Financial Management Analysis
The main aim of this report is to analysis the financial performance of the company. For this, XERO Ltd selected that is Software Company. In the first part of the report, debt valuation of the company was calculated where it is found that cost of debt is 0.15%.
In the second part, the cost of equity is zero because company is not paying dividend to shareholder. In the third part of report, WACC calculated and it was found that WACC is 2.48%. The another section of research depicts that capital structure of the company is not appropriate because it is using more equity.
From the financial report of the company, it is identifies that XERO used to both sources of the finance that helps the company to conduct its business activities smoothly. In this, it is also found that in the context of long term finance, the company uses the stock, long term bank loan and debenture. These debts are payable in more than one year.
At the same time company is also using the short term debt in the term of the creditor, bank over draft and advance from customer etc (Zimmerman and Yahya-Zadeh, 2011).
In the capital structure of the company, it is found that company is using both debt and equity to complete the financial objective. The below table depicts the capital structure of company
|Capital Structure of XERO ($000)|
On the basis of the above table, it can be said that company is more focusing on the equity finance to run the business (Bogdan et al. 2012). However, it is decreasing its equity contribution from the capital to come consistent with the industry.
XERO is operating business in the IT industry that is already growing well at the current time. At the same time, the company is also increasing total sales year by year. These positive factors of the industry support the company to increase its capacity to raise short term and long term debt (Conboy, 2010).
In the accounting and finance, the cost of the debt is also known in which rate the company is paying interest paid to its debtors. In the same concern of this, it is found that XERO paid 107 ($000) cost of in the total debt 69100 ($000) with 0.15% cost of debt.
Cost of equity indicates to the dividend paid against the money of the equity shareholders. In the context of the XERO, it is found that there was not any cost of equity because company did not pay any dividend to the equity share holder. The reason of this may be that company is facing loss (Edame & Okoi, 2014).
From the annual report of XERO, it is identified that the company is facing the huge loss from its business activities. However, the company has expectation that its revenue will increase the in future with the 10% growth rate. At the same time, it will be also able to pay dividend with 2%-2.5% annual to its shareholder. In the coming year, the company expected that it will overcome its loss by 60% (Frow et. al. 2010).
Value of stock by comparables approach
Comparables approach is a significant technique in order to identify the value of stock. In this, below formula is used:
Comparables approach = P/E (Ayam, 2015)
P = Market value per share
E = Earnings per share
Stock value = 32.34/0.5
Value of stock by constant dividend growth rate model
Dividend growth rate model (P) = D/k-g (Dawson, 2015)
P indicates to value of stock
D indicates to dividend paid = 0.0%
K points to required rate of return = 2.75
G points to expected growth rate = 2.0%
Stock value = 0.0/(0.0275-0.02)
P = 0.0
The market price of XERO’s stock is $32.34AUD. On the other hand, comparables approach shows that value of the stock is $64.68AUD and dividend growth rate model shows that value of stock is $0.0AUD. Hence, it can be said that there is no reasonable compared to the market price of XERO’s stock (Fairclough, 2013).
In order to measuring the value of the stock, it is found that there was a need of the market value of the stock that was identified from the trading site such investing.com. On the other hand, required rate of return was also required that was found from 10 years Treasury bill.
Typically, the WACC indicates to average cost of the capital that company paid on the debt and equity. It is calculated from the below formula:
WACC = x Re + x Rd x (1 – Tc) (Hall, J2012)
Re points to equity’s cost = 0.0%
Rd points to debt’s cost = 0.15%
E/V = % of equity in capital = 76.4%
D/V = % of debt in capital = 23.6
Tc indicates to tax rate 30%
WACC = (0.764 * 0.0) + (.236*0.15) * (1-0.30)
In order to calculate the WACC of XERO, the Australian corporate tax rate is concerned. At the current time, it is found that Australian corporate taxation rate is 30%. It means that a company has to pay 30% tax on its operating income.
In the context of XERO, it is found that there is difference in cost of debt and cost of equity. In this, cost of debt is 0.15% and cost of debt is 0.0%. This difference is because the company is not providing dividend to its shareholder because it is not generating profit (Kooijmans, et. al. 2012).
According the accounting principles, capital includes the amount of net assets or equity. It does not include any kind of liabilities that is why, current liabilities should not be included in the cost of capital. If, it is concerned in the cost of capital then it is possible that there will be error in the financial statement.
The WACC is calculated 2.48% that means company pays 2.48% average return to its investors in against of 1AUD. It is not good for the company perspective because company is facing already lost and it also increases the amount of loss (Brigham and Houston, 2011).
From the study of XERO Ltd, it is found that company did not make investment in the recent time. Due to this, it can be determined that the company did not concern on WACC in its investment decision making.
From the capital structure of XERO, it is found that 76.4% is equity and 23.4% is debt that debt to equity ratio is 30.83%. On the other hand, it found that industry debt to equity ratio is 90.23%. On the behalf of this, it can be said that Capital structure of XERO is not consistent with the industry (Cecilia, 2015).
Optimal capital structure of XERO shows that company is more depending on the equity. In the total capital of the company, there is 76.4% only equity. The optimal capital structure ratio is found 30.83%. A good optimal capital structure should have near 100% where contribution of debt and equity should equal.
The below figure shows the financial performance of XERO Limited:
On the basis of the above figure, it can be said that financial performance of XERO is not good because company is not able to earn profit from its business operation. However, it is generating good sales and gross margin but net profitability is not appropriate. At the same time, the company is also depended on equity finance for fund.
The literature findings of Clowes and Scriven (2010) determine that a company cannot run long time if it is not generating profit. It also determines that in order to have an effective capital structure, it is essential for an organization that it should have balance between the equity and debt.
But, in the context of XERO, company neither earning profit nor have balance between the debt and equity. Hence, it can be said that financial performance of the company worst. The management of the company should concern and take effective decisions.
From the above discussion and finding, it can be determined that the knowledge of the accounting and finance is essential for an investor to make a right decision on the investment. It helps the investors to identify the actual performance of the company in the industry (Cornett, et. al. 2011).
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