Discuss the management of Equity and Debt as part of the long term funding requirements of companies.
The report is intended to conceptualize management of equity and debt. Debt equity ratio plays a crucial role in assessing the risk level of a particular company. The dependency of the ratio lies in the amount of both long term and short borrowings divided by the shareholder’s fund, popularly known as proprietary funds. Thus it is important to understand the various findings of the ratio and working of the same. From the perspective of the risk debt equity ratios lower than 0.4 or lower are considered as ideal for a particular company, the higher is the ratio it is more difficult for the company for borrowing of credit. Hence it is crucial for a company to maintain a low debt equity ratio for the purpose of the balancing the risk and take financial credit during emergencies or debt crisis. (De Franco et al. 2013).
The study shows the comparison of the debt equity ratio on the basis of two non financial companies based on London Stock Exchange, namely Tesco PLC and Sainsbury’s. Both the selected companies are leading retail companies of UK. The calculation of the debt equity ratio of both the company’s excludes the financial services of both the companies. For the purpose of the evaluation for the debt equity ratio the annual report for the last five years has been taken into consideration. The total amount of the debt and the equity has been represented in form of graphs and charts for a clear visual representation of the changes in the value of debt- equity for last five years. All the values of the shareholders find and long-term debt of the company has been studied from the annual reports of the selected organizations. (Tesco plc. 2016)
Equity is the difference of the presently available assets for the company and the liabilities currently incurred for a particular financial year. Equity can also be calculated based on the shareholder’s funds is divided by the total value of the assets. The equity shows the overall financial strength of a particular company and acts as the test for a sound capital structure for a particular company. The maintenance of higher amount of equity by a company ensures that the lower amount of interest is required on the available capital. On the other hand, a company with lower amount of equity is prone to losses (Bolton et al. 2015).
In the main components of the equity comprises of the components such as Capital and reserves, called up share capital, share premium and reserve created for the purpose of profit and loss. The annual report of a company represents the retained earnings, which is essential for the purpose for calculation of the amount of the equity. (Schmitz 2015). In practical scenario, a company has to make amendment sand reveal the same related to the various types of the changes for equity by the revilements of the various types of particulars such as comprehensive income or losses, changes in the fair value of the finances available for the purpose of sale. The various type of the equity instrument used by a company is further recorded at the proceeds of the direct cost received. The equity components also take in to consideration the annual report also includes the perpetual capital securities and the perpetual convertible bonds (Green 2013).
The main purpose for the management for the equity of the company is to keep the present members satisfied. If the amount of equity is managed effectively financing of the debt. A liability level affects liability to obtain credit and then various terms and conditions. The sufficient amount of the availability of the equity allows for additional financing of the debt at the time of emergency and various process related to the aversion of the risk (Finocchiaro and Mendicino 2013).
The debt ratio is firm’s total liabilities in terms of the percentage of the total assets. In other words the debt shows the number of assets, which a firm must sell off in order to pay off the liabilities. Then formula used to calculate the debt ratio is used as total liabilities over the total assets. The various type so of the debt management techniques is essential for a company to know about the various types of the payment which are held with the creditors and they need to be addressed at soon as possible in order to clearance of the same. The various types of the debt management techniques plays an essential role for the purpose of maintaining a feasible financial position of a company and improve the overall financial, situation through a reduced policy structure to keep the amount of then debt low. The debt has a direct impact on the debt equity ratio for the company and keeping then amount of debt low is essential to maintain a low amount of the overall debt equity ratio. The main purpose of the debt management team of the company is to formulate a plan for speaking to the unsecured creditors of the company. These creditors need to b e negotiated for the purpose of the payment and the final payment terms should be kept low as much as possible. The debt management technique is important to keep the repayment affordable at the end o the each moth and clearing of the various types of the creditors in order to keep the amount of the creditors lower. (Blessing 2012)
An extensive analysis of the Annual report of a company includes the various types of the debts such as bank overdraft, borrowing (both long and short term), financial leases, then various type of the financial derivative. The purpose of the report is to include the calculation of the various types debt and the equity components of the nonfinancial firms the annual report clearly states that the debt evaluation excludes the value of the selected company’s own net debt balances (Long and Phi Nga 2015).
Some of the important components of the debt include components such as Inventories and trade and other receivables, deferred tax liability, Post-employment benefits, Liabilities of the disposal groups. The important aspect of debt management includes the forecasting of the debt from beforehand and keeping the reserves in case of a financial crisis. (Alves et al.2016).
The importance of the debt management technique lies in the flexibility to make the payment related to the provisions made for the future investment, which are made by a company in general perspective.
The evaluation of the debt equity ratio is based on the comparison of the Debt-equity is based on the calculation of five year basis.
