Effective Working Capital Management of an Organization

| | |Financial Management Assignment 1 (FIN5209FMA) – | |SEMESTER 1, 2018 | Executive summary In order to attain a good functioning system of the organization, it is very important that the flow of operations is done in an effective manner, also seeking that the working capital management has been utilized. The company should also try to focus on enhancement of the risk management system, structure of capital and the capital management factors so that it can live up to the expectations of the customers

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Financial Management Assignment 1 (FIN5FMA) – SEMESTER 1,
2018

Fortescue Metals Group Limited
Executive summary
In order to attain a good functioning system of the organization, it is very important that the
flow of operations is done in an effective manner, also seeking that the working capital
management has been utilized. An overall change in the enhancement and development of the
organization is being made by the working capital changes. Thus all these factors have made
it very important for the management to focus on these kinds of risks and changes so that
company may not face any major issues in near future. The company should also try to focus
on enhancement of the risk management system, structure of capital and the capital
management factors so that it can live up to the expectations of the customers and provide
competition in the market. This report will be making a clear analysis of the nature of
Fortescue metals group show that the decision-making process can be enhanced.
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Fortescue Metals Group Limited
Contents
Introduction...........................................................................................................................................3
1. Determination of working capital and the financial policies of FORTESCUE limited......................3
2. Determining the capital structure approaches of FORTESCUE Limited.........................................4
3. Determination of dividend policy and distribution of earnings that are undertaken by the
organization...........................................................................................................................................5
Evaluation of structure of corporate governance policies and structure of the company....................6
4. Corporate Accounting policies.......................................................................................................7
Conclusion.............................................................................................................................................8
References.............................................................................................................................................9
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Fortescue Metals Group Limited
Introduction
When it comes to the business of iron ore and mining, Fortescue stands as a major company
that operates in the region of Pibara. It is ranked after the giant name of BHP Billiton, Rio
Tinto and Woodside Petroleum. The company boasts of strong fundamentals and a strong
presence that aids the functioning of the business. The company is well known for strong
policies that is in direct link to the attainment of iron ore business (Fortescue Metals Group,
2017).
1. Determination of cost of various sources and WACC of
FORTESCUE limited
Debt and equity can be treated as the major sources of finance that is present in the
company’s structure and that influences the WACC of the company. the WACC of the
company stands at 12.6%. The WACC of the company is composed of debentures, equity,
retained earnings. This means that Fortescue does not use the cheaper source of finance. The
long term sources are being used by the company because it will lead to a significant decline
in the WACC. When the long term finance enhances, the WACC declines . Hence, from the
computation, it can be seen that the cost of equity is greater than the cost of debt.
Weighted
average cost of
capital
Particular Amount Cost (%age)
Equivalent
Capital WACC
Debentures 5655226209 11.54% 0.172381517 2.0%
Equity 16241190780 12.80% 0.495060852 6.3%
Retained
earnings 10910036401 12.80% 0.33255763 4.3%
Total 32806453390 12.6%
Total
Working- Calculation of cost of debt
Interest expenses 652626105
long term debts 5655226209
Interest expenses 11.54%
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Fortescue Metals Group Limited
Working capital of the organization can be affected in a lot of ways including the blockage of
massive resources in its stocks. Also, companies try to keep small inventories and stocks
stored with them so that there may be no problem arising in the near future for debt
obligations. Also, the calculation of the firm's ratio has stated that it is greater than the normal
rate of 1:1 thus making it profitable in nature. Also when an analysis is made on the data of
past 5 years then the ratio will be observed to have high value only. This helps us to state that
every penny have been utilized by the firm in buying current assets and liabilities is very
significant for the developments that may be made in the firm and future (Fortescue Metals
Group, 2017). The current ratio in all the past 5 years remained more than one indicating that
the company has sufficient current assets to meet the current liabilities.
