The company that we have chosen in this Business Finance assignment is Sime Darby Berhad. The name "Sime Darby" was formed in 1910 from the names of two European business partners: William Sime and Henry Darby. Sime Darby Berhad is the largest conglomerate in Malaysia and one of the largest in south-east Asia. With 543,579 hectares of plantation land in Malaysia and Indonesia, Sime Darby Plantation is the world's largest listed plantations company and the world's number one palm oil originator, accounting for about six per cent of global palm oil production. The Group has a significant presence in both upstream and downstream palm oil activities. The company operations span across 20 countries and is supported by a team of over 100,000 people worldwide. A company that determined is a successful Malaysian-based multinational with core businesses in plantation, property, motors, industrial, energy & utilities and with growing presence in China and healthcare.
Within its orbit are more than 270 operating companies in 23 countries, with its most extensive foreign operations in Hong Kong which accounts for 25 percent of revenues, Singapore which is 14 percents, and Australia which is 11 percent. The company generates 38 percent of its revenues domestically. The Group's principal activities are operating rubber plantation and providing plantation or agricultural consultancy services.
Its broadly diversified activities include a wide range of industries, with the core businesses being plantations which including oil palm and the company's original business, rubber, tire manufacturing, heavy equipment and motor vehicle distribution, property development, power generation, engineering services, operating oil and gas, power and utility, developing property and other activities. Other business operations include paint manufacturing, refrigeration product manufacturing, travel and tourism services, hospitals, and golf courses. Operations are carried out in Malaysia, Indonesia, Singapore, China, Australia, Europe and other countries.
Discussion: Sources of Finance
Source of finance
Source of finance is about the way that company gained the money to operate the company. A company would choose from among various sources of finance depending on the amount of capital required and the term for which it is needed. Finance sources can be divided into three categories, namely traditional sources, ownership capital and non-ownership capital. Besides, it also can be differentiated by long-term, medium term, short-term source of finance.
Share Capital
Share capital also known as "equity financing". It refers to the funds raised by issuing shares in return for cash or other considerations. The amount of share capital reports on its balance sheet only accounts for the initial amount for which the original shareholders purchased the shares from the issuing company. It can be change over time because each time a business sells new shares to the public in exchange for cash, the amount of share capital will increase. Share capital can be composed of both ordinary and preference shares. But in the financial report of Sime Darby, we discovered that this company only issued ordinary shares.
Ordinary shares are a share that does not have any predetermined dividend amounts. An ordinary share represents equity ownership in a company and entitles the owner to a vote in matters put before shareholders in proportion to their percentage ownership in the company. Ordinary shareholders are entitled to receive dividends if any are available. They are also entitled to their share of the residual economic value of the company. As such, ordinary shareholders are considered unsecured creditors. Ordinary shares include those traded privately as well as shares that trade on the various public stock exchanges. The true value of an ordinary share is based on the price obtained through market forces, the value of the underlying business and investor sentiment toward the company.
Basically, equity share capital is the most suitable alternative for Sime Darby Berhad to raise their capital. Company not required paying dividends to ordinary shareholders. Ordinary shares do not have any maturity date, which means that the issuing company has no obligation to redeem them. Raising equity by issuing ordinary shares lowers the interest rate that a company will have to pay on debt.
Advantages:
Investors are often prepared to provide follow-up funding as the business grows.
Can raise capital from a large number of investor through issuing shares or bonds
Its existence is not limited by the withdrawal of its owners
Central control over the operations by the board of directors
Not bound by the contract of one of the owners.
Investors only realize their investment if the business is doing well, for example, through stock market flotation or a sale to new investors.
Investors have a vested interest in the business success, for example, its growth, profitability and increase in value.
Disadvantages:
Depending on the investor, you will lose a certain amount of your power to make management decisions.
Have to invest management time to provide regular information for the investor to control.
There can be legal and regulatory issues to comply with when raising finance, for example, when promoting investments.
Basically, equity share capital is the most suitable alternative for Sime Darby Berhad to raise their capital. Company not required paying dividends to ordinary shareholders. Ordinary shares do not have any maturity date, which means that the issuing company has no obligation to redeem them. Raising equity by issuing ordinary shares lowers the interest rate that a company will have to pay on debt.
Reserves
Share premium usually found on the balance sheet, this is the account to which the amount of money paid (or promised to be paid) by a shareholder for a share is credited to, only if the shareholder paid more than the cost of the share. The share premium account may be used to issue bonus shares, write-off equity related expenses like underwriting costs, etc.
