Industry and business risk that faced by Toyota in the automotive market is highly competitive in the market which may influence the Toyota to facing the competition from the same automotive manufactures it operates. In the market where Toyota compete with other automotive manufactures are from the aspects of product quality and features, safety, reliability, the amount of time required for innovation and development, pricing, fuel economy, customer service and the terms of financing. The highly competitive market may lead to the lower the sales unit of the vehicle. Besides, Toyota also faces with the risk which comes from the worldwide automotive industry which is highly volatile. Toyota market can be considerable volatility in demand and it is largely depend on the social, political, and economic conditions. The weakness in the demand of the Toyota Company will affect the financial condition and result of operations. Therefore, the volatility demand of the Toyota Company may influence their lower in unit sales and cause the downward price pressure which in turn will affect Toyota's current financial position and results of operation.
3.2 Financial Market and Economic Risk
Furthermore, Toyota is also facing with the financial market and economic risks which included the fluctuations in foreign currency exchange rates and interest rate. Toyota Company is exposed to the fluctuation of the currency in U.S. dollar, euro and to a less extent which is the Australian dollar, Canadian dollar and British pound. Toyota Company is using the currency of Yen in their trade. The fluctuations are affected the way of Toyota doing business. Other than that, Toyota's also face with the translation and transaction risk through the unstable of the exchange rate and therefore influence the consolidated financial statements that are presented in Japanese Yen. Changes in the foreign currency exchange rates may cause the company risk to increase because the product pricing and raw material that purchased from the other country can be directly affected. The company must manage well to avoid the negative impact from the fluctuation of the foreign currency exchange rate and the changes in the interest rate.
Other than that, Toyota also facing the risk in the high prices of raw materials such as the steel, precious metals, non-ferrous alloys, aluminum, and plastic parts. The increase in price of the material cost may lead to the higher production cost for Toyota. The high price in the production cost must bear by Toyota because they can't pass all those costs on to its customers or absorb by their suppliers. In the long term, the high price of the production cost will affect the Toyota's future profitability. Therefore, the increase in price of the raw material cost must be manage well by the Toyota company, if not it may lead to the company risk.
3.3 Political, Regulatory and Legal Risks
Political, regulatory and legal risks are also faced by the Toyota Company. The automotive company may face the various governmental laws and regulations which may influence the way of company doing their business. Most of the governmental and regulatory risk facing by the Toyota Company which regard to vehicle safety and environmental matter such as those emission levels, fuel economy, noise and pollution. Toyota is required to implement the safety measures. The safety measures that must be implementing are like recalls for vehicles that do not or may not comply with the safety standards of laws and governmental regulations. The significant costs that incur for the Toyota Company in order to implementing the safety measures which is to meet the laws and governmental regulations may cause the Toyota's financial condition and results of operations adversely affected.