The working capital of the organization can be regarded as an effective and constant highlight
that can help to meet the requirements of the current liabilities and current assets at a basic
level. Also, the ratio values have stated that the Fortescue Limited have been trying to
safeguards its current assets so that there will be no problems arising in the future for the
operation of the organization (Fortescue Metals Group, 2017). So it can be clearly stated that
the organization is free from any kind of risk obstruction that may provide problems in the
smooth flow of operations. The quick ratio was below one in the year 2017 however, the past
year trend indicate that the company has strong liquidity and will be able to discharge the
obligations. It is also very important for the organization to look after debt obligation so that
the investment policies and management can be maintained properly.
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Fortescue Metals Group Limited
2. Determining the capital structure approaches of FORTESCUE
Limited
The scale of the operations that have been carried out by the company has been stated to be
very huge in nature and also the value of $10897.02 billion was reported as resources of the
organization. All the smooth flow of operations that are being carried out by the company
have held its investors and shareholders to be satisfied and thus helping the company in order
to improve their goodwill and the reputation within the industry. It has also been observed
that the company has tried to rely on the debt resources of the finance so that it can meet up
to the expectations of the objectives and goals that have been set by it. This also clears the
decline of the debt value from $12257.81 to $8992.72 (Fortescue Metals Group, 2017). Also,
it is clear that the operating cash in hand that the company keeps with it is majorly used to
satisfy the future obligations which are the positive indicator for the firm.
The calculation of the debt to equity ratio can also help in the assessment of the problems. It
has also been observed that the company have relied on its debt sources of finance for a long
time and used it to operate the functioning system of the organization so that the future debt
obligations could have been met through interest payments. This may be a negative aspect for
the stakeholders and owners of the company as it shows that less dividend will be provided to
them. Also, the dependence on debt obligations by the organization is also of great concern.
The company has also tried to decrease the long-term debts and current liabilities so that the
debt to equity ratio can still have a value more than 0.5 which will help the company to
balance the ratio in a proper manner.
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Fortescue Metals Group Limited
The total profit that has been incurred by the company in the past 5 years has now been
encountered to decrease in the year 2016. The debt level of the company has increased
meaning that the company has more of debts as compared to equity. The debt equity stands
above 0.70 and this indicates that the company has relied more on debts (Fortescue Metals
Group, 2017)
The increase revenues of the firm can be the reason for the massive sales that have been made
during the past few years. Also, it was witnessed that the net revenues reported a major value
of increment when there was a fall observed in the debt obligations of the company. Hence
the massive amounts of resources that have been utilized by the firm in order to take
advantage of the small market capitalization have helped it to increase the financial measures
(Gibson, 2012).
The debt equity ratio of the company is not ideal because going by the standards it should be
2:1 however, going by the computation it is seen that the debt equity ratio is not optimal and
below the desired ratio. Hence, the company needs to set standard and raise the level of debt
to get the utmost benefit. For an optimal structure it needs to derive two-third of the capital
financing from debt and one-third from the shareholder equity.
The company is also said to meet with the needs of the future debt obligations easily because
it has a lot of resources that have been stored as stocks and resources and also the interest
payments that are to be paid, do not pose any major threat to it. This also clearly states that
the company will not become vulnerable when the repayment of the debt all obligations are
needed to be made in the form of interest payments (Carmichael & Graham, 2012). It is
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Fortescue Metals Group Limited
believed that this type of companies is having an effective structure which can be used by
them in order to survive in a competitive environment thus leading it to maximize the profits.
2013 2014 2015 2016 2017
Total equity 5,698.00 8,035.00 9,797.00 11,301.00 12,637.00
Total debt 16,800.00 16,056.00 18,016.00 14,739.00 12,214.00
Debt equity
ratio
0.3328909 0.3395232 0.5018199 0.5452506 0.7690056
3. Determination of dividend policy and distribution of earnings
that are undertaken by the organization
For the purpose of ascertainment and determination of dividend policy and distribution of
earnings in an organization, computation of ratio is taken into consideration. Ratio analysis
forms a basis for the ascertainment of dividend policy and distribution of earnings. Dividend
payout ratio is one fine example so as to determine the figures for distribution of earnings
(Greene, 2018). The company’s dividend payout ratio as per the provided details have sloped
upwards in the year 2013 and 2014 which means that there was the provision of dividends in
these 2 years. Alternatively, the details also state that the net income of the company has a
downward trend in the year 2015 which has further allowed the dividend to fall in the same
year. This further means that the NI of the company is directly related to its distribution of
dividend. It means that the greater the profits in a company during the year greater will be the
distribution of dividend. The company has a profound dividend payout and it is on account of
the rapid growth of its business (Ferris et. al, 2010). This company is apt for the investors to
consider so as to employ their investments.
