Recommendations For Wal Mart's Improved Financial Position example essay topic

Introduction Every business decision is associated in one way or another with the financial condition of the organization. The results of a working capital analysis will assist in the determination of organization's ability to remain in a particular line of business. The primary focus of Team C's analysis of Wal-Mart, Inc is its current and future financial condition. The most imperative areas that are found in the Capital Structure Analysis Report fall into the following categories: Working Capital Management, Valuation and Investment, and Cost of Capital.

The company's operational processes within each area can be examined and related financial data reviewed. Once the financial data is collected and calculated potential areas for improvements can be identified and corrective or innovative measures can be implemented. As in all businesses, which include Wal-Mart, it must be considered that there is always room for improvement. Working Capital Management In order to fully understand the company's financial position a financial manager must consider the amount of net working capital available. The net working capital is the difference between current assets and current liabilities. Companies normally have a positive net working capital.

The components of working capital change continually within the cycle of operations. (Brealey, 2001) Therefore, an effective manager will monitor the cash conversion periods to determine the length of the production process. The longer the process, the longer the company's money will be tied up in the process. The two elements in the business cycle that normally absorb the most cash are inventory and receivables. The main sources of cash are payable's and equity or loans.

Speeding up the working capital cycle will generate more cash for the company. web This management of working capital will allow the company to maximize its use of existing cash flows as well as leverage additional sources of working capital. Underperforming Company Ratios Although Wal-Mart is performing well overall and remains a leader within the retail industry, the company is not without opportunities for improvement. An analysis of the financial ratios for the company over the last three years as well as an industry comparison has identified areas in which the company could enhance its processes through capital management. (See Appendix A for actual data) Although the current ratio has remained stable over the last three years, it is significantly below the industry average. The current ratio indicates that the company has had significant debt at the end of each year that it would need to pay off by the end of the following year.

The amount of this debt increased each year, as evidenced by the slight decrease in the ratio. In order to avoid the continual decrease of the ratio the company would need to reduce the amount of debt incurred each year. The quick ratio has also remained stable, but well below the industry average. This signifies that the proportion of assets that are easily liquidated is below that of other companies. If it became necessary to liquidate some assets to raise capital, the ratio indicates that the company may have difficulty. The asset turnover ratio remained consistent with industry averages for the last three years.

In other words, the amount of revenue covers the cost of acquired assets. However, in order to continue its profitability, the company may want to increase this number. The company's problem appears to lie within the management of its liabilities and improvements in capital management strategies may assist in the reduction of these problem areas. Recommendations / Strategies A working capital strategy is a financial plan that details the company's intentions regarding the management of assets and liabilities. Plans for improvements are formulated and implemented following the identification of weaknesses.

These plans would require a review of the company's long and short-term goals. Last year's annual report reveals the following pertinent information: the Wal-Mart segment accounted for 68% of company sales (a 10% increase over the previous year), the Sam's Club segment accounted for 13.5% of company sales (an 8.9% increase), and the International segment accounted for 18.5% of company sales (a 16.6% increase), and cash flows increased 3 billion due in part to improved inventory management. web The short-term goal is to reduce liability / increase cash, thereby increasing the under performing ratios, and the long term goal is to continue its international expansion efforts while maintaining sales and profits. In order for management to make the most appropriate decision the potential negative consequences of the planned changes must also be analyzed. To meet company goals, potential changes in the following areas should be explored: cash and marketable securities, short-term financing, credit policies, and inventory management. Cash and Marketable Securities Cash and marketable securities are important current assets. A financial manager can review financial documentation to identify significant sources of cash and can forecast future sources and uses of cash.

The company may also choose to purchase or sell securities in order to enhance its financial position. A review of the last three annual reports shows that company debt has increased due to the expansion efforts while sales have steadily increased at a rate of only 12%. Total current liabilities have increased by 37% and long term debt has increased by 9%. Total current assets increased by 24% and total assets increased by 25%. These numbers show that although the company has increased its current assets, it has increased its current liabilities at a higher rate. The easiest way to attempt to correct the problem and accomplish the identified short term goal is to increase sales and / or decrease debt.

