Custom «Financial Management Group Assignment» Essay Paper

The purpose of this report is to analyze the performance of the company under consideration – Burberry. This analysis should be made to propose optimal recommendations for its shareholders. Shareholders are not only interested in official information, presented by managers, but also in a deep and independent analysis.

The main goal of the report is to answer the question whether shareholders should continue their cooperation with the company and what they can expect from such cooperation. Taking into account this goal, the report is going to have the following structure: introduction (background information about the company and industry), agency theory and corporate governance, financial analysis of the company’s performance, cost of capital, capital structure, dividend policy of the company, long term finance, portfolio theory, and CAPM. Another important issue is to define and select informational sources that will be used to conduct the report. These sources are the following: the company’s official website, financial statements and reports, industry’s researches, readily available financial information and quotes, official reports, etc.

Burberry is a British company that specializes in the production and sales of clothes and accessories. The company was founded in 1856 and has become a world known brand, since that time. The company proposes luxury brands for its customers. It means that it is focused on the upper segment of the market. The products are sold via two main sales channels – retail and wholesale. Retail accounts for 68% of the overall sales. That is why it is not surprising that the company has almost 200 mainline stores. It also cooperates with other business entities via franchise and other similar mechanisms. The main company’s products may be pointed out: outerwear, watches, eyewear, trench coats, handbags, leather products, etc. The company is listed on the London Stock Exchange and is considered one of the best options for investors. Some additional information about the company can be got from the following quote:

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Burberry is mad for plaid. The 156-year-old company has long been associated with its gabardine-checked fabric, invented by founder Thomas Burberry. Burberry-lined "trench" coats, worn by British soldiers in WWI, became a company icon. Burberry operates retail and wholesale businesses and a licensing network. (The luxury brand's retail sales far outweigh its wholesale revenues.) Some 235 mainline stores and outlets, and 200-plus concessions in upscale department stores worldwide sell men's, women's, and children's apparel and accessories; it boasts the Prorsum and Burberry London brand names. Burberry has experienced a fashion renaissance and has expanded into baby clothes, blue jeans, and personal products (Burberry company profile).

Therefore, the company is a really good option for investors. However, a deep analysis of its performance must be conducted to define whether it is reasonable to invest in the company or continue to hold its shares. It is the main task of this report, as it has been already mentioned.

First of all, it is worth mentioning about agency theory and corporate governance. One of the most appropriate definitions of the term agency theory is the following:

Agency theory is a supposition that explains the relationship between principals and agents in business. Agency theory is concerned with resolving problems that can exist in agency relationships; that is, between principals (such as shareholders) and agents of the principals (for example, company executives). The two problems that agency theory addresses are: 1) the problems that arise when the desires or goals of the principal and agent are in conflict, and the principal is unable to verify (because it difficult and/or expensive to do so) what the agent is actually doing; and 2) the problems that arise when the principal and agent have different attitudes towards risk. Because of different risk tolerances, the principal and agent may each be inclined to take different actions (Agency theory definition).

Agency theory explains relations between the different parts in the business and proposes the ways how these relations may be improved. The relations between the company and its shareholders are in the focus in this particular case. Analyzing these relations, the whole range of problems may be pointed out. The most important problems are: whether the company accounts interests of shareholders in its performance; whether there is a conflict of interests between the company and its shareholders; how these two subjects cooperate to resolve conflicts and reach the best synergetic effect for the company, etc.

The task of any company is to realize and protect the interests of these stakeholders. That is why a company should predict the way of such an influence and optimize it. In order to do it, a company should know its stakeholders and their interests. First of all, the different types of stakeholders must be defined. The following types of stakeholders may be pointed out: owners of a company, shareholders, employees, managers, clients, partners, creditors, investors, vendors, partners, regulative bodies, citizens, society in general, etc.

These different types of stakeholders have the different interests. Somebody is interested in profits; while others want to know about financial benefits. The other ones are interested in long-term prosperity and personal well-being. It is very difficult to combine all these interests, especially, when the problem is related to corporate social responsibility in the modern world. The following recommendations how to account these interests and protect them may be provided:

1. To define all the stakeholders, including even local citizens and competitors. There should be more important and less important stakeholders in the modern business world;
2. To understand all their interests and desires related to a company’s performance. Some interests are declared by stakeholders while the other ones should be derived from their behaviour and performance;
3. To group these interests. The most important interests should be realized the first. Also, it is important to understand that it is more reasonable to start with easy tasks. Results will be seen and will motivate all the company’s stakeholders.
4. It is very important to negotiate with stakeholders on a constant basis. Interests may change from time to time, and a company must monitor these changes and try to meet them;
5. A company’s stakeholders must take an active part in the process of development and realization of a business strategy. They should also feel themselves responsible for the final outcome. They will support a company in such a case;
6. A company has to learn experience of the other institutions and share its own experience. The world will be improved in such a way since a synergetic affect is going to be created;
7. Some formal memorandum between a company and stakeholders must be signed. This memorandum must reflect a company’s tasks and objectives, as well as stakeholders’ interests;
8. Stakeholders must have an opportunity and instruments to influence performance of a company. There are a lot of such instruments: regular meeting, negotiations, public control, etc;
9. A company must constantly report to stakeholders. It is going to create an atmosphere of trusts in relations between a company’s managers and stakeholders. Trust is very important in the modern business world.

