FINANCIAL ANALYSIS & MANAGEMENT

FINANCIAL ANALYSIS & MANAGEMENT

TABLE OF CONTENTSFIGURES LISTS2TABLE LIST2INTRODUCTION3ANALYSIS4QUESTION 1. IS THE PROFIT BEFORE TAX SOLE RELEVANT MEASURE FOR COMPANY PERFORMANCE?4QUESTION 2. THE INVESTMENT 7QUESTION 3. THE REMUNERATION & THE APPOINTMENT10QUESTION 4. MANAGEMENT ACCOUNTANT & FINANCIAL MANAGER13CONCLUSION15REFERENCES16

figures listsFigure 1. A Model of Strategic Management4Figure 2. Share Price Maximization5Figure 3. Optimized Corporate Organization11

table listTable 1. Initial Investment for News Review Ltd7Table 2. Assumed Net Cash Flow Table8Table 3. NPV Table with cost of capital at 10%8

INTRODUCTIONMost of everyone dream about owning a rich and successful public company, building an empire and win in fierce business battlefield. Mark Golledge a 65-years old businessman also share the same thought. He is the major shareholder of News Review Ltd., a private publishing company. He wants to expand his business into e-paper and newspaper; therefore, he hire Raymond Cash as a Managing Director regarding to the recommendation of his friends. Raymond proposed some expansion plans for the company, inclusive of listing on the stock market. Those questions will be covered throughout this report. As a result, this report will emphasize on how good or bad those proposals are. We will state out the solutions as well as recommendations for each that Mark needs us to support him. We will see if profit before tax would be a good sole objective for a possible-listing company; how to assess the long-term projects and investment by using the technique of Net Present Value (NPV); whether the benefit of the Managing Director or CEO will be stick with the companys goal of achievement and the tools to rate the performance; and last but not least, seeing how corporate governance play an important role in News Review Ltd.

ANALYSISQUESTION 1. Is the profit before tax sole relevant measure for company performance?1. Profit Maximization Cannot Be The Sole Objective: For long the profit has been the objective and achievement of a lot of firms and companies. Once someone steps into the business, he/she would like to bring the company listing on the stock exchange market, becoming a public company or corporation. Then, when the company is organized as a corporation, it can attract a variety of investors (Meyers, 2003) and therefore, more cash would be gathered to expand the operation of the company. However, in order to attract the investors, Raymond states that the company should put the sole objective of maximizing the profit before tax. Therefore, the profit before tax would be the sole relevant measure for the companys performance. Actually, would profit maximization be the sole objective of the company once the company is listed? However, profit maximization should not be the sole objective of a firm because of the reasons stated below. Firstly, the profit maximization would likely link with the increase in the risks. The philosophy is that there is a straight association between profit and risk high risk, high return (Thukaram, 2003). In case Raymond the Managing Director put the profit maximization is the sole objective of the company, the risk factors have the possibility to be ignored. In the view of Strategic Management, ignoring the risks is not a very smart choice, especially for a new venture listing public in the first time, scanning the environment, building the input stage matrix to evaluate the competitors, risky factors (Internal Factors Evaluation, External Factors Evaluation, Competitive Profile Matrix, etc.) is a very important step to build up and keep the certain growth of the company (David, 2012).