Revaluation reserve is an accounting term used when a company has to enter a line item on their balance sheet due to a revaluation performed on an asset. This line item is used when the revaluation finds the current and probable future value of the asset is higher than the recorded historic cost of the same asset. A revaluation reserves fall under the category of supplementary capital, in that it does not reflect ordinary business results. Because of this revaluation, reserves typically are not counted as capital that can be leveraged for financial institution's, such as a bank's, contractual provisions.
Capital reserve is a type of account on a municipality's or company's balance sheet that is reserved for long-term capital investment projects or any other large and anticipated expense(s) that will be incurred in the future. This type of reserve fund is set aside to ensure that the company or municipality has adequate funding to at least partially finance the project. Contributions to the capital reserve account can be made from government subsidies, donated funds, or can be set aside from the firm's or municipality's regular revenue-generating operations. Once recorded on the reporting entity's balance sheet, these funds are only to be spent on the capital expenditure projects for which they were initially intended, excluding any unforeseen circumstances.
Retained profits is the percentage of net earnings not paid out as dividends, but retained by the company to be reinvested in its core business or to pay debt. It is recorded under shareholders' equity on the balance sheet. Most of the time, companies retain their earnings in order to invest them into areas where the company can create growth opportunities, such as buying new machinery or spending the money on more research and development. The retained profits general ledger account is adjusted every time a journal entry is made to an income or expense account.
Advantages:
Reserves can create from profit, especially retained earnings, for example, accumulated accounting profits.
Reserve is one of the sources of finance that which is appropriate to the company because equity reserves can help company create profit and accumulate accounting profits in the future also.
Borrowing
Long term loan
Is a form of financing that is provided for a period of more than a year, some run for as long as for 20 years. Long term financing services are provided to those business entities that face a shortage of capital. It is different from short term loan.
Term loans are negotiated between the borrowing business and financial institution such as clearing bank, an insurance business or a merchant bank. This sort of finance is very important because as much as 20 percent of new finance raised by businesses other than through retained profits. Besides, term loans are like loan notes in that security is usually given to the lender and loans are made up to 20 years. Besides, they are not traded in the capital market. Some terms loans are repayable in instalments so that each monthly or annual payment consists of part interest and part capital repayment. Term loans tend to be very cheap to negotiate so it made them very popular with businesses of all sizes. Term loan can be long term loan and short term loan. Besides, term loan can also secured loans and unsecured loans.
Medium Term Notes is a debt note that usually paid back in 5 until 10 years, but the term may be less than one year or as long as 50 years. They can be issued on a fixed or floating coupon basis. Medium Term Notes can be issued with a fixed maturity date which is no callable.
Secured loan is a loan in which the borrower pledges some asset as collateral for the loan. Banks and other finance companies often require security for a short-term loan just as they do for a long-term loan. Security for short-term loans usually consists of accounts receivable, inventories or both. In the event that the borrower default, the creditor takes possession of the asset used as collateral and may sell it to satisfy the debt by regaining the amount originally lent to the borrower.
Unsecured loan is a loan that is not backed by collateral. Unsecured loans are based solely upon the borrower's credit rating. As a result, they are often much more difficult to get loan. However, an unsecured loan is considered much cheaper and carries less risk to the borrower.
Advantages:
Longer period to pay back.
More stable than short term debt.
Linked to growth of company's operating capacity.
It is desirable as well as an important component of any loan as it helps in lowering the monthly instalment.
Help to protect the lenders interests.
It is seen that if the borrower violates any standard or restrictive provision, the lender can demand immediate repayment of the debt.
The long-term borrowing interest rate is much lower than the short-term borrowing.
It's like having a multiplier effect, a borrower whose return on capital is higher than the interest rate on the debt is basically using other people's money to produce returns for themselves.
Borrowing is that it does not dilute the value of shareholders' equity by adding to the number of shares outstanding.
Disadvantages:
Costly interest charges.
Restrictive clauses and covenants
Long -term borrowing for Sime Darby Berhad this kind of huge and listed company is one of the sources of finance which is appropriate to the company used. Sime Darby Berhad needs to have a larger capital to run off the business. Long-term borrowing also can be used to finance business investments that have longer payback periods. For example, the purchases of machinery, which may help the company, produce goods over a 5-year period.
Short term loan
Normally used to provide money that has to be paid back within a year. The period may be shorter than one year as well.
