CFS Asgnmnt (Senior Sample)

Faculty of Management BBA (Hons) Finance with Multimedia Corporate Financial Strategies (Individual Assignment 1)

Name

: Sutera Dewi Binti Mohd Ariffin

ID

: 1102702031

Section

: B02B

Lecturer : Chan Kok Tim Introduction Building a high performance and sustainable business requires great effort, but it is not an activity that is unmeasurable. It can be measured in some ways. For instance, financial service firms attempt to be as profitable as they can and want to grow rapidly over time but they also have to worry about their value sustainable. If they are publicly traded, they are judged by the total return they make for their stockholders. Therefore, to grow over the long term in today’s turbulent economy, one need to set a clear strategy designed to enhance revenue and motivate people to execute effectively (Thornton, 2010). In this study, valuation is required in order to create and sustain value for firms. Valuations are a function of looking into the future and adjusting for things that will alter value. It discusses on measuring the historical financial performance and gaining an insight into a company’s ability to create value apart from measuring, managing, and maximizing shareholder’s value. The solid framework of valuation includes the analyzing of historical performance by reorganizing a company’s financial statements to reflect economic rather than accounting performance, forecasting performance on how to think about a company’s future economics, estimating the cost of capital, interpreting the results of a valuation in light of a company’s competitive situation and last but not least linking a company’s valuation multiples to the core drivers of its performance (Wiley, 2010). Overall, the basic principles of valuation apply just as much for other multinational firms as they do for financial services firms.

When it comes to measuring value-creation, we need to focus on the return that management will generate from the capital they have already invested. It can be done by comparing the rates of return to the cost of capital. So, the right metric needs to be adapted in order to achieve balance and enhance long-term profitability. The metrics that I have chosen to focused into are Return on Investment (ROI), Return on Assets (ROA) and Earnings Before Interest, Tax, Depreciation and Amortization (EBITDA).

1.0 Return on Investment (ROI) 1.1 Definition Return on Investment (ROI) is one of the most popular evaluation metrics used in business analysis. Decades ago, ROI was conceived as a financial term and defined as a concept based on a quantifiable analysis of financial returns and costs and as at present, ROI has been widely recognized and accepted in business and financial management in the private an public sectors (Botchkarev & Andru, 2011). Basically, it is a performance measure used to evaluate the efficiency of a number of different investments. For example, it may provide company a rationale decision for future investment and thus able to make decision on which projects to pursue. It also measures the benefits to costs of the investment, profits achieved after expenses, value of an investment, cost savings, and other efficiencies obtained. 1.2 Methodology ROI = (Gain from Investment - Cost of Investment) / Cost of Investment In calculating ROI, the benefit or return of an investment is divided by the cost of the investment and the result is expressed as a percentage or a ratio. Usually, this metric is called benefit-cost ratio where gain from investment is the revenue. However, the results of the calculations may have different meaning. For example, ROI of 100% means that the amount of the return is equals to the amount of money the company has invested whereby no additional money was gained. In other words, it simply means 100% of ROI

is gaining the same amount of profit. For example, an investor buys RM2,000 worth of stocks and sells the shares 2 years later for RM2,200. The net profit from the investment would be RM200 and the ROI would be calculated as follows: ROI = (200 / 2,000) x 100 = 10% Therefore, the return on investment that the investors received is 10% from the profit.

1.3 Application & Possible Practice in Corporate Environment These days, many companies apply ROI to identify the return they will get when doing marketing and advertising, whether it will yield them higher return or not based on previous successes. This way, ROI becomes not only an indicator over the last year, but also how much a company could expect in the following months. Example of companies that uses ROI as their marketing based decision is normally companies with new diversified products such as food & beverages companies, healthcare products companies and so on. With new entrants coming in, they will need to have a marketing strategy so therefore they apply ROI to further make decisions on whether they should invest in doing more marketing or not.

2.0 Return on Assets 2.1 Definition Return on assets (ROA) on the other hand is the profitability ratio that measures the net income produced by total assets during a period by comparing net income to the average total assets. In other words, it measures how efficiently a company can manage its assets to produce profits during a period. A higher ratio of ROA shows that a company is more effectively managing its assets to produce greater amounts of net income. Therefore, the higher the ROA of a company, it means the company is in a good state. 2.2 Methodology ROA = Net Income / Average Total Assets A company's return on assets (ROA) is calculated as the ratio of its net income in a given period to the average total value of its assets. For example, if company A has a net income of RM100 and assets of RM500, then its ROA would be 0.20 or 20%. Assume Company B has RM100 in net income and RM400 in assets. Its ROA is then 0.25 or 25%. Therefore, Company B is a more profitable investment rather company A because it generates 25 cents in revenue higher than company A. 2.3 Applications & Possible Practice in Corporate Environment Amway Malaysia Holdings Berhad uses ROA to identify how well they use what

they have to generate earnings and to compare their state to other similar industry. In a view, their annualized net income for the quarter end of September 2014 was RM100.1 Mil where its average total assets was RM343.2 Mil. Therefore, Amway Malaysia Holdings Bhd's annualized return on assests (ROA) for the quarter end of September 2014 was 29.16%. ROA of a company from different industry varies. For retailers like Amway Berhad, a ROA of higher than 5% is expected. For example, Wal-Mart has a ROA of about 8% as of 2012.