Figure 1. A Model of Strategic ManagementSource: (Wheelen and Hunger, 2012)Secondly, if the profit maximization is the sole objective, the timing pattern has the possibility to be not taken into account. The higher profit does not mean that the investors can receive the return from the initial investment sooner - the receipt of funds sooner than later is preferred (Zutter and Gitman, 2012). For example, News Review Ltd applies the profit maximization as the sole objective; hence, the profit of News Review Ltd would be quite high in comparison with Daily Journals Ltd a competitor also lists on stock exchange as well. However, the return flow of News Review Ltd is 7 years whilst Daily Journals Ltd just needs 4 years. Certainly, Daily Journals Ltd would be much more attractive because the investors would invest in Daily Journals Ltd first to gain profit quickly, then they will use that money to invest other company. Last but maybe the most important, when the maximizing profit is the sole and priority objective, the interest of the shareholders is ignored as well. The company can cut the dividends to invest the cash to increase the future profit (Meyers, 2003). Moreover, in the point of entrepreneurship view, the company may have the possibility to ignore the social responsibility toward customers, employees or even companys culture as well. In the long-term strategic management, when the shareholders, employees, customers interests are ignored, the company surely cannot survive on the market (Thukaram, 2003). 2. The Solutions:Since News Review Ltd is possible to list on stock market, there is a solution for this company to consider instead of putting profit before tax as the sole objectives: maximizing the shareholders wealth. The wealth of the owners are measured by the price of the share on the stock market. This price is based on the cash flows timing including of the earnings per share (EPS) which indicates the firms future return, magnitude and risk factors as well (Zutter and Gitman, 2012). A popular misunderstanding thought is that if we put the maximizing the shareholders wealth as a firms objective, the managers can do any greedy and selfish thing in order to please the shareholders interests (without caring the employees, customers or suppliers, etc.); and hence, many ethical business issues appear. However, lets imagine how a manager can increase the share price of stock if the employees are not loyalty with the company, customers choose to anti the products, and there is no any good long-term relationship with the suppliers (Meyers, 2003).

Figure 2. Share Price MaximizationSource: (Zutter and Gitman, 2012)QUESTION 2. The investment The Managing Director Raymond Cash tend to expand the business by buying the new newspaper printing machine and purchasing new office. Actually, when expanding the business, the company would need to invest a large sum of money for the necessary assets. Additionally, there are many choices of newspaper printing machines and offices for the News Review Ltd to choose; we can assign of each suitable choice into different Projects. Therefore, we will have Project A, B and C, and may be more for the management level to be able to rate the efficiency of each project. However, it seems that Raymond has not presented any method in order to present for Mark to see how and when the initial investment in each project can make the return especially with the shareholders when they want the optimum return (Meyers, 2003). There are some tools and techniques that can help the managers to give out decision with the project such as Payback method, Internal Rate of Return (IRR), Net Present Value (NPV), Profitability Index (PI), etc. Among of them, Net Present Value (NPV) seems to be the most popular method used by most large companies (Zutter and Gitman, 2012). The NPV has some advantages: NPV considers to the time value of money which is the most important concept in Finance (Hillier et al., 2003). All cash flow in each period is considered. The NPV takes account of cost of capital as well.The formula for NPV can be seen as:

From the formula above, there are two situations that can help the manager making up his mind: If the NPV > 0, just accepting the project. If the NPV < 0, simply rejecting the project. Now, for illustrate, lets consider one Project for News Review Ltd, the below Board will reveal what this Project includes:

Table 1. Initial Investment for News Review LtdINITIAL INVESTMENTDESCRIPTION

Source: http://property.joneslanglasalle.co.uk/property-search/property-details.aspx?t=c&id=JLLATC30188An office for sale from Jones Lang LaSalle with the price of 460,000 if the Managing Director wants to purchase. This office is based in Unit 3, Yoeman Park, Test Lane, Nursling, Southampton, SO16 9JX, Hampshire, South East.

Source: http://www.ebay.com/itm/1986-Heidelberg-102FP-Printing-Press-/281188110538?pt=LH_DefaultDomain_0&hash=item41781e10caThe 1986 Heidelberg 102FP Printing Press newspaper printing machine system bought from EBay with the price of 70,000.

