted this dividend policy in line with the decision of the Board of Directors to “restore the dividend cover to a more robust position”. The company revised the dividend policy in consideration of the future growth prospects of the company where there may be a need for using the internal resources of the company for acquisition of other entities or any other planned capital expenditure. Relationships between the Three Different Policies There is a clear relationship between the investing, financing and dividend policies of the company. With a view to go in for investments in more smaller companies in different geographical locations and expansion of the business the company has been adopting a conservative dividend policy from the year 2005 through 2006. Similarly the company has embarked upon major investment decisions of acquiring more subsidiaries in France and Germany with a view to expand the business operations in different geographical locations. The statement in the Annual Report for the year 2005 on the dividend policy of the company reaffirms the investment policy of the company that the company wants to conserve the internal resources for future growth prospects. The acquisitions confirm this policy of the company and the financing and capital structure and the investing decisions of the company have also been moved in this direction only. Task 2 Market Value Added: The Market Value Added is given by: Market Value Added = Company’s Market Value – Invested Capital (Value Based Management) The market value of the company can be calculated on the basis of the historical stock prices obtained from the internet multiplied by the number of shares. The invested capital is represented by the shareholders’ equity displayed in the five year financial summary of the company. Particulars Year 2004 Year 2005 Year 2006 Market Price/Share 244p 118p 166.5p Average No of Share 42569 42569 63267 Market Value £ Million 103.87 50.23 105.34 Invested Capital £ Million 44.2 44.3 80.3 Market Value Added £ Million 59.67 5.93 25.04 Where there is a higher market value added it implies that the company has created considerable wealth for the shareholders. If the market value added is negative, then the financial decisions of the management has not contributed to the company in line with the confidence placed by the capital market. This means that the company has destroyed the wealth earned using the shareholders funds. Market Book Ratio: Market Book Ratio is given by: Book Value of the Firm/Market Value of the firm (Investopedia) Particulars Year 2004 Year 2005 Year 2006 Book Value of the Firm £ Million 73.60 73.40 146.3 Market Value of the Firm £ Million 103.87 50.23 105.34 Market Book Ratio 0.71 1.46 1.39 The market book ratio identifies the undervaluation or overvaluation of the shares. If the market book ratio is one and above it implies the share is undervalued. If the market value is less than then the stock is overvalued. Total Shareholder Return The Total Shareholder Return is given by: Total Shareholder Return = Market Price end - Market Price Begin + Dividend/Market Price Begin (Value Based Management) Particulars Year 2004 Year 2005 Year 2006 Market Price end 244p 118p 166.5p Market Price Begin 236p 244p 118p Dividend 10.5p 7.2p 7.2p Total Shareholder Return 7.84% (4.86%) 4.72% Task 3 The company’s performance on the basis of the five year financial review shows that the company had done well during the years 2002 to 2005. But the year 2006 has shown a declining trend in the performance. This is evident from the reduction in the free cash flow available to the shareholders. From a 15.0p cash flow that was available in the year 2005 the position as on 2006 was a negative free cash flow of 11.1p. This situation makes the position of the company very risky. As an alternative to the market value of the shares the free cash flow per share can be used as the basis to calculate the Market Value Added and the Market to Book Ratio, which will be a more realistic financial situation of the company. The calculations are: Value of the company based on Free Cash Flow: Particulars Year 2004 Year 2005 Year 2006 Free Cash Flow/Share 17.3p 15.0p (11.1)p Average No of Share 42569 42569 63267 Value £ Million 7.36 6.38 (7.02) Invested Capital £ Million 44.2 44.3 80.3 Value Added £ Million (36.84) (37.92) (87.32) Though the valuation of on the basis of the market value is showing somewhat a healthy position the valuation on the basis of free cash flow shows a negative addition to the wealth of the shareholders. Hence it is very risky to invest in the shares of this company. From a shareholder perspective there is a continuous decline in the share prices from March 2005 when the average closing was 220p the market price came down to 102p in Dec 2005 and it showed an increasing trend. The quarterly volatility is at 42.38% which makes the investment somewhat risky in the shares. The inflation to the assets by enhancing the intangible asset value of goodwill on the acquisition of the new subsidiaries has to be taken with a bit of skepticism till the company is able to prove its performance in the new markets. The market value of the company is being determined on the basis of the dividends and earnings per share. There has always been a debate whether the earnings or cash flow is to be taken for the valuation of the shares of a company. The earnings can always be adjusted by accounting rules to show a higher performance without the actual cash flow into the company. The market value of the shares of Abacus Plc is the fitting examples for the variation in the values on the basis of earning and cash flow. The market value of the shares obviously takes into account the earnings of the company and hence the market value shows a higher value for the company. But actually the company’s valuation is highly vitiated by the market price, as in fact there is no addition to the wealth of the company in the past three year. The earnings per share obviously will not look in to the wealth creation by the Directors and the company has not added to the real wealth of the shareholders. References: Value Based Management ‘Market Value Added – MVA’ Value Based Management ‘Total Shareholder Return’ http://www.valuebasedmanagement.net/methods_tsr.html> Investopedia ‘Book – to – Market Ratio’ Ross A.Stephen, Westerfield W.Randolph, and Jaffe Jeffrey (2004) ‘Corporate Finance’ Edition VII Tata-McGraw Hill Publishing Company Ltd. 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