Role of financial management in Wolfson Microelectronics plc.
Financial management is related to the acquisition, financing and management of assets with a future goal and planning.
Efficient financial management requires the laying down an objective or goal, because judgement whether a financial decision has been rightly taken or not must be in light of some standard. The most important goal of a firm in financial context is to maximize the value (wealth) of firm and of the shares holders’ wealth.
Maximizing the wealth of share holders (owners) of the firm is judged by the effect of share price which is the result of business decisions.
Thus we define role of financial management into three areas:
Investment decisions for an investor are based on historical prices and security analysis of financial assets such as stocks and bonds. However from company’s point of view investment is all about finding out new feasible ways to manage the business mainly in area of production, distribution and marketing.
Further more, company also considers which portfolio of the different types of financial assets to hold. A common example could be common stocks, preferred stocks, bonds and debentures etc.
With regard of Wolfson Microelectronics, it made investments in Research and Development of capital equipment and soft wares to $10.6 m alone in 2004. Furthermore, company has intentions to significant contributions to research in the future. As a result value of fixed assets rose to $ 29,680k in the year 2004.
Wolfson unveiled two main ideas behind putting capital expenditure (long-term investments):
- to time the market requirement
- decrease production cost by constant research and design
Wolfson clearly showed its intention not to distribute retained earnings among its shareholders due to the need of capital expenditure in future projects. The future electronics market belongs to consumer’s digital portable stuff. Wolfson’s management is planning to contribute in this huge market share around the world, making it sure they keep alive with the high demanding consumer market in the future, though they are newly born public listed company in the London Stock exchange.
1. Refer: Balance sheet figures (Pg. 53) of Wolfson Microelectronics plc. Annual Report and Accounts 2004
This is the second major issue of the firm as the management needs to ascertain
- How much money could be available by floating stocks in the market? Based on both factors, a company forms its capital structure. This is also referenced as ‘finance mix’.
- How much money they could borrow to run their business with getting in trouble of getting default or excess borrowings.
Wolfson raised investment money to meet their requirements by issuing stocks (an increase of $ 9105 k) and increasing debt by $ 8273 k. In other words, it financed its projects by issuing stocks and bonds to its stakeholders.
Wolfson plc. also mentioned financing of $1204 K as negative-inflow stream as compare to $39,364 K in year 2003 in the form of share capital issues and bank term loan. (3.)
3) Dividend policy:
In addition to two important decisions, dividend policy must be viewed as an integral part of the firm’s financing decision. The dividend payout ratio determines the amount of earnings that can be retained in the firm.
Dividend payout ratio =
Annual Cash dividends
Wolfson paid equity dividends of $ 407 K in year 2003 but no dividends were paid in year 2004, but on non-dividend equity, company did not pay dividends to its shareholders. So the dividend payout ratio is Zero for year 2004.
As described earlier, it has been clearly mentioned in the annual report to retain all future earnings for investment in development and expansion of business and the management does not expect to pay dividend at least for some years in future. (2.) However, this is not an encouraging sign for shareholders of Wolfson because stock investors often judge performance of the company stocks by their growth which is possible by declaration of dividends.
2.Refer consolidated cash flow statement (Pg.54) of Wolfson Microelectronics plc. Annual Report and Accounts 2004
3. Notes to Cash flow statement (Pg. 72) of Wolfson Microelectronics plc. Annual Report and Accounts 2004
If we combine the effects of the financing, investment with dividend policy, the relation could be in a shape of three schools of thought:
- Some argue that Dividend policy is irrelevant because for a company investment and debt decisions are not relevant by the amount of dividend payments. This is also due to the fact when we say that capital markets are perfect and complete and all information is available regarding market conditions and its constituents (companies).
- Some say that High dividends increase Stock value. They provide the reason that dividends are more certain than capital gains (price growth of the securities), so a firm which is paying less returns but sticks with the dividends is more attractive for the share holders.
- Thirdly, low dividends increase stock value because some argue that dividends actually hurt the investors in shape of taxes, so less dividend income means less tax deduction for the shareholder.
Is Wolfson successful to satisfy needs of Shareholders?
Certainly not according to the annual report 2004. As we discuss earlier, stock investors are not impressed at all knowing the fact company is not paying dividends, but one has to consider that Wolfson is a new public listed company in London Stock Exchange which has a great impact of its group directors holdings.
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If we look at the current price trend of Wolfson Micro Electronics plc. (source: uk.finance.yahoo.com), we find that there is good improvement in market price as it is trading above 200p per share from Sept, 2005 to date. The volume of the stock traders is also increased from July onwards, although in odd days there are sudden fall in price and volume which is bit worrying for shareholders.
But the good aspect is Wolfson stock is performing above average as compare to FTSE index. If we see the chart 2.2, creating good price increase from beginning of this year.
Let’s talk about the expectation of shareholder and growth rate of stock price in absence of dividends (as in the case of Wolfson). As shown in chart 2.3, if there is a decline in dividends, as a result the expectation level will also be decreasing and so as the price of the stock. A rise in the dividend growth then put the expectation of the investors at increasing level as well as the growth in stock price occur.
Would it be better if Remuneration package for a Director is based on Shareholders wealth?
The concept of shareholder’s wealth arises from the theory that a company should only work solely for the benefit of these people and has responsibilities to its owners. That could be an effective style in management and it sounds very good for the investors. Following points should be observed in this regard:
- If company is giving dividends to its share holders from the reserves allocated in the company retained earnings then there is a secure feeling for stockholders that they will not lose all of their money if company goes bankrupt.
- Management if decides to use dividends for increasing future value of the firm by utilizing them in capital expenditures, then this also makes sense for a firm like Wolfson that is involved in digital technology. We know that innovations and inventions are constantly taking place in this industry which means high proportion of firm’s money is spent on R&D of new products.
- We have to bear in mind that distribution of dividends also require transaction cost for a firm to pay in the shareholders account plus dividend income is taxable for shareholders.
Knowing these facts, if were a Director of Wolfson I would not decide in company’s meetings not to distribute dividends to our shareholders at all for number of years. Rather than I would continue to give shareholders at least some amount of returns in form of dividends. Why I should go for the decision, this is because of following reasons
- Directors and top management are bound by fiduciary duties to act in the good interest of shareholders.
- Value of my firm will increase if shareholders have more trust in our performance. If we allocate a portion of profit towards them that means that as Directors of Wolfson, we give respect to our shareholders even in tough period of our business cycle (we know our company is new to the stock market but has opportunities to capture its share in the market).
- Moreover, total shareholder return of Wolfson would be lower than its competitors in the market because when stock investor compares the performance of different companies for his investment, it would be inevitable that share price appreciation and dividends paid are not in a row in our company. The reference group of companies (having similar business) in same sector would also pose threat for us when a shareholder takes investment decision.
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