While overall company sales increased, some stores reported decreased sales. Internationally, sales have been consistent for the last three years; however, the majority of those sales are generated in Canada, the UK, and Mexico. Some decrease in revenue may be the result of! SS rapid development of new stores in the International Segment!" . web An option for decreasing the amount of debt and increasing sales would include slowing the expansion process in less productive areas and concentrating on the more productive markets. Sources and Uses of Short-term Financing Sources and uses of short-term financing are critical elements of effective financial management. Financial managers normally seek to match maturities when financing assets.

The financing methods have a direct impact upon the ratios targeted for improvement. Within the last three years Wal-Mart has financed operations internally and externally. Accounts payable increased an average of 12% and financing using commercial paper increased an average of 123%. The amount of common stock issued has decreased each of the last three years. Within the next fiscal year, the company plans significant expansions and plans to finance these efforts through cash flows from operations and a combination of commercial paper and issuance of long term debt. web Wal-Mart should explore the lowest interest options of debt financing as well as consider a reduction in the amount of debt taken on annually. This can be accomplished through lender or finance analysis and market research.

Credit Policy The credit policies of a company have a direct impact upon its financial position. Management must be careful about the credit terms it offers customers and must be able to collect on accounts receivable in a timely manner. Although accounts receivable is an asset, the money has not been received by the company; therefore it cannot be used to invest in additional inventory or projects. Managing the float will increase cash flows when Wal-Mart has difficulty collecting accounts receivable or paying creditors. One option is for the company to become stricter in its credit terms with customers by demanding payment sooner. However, since the company's average collection period is small and significantly less than the industry average it is not a recommended strategy.

Another option is to make payment arrangements with creditors. This option is a better approach for the company because it won! |t threaten customer relations. The established goal is to strengthen it asset turnover ratio. Positive customer relations, which would lead to increased sales, would increase the ratio. Since there are no known problems with creditor relations, this strategy would be better suited to meet company needs.

Inventory Inventory is another important asset and one that must be managed well in order to maximize company revenues. Inventories have a direct impact upon the current and quick ratios as well as the asset turnover ratio. The company currently utilizes the LIFO method domestically and the FIFO method internationally. The inventories and costs of good sold increases are consistent with the increase in sales, indicating that inventory is currently well managed by the company. However, attempts should still be made to identify cost saving methods of management, such as negotiating prices with suppliers. Sales are expected to continue to rise so inventory managers should be prepared for additional costs associated with inventory turnover.

Identifying ways to decrease the inventory costs without sacrificing product quality would maximize the cash flows from increased sales. Recent improvements in inventory methods have contributed to the overall increase in revenue and those improvements should continue into the next fiscal year. web Effective planning is not complete until the probable consequences of the plan are reviewed and the implementation process is monitored for potential problems. The recommendations for Wal-Mart's improved financial position include: a decrease in current liabilities, maintenance of at least 12% in sales annually, a decrease in the cost of inventory, and managing the float when necessary. Reducing the amount of liability may not be an easy task, given the company goal of expansion. Management will have to decide at what rate to slow the expansion or choose the most profitable areas in which to expand in order to meet short term financial goals. Sales are expected to remain constant and a decrease in debt is not expected to have a negative impact on this amount.

Those areas generating fewer sales than expected, such as the Sam's Club division, may be monitored closely. Although recent sales have improved due to the renewed focus on the business member, this segment should be monitored for continued improvement. Inventory managers must ensure that product quality is not sacrificed in attempts to reduce costs. Customer service, domestic or international, will not be affected by the recommended changes. Expansion into those less profitable areas can proceed once profits are maximized in other areas. This strategy will increase cash flows.

Profitability will increase when current liabilities and costs are decreased and sales are increased. By slowing the expansion processes the company can maximize its current financial position by reducing current debt. The long term goal will still be met although at a slightly slower rate in order to reduce costs. Valuation and Investment Section (Bloomberg database) Wal-Mart's stock price has performed relatively favorably over the last five years with the exception of 2003, in which it dropped 20.3 percent, however this drop in 2003 was not significant enough to eliminate the gains from previous years. The average change in price year to year is still strong at 5.8 percent. This shows that investors have been showing their confidence in Wal-Mart by investing in the company.

The performance also shows that Wal-Mart is sharing it's earnings with investors with a steady increase in dividend yields over the past five years. This trend is an attractive characteristic to investors and suggests a positive return in the future. Although the price to earnings ratio has been decreasing it still remains strong and indicates that the market anticipates growth opportunities in the future. The expected growth over the next twelve months is 18.2%, it is expected that the dividend yield will continue to increase and the earnings per share will increase to an average of 2.4 per share (web).