Australia was the first company to formulate the policy of imputation of tax in the year 1987.
This highly influenced the dividend policies in every organization. This further helped in
minimizing the effect of double taxation on the dividend of income. Franking credit and
after-tax net credit can also help the shareholders of the organization in attaining a bigger
opportunity.
Regular dividend policy – in this scenario, the investors get dividend at the normal rate. Such
a dividend policy is possible when the company consists of regular earning.
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Fortescue Metals Group Limited
Stable dividend policy – in this scenario, a certain sum of money is paid regularly to the
shareholders. It consist of 3 types that is the constant dividend per share, the constant pay oit
ratio and the stable rupee dividend.
Low regular dividend – this dividend is payment of low divided at regular intervals but the
extra cash dividend is paid when there is higher earnings. Such a method supplements the low
dividend payout
Smoothed dividend policy – this dividend policy is paying regular dividend by the company
and it is upon the action of the company whether or not to pay dividend in any of the year.
Going by the overall discussion, it can be commented that the company should follow regular
dividend as it has strong fundamentals and earning profits. Therefore, going by the trend and
its operations it can be said that the company is having strong dividend history and must
continue with that.
Reportedly, Fortescue has a dividend per share at $0.07 and the issued number of shares for
about 3113.8 during the year 2017. Fortescue paid an aggregate dividend of about $217.966
which was determined by multiplying the dividend per share to the issued number of shares.
It is seen during the year 2016 that the net income of the company has increased but the
dividend has gone down the graph. It was based on the Fortescue’s variation in the context of
its share prices. On account of the increments in the level of debt and fall in the same due to
their squaring up, the prices of shares of the organization did not reflect a mass volatility
(Laux, 2014). All such facts together indicated that all these trends are directly in line with
the international scenario and the product’s performance in the market. Also, Fortescue is
capable of performing its operations in the future and survive the toughest competition.
2013 2014 2015 2016 2017
Div 0.11 0.06 0.29 0.19 0.07
Div payout ratio 0.49 0.6 0.93 0.13 0.43
The key drivers of firm are the strong operations of the company. Fortescue has a strong
reach and availability thereby accounting for rapid sales. The sale is the main driving force.
Further, the company has kept a strong control over the operational expenses and this has led
to immense support. Other driving force are the strong fundamentals together with a strong
balance sheet making it a potential bet.
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Fortescue Metals Group Limited
Evaluation of structure of corporate governance policies and
structure of the company
For sustaining its business operations in the future and surpass all its competitors in the
industry it is substantial for every organization to pursue effective corporate governance
principles and measures within its framework. In order to make Fortescue achieve long-term
success, not just the Board of the company but also the management are working hard
towards the vision (Flannery, 2018). Fortescue has the effective structure of corporate
governance policies laid in its framework and has all the guidelines related to ASX principles
and recommendations. It is also observed that the organization has fully adhered to
stewardship, corporate accountability, and transparency within its framework. The procedures
and policies of the organization are taken care of by a sub-committee especially appointed by
Fortescue which comprises of nomination and remuneration committee, audit and risk
committee and finance committee (Flannery, 2018).
The company’s board of directors comprises of executive directors and non-executive
directors so as to protect the shareholder's interests. The company is able to achieve
worldwide experiences, mining experiences, capital projects, etc in the presence of such
corporate governance structure. The company is seen hiring employees not taking their age,
gender, race, etc into consideration rather considers their skills, knowledge, attributes, and
aptitudes (Ross et. al, 2014). The Board controls to regulate and monitors the performance of
the top executives. With the dominance of effective and structured corporate governance, the
toughest of worldwide market situations can be tackled and handled. Fortescue has legitimate
and structured corporate governance which made it easier for the company to solve all the
difficulties and overcome the obstacles that came in its way (Brigham & Daves, 2012). This
means that the first and foremost rule for an organization is to double check its strategies that
are to be formulated. It is also noticed that during 2017 there has been the appointment of
many independent directors which will now be reduced as what reflected in the variations in
the composition of the board. The directors are also allowed to take independent decisions
and plans so as to protect the interests of its shareholders.