Generally, it is very important to maintain positive relations with shareholders. In fact, the company performs in order to increase their well-being. Analyzing the company under consideration, it should be stated that it pursues positive relations with all the stakeholders. We talk about stakeholders since almost all the shares of the company are held by institutional investors. It does not change the situation with agency theory since it describes relations with all the stakeholders. There have not been some significant conflicts of interests between the company and stakeholders since it was founded. That is why it is quite difficult to analyze the ways how the company resolves big conflicts. However, there have been some minor ones, and the company has always managed to find the way to resolve them. The most interesting thing is that institutional investors are the major shareholders of the company nowadays. Such investors are mainly interested in growing dividends for themselves. Also, the growth of the company’s value is very important. That is why they may be ready for severe steps in order to guarantee such a situation.

Another important concept that should be discussed is corporate governance. “Corporate governance is the relationship between all the stakeholders in a company. It includes the shareholders, directors and management of a company, as defined by the corporate charter, bylaws, formal policy, and rule of law” (Corporate governance definition).

Thus, it is a quite similar term to the term agency theory. However, this term describes relations between the stakeholders inside the company, as well as relations between the company’s employees and managers. These relations may be divided into horizontal and vertical relations. Vertical relations are between employees from one level of the company and vice versa. Also, this term describes informational flows between the levels of the company. This flow should be smooth and operative. Only in such a case, the most effective decisions may be made on time.

Corporate governance is on the high quality level in the company under consideration. Such a situation can be called as one of the keys to the company’s success. All employees know that they should work together in order to reach the common goal. Everyone should contribute something. It unites employees among the common goal and boost performance of the company.

Corporate governance may be effectively realized only in the company with a high corporate and organizational structure. Burberry is characterized with such items. Burberry has 156 years of experience. These years have let the company develop the most appropriate organizational culture, where the most important value is satisfaction of customers and growing well-being of stakeholders. As a result, all employees in the world are united around this particular goal.

The next task of the report is to conduct financial analysis of the company. Financial analysis is an instrument that is needed for both external and internal users of information. Internal users of information about a company are, first of all, a company’s managers and shareholders. External users are a company’s clients, partners, investors, and creditors. They need information in order to make their business decisions. Of course, the quality of these decisions and their results depend on the quality of information obtained.

This information is provided in the financial statements, such as balance sheet, income statement, etc. However, it is not enough to see simple numbers. Some analysis of these numbers should be conducted. Financial analysis is the instrument to do it. 

Two main types of financial analysis can be pointed out – horizontal and vertical. Horizontal financial analysis is an analysis of the main trends in the history of a company’s performance. Vertical financial analysis is associated with computation of the different financial ratios. Usually, the following areas of a company’s performance are analyzed – liquidity, profitability, financial stability, and debt management.

In order to conduct a financial analysis of the company, its annual report, which can be found on the official website of the company, is to be used. It will be an annual report for 2011-2012.  Simple horizontal analysis of the company’s performance will be conducted.

Generally, the company is said to have demonstrated positive dynamics of performance for the last years. The main financial indicators have demonstrated growth – assets, current assets, financial results, etc. Thus, we can talk about the expansion of the business. Since the company specializes in the luxury brands, growth of its financial performance is mainly associated with growth of demand for the company’s products.

Some slowdown was in 2008-2009. We tend to relate it to the global financial crisis and its consequences. In this case, specialization on the luxury brands has played a bad role in the Burberry’s history. People decreased demand for a lot of goods during the crisis as luxury clothes cannot be called as the most important things. It has led to falling sales of the company under consideration. However, the current year is really successful. The company shows that it has managed to overcome the consequences of the global financial crisis.

It can be more vividly shown via an effective instrument of vertical financial analysis – ratio analysis. The following ratios are going to be calculated: ROA, current ratio, ratio of financial independence, and debt ratio. They characterize the most important sides of the company’s performance – profitability, liquidity, financial solvency, and debt management. These financial ratios for the company for the last two years are provided in the following table.

In general, financial condition of the company is considered to be quite good. It demonstrates a good degree of profitability and liquidity. It is a really good sign for the company’s creditors and investors. It means that the company is able to generate profits and pay off the debts. The other important thing is that Burberry demonstrates positive trend in the main financial indicators. Taking it into account, we may expect only improvement of the situation in the future. Of course, such a high level of financial performance is reflected in the dynamics of the company’s shares and also dividend policy, which is to be talked about below.

The next question is related to the previous one. We should say a few words about the cost of capital and the capital structure. Any company needs capital to perform and realize its business goals. There are two possible ways to get financing for a company – debt financing and equity financing.