There are various legal proceedings that Toyota may face. The legal proceedings of various issues are regarding the product liability and infringement of intellectual property. Lastly, the political instabilities, fuel shortages or interruptions in transportation systems, natural calamities, wars, terrorism and labor strikes is the risk which subject to the Toyota Company that conducting their business worldwide. Any occurrence of these events in the market that Toyota purchases materials part and components may result in delays in the operations of Toyota's business which may adversely affect Toyota's financial condition and the operation performance. (Toyota annual report, 2010)
4. Strategies by the Company
4. 1 Asset and Liabilities Management
Asset Liability Management (ALM) is a critical function for any manufacturer industry. Toyota is one of the company which leading the car manufacturer industry. Therefore, ALM is become increasingly important to define measure, monitor and manage. There are two types of asset which are tangible and intangible. The tangible assets is asset that has physical form which include buildings, land, equipment, products, office automation equipment, networks, cash, securities and bonds. However, the intangible assets is asset that not physical in nature which consists of intellectual property rights, such as patent rights, trademarks, copyrights and design rights. Toyota is one of the big companies who lead the car manufacturing industry also possesses variety of tangible and intangible assets to improve and extend their business. Toyota manages its assets effectively to prevent from being lost, stolen or used illegally (Toyota code of conduct, 2006)
Toyota will not use the company's tangible assets for personal unless those authorized by the company. Toyota follows the rules with regard to the treatment of tangible assets (e.g. rules relating to the removal of assets from the company premises) to prevent loss or theft. On the other hand, Toyota also doesn't allow tangible assets of personal or other companies inside the company unless the action has been approved with company rules and procedures. Besides that, intangible assets mainly software that are created directly or indirectly by Toyota employee should belong to Toyota. The intangible assets will easily stolen by others. In order to prevent all the software copyright stolen by competitor, Toyota had protected all intellectual property of the company against any infringements (Toyota code of conduct, 2006)
Allowance for doubtful accounts is one of the methods used by Toyota for asset and liabilities management. The allowance for doubtful accounts is a balance sheet account that reduces the reported amount of accounts receivable. This is useful method to be used by Toyota who selling products on credit to thousands of customers with likely risk that a few customers who will not able to pay the full amount they owe to the company. Collectability risks are consumer and dealer insolvencies and insufficient collateral values (less costs to sell) to realize the full carrying values of these receivables. Therefore, estimate amount of allowance by management is needed for doubtful accounts and credit losses to represent the asset impairment in the portfolios of finance, trade and other receivables. A systematic, ongoing review and evaluation performed as part of the credit-risk evaluation process for Toyota to determine and estimate the allowance should be allocated to the doubtful accounts and credit losses. Financial reports are encouraged recording amount in the allowance for doubtful accounts. In order to reduce the bad debt risk, the historical loss experience, the size and composition of the portfolios, current economic events and situation, the estimated fair value, adequacy of collateral and other relevant factors are important as part of the considerations factor before approving any sales and purchase. (Toyota annual report, 2009)
Marketable securities and Individual securities are important assets to Toyota as well. Equity market is one of the liquid securities which can be converted into cash faster. Toyota's marketable securities consist of debt and equity securities. It plays an important role to help Toyota increase their revenue but with certain amount of risk. Another one is Individual securities. It is a available-for-sale are reduced to net realizable value for other-than-temporary declines in market value. Toyota will consider the length of time and fair value to determine if a decline in value is other-than-temporary. Toyota's strategy is to invest on securities via retain its investment in the company for a period of time so that is sufficient to allow for any anticipated recovery in market value. Average-cost method is use to determine the company's gains and losses which reflect in the statement of income (Toyota annual report, 2009).
Financial instrument is a document which represents a legally enforceable agreement between two or more parties on payment right. Toyota has certain financial instruments, including financial assets and liabilities and off-balance sheet financial instruments in the normal course of business. All Toyota's financial instruments are executed by financial institutions, and almost all foreign currency contracts are denominated in U.S. dollars, Euros and other major industrialized countries currencies. These instruments are subject to price fluctuations and credit risk in the event counterparty. If the counterparties fail to meet the contractual terms of a foreign currency or an interest rate instrument, Toyota's risk is only limited to the fair value of the instrument. Although Toyota may be uncovered to losses in the event of nonperformance by counterparties, it does not anticipate significant losses due to the nature of its counterparties. Moreover, Toyota does not have a significant exposure to any individual counterparty. Based on the creditworthiness of these financial institutions, collateral is not required of the counterparties or of Toyota. Toyota believes that the overall credit risk related to its financial instruments is not significant (Toyota annual report, 2009).
In order to reduce losing risk, Toyota had chooses to use interest rate swap agreement between two or more counterparties for future interest payment exchanged based on a specified principal amount. Interest rate currency swaps agreements primarily to convert its fixed-rate debt to variable-rate debt. Furthermore, notes and loans payable issued in foreign currencies are hedged by concurrently executing interest rate currency swap agreements (Toyota annual report, 2009).