So, regarding to Raymonds proposal, we will have an initial investment inclusive of a new office and printing machine at: 460,000 + 70,000 = 530,000. We also make an assumption of News Review Ltd cash flow in 5-years at the cost of capital of 10%:Table 2. Assumed Net Cash Flow TableYearNet Cash Flow ('000)

1126

2243

3398

4415

5516

When applying with the NPV, the result would be:

Table 3. NPV Table with cost of capital at 10%YearNet Cash Flow ('000)Present Value at 10%Discounted Cash Flows ('000)

11260.909115

22430.826201

33980.751299

44150.683283

55160.621320

Total1,218

In Capital530

NPV688

According to the table above, we can see that with the NPV at 688,000 (NPV > 0); this project is worthwhile to be invested. As a result, with this NPV tool, we can consider and mix with other Projects together. Since Mark is thinking with an e-paper, he can put the initial investment coming along with spending in e-commerce, online advertising, etc. Our recommendation is that the Finance & Accounting Department should conduct the Proforma Costs for initial investment along with the Forecasting Cash Flow in order to find the most suitable Project or Portfolio for News Review Ltd. Moreover, we also suggest that the company should correlate with internal audit committee or a 3rd party Audit Firm (such as Deloitte, Ernst & Young) in order to ensure the transparency in Purchasing process. QUESTION 3. The remuneration & The appointment1. The Remuneration Of Raymond Cash:Raymond said that his reward should be connected with the profit before tax in order to guarantee goal correspondence with companys objective. In our point of view, it is strongly recommended. Since Raymond is a Managing Director and elected by the shareholder, he will cope with shareholders interest once he has the right incentives to do (Meyers, 2003). Now, lets imagine if shareholders pay Raymond a fixed salary, no incentive, no bonus regarding to the revenue of the company; here are the problems that shareholders can face: No effort to boost the revenue: Raymond can find a way to boost the revenue and maximize shareholders wealth. One of his decision can be using the profit or equity to invest in other projects that can help expanding more the company and it is surely a high-pressure job. However, with no incentive or bonus from expanding the company or increasing the revenue, he can choose a safe way to manage, receiving monthly salary without any worry. Safe and small investment with low NPV: as we state in the Question 1 part, High risk high return; with the fixed salary, when being in a situation of investment decisions between Projects, Raymond would like to choose a safest one although the others can help to generate much more NPV. This is quite a waste if the company has plenty of cash, but giving out limited investment opportunities. This is called entrenching investment (Meyers, 2003).In case that Mark Golledge still feels confused about this recommendation, we can suggest some techniques that can help the shareholders to evaluate the performance of the Manager:a. Return on Investment (ROI): The Return on Investment (ROI) is used to assess the investment gains in comparison with the investment cost. The ROI can be calculated with the formula:

For example, in News Review Ltd, if the shareholders decide to invest 530,000 with the net profit of 124,000 at the cost of capital 10%. Then the ROI will be:

Then, we can deduct with the cost of capital: 23% - 10% = 13%. This 13% will be added into shareholders value and called Net Return On Investment (NROI).b. Economic Value Added (EVA ): Economic Value Added (EVA ), simply, is the value created for shareholders after deducting all charge of capital. The EVA is also an innovative method because it takes account of Return on Capital Employed (ROCE); therefore, it also can show for the shareholders to see how efficient the Managers use the Capital assigned (Vernimmen et al., 2009) as well as how good the companys operation is.

EVA = Capital Employed (ROCE WACC (Weighted Average Cost of Capital))

2. The Appointment:Raymond Cash also show his wish to build his own all the Board Members. In News Review Ltd, the position of Raymond is not same with Mark Golledge major shareholder. Therefore, at some point, there is some interest conflict between Managing Director and shareholder. Raymond is responsible for daily operation while Mark cannot take control over him all the day. As a result, regarding to the Corporate Governance, it is not a good idea to grant him such power because the Board Members have the responsibility to manage and supervise the activities of the Managing Directors. Therefore, lets imagine if Raymond appoint his best friends, his relatives, parents, siblings, etc. into the Board Members, does it guarantee the efficiency in controlling company daily operation? In addition, once the company is listed on the stock market, will the investors be attracted with a company which does not have the transparency in the Management Level? As a result, an optimized corporate company can be organized as the illustration below:

Figure 3. Optimized Corporate OrganizationSource: (Zutter and Gitman, 2012)Therefore, regarding to the flow chart, our recommendation is that a Nomination Committee should be established. This Nomination Committee will conduct the appointment of Board Members and even the re-election in the future.