The debt equity calculation of Tesco PLC is shown below as follows:
|
TESCO |
|||||
|
Particulars |
2012 |
2013 |
2014 |
2015 |
2016 |
|
(£ 000) |
(£ 000) |
(£ 000) |
(£ 000) |
(£ 000) |
|
|
Total Debt |
£ 6,838 |
£ 6,597 |
£ 6,597 |
£ 8,481 |
£ 6,085 |
|
Shareholder’s Fund |
£ 17,801 |
£ 10,464 |
£ 9,399 |
£ 12,450 |
£ 12,682 |
|
Debt/Equity Ratio |
0.384 |
0.630 |
0.702 |
0.681 |
0.480 |
(Sokolowska and Wisniewski 2015)
Graphical representation of the debt/equity ratio
The debt equity calculation of Sainsbury PLC is shown below as below:
|
Sainsbury PLC |
|||||
|
2012 |
2013 |
2014 |
2015 |
2016 |
|
|
(£ 000) |
(£ 000) |
(£ 000) |
(£ 000) |
(£ 000) |
|
|
Total Debt |
£ 1,980 |
£ 2,162 |
£ 1,164 |
£ 1,467 |
£ 1,826 |
|
Shareholder’s Fund |
£ 5,629 |
£ 5,734 |
£ 5,539 |
£ 6,005 |
£ 6,365 |
|
Shareholder’s Fund |
0.352 |
0.377 |
0.210 |
0.244 |
0.287 |
The graphical representation of Sainsbury PLC is shown below as follows:
Comparison of the debt/ equity ratio of Tesco PLC
The analysis of the debt equity shows that the company is able to keep the debt equity ratio sufficiently low to around 48%. The analysis of the financial data showed an increase in the debt amount in the year 2014 with a debt equity ratio of 0.702 and the company observed the lowest amount of debt equity ratio in the year 2012. In the present times, the debt equity ratio was observed to be 0.480. The graphical representation further shows the decreasing trend of the debt equity ratio of Tesco PLC. (Palley 2013).
Comparison of the debt/ equity ratio of Sainsbury’s PLC
The debt equity ratio analysis of Sainsbury’s PLC shows that the company had observed the best debt equity ratio in the year 2014 with a ratio of 0.210. The debt equity ratio of Sainsbury’s PLC further shows that the debt equity ratio at the initial level that is in the 2012 was 0.352 and it increased to 0.377 in the year 2013. This can be clearly seen with the graphical representation which shows that that initially the company has observed a high amount of debt in the year 2012, then it observed a decrease in the year 2014 and it was again able to manage its debt equity ratio to a standard position in the year 2016. (Said 2013).
Comparison of debt equity of Tesco PLC with Sainsbury’s PLC
The comparison of the financial position of both the company shows the financial position of Sainsbury’s PLC is in a better position than TESCO. As per the recent data of the annual report of Tesco the debt equity ratio of the company stands at 0.480 approximately whereas the debt equity ratio of Sainsbury’s PLC is observed to be 0.287. This measure of the financial performance by the company is found to be ideal to be maintained by the company as it will help the company to secure a better scope to obtain financial credit in the future. (Langenmayr et al. 2015).
Conclusion and recommendation
The first section of the report gives a general perspective of the management of the debt and equity by a company. The understanding of the various types of the concepts for the debt equity management is based on the present industry standards. After the comparison of the balance sheet of both the companies for the past five years it had been observed in Tesco needs to lower the debt amount considerably. It had been further observed that highest amount of the debt of the company was observed through bank and borrowing from the financial institutions. This trend was found to be similar for all the five years. The average borrowing was observed to be at 12000 million pounds for all the five years. This amount needs to be improved for the purpose of the improvement of the debt equity ratio. On the other hand the high amount of equity has been observed from the funds observed from share premium account and it should further work on improving it even further. The main source of the debt has been observed from the borrowing of the company which is approximately observed as 2000 million for the past five years. This needs to be reduced by the company to reduce the debt equity ratio and improve the financial performance of the company. Hence it is important to consider all the aspects to improve the debt equity ratio (Levi and Segal 2015).
Reference List
Alves, N.S., Mendes, T.S., de Mendonça, M.G., Spínola, R.O., Shull, F. and Seaman, C., 2016. Identification and management of technical debt: A systematic mapping study. Information and Software Technology, 70, pp.100-121.
Blessing, P.H., 2012. The debt-equity conundrum–a prequel. Bullr Int Tax, pp.198-212.
Bolton, R.N. and Tarasi, C.O., 2015. 14. Risk considerations in the management of customer equity. Handbook of Research on Customer Equity in Marketing, p.335.
De Franco, G., Vasvari, F.P., Vyas, D. and Wittenberg-Moerman, R., 2013. Debt analysts’ views of debt-equity conflicts of interest. The Accounting Review, 89(2), pp.571-604.
Finocchiaro, D. and Mendicino, C., 2013. Debt, Equity and Monetary Policy.
Green, S.F., 2013. Achievement and Private Equity in the UK. The Social Life of Achievement, 2, p.139.
Langenmayr, D., Haufler, A. and Bauer, C.J., 2015. Should tax policy favor high-or low-productivity firms?. European Economic Review, 73, pp.18-34.
Levi, S. and Segal, B., 2015. The Impact of Debt-Equity Reporting Classifications on the Firm’s Decision to Issue Hybrid Securities. European Accounting Review, 24(4), pp.801-822.
Long, P.Q. and Phi Nga, N.T., 2015. Debt risks and risk management of public debt: survey from theory to practice. Economic Studies, (8), pp.69-77.
Palley, T.I., 2013. Financialization: what it is and why it matters. In Financialization (pp. 17-40). Palgrave Macmillan UK.
Said, H.B., 2013. Impact of ownership structure on debt equity ratio: A static and a dynamic analytical framework. International Business Research, 6(6), p.162.
Schmitz, C., 2015. Equity valuation of Tesco Plc (Doctoral dissertation).
Sokolowska, E. and Wisniewski, J., 2015. Liquidity management by effective debt collection: a statistical analysis in a small industrial enterprise. Ekonomika, 94(1), p.143.
Tesco plc. (2016). Tesco PLC. [online] Available at: https://www.tescoplc.com/ [Accessed 23 Jul. 2016].
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