Critical Analysis Of Financial Structure And Sources Of Finance Of Schlumberger Company

Importance of Wealth Maximization and Risk Minimization Model

The financial structure of the company plays an important role in determining the capital trade off-theory taken by the company. There are various sources of external financing which the companies can go through and some of the external source of financing is the usage of the equity and debt. The management of the company should have an aim of maximizing the wealth of the shareholders and the company can achieve the same when the company invests the investible amount into positive NPV projects. The external sources of finance available for the company determines the potential for the company to generate the sources of capital for the company (DeAngelo and Stulz 2015). The management of the company evaluates and identify the various sources of capital for the company and identifies the best possible sources of financing structure for the company according to the company’s prospects and goals. The various sources of financing structure for the companies needs to be evaluated based on the cost benefit analysis for the company (Zeitun and Tian 2014). The management of the company should formulate plans and surveys accordingly for the company so that the same is beneficial for the company in the end. The efficiency of the company lies with the profitability and the efficiency ratio of the company and the same shows the return on assets generated by the company and the return on the total assets of the company (Graham, Leary and Roberts 2015).

The importance of the wealth maximization is important for the company and is the superior goal for the company. It is common for the management of the company that the interest of the management of the company and that of the stakeholders of the company should be common so that in the long-run both the parties work on a common goal and interest for the company (Queen 2015). Maximization of shareholders wealth should be the primary motive and object for the company so that the work in the best interest of the stakeholders. Shareholders are the real owners of the company who have invested the capital after assessing the prospects and the growth of the company (Russo et al. 2016). Thus, it is crucial for the management of the company to identify the sources and ways where sustainability in the payment and growth of dividends can be paid (Heath et al. 2018). The company should follow the optimal dividend policy and should give priority to the shareholders of the company by following a common interest in the long-term perspective of the company. The importance of alignment of interest in the company between the shareholders and the management of the company plays an important role and the same should be carefully reviewed. The present value of the expected future cash flows flowing to the investors/stakeholders of the company will be the key factor showing the profitability of the company (Vaillancourt, Alcocer and Bahn 2015).

Risk minimization is the key factor that the company should undertake in order to attain the sustainability of returns for the company. The risk minimization model should be based on the risk and return characteristics of the investors and that of the company. Risk is an important factor, which plays a crucial role in the investment, and the same should be analyzed and evaluated for the investments the company undertakes, which can modify the return of the investors. The stakeholder’s model of a company shows the interest of the management and the compliance of the same with that of stakeholder’s interest. The company operates in a situation where the business risk of the company is generally high due to the operations of the company. The increase in the debt of the company will increase the financial risk of the company and which would not be better for the company.

Brief Description of the Company

The crucial problem identified with the above model is that one of the model deals with the application of risk minimization and the other deals with the stakeholder’s model where the general principles contradict with each other. The key principle outlining the risk minimization approach says that the risk for the investment should be limited and reduced by the management of the company. However, the principles of the stakeholder’s model says that the wealth of the stakeholders should be maximized in order to align interest of the stakeholders and the management of the company. The same would allow the company take a significant amount of risk, which will then be contradictory to the risk minimization model of the company. The company claims to follow a sustainable dividend policy where the dividend paid by the company is said to be adequate for keeping an aligned interest between the management of the company and the shareholders of the company. The company should follow the bird in hand theory, which is optimal from the shareholders viewpoint where the maximum amount of profit earned is paid to the shareholders of the company in the form of dividends.

Schlumberger Company is the largest company operating in the Oilfield services from the year 1926 and the company has been performing in the area with an employee base of around 100,000 people. The stock is listed in the New York Stock Exchange and a key component of the S&P 100 and S&P 500 component. The company is the world’s largest and leading provider in the field of technology and reservoir characterization, drilling, processing and production of the oil and gas industry (Robb and Robinson 2014). The company has its operation in more than 85 countries and supplies the major kind of products and services to major companies and different types of companies globally. The revenue of the company is primarily derived internationally and from the domestic operation where the company derives the revenue from various types (Kalyuzhnova and Patterson 2016). The company is having four principal offices certainly in four major areas like Paris, Houston, London and (Hague Korajczyk et al. 2015). The reported revenue for the company is around 2781million dollars for the year 2016. The company works often in the remote and certain challenging condition, which makes the financials of the company volatile. There are various factors, which affect the operations of the company and the financials of the company (Sharfman 2014). The prospects of the company is significantly dependent on the macroeconomic environment under which the company operates. The changing market conditions and the business environment under which the company operates has been volatile and cyclical as the oil market and the changing business and market condition changes. Volatile Business cycle and fluctuations in the exchange rate has been the key factor for the volatile performance of the company. During the analysis of the company, it was found that the liquidity position of the company were found to be decreasing from the trend period 2013-2018 which is not a good sign for the company.