Generally, Toyota has funded its capital expenditures and research and development activities primarily through cash generated by operations. In year 2009, cash generated by operations decreased as a result of the performance dropped in the vehicle sales. The rapid contraction of the automotive market caused the sales decreased in year 2009. Therefore, Toyota funded cash partially through additional loans and issuance of notes. However, Toyota gained sufficiently fund its capital expenditures and research and development activities mainly through cash and cash equivalents on hand, cash generated by operations, loans and issuance of notes during year 2010. Other than that, Toyota also funds its financing programs for customers and dealers, including loans and leasing programs (Toyota annual report, 2010).
4.2 Financial Management
Unsurprisingly, Toyota is redoubling efforts to gain the trust from their customers. There are three elements of Toyota's financial strategy which are growth, efficiency and also stability. These elements of Toyota are then give impact on the profitability of Toyota vehicles as well as the trust of customers.
In year 2010, the announcements of recalls and other safety measure of Toyota certain models of vehicles in several countries and this incident getting worse have eventually affect the financial results of the automotive and the financial services operations. Besides, it leads to a number of claims, lawsuits and government investigations. It show a net loss of ¥436,937 in year 2009, and a slowly recovery in year 2010. Besides, it leads to a number of claims, lawsuits and government investigations and those recalls and safety measure are implemented as compensation to Toyota vehicles user and to the public as well.
Toyota announced a safety campaign in North America for certain models of Toyota and Lexus vehicles related to floor mat entrapment of accelerator pedals during November 2009. Also, Toyota has recalled in Europe and China in certain models of Toyota vehicles related to sticking accelerator pedals in January 2010. In February 2010, Toyota has announced worldwide recalls associate with the software program that controls the antilock braking system (ABS) in certain vehicles models including the Prius. Therefore, it would be one of the factors that impacted the financial results.
In the past, Toyota's capital expenditures are mainly focus on research and development activities through cash generated from operations. In order to ensure and create a sound financial base, Toyota has funded cash partially through additional loans and issuance of notes in the fiscal 2010. In the fiscal 2011, Toyota is expected to have sufficient fund its capital expenditures and research and development activities through cash and cash equivalents on hand, and cash generated by operations. Hence, Toyota will use its funds for the development of environment technologies, introduction of new products and so on. As we can see, the cash and cash equivalents of year 2010 decreased from ¥2444280 (2009) to ¥1865746, it indirectly implied it is funded at their research and development (as a part of capital expenditures). Due to the variety of contraction of automotive markets, the worldwide automobile financial services industry has become competitive. Hence, customers able to get financing for Toyota vehicles from alternative sources when competition increases, margins on financing transactions decrease and market share also decrease.
Apart of this, Toyota also funds its financing programs for customers and dealers. Their mainly financial services operations consist of loans and leasing programs which from both cash generated by operations and borrowings by its sales finance subsidiaries. In fact, the profitability of Toyota's financial services operations can affect by funding costs. To be honest, these are a number of factors that affected by funding costs, some of these are not in Toyota's control. The funding costs decreased during fiscal 2009 and 2010 because of the lower interest rates. By the way, Toyota has enlarged its network of finance subsidiaries due to provide financial services in many countries. In other words, Toyota is looking forward to broaden its ability to raise funds in the local market from the worldwide by expanding its network of finance subsidiaries.
Capital Structure
2009
2010
Total Liabilities
63.52%
63.98%
Total Equity
36.48%
36.02%
Table 1.0 Capital Structure of Toyota in year 2009 and 2010
As we can see, the capital structure for year 2009 and 2010 didn't make any major changes. This means that Toyota's good practice in managing their capital structure doesn't caused Toyota damaged by the current brake issues, even it played seriously. In addition, Toyota's current asset remained in range 1.067 and 1.22, which implied the liquidity management are in their control, it have also extra cash to funding and for emergency purposes. Besides, it also shows that the current issue doesn't damage the whole capital structure as well.