QUESTION 4. Management Accountant & Financial ManagerRaymond said that he would like to remove the Management Accountant and Financial Manager in order to reduce the cost for company because the jobs in Finance Department seem similar. Instead, he will assign the Financial Accountant who is felt to be competent. In some companies, especially during the economic crisis time, reduce the human resource cost to save the budget is an important decision. However, when a Managing Director wants to remove the Management Accountant and Financial Manager, promoting a Financial Accountant into those positions because of the similarity in Finances jobs, the owners have to question first about that Directors ability. We will consider the differences between Management Accountant and Financial Manager: MANAGEMENT ACCOUNTANTFINANCIAL MANAGER

The role of Management Accountant will focus mainly in specific internal activities of the business, manage those activities record to support the decision making of the management. He/she can take deep look into the non-financial information such as: how the Sales department chase the payment of customers, taking care of transaction contracts detail, etc. The Management Accountant also takes responsible for the internal accounting, producing the balance sheet reports and tax obligations. The reports can be prepared in any period. Financial Manager will take care of the companys cash, help to raise the capital and keep the relationship with bank. He/she will take care in monetary basic, take a look of the whole business, giving out how the business trend and historical business perspective in order to attract more investment. Financial Manager also ensure that the short-term cash surplus will be spent wisely and prepare the financial statement reports. The reports will be prepared periodically and in financial standards formats.

For the reason above, a Financial Accountant can be good in the financial management part, provide the full financial information monthly to customers and shareholders, etc. He/she can be good in presenting the whole business data in simple Profit and Loss perspectives in order to attract the investment. However, regarding to the internal accounting management which is also a very important part, News Review Ltd should keep a controller so as to enhance the cost management, ensure the efficiency in productivity and resource management. Moreover, since Raymond is a Managing Director, therefore, he has the right to appoint the Managers. Therefore, according to Corporate Governance aspect, there should be an internal audit committee which is independent with the Management level. This internal audit committee will ensure that the resources be used with the right direction.

CONCLUSIONIn conclusion, shareholders should take a very careful consideration not only toward the Raymond Cashs proposal but also the actual ability, education background, experience of the Managing Director as well not just by recommendations from friends. Moreover, the shareholders should also have a look into the financial investment techniques, especially the NPV, IRR and ratios (ROCE, ROI, etc.) to augment the usage of resources. Listing the company on the stock exchange would be a good initial step to expand the operation, News Review Ltd just need to show how efficient the company manage the cash, with a good Management Level and internal governance, the company is ensure to achieve the success and attract more investment.

REFERENCESBygrave, W.D. and Zacharakis, A. (2011) Entrepreneurship 2nd Edition, New Jersey: John Wiley & Sons, Inc.David, F.R. (2012) Strategic Management: Concepts and Cases (13th Edition), New Jersey: Pearson Prentice Hall.Hillier, D., Ross, S.A., Westerfield, R.W., Jaffe, J. and Jordan, B.D. (2003) Corporate Finance, 6th edition, Irwin: McGrawHill Primis.Meyers, B. (2003) Principles of Corporate Finance, 7th edition, The McGraw-Hill Company.Thukaram, R.M.E. (2003) Management Accounting, 1st edition, New Age International Pvt Ltd Publishers.Vernimmen, P., Quiry, P., Dallocchio, M., Fur, Y.L. and Salvi, A. (2009) Corporate Finance: Theory and Practice, 2nd edition, West Sussex: John Wiley & Sons.Wheelen, T.L. and Hunger, J.D. (2012) Strategic Management and Business Policy: Toward Global Sustainability, 13th edition, New Jersey: Prentice Hall.Zutter, C.J. and Gitman, L.J. (2012) Principles of Managerial Finance, 13th edition, Prentice Hall.

News Review Ltd. | FINANCIAL ANALYSIS AND MANAGEMENT15