Based on the analysts! | predictions of performance over the next twelve months Team C recommends buying and holding Wal-Mart stock. Wal-Mart is the second largest company in the world. It is the leading discount store in the industry. Other competitors such as Target and K-Mart do not have the stable and strong market-share that Wal-Mart is currently experiencing. Although Wal-Mart's competitors are gaining momentum the goals Wal-Mart has for 2005 will provide the company ample opportunity for growth. According to the most current annual report the firm expects to add 250 more stores.

This aggressive plan reveals the significant growth opportunities that the Wal-Mart has over the next year. The price to earnings ratio has significantly decreased since 1999 and over the last two years there has been a significant drop. This means that over the last five years the market has been decreasingly optimistic of Wal-Mart's growth opportunities. However, the Wal-Mart's P / E ratio remains comparable to the industry's average of 22.2. So, even though the market does not expect the company to grow as much as it has in the past the P / E ratio indicates that the market is still relatively optimistic about growth opportunities over the next year. In the previous year Wal-Mart has taken significant steps to enhance their earnings per share for their shareholders, one of these steps in the!

SS share-repurchase!" program. This program has already repurchased $13 billion in shares (web). This reduction in outstanding shares has concentrated the growth for current shareholders and the effect has been revealed in the increase in earnings per share over the last five years. According to the annual report the board of directors has authorized an addition $7 billion to be repurchased, this will further concentrate earnings to current shareholders and reaffirms the buy recommendation.

The market risks that the company anticipates over the next year are in interest rates and foreign exchange rates. Wal-Mart's approach to hedging against this risk is two fold. First they move their some of their debt around shopping for the best interest rates. Second they maintain a 50% mix of floating and fix rate ratio. This allows the company the flexibility to control the effect on profit from increasing interest rates. To control the foreign exchange rate risk they hedge against their investment in the UK by capitalizing various foreign debt opportunities (web).

The efficient management of market risk further supports Team C's recommendation. Performance in the highly competitive discount retail industry can greatly be affected by a number of factors. In addition to competing within the industry for consumer dollars, the industry must compete with other companies outside of the industry for retails sites and staff. Wal-Mart has created an employee centered program to attract and retain quality employees and its size and sales approach allows for it to effectively compete for adequate and quality retail locations. The other risks that the industry faces are in increased operational costs. Wal-Mart controls its costs by having a state of the art distribution and inventory system and by having significant buying leverage with suppliers. (web) Wal-Mart has an innovative approach to managing the risks that the industry faces, this approach supports Team C's position that Wal-Mart will have a stable and growing position within the industry.

58 x. 132) + (. 42 x. 213) = 16.61 Capital-asset Pricing Model (Beta) Capital Pricing Asset Model Wal-Mart Treasury bill rate (rf) 3.58%Expected market return (rm) 11%beta.

86 rm - rf 7.42%CAPM 9.96 Expected return on stock = risk-free interest rate + (beta "afn market risk premium) r = rf + f'O (rm! V rf) r = . 0358 +. 86 (. 0742) r = 9.96 The discount rate can be described as the opportunity cost of capital from which an organization determines the amount or return that is being given up for investing in the project. Determining the discount rate to utilize in calculating the weighted average cost of capital and the capital-asset pricing model is important especially as the capital expenditure increases and length of time extends.

Some of the relative strengths of the weighted average cost of capital include the adjustment for taxes. Taxes can have a significant impact on the final result of the overall weighted average cost of capital. Largely because the interest payments are deducted from the organization's income before tax is calculated. This can paint a different picture when assessing the debt of the organization. One of the weaknesses in utilizing the weighted average cost of capital includes the need for market value versus the book value information. In order for an evaluation of the company's cost of capital, a financial manager must consider the future gains and cash flows of the organization.

The book value fails to capture the true outside value associated with firm's securities or equity. The market value can indicate a considerable higher value than the indicated book value. Hence, only the market values of the organization can provide the proper means to calculate the weights. The capital-asset pricing model or CAPM relative strength lies in its simplicity. The CAPM makes use of the stock market, which is a representation of the all securities and the market risk associated with it.

This allows the individual or organization to assess the amount of risk and reward they are willing to assume. The risk is considered to be equal to the stock's beta times the market risk. One of the weaknesses associated with CAPM include the fact that it relies on the indexes of the stock market and not the entire world economy of bonds, real estate, foreign and other such securities. Therefore it fails to capture everything that is happening in the market.

