The following study deals with financial administration. It deals with theories of capital structure and dividend policy. The study is also related to financial terms such as credit policy, financial planning and forecasting.
Task 1: Explaining Target Capital StructureTarget Capital Structure
Capital structure is in what way a company finances its business activities and operations by utilizing varied sources of funds. Target capital structure can be termed as the combination of common equity, debt and preferred stock that will design and arrange the company’s stock prices smoothly and efficiently (Reinhard and Li, 2010). An organization will focus on maintaining its target capital structure when it raises the new capital. Firms set their own mixture of debt and equity they need to finance their assets subject to the desire of investors to offer such funds. The four major factors influencing the capital structure decision are business risk, firm’s tax position, financial flexibility and debt of the business (Shim and et.al., 2008).
Capital Structure of Tesco and Vodafone
Tesco is world’s largest retailer of groceries and merchandise in UK having chains of retail stores all over the world. Vodafone is a British multinational telecommunication services headquartered in London providing digital and networking services in many countries. There is a major difference in the capital structure of both the organizations.
Capital structure of Tesco includes analysis about cost capital and key risk. Capital gearing of Tesco maintains an average of 51% that reflects that the average capital that they have raised had been utilized in leveraging their business to significant retained earnings. Tesco use their revenue to invest more diversification of funds in order to sustain their expansion and operations to remain the leading retailer in the world. On the other side capital structure of Vodafone is concerned with the strategy of providing cost efficient, secure and timely financial resources to the Group and control the capital structure in line with its targeted low single A- credit rating (Broadbent, 2003). The company relies on the policy of borrowing centrally using an assortment of short term and long term capital market issues and loaning mediums to meet expected funding needs. They use the derivative instruments to control the currency and interest rate risks.
Task 2: Dividend Policy And Theory
Dividend is a distribution of portion of an organization’s earnings, decided by the Board of directors to its shareholders. It can be in the form of cash, stock, property etc. Designing a dividend policy is tricky for the Board of directors and finance managers of the company. Dividend policy is a policy, concerned with the distribution of dividend among the shareholders of the company. It is related to financial policies regarding payment of cash dividend. If a company is in good financial position it may decide that it will not pay the dividends and will reinvest it further. However, if the firm decides to pay the dividend then it must make a decision regarding how it will payed and at what rate they are going to pay (Bhattacharyya, 2007). There are different types of dividend theories, which affect the distribution of dividend by the companies.
In my point of view, Walter’s theory of dividend is the most relevant because Professor Walter has intellectually studied the importance of relationship between the cost of capital and the internal rate of return in computing optimum dividend policy, which raises the wealth of the shareholders. The theory suggests that the whole investments of the company are financed by mode of retained earnings only. It tells that cost of capital and internal rate of return of the firm remains constant (Pandey, 2006). It also suggests that business organization has an infinite value and earnings of the corporations will never change and it will either be distributed as dividend or reinvested internally. The theory provides a simple framework to study the relationship between market value of share and dividend policy. The theory can be useful in showing the effects of dividend policy on all equity firms under different assumptions about the rate of return.
Task 3: Credit Policy And Its Variables
Credit policy is a policy concerned with terms and conditions for supplying goods on credit. There are four types of variables involved in developing an optimum credit policy. First is the credit standards, these are the criteria which a firm follows in identifying customers with an objective of credit extension (Bhattacharyya, 2007). The company can set a rigid credit standard which means selling mainly on cash basis and extend credit only to the financially able and strong customers. Setting this type of standards will result in low cost of credit administration and no bad debt losses. Second is the credit analysis which means identifying the risks associated with the credit in terms of character, capacity and condition of the customer. Character deals with customer’s willingness to pay, the credit manager will examine whether the customer will make sincere efforts fulfill their credit obligations.
Capacity refers to the judgment of ability of the customer by recognizing the customer’s assets and capital which can be offered as security. Condition refers to the current economic and other conditions which can influence the customer’s ability to pay. Third is the collection method of credits, it creates a structured environment that looks after organization’s most precious asset and its account receivables. The collection policy must be a living document upgraded in with respect to changing economy, competitive environment and market trends. It can be applicable to all the customers of company with limited exceptions (Turvey, 2013). Fourth is the cost associated with the accounts receivables such as collection cost, default cost, capital cost and delinquency cost.
Credit policy must be adopted in response to sales strategy of the business. The terms and conditions regarding credit policy must be flexible and transparent. Rate of interest charge on the credit must be taken into consideration carefully.
Task 4: Financial Planning And Its Importance
Financial planning means to prepare the financial plan; it is the estimation of funds requirements for performing the financial operations of the business (James, Leavell and Maniam, 2002). Financial planning is the process of defining financial goals and planning the investments. Steps involved in making a financial plan are:
- Identifying current financial position
- Setting the financial targets and goals
- Recognizing the gaps between current and target situation
- Prepare the financial plan
- Execute and implement the plan
- Monitor and review the plan frequently.
From the business point of view all steps of financial planning are important. Identifying correct financial goals and targets is important because while doing the financial planning it is important to have a clear idea about the position of the business. Preparation of financial plan is important because it requires true information, facts and theories. It requires reviewing various investment options and sources (James, Leavell and Maniam, 2002). Recognizing the gap between current and target situation is also important because it will offer a clear picture of shortfall; this step will help in identifying right investment at right place to raise needed money on the required time. Implementing the plan is also important because it is the step which put things into action and finally monitoring and review the plan is the most important steps in financial plan because it requires careful and efficient evaluation & controlling of the plan.
With the help of financial plan income can be managed effectively, it enhances the cash flow by carefully controlling the expenditure, spending, costs and prototypes of the business. Financial plan provides guidance in selecting right type of investment policies for the company. Process of financial plan removes the hindrance and uncertainties which can restrict the financial growth of the business (Shim and et.al. 2008).
- Reinhard, L. and Li, S. (2010). A note on capital structure target adjustment – Indonesian evidence. International Journal of Managerial Finance. 6(3). pp.245 - 259
- Bhattacharyya, N. (2007). Dividend policy: a review. Managerial Finance. 33(1). pp.4 – 13.
- Turvey, G. C. (2013). Policy rationing in rural credit markets. Agricultural Finance Review. 73(2). pp.209 – 232.
- James, J., Leavell, H. W. and Maniam, B. (2002). Financial planning, managers, and college students. Managerial Finance. 28(7). pp.35 – 42.
- Broadbent, M. (2003). Managing financial resources. 3rd ed. Elsevier