3.0 Earnings Before Interest, Tax, Depreciation and Amortization (EBITDA) 3.1 Definition EBITDA (Earnings Before Interest, Tax, Depreciation and Amortization) is the most commonly used valuation metric for businesses. It reports a company's profits before interest on debt and taxes owed or paid to the government are subtracted. It can be used to compare the profitability of a company with other companies of the same size in the same industry but which may have different levels of debt or different tax situation. EBITDA is simply the figure of profit generated with the business’ operations and present assets. In some industries, like manufacturing, companies have large amounts of fixed assets which are subject to heavy depreciation charges. In others, a company may have acquired plenty of intangible assets which will be subject to large amortization charges. That is why EBITDA is created which is to simplify analysts of a company to compare their ability to generate profit without the distorting effects of depreciation and amortization. Today, it has become one of the most important financial measurements of value used. 3.2 Methodology EBITDA = Revenue - Expenses (Excluding Interest, Tax, Depreciation and Amortization) In the calculation of EBITDA, working capital is ignored and no consideration is

given to capital expenditure because it is an indirect measure of depreciation. Federal and local income taxes are excluded from the calculation of EBITDA. The reason for this being is that theoretically the business’ operations are separate from the taxing environment in which the business resides therefore the total earning or proper to say the profit before all else is being reduced is the EBITDA. Earnings are generated from the net income of operations before any other income or expenses which is fundamentally known as net operating income (NOI). 3.3 Application & Possible Practice in Corporate Environment There are many companies that practice EBITDA as their performance measure for the value of their company. It is also used as an alternative to P/E Ratio to determine the fair market value of a company. I chose Glomac Berhad as an example for this metric measure where as of today, Glomac Berhad's enterprise value is $284.5 Million and its earnings before depreciation and amortization for the trailing 12 months which ended in July 2014 was $47.7 Mil. Therefore, Glomac Berhad’s EBITDA ratio for today is 6.93. We can see that Glomac Berhad’s EBITDA is quite high relatable to what nature of business they are pursuing which is the property development company. Their rate of returns are high.

Conclusion In summary, all 3 metrics have their own way is measuring a firm valuation performance. From my overall understanding, ROI is not only being calculated to give investors the decision on whether to continue making higher investment or not, but also is used to compare the company’s profitability as it calculated the revenue after cost of investment has been deducted. Therefore, a higher ROI of a company, the better as it actually gives profit to them. ROA on the other hand measures how efficiently a company can manage its assets to produce profits during a period. It gives the company the overall view of whether the company is using money to purchase asset to produce their profits effectively or not. This is because when operating, purchasing asset is funded by debt so ROA gives the measure of the higher return on the assets, the better it is because it relatively gives profit to them. Whereas EBITDA actually calculates the earnings of a company before all other factors such as interest, taxes, depreciation and amortization is being reduced. Its like companies use this method to see their clean profit before all else are reducted. But of course it is not so accurate to represent a companies real earnings as it does not state out the company’s cash outflow. In conclusion, all of this metrics actually measures profitability and plays a huge role in utilizing the technique that will help to measure and analyze the firm’s value and

provide indications for better or worst performance.

References Grant, T. (2010). How to create and sustain value. Retrieved from: http://www.grantthornton.ca/ Edward, L & Praveen, R. Creating Value in Financial Services. Retrived from: http://www.stern.nyu.edu/ Matt, H. (1999). Course 8: Creating Value through Financial Management. Retrieved from: http://www.exinfm.com/ Alexei, B & Peter, A. (2011). A Return on Investment as a Metric for Evaluating Information Systems: Taxonomy and Application. Retrieved from: http://www.ijikm.org/ David, F. Practical Metrics and Models for Return on Investment. Retrieved from: http://davidfrico.com/ Leo, S. Valuation Metrics for Small Businesses. Retrieved from: http://www.businessdictionary.com/ Ben, B. (2014). Focus on Mergers & Acquisitions: EBITDA and Cash Flow, A Tale of

Two Metrics. Retrieved from: http://rubinbrown.com/ Tom, H. (2008). ROE vs ROA. Retrieved from: http://www.decisionanalyticsblog.experian.com/ Christine, C. (2012). Real Examples of Social Business ROI. Retrieved from: http://www.forbes.com/