4.3 Foreign Exchange Management
As Toyota is a multinational corporation, Toyota has faced foreign currency exposures related to buying, selling and financing in currencies in different foreign countries. The foreign currency risk which exposed by is related to future earnings, assets and liabilities. The reasons are due to operating cash flows and various other financial instruments which are denominated in foreign currencies. Due to Toyota most profitable market is still in America and Euro countries, U.S. dollar and the euro are the impact of the foreign exchange risk. As a result, Toyota tries to manage the problem by using financial derivatives instrument. There are forward contracts, foreign currency options, currency swap and others to overcome the financial currency exchange risk exposures and fluctuation. The following methods like value-at-risk analysis, forward contract, hedging and netting are going to further explain how Toyota manage the foreign exchange risk.
4.3.1 Value-at-risk analysis (VAR)
Toyota uses a value-at-risk analysis ("VAR") to evaluate its exposure to change in foreign exchange currency rates. The value-at-risk is the combined foreign exchange position which represents a potential loss in pre-tax earnings. The value-at-risk was estimated by using a variance/ covariance model and assumed a 95% confidence level on the realization date a with a 10-dayholding period. Toyota has changed the model used for calculation of value-at-risk from "variance/covariance" method to "Monte Carlo Simulation" method. This is due to more effectively to the risk management purposes. By using this value-at-risk analysis, Toyota is able to manage their global risk effectively.
4.3.2Forward Contract
Forward contract is an agreement to exchange currencies of different countries at a specific future date and at a specific forward rate (Eiteman, D.K., Stonehill, A.I., Moffett, M. H., 2001). Due to fluctuation in interest rate, Toyota's revenue, gross margins, operating costs, operating income and retained earnings are influenced. In different countries, the forward exchange rate contracts are used to avoid foreign exchange risk to the local currencies. This is to engage in foreign currency settlements with domestic counter parties. Besides, the forward exchange contracts are functioned to offset the earnings impact relating to exchange rate fluctuation on certain monetary assets and liabilities purchases currency options to hedge certain portions of forecasted cash flows denominated in foreign currencies. Additionally, the forward exchange contracts also hedge net investments in the international operations. This reduces foreign exchange risk and transaction costs in those settlements by handling receipts in the foreign currencies in which they are denominated.
4.3.3 Natural Hedging
Another method that Toyota anticipates currency exchange rates is natural hedging. Natural hedging works to manage an anticipated exposure to a particular currency by acquiring a debt denominated in that currency. Thus, if a firm has a long term inflow in one currency, the firm can acquire an outflow in the form of a loan in the same currency and use the inflow to service the debt. For instance, Toyota's main markets are the USA and Europe, it can take out loans in Euro or dollars and use the operating income from its operations to pay for the loan. Therefore, Toyota will not have to worry about the exchange rate fluctuation, as it will be paying the loan from proceeds generated from local operations. Besides, Toyota seeks its British suppliers to bill in the Euro to reduce or avoid from the risk. This is an effective way to eliminate currency exposed when the cash flow is relatively constant and predictable over time.
4.3.4 Netting
Netting intercompany transfers is another form of international cash management strategy that Toyota works. It requires a high degree of centralization. The basis of netting is within a closed group of related companies, the total payables will always equal total receivables. Netting is useful to large number of separate foreign exchange transaction occur between subsidiaries (Eiteman, D.K., Stonehill, A.I., Moffett, M. H., 2001). Thus, instead of Toyota paying to different subsidiaries in different countries, the subsidiaries can net off each other's debt and not deal in the foreign exchange market. As this is still not to exercised by every subsidiary, Toyota should establish an in house netting centre. The functions of house netting centre are to reduce the bank transaction cost, such as spread between foreign exchange bids and ask transfer fees. The exposure that remains the net payments to payees and they can be hedged in the forward market. The advantages of netting are to reduce in foreign exchange conversion fees and funds transfer fees not involved in on foreign exchange transactions.