Corporate Accounting policies
Fortescue has formulated certain managerial policies which have made it a stronger entity
amongst all its competitors. The company has maintained its effective dividend policy as it
has been providing substantial dividends to all its shareholders continuously since 5 years.
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Fortescue Metals Group Limited
There is an increment in dividends paid to shareholders every year. The profits are becoming
enormous while the liabilities are getting reduced (Brigham & Daves, 2012). This reflects the
inverse relationship between the dividends and liabilities of an organization. Fortescue also
has a relaxed a fat cat policy along with a conservative policy in the year 2013 and 2014 as
reflected in its annual report. For financing of fixed assets, current assets and temporary
current assets the utilization of long-term finance sources has been noticed.
There has been huge debt obligation for many years that has disturbed the capital structure of
the company. Comparatively, the organization had made more profits in the year 2014 over
2012 which further declined in 2015 and 2016. This signifies that the organization has been
employing various strategies in these years that negatively impacted its net profits and
accounted for the rise in its liabilities. Also, the utilization of debts so as to attain significant
results is impacted by the accumulation of retained earnings. It is required for the
organization to eliminate the use of debt sources of finance and make utilization of equity
sources of finance within its framework so as to overcome the obstacles and encourage
hassle-free business operations for the years to come. The interest payments accumulated
over the years can also be controlled by enhancing the equity funds.
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Fortescue Metals Group Limited
Conclusion
Considering the above facts it can be ascertained that the portfolio of Fortescue is dicey and
reflects major setback to all its business operations. This is because of the fact that the
organization has been initially depending on its debt sources of finance so as to encourage
smooth flow in its operations. Also, on the contrary, if Fortescue has opted for equity funds
and not just rely on debt funds, the organization’s dividend policies and must not have got
impacted. In order to have future developments, the organization should minimize its
dependency on debt financing. The structure of the corporate governance opted by the
organization makes it easier to tackle the market competition and surpass its competitors so
as to sustain its business operations. This also means that it is easier for the company to take
risky ventures into consideration and without any risk of survival or threats to its future
existence.
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Fortescue Metals Group Limited
References
Brigham, E. and Daves, P. (2012) Intermediate Financial Management. USA: Cengage
Learning.
Carmichael, D.R. and Graham, L. (2012) Accountants Handbook. Financial Accounting and
General Topics, John Wiley & Sons.
Deegan, C. M. (2011) In Financial accounting theory. North Ryde, N.S.W: McGraw-Hill
Ferris, S.P., Noronha, G. and Unlu, E. (2010) The more, merrier: an international analysis of
the frequency of dividend payment. Journal of Business Finance and Accounting. [online].
37(1), p. 148–70. Available from: https://doi.org/10.1111/j.1468-5957.2009.02174.x
[Accessed 25 May 2018]
Flannery, T. (2018) Benefits: A Winning Strategy in the Talent Game. Compensation and
benefits review. [online]. 49(1), 58-99. DOI: https://doi.org/10.1177/0886368718768630
Fortescue Metals Group. (2017) Fortescue Metal Group Annual report and accounts 2017
[Online]. Available at: https://www.fmgl.com.au/docs/default-source/default-document-
library/fy2017-annual-report.pdf?sfvrsn=1f931875_2 [Accessed 25 May 2017].
Gibson, C. (2012) Financial statement analysis. Mason, Ohio: South-Western.
Greene, R.J. (2018) The Good Kind Of Pay Discrimination. Compensation and benefits
review. [online]. 49(1), p. 56-77. DOI: https://doi.org/10.1177/0886368718768628
Laux, B. (2014) Discussion of The role of revenue recognition in performance reporting.