A historical review to the stock market indicates several times where there has been a loss of relationship between market portfolios and the beta utilized in calculate the risk involved. The CAPM also does not take in to account how the organization is financed outside of the firm's common stock. The cost of capital from the CAPM is no longer accurate when several securities come into play. Methodologies The two methods could potentially produce different results depending on how well the individual utilized the principal tools associated with the two methodologies.

The WACC takes into the various mixtures of securities of the organization. This includes an organization's common stocks, bonds, preferred stock or other securities. The WACC utilizes all of the organizations unique securities in determining the risk associated with the risk of a project or investment. The CAPM utilizes the stock market, which includes well-diversified investors.

The method relies on two principles, one is the compensation for the time value of money, and the second is a risk premium associated with a beta value and the market risk premium. The CAPM calculation is affected by the sensitivity and fluctuations of the market versus more of the unique risk associated the determining WACC. Past Financial Performances and Future Prospects The calculations for Wal-Mart's past performances and future prospects indicates an organization that has a rather high expected rate of return demanded by equity investors and rate of return being paid on debt. The indicated WACC value of 16% is somewhat high and therefore is something the organization must be considered of when taking on new projects due to the fact that the organization's cost of capital is based on an equal-risk expansion of the business.!

SSA primary reason for studying the WACC is that the value of the firm is maximized when the WACC is minimized. !" (Brealey, 2001) Wal-Mart is an organization that has continued to expand and grow domestically and internationally. Their solid sales performance should aid in the organization ability to continue this expansion through new investment opportunities. Interest costs on debt and capital leases, as well as net interest income, deceased by 0.1% for 04 in comparison to the previous year. This decrease is due to the lower interest rates on outstanding debt.

The organization's total assets increased $10.1 billion in comparison to the total assets from 03. The market value of the Wal-Mart's common stock is substantially higher than the par value of $. 10. Wal-Mart managed to repurchase $5 billion of their common stock back in 04.

Many factors influence an organization's ability to repurchase common stocks including the cost of equity and the after tax cost of borrowing. Wal-Mart's overall financial statements appear to be positive indicating an organization that should continue it's aggressive future expansion plans. Recommendation for Cost of Capital To lower a firm's cost of capital we need to understand that the cost of capital is weighted average of the costs of all the organization capital structure components. In order for the Wal-Mart to lower its cost of capital the firm ideally needs to find a capital structure of debt-equity that increase the value of the organization and lower the discount rate. The values and discount rates used in determining the WACC move in opposite directions from one another. An optimal or target capital structure will result in achieving the lowest possible WACC for the firm, thus reducing it's the cost of capital.

Conclusion In preparing the Capital Structure Analysis Report, key areas were reviewed and analyzed in order to assist in the decision making process for further improvements. As seen in the area of working capital, Team C focused its attention towards the management of assets and liabilities. The specific areas reviewed included cash and marketable securities and was determined that a positive option would be to decrease the amount of debt and increase sales. This can be achieved by exploring the sources and uses of short-term financing.

Other key areas included credit policy and inventory, which was determined to have a direct impact on the financial position of Wal-Mart. In the valuation and investment area, Wal-Mart has proven to be a stable organization as the second largest company in the world. It remains quite competitive with its discount rates, thereby insuring its place in the future market.

Bibliography

Bloomberg Data baseBrealey, R., Myers, S., & Marcus, A. (2001).
Fundamentals of corporate finance, third edition. New York: McGraw-Hill. web web web 2004.
pdf Appendix Stable Wal-Mart Ratios Fiscal Year 2001 2002 2003 Leverage Debt Ratio.
6.62. 53 Times Interest Earned Ratio 9.8 14.3 18.0 Liquidity Current Ratio. 93 1.04. 92 Quick Ratio. 15.15. 17 Net Working Capital. 15.15 7.8 EfficiencyAsset Turnover Ratio 2.52 2.57 2.56 Average Collection Period 3.6 2.9 2 Inventory Turnover 7.8 7.6 7.8 Profitability Net Profit Margin 3.03 3.26 3.59 Payout Ratio. 19.17. 23 Table Industry Averages Fiscal Year 2001 2002 2003 Leverage Debt Ratio 1.