4.4 Other global risk management
4.4.1 Operating Risk Management
There are other global risks that may Toyota Company face and manage it. Other global risk management that Toyota Company trying to manage is included those operation risk management, commodity price risk management, and Toyota Company reputational risk management. Those are also the important strategies that managed by the Toyota company to reduce their company risk.
Firstly, the operational risk is the risk of loss resulting from the failed or inadequate company internal controls and corporate governance. These risks can occur in many forms including the error in doing business, failure of their internal control and causes by the company's employees or those contracted to perform services for the company that and the vendors that do not perform in accordance with Toyota's contractual agreement. Therefore, these event should be well manage to avoid any potentially losses or the damages which may dangerous the position of the company.
Toyota managed those operational risks by adopting the several strategies to reduce the risk that they facing globally. They diversifying their company operation and financing which exposure to the risk such as localized much of their production by constructing production units in the countries which they operates globally. Toyota can match the desired currencies of local revenue with local expenses through their local operation because they can easy to purchase most of the supplies and resources used in the production process. For example, Toyota can ask its suppliers in Malaysia to settle all the bills using Ringgit Malaysia. This reduces Toyota's exposure to changes in the value of Ringgit Malaysia. Other than that, Toyota takes the advantages in interest rate differentials by raising the funds in more than one place. This strategies is called diversify of its finance. For example is like Toyota borrows money from the different country such as Japan, United States or Europe which is simple to take the advantages of the interest rate differentials. They will borrow from the country where they expected the interest rate at that country may fall. For example, if the Toyota borrows from the America and they expected the fall of interest rate in the America which will lead to a fall in the value of dollars in relation to the YEN. Toyota Company, by taking the advantages of the interest rate in the America will make loan and other commitments denominated in dollars less expensive in Yen terms. Therefore, Toyota will gain from the expected depreciation of dollar.
4.4.2 Commodity Price Risk
Commodity price risk also one of the global risk that facing by the Toyota Company. As the commodity prices rises, the Toyota exposure to the changes in commodity prices which may directly influence their business operations. The increase in the commodity prices will increase the will increase the company cost as well. The increase in the cost of the customer which cannot pass to the customer or absorb by the supplier can affected the company's profit margin. The high or low in commodity price like non-ferrous alloys like aluminum, precious metals like palladium, platinum and rhodium and ferrous alloys that use by the company in their production of the motor vehicles may decide the high or low cost in the Toyota production. However, Toyota does not use the derivative instruments to hedge the fluctuation of the commodity price risk. It used to manage their commodities price risk by holding the minimum stock levels.
4.4.3 Reputation Risk
Other than the operational risk management and commodities price risk management, the reputation risk management also important to the company of Toyota that operates globally. Toyota has hundreds of companies headquartered in other countries will have different culture and facing the different situation and image. Besides that, Toyota is also putting their effort to build its reputation of the company on quality and reliability of their product. However, the incidence of the brake problem had caused their long-term reputation drops. They are trying to solve the problem and various actions had been taken to gain back their customer confidence toward their product. The reputation is not built by one night but it needs the long term effort to gain the image of customer to a company. Other than that, Toyota always try to create a faster, more flexible framework for making communications decisions across borders, cultures, and time zones when problems merge with globalize reputation management. Toyota is putting their effort to gain back their customer confidence and their company reputation. The reputation is important for a company because it can mainly influence the company sales and profit margin. Other than that, the company also manage their globalize reputation by using the influencer mapping which is the process of identifying technical, social, and political influencers.
This program should be the long term implement and ongoing program to build the good relationship between the company's managers and engineers, and those influential outsiders from the different location. Therefore, Toyota Company may try to integrated reputation management by building the long term relationship with government leaders and their staff members, regulators, and non-governmental organizations and political parties. This is the important part of the globalized reputational risk management. Lastly, Toyota should continue their effort in building their reputation in globalized so their image in automotive manufactures can be well maintain and increase their profit margin for the company.
5. Conclusion
Toyota