Accounting and Business Research. [online]. 44(4), 380-382. Available from:
http://www.ccsenet.org/journal/index.php/ijbm/article/viewFile/4235/3672 [Accessed 17
May 2018]
Ross, S., Christensen, M., Drew, M., Bianchi, R., Westerfield, R. And Jordan, B.(2014)
Vaitilingam, R. (2014) The Financial Times Guide to Using the Financial Pages. London: FT
Prentice Hall.
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Fortescue Metals Group Limited
Appendix
FORTESCUE METALS GROUP LTD
(FMG)BALANCE SHEET
Fiscal year ends in June. AUD in millions except per
share data.
2013-
06
2014-
06
2015-
06
2016-
06
2017-
06
Assets
Current assets
Cash
Cash and cash equivalents 2327 2546 3100 2132 2389
Total cash 2327 2546 3100 2132 2389
Receivables 441 621 379 325 183
Inventories 1036 1557 1007 746 764
Deferred income taxes 9 46
Prepaid expenses 116 29
Other current assets 19 0 64 61 49
Total current assets 3948 4753 4595 3263 3387
Non-current assets
Property, plant and equipment
Gross property, plant and equipment 19456 21028 26721 27739 27653
Accumulated Depreciation -955 -1847 -3637 -5026 -6212
Net property, plant and equipment 18500 19180 23085 22713 21442
Intangible assets 43 71 57 20 9
Other long-term assets 6 87 76 43 13
Total non-current assets 18550 19339 23217 22777 21464
Total assets 22498 24091 27812 26040 24850
Liabilities and stockholders' equity
Liabilities
Current liabilities
Accounts payable 401 421 232 256 304
Short-term debt 190 161 195 110 103
Capital leases 31 2 7 15 55
Deferred income taxes 707 360 891
Deferred revenues 41 994 807 653 599
Other current liabilities 861 1186 957 807 911
Total current liabilities 1525 3471 2198 2200 2863
Non-current liabilities
Long-term debt 12801 9648 11664 8327 4646
Capital leases 661 334 594 665 1009
Deferred taxes liabilities 868 1225 1786 2020 2024
Deferred revenues 357 760 1109 755 581
Pensions and other postretirement benefits 6 4 5 3 4
Minority interest 4 15 17 19 18
Other long-term liabilities 578 599 642 749 1069
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Fortescue Metals Group Limited
Total non-current liabilities 15275 12585 15818 12538 9351
Total liabilities 16800 16056 18016 14739 12214
Stockholders' equity
Common stock 1392 1368 1685 1752 1676
Other equity -66 71 60 44 51
Retained earnings 4359 6593 8052 9504 10910
Accumulated other comprehensive income 13 2 0 0
Total Stockholders' equity 5698 8035 9797 11301 12637
Total liabilities and stockholders' equity 22498 24091 27812 26040 24850
Income Statement
FORTESCUE METALS GROUP LTD (FMG)
INCOME STATEMENT
Fiscal year ends in June. AUD in millions except per
share data.
2013-
06
2014-
06
2015-
06
2016-
06
2017-
06
Revenue 8755 12477 11164 9538 10982
Cost of revenue 4389 5551 7879 5172 4759
Gross profit 4365 6926 3285 4366 6222
Costs and expenses
Sales, General and administrative 262 197 122 70 73
Depreciation and amortization 499 1024 1829 1675 1616
Interest expense 330 726 779 73 94
Other operating expenses 616 824 8 724 582
Total costs and expenses 1707 2772 2738 2542 2365
Income before income taxes 2659 4154 547 1823 3857
Provision for income taxes 776 1245 135 497 1136
Other income 0 0 0
Net income from continuing operations 1882 2909 411 1326 2721
Other -11 1 -1
Net income 1882 2898 413 1325 2721
Net income available to common shareholders 1882 2898 413 1325 2721
Earnings per share
Basic 0.6 0.93 0.13 0.43 0.87
Diluted 0.6 0.93 0.13 0.43 0.87
Weighted average shares outstanding
Basic 3114 3114 3114 3112 3111
Diluted 3115 3114 3120 3112 3124
EBITDA 3488 5904 3155 3571 5567
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Fortescue Metals Group Limited
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