Sources of Long Term Finance

There are various types of long-term sources of finance available for the companies and the same should be analyzed and evaluated based on the suitability of the profile of the company. The risk and return analysis for the company should be done for the different kinds of sources of finance available for the company and the implication on the capital structure of the companies. The external sources of finance available for the company determines the potential for the company to generate the sources of capital for the company (Albul, Jaffee and Tchistyi 2015). The listed companies have primarily various sources of financing options available for the companies like issue of equity shares, preference shares, long-term debt financing like debt financing, debentures, term loans, venture capital, and trade credit are some of the sources of long term financing for the companies (Baker and Wurgler 2015). The various types of external sources of finance available for the companies are generally evaluated that the same matches with the capital structure of the company or not. The Schlumberger Company should evaluate the various sources of financing available for the company and optimally look at the best possible source of financing for the company. The current debt structure of the company says that the primary two sources of financing on which the company is dependent is the debt and equity financing. Where the ratio of each of the funding source is on the ratio of 40:60 and the company has tried to maintain the debt equity structure of the company as analyzed from the financial statement of the company. Application of debt financing may be suitable for the company in the case that the same helps the company in the effective tax rate of the company by including the interest paid by the company as in the form of tax-deductible expenses for the company. The interest paid by the company helps in reducing the statutory tax rate of the company and the same will reduce the effective rate of the company at the same time.

The various types of long term financing opportunities available for the companies were selected based on the capital structure of the companies. The company Schlumberger has a debt equity ratio of around 39.92% and 39.64% in the year 2017 and 2016 respectively. The debt to equity ratio for the company has been consistent and should be sustainable for the company. The company operates in a situation where the business risk of the company is generally high due to the operations of the company. The increase in the debt of the company will increase the financial risk of the company and which would not be better for the company. The company current have its common equity share as the primary base, which contributes about 60% of the total capital structure for the company. The capital structure for the company is primarily from these two common sources of financing such as equity and debt financing.

Particulars	2017	2016
Long Term Debt	14875	16463
Equity	37261	41529
Debt/Equity Ratio	39.92%	39.64%

Liquidity/Financial Health	2013-12	2014-12	2015-12	2016-12	2017-12
Current Ratio	1.94	1.74	1.91	1.59	1.21
Quick Ratio	1.47	1.32	1.54	1.24	0.86
Financial Leverage	1.7	1.77	1.91	1.9	1.95
Debt/Equity	0.26	0.28	0.41	0.4	0.4

The debt structure for the company has been currently increasing from the last five year of trend analyzed for the company, which shows that financial risk of the company may be high for the company and increasing for the company from the year 2013-2018 trend period analyzed for the company.  The company should maintain the debt to equity ratio for the company at the optimal level so that the financial; risk of the company says well within the risk tolerant level of the company. The financial risk of the company may significantly increase if the management of the company takes a significant amount of debt borrowing to finance the assets of the company, which in turn will increase the financial risk of the company.

The weighted average cost of capital for the company may be derived from the various financing structures or the external sources of capital from which the company borrows various type of funds such as equity or debt financing (Allen, Carletti and Marquez 2015). The weighted average cost of capital for the company is derived by the amount of debt exposure of the company and the equity level in the company and the interest rate charged by the debt on the company and the required rate of return on the equity of the company (Padfield 2017). The required rate of return on the equity of the company and the interest rate on the debt multiplied by the weightage of the debt and equity of the company forms the weighted average cost of capital for the company (Faccio and Xu 2015). The main difficulty encountered in the calculation of the weighted average cost of capital for the company is estimating the required rate of return on the equity for the company. The same is derived by the formula of Capital Asset Pricing Model where the formula applied for the same is:

Required Rate of Return on Equity (Re): Risk Free Rate of Return (Rf) + (Return on Market- Risk Free Rate of Return)*Beta

The estimate and the selection of the market index as a proxy for taking the return on market is the crucial input which one should undertake and estimate for deriving the return on equity for the company. The market proxy is the benchmark taken usually for deriving the return on equity for the company (Serfling 2016). The beta factor taken in the formula is the sensitivity or the incorporation of the standard deviation of the stock with respect to the market index of the stock. The beta shows the sensitivity value of the stock with respect to the changes in the value of the market (Danielson, Heck and Shaffer 2015). The beta factor taken into account for the company Schlumberger if is greater than 1 which will indicate that if the return and the risk factor of the market index changes by 1 then the stock will move greater than 1 (Denis 2016).

Growth Profitability and Financial Ratios for Schlumberger Ltd
Key Ratios -> Financial Health
Balance Sheet Items (in %)	2013-12	2014-12	2015-12	2016-12	2017-12
Cash & Short-Term Investments	12.47	11.21	19.17	11.87	7.07
Accounts Receivable	17.13	16.7	12.91	12.04	11.23
Inventory	6.86	6.92	5.52	5.42	5.62
Other Current Assets	2.62	2.08	1.97	1.36	1.78
Total Current Assets	39.08	36.91	39.57	30.69	25.69
Net PP&E	22.5	23.01	19.73	16.45	16.08
Intangibles	28.93	30.1	29.67	44.7	47.89
Other Long-Term Assets	9.48	9.97	11.03	8.16	10.34
Total Assets	100	100	100	100	100
Accounts Payable	6.21	6.51	4.79	5.17	6.45
Short-Term Debt	4.16	4.15	6.73	4.07	4.64
Taxes Payable	2.23	2.47	1.78	1.53	1.71
Accrued Liabilities	6.99	7.35	6.62	6.35	6.53
Other Short-Term Liabilities	0.62	0.78	0.94	2.31	2.03
Total Current Liabilities	20.21	21.25	20.85	19.43	21.35
Long-Term Debt	15.53	15.84	21.32	21.24	20.78
Other Long-Term Liabilities	5.3	6.17	5.22	6.33	6.38
Total Liabilities	41.03	43.26	47.39	47	48.52
Total Stockholders’ Equity	58.97	56.74	52.61	53	51.48
Total Liabilities & Equity	100	100	100	100	100
Efficiency	2013-12	2014-12	2015-12	2016-12	2017-12
Days Sales Outstanding	92.12	85.16	102.64	119.22	104.75
Days Inventory	48.49	45.05	54.03	60.41	56.87
Payables Period	39.8	41.47	48.89	54.86	59.25
Cash Conversion Cycle	100.81	88.73	107.77	124.77	102.36
Receivables Turnover	3.96	4.29	3.56	3.06	3.48
Inventory Turnover	7.53	8.1	6.76	6.04	6.42
Fixed Assets Turnover	3.03	3.19	2.46	2.12	2.5
Asset Turnover	0.7	0.73	0.53	0.38	0.41

Conclusion

The company Schlumberger should analyze various type of capital structure for the companies and develop a risk return characteristics of each of the capital sources. The various capital structures preferred by the companies must be evaluated according to the capital structure policy of the company and after assessing the financial and business conditions of the company. The weighted average cost of capital for the company should stay well within the industry standards. The company should evaluate the various sources of the long term financing option available for the company and selecting the optimal financing option for the company. The inclusion of debt financing and other sources of long term financing in the capitals structure of the company and the benefits from the same were some of the crucial factors that were taken into consideration into the assignment. The weighted average cost of capital or the company was selected by identifying the various sources of long-term financing the company is exposed with and selecting the best possible source of capital structure of the company. The company operates in the oil sector, which suffers from high business risk and the liquidity position of the company at the same time has degraded over the five-year horizon time. The financial risk of the company or the exposure of the debt of the company at the same time should be optimal so that the risk tolerant level of the company remain well within the company risk policy. The company should follow the optimal dividend policy and should give priority to the shareholders of the company by following a common interest in the long-term perspective of the company. Thus, it is crucial for the management of the company to identify the sources and ways where sustainability in the payment and growth of dividends can be paid. The importance of alignment of interest in the company between the shareholders and the management of the company plays an important role and the same should be carefully reviewed.

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