Compare the Annual Reports of 2 Companies (Accounting)
Using your textbook, other books, journals and/or internet resources explain the key advantages of one key source of finance for a company.
The process of funding a new business or trying to expand an already existing business or an old business is challenging because of the task involved in selecting the right source of financing that unique situation. Ideally, there are several options to select from when seeking sources of finance. However, each source of finance comes along with its advantages as well as its drawbacks. As such, no one option is better than other sources of finance in all cases. For example, considering the case of raising finance through personal savings and assets: this is the most common method used by most investors, both small and large, to come up with ways of raising capital for investments. An investor’s personal savings and assets make a great source of capital, because it has a low cost of acquisition since the investor already has the funds. Furthermore, there is no interest required by banks and other lending institutions required for payment by the investor, i.e. a bank loan. In addition, the advantage of this mode of finance is that the investor does not have to share his or her returns on investment with other investors who may help raise capital.
Collect the latest annual reports of two publicly traded companies (companies whose shares are bought and sold on the stock market) in the same industry and carry out the following tasks:
a) Explain the long and short-term sources of finance utilised by each company in two consecutive years.
The two companies under consideration are Wal-Mart retail stores and General Motors Limited, both incorporated in the United States of America and listed on the New York Stock Exchange. Wal-Mart retail stores are a chain of retail stores with global presence. It deals with trading general merchandise for use by consumers, for example, household items, groceries, children’s toys, and many others. The company is among the most profitable businesses to invest in found in the United States. It utilizes funds from all quarters. For instance, the short-term sources of funds used to finance their objectives in the past two years were the return on investments that the company made. The company recorded an impressive profitability over the past two years and as such used part of its profits, after settling shareholders through dividend payouts to fund its short-term projects. On the other hand, the company used mergers and acquisitions to finance its long-term financial goals.
General Motors is also a multinational company with great presence in the United States of America as well as with a commanding following within all other states. As such, it managed to expand its operations in various parts of the globe. The main practice of General Motors is to design and manufacture automobiles that it sells to the market. As such, it requires a lot of capital to finance its day-to-day operations as well as financial projects. The sources of funds in the long term for the projects run by General Motors were successful bailouts from the Troubled Relief Funds Program set aside by the government to aid poorly performing firms from collapsing due to economic constraint. The company used the little profits it made after support of the federal government of the United States to fund its short term projects.
b) Calculate gearing ratios and comment on the long-term debt to equity ratios in each company for two consecutive years.
The gearing ratio for the Wal-Mart retail stores is positive. This means that it is a good result owing to the profitability of the company. As such, the shareholders of the company have an assured rate of return on investment that is more lucrative and profitable as seen in the equity ratios of the company. On the other hand, General Motors has negative gearing ratio whereby it has a dismal equity ratio owing to the worldwide losses the company recorded over the past two years. This negative gearing does not guarantee its shareholders a good return on their investments.
c) Calculate the dividend cover, dividend yield and interest cover ratios for both companies for two consecutive financial years. Based on your calculations and other relevant information, explain the risks and reward for shareholders and loan providers for both companies.
Shareholders of Wal-Mart retail stores are a happy lot. This is because they have assurance of a lucrative dividend payout from their company on the annual basis owing to the great profitability of the company. In addition, financial providers of the company have a surety of the settlement of their debt because the company is flourishing in the business sector. As such, it is not risky at all for an investor, either as a shareholder or as a financier to invest their finances in Wal-Mart stores because they have an assured return on investment. However, the case is bleak on the other side of the divide. General Motors is performing poorly financially therefore both shareholders and financiers are at a great risk of losing their investments due to the high risks involved owing to the dwindling returns of the company over the past two years.
d) How would the return to both (shareholders and loan providers) vary if the ‘Profit before Interest and Tax’ rises or falls? (A sensitivity analysis is required by simulating data within a reasonable range)
A change in the profit before taxes equally affects returns on both shareholders and providers of loans. A rise in the profit before taxes would mean higher return on investment to both parties, while a lower or a fall in profit before interests and taxes would mean that the returns on these concerned stockholders would fall.
Based on your calculations above and other relevant information, conclude which of the two companies is less risky in terms of its capital structuring and give reasons in support of your views.
The company that is less risky to invest in is Wal-Mart Retail Stores. This is because the company has a record of profitability streaming over the years. As such, the company is in the position to guarantee its financiers as well as its shareholders a lucrative return on investment. This is because of the solid capital structure that the company has, combined with the reputable brand image and name that the company boosts of, which enables it record high volumes of sales over the years, hence an assured profitability.
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