The company under consideration uses almost equal correspondence between these two items. It can be proved by comparing financial independence ratio and debt ratio, which have been provided above. Debt financing and equity financing are used by the company for the different purposes. Burberry uses debt financing for short-term goals; while equity financing is used to finance long-term projects and general growth of the company. As a result, Burberry has managed to get almost optimal cost of capital. This cost of capital can be evaluated via the so-called weighted average cost of capital (WACC).

WACC is a calculation of a firm's cost of capital in which each category of capital is proportionately weighted. All capital sources - common stock, preferred stock, bonds, and any other long-term debt - are included in a WACC calculation. All else equal, the WACC of a firm increases as the beta and rate of return on equity increases, as an increase in WACC notes a decrease in valuation and a higher risk (WACC definition).

The company is characterized with 7% WACC. We believe that this indicator is almost optimal, especially in the conditions of the current global financial crisis. The main burden is associated with payments to the mentioned institutional investors. Such a factor just forces company to pursue an appropriate dividend policy. The company is forced to pay sufficient dividends to satisfy the investors. On the other hand, such an approach to dividends increases trust to the company and attracts new investors.

The cost of capital and the capital structure are associated with such a term as long term finance. The company may need capital for the different purposes, but it should be always targeted on the long term strategy and, respectively, long term finance. The company finance long term projects and its own growth. The sources of such financing, used by the company under consideration, are the following: reinvested earnings, equity financing, long term financial borrowings, etc.

To answer the following question of the report we, first of all, have to provide a definition of the Capital Asset Pricing Model (CAMP). The Capital Asset Pricing Model is “a model that describes the relationship between risk and expected return and that is used in the pricing of risky securities” (Capital asset pricing model definition).

This particular concept is one of the most popular theories in the world of investments. Using it, investors are able to determine the risk of some particular securities or a market, in general. It also helps investors to calculate the expected rate of return on their portfolios. In other words, it is a great instrument that can be used in the process of making investment decisions.

Since the Beta describes a security’s correlation with the whole market, we believe that, if we owned half of all the stocks traded on the major exchanges, the Beta of our portfolio would be close to one. It means that our portfolio would demonstrate dynamics similar to a market’s one. It is not surprisingly, taking into account a fact that we own a half of all securities, traded on this market.

The main idea of the CAPM for investors is that they should be compensated in two ways: time value of money and risk. The first part of the mentioned formula represents the time value of money. It is represented by the risk-free rate that describes the value that investors should receive in any case.

On the other hand, the CAPM shows corporations what should be done to attract investors. In other words, it shows them what steps should be taken to make the expected rate of return on their shares the most attractive option for investors.

Corporations can influence Beta of their shares. This ratio is determined by a lot of factors including the overall success of a company’s performance, its work with shareholders and potential investors, as well as its performance in the fund markets. If these particular issues are changed, a company is capable of affecting its beta and, respectively, the expected rate of return on their shares.

Simply speaking, the CAPM and beta are used to explain and forecast performance of the company’s shares. First of all, the dynamics of shares of Burberry should be described. The company’s shares have demonstrated quite stable dynamics for the last years. The dynamics is given below.

Periods of growth have been replaced by periods of decline. The most difficult times were in the period of the global financial crisis. However, the general trend to growth has been demonstrated since 2009, a formal end of the global financial crisis. The current period can be characterized as a period of volatility and uncertainty for Burberry’s shares.

We have used the CAPM to calculate the company’s beta. As it has been already mentioned, Beta demonstrates the correlation between the market index and the share. The closer is this value to 1, the highest is correlation. We must say that these shares are not aggressive, since Beta is 0.68. It means that Burberry’s shares move together with the index; however, the pace of such movement is slower. They can be even called conservative. That is why these shares are good for conservative and calm investors that desire to save capital. The situation has changed a bit when institutional investors came to Burberry since they are interested in aggressive growth of the shares. In any case, these shares are a good option for the short and  long-term investments.

Conclusion

Burberry is a British company that specializes in production and sales of clothes and accessories. The company was founded in 1856 and has become a world known brand since that time. The company is listed on the London Stock Exchange and is considered as one of the best options for investors. The task of this report was to define whether the shareholders should continue cooperation with the company. The final answer is yes.

The company maintains mutually beneficial relations with all the stakeholders. In fact, it is a part of the company’s mission to improve life of stakeholders. There have not been some significant conflicts of interests between the company and stakeholders since it was founded.

The company has demonstrated a positive dynamics of performance for the last years. The main financial indicators have demonstrated growth – assets, current assets, financial results, etc. Some slowdown was in 2008-2009 as the company was influenced by the global financial crisis and its consequences. However, the current year is really successful. The company shows that it has managed to overcome the consequences of the global financial crisis.

Generally, we can say that financial conditions of the company are quite good. It demonstrates a good degree of profitability and liquidity. It is a real good sign for the company’s creditors and investors, since it means that the company is capable of generating profits and paying off the debts.

Corporate governance is on the high quality level in the company under consideration. Probably, such a situation can be called as one of the keys to the company’s success. All the employees know that they should work together in order to reach the common goal. Burberry is characterized with a high degree of corporate governance, positive financial results, and dynamics of the shares. Taking it into account, we may recommend the shareholders to continue to trust the company and its managers.