Bank overdraft is alternative term for draft. An overdraft occurs when withdrawals from a bank account exceed the available balance. That may be denoted as negative balance on the account. If the amount overdrawn is within overdraft limit, the interest is charged at agree rate. If the amount overdrawn is over than agree rate, the interest rate is higher.
Other short term borrowing is means borrow from other people, financial institution or bank.
Commercial Papers are an unsecured promissory note issued by the financial institution, large bank and corporation with very short maturity period. Usually the maturity period is 2 until 30 days and no more than 270 days. Commercial paper only secured by the reputation of the issuer.
Secured loan is a loan in which the borrower pledges some asset as collateral for the loan. Banks and other finance companies often require security for a short-term loan just as they do for a long-term loan. Security for short-term loans usually consists of accounts receivable, inventories or both. In the event that the borrower default, the creditor takes possession of the asset used as collateral and may sell it to satisfy the debt by regaining the amount originally lent to the borrower.
Unsecured loan is a loan that is not backed by collateral. Unsecured loans are based solely upon the borrower's credit rating. As a result, they are often much more difficult to get loan. However, an unsecured loan is considered much cheaper and carries less risk to the borrower.
Advantages:
Relatively easy to negotiate
Free up funds for investment opportunities in the short term
Disadvantages:
Time and resources for monitoring and maintaining short-term credit
Not useful for long term capital needs
More debt may increase your actual cost of borrowing, for example, the interest rate paid on the debt.
With public companies, the ratings agencies will see the additional debt burden and possibly lower the company's rating, which automatically boosts borrowing costs.
Could have a downward spiraling effect on the company as its borrowing costs go up, but suddenly less capital is available to draw from due to the lower credit rating.
I think short-term borrowing is not very appropriate for Sime Darby Berhad. Because the interest of short-term borrowing will be higher than the long-term, so the company should pay more with it. Besides that, the increase in default risk, bankruptcy risk, and a plethora of interest rate and market risks related to having more debt on a company's balance sheet.
Trade payables
Trade payables are also known as accounts payable and refers to money that a person or company owed to creditors, lenders, vendors or suppliers for products or services rendered, but has not paid yet. For example like product or services purchase on credit. This item appears on company's balance sheet as a current liability. Payables are considered short-term if due within 12 months. On the other ways, payables due longer than 12 months are considered long-term. Credit terms of trade payables and amounts due to customers of Sime Darby Berhad ranged from 7to 180 days.
For Sime Darby Berhad, it is not very suitable with trade and other payables this kind of source of finance. Because of from suppliers, may cause the company to take on more business risk in offering aggressive credit terms to customers. Besides that, the payables will charge them (Progress Billing) charge, so it is not very suitable that Sime Darby Berhad dealing with those payable.
Disadvantages:
May cause the company to take on more business risk in offering aggressive credit terms to customers.
The suppliers change their credit terms, the company will be put in a position of payable-receivable mismatch (i.e. paying faster than collections). Changing its own credit terms may mean loss of customers and market share.
Badly maintained credit lines (late payments etc) may result in the company being 'blacklisted' by credit bureaus or industry players, making it more difficult or expensive to obtain financing in future.
For Sime Darby Berhad, I think it is not very suitable with trade and other payables this kind of source of finance. Because of from suppliers, may cause the company to take on more business risk in offering aggressive credit terms to customers. Besides that, the payables will charge them (Progress Billing) charge, so it is not very suitable that Sime Darby Berhad dealing with those payable.
Other possible alternative sources of finance?
Preference share
Preference share also called preference stock or preferred stock is typically a "higher ranking" stock than common stock and its terms are negotiated between the corporation and the investor. The preference stockholder will receive their dividends before common stockholders do. The preference stock dividend is usually fixed from year to year. Preference stock is also known as a "hybrid" security because it has both debt and equity characteristics. Preference stock is like a debt primarily because preference stockholder do not have an ownership claim, nor do they have any claim on the residual income of the firm. It is also similar like equity because it has an infinite maturity and lower priority claims against the firm than the bondholders have. A firm can fixed its financial cost whereas ordinary share do not fixed the financial cost. It can avoid the danger of bankruptcy if earning is too low to meet these fixed charges. If the company can't pay the dividend, it will postpone to next year.
Preference stock can also avoid sharing control with new investor because preference stockholders do not have voting rights compared to ordinary stockholders. Preference stocks can be an appropriate source of financing to Sime Darby Berhad as alternatives of issuing common stocks because preference stockholders do not have any voting rights on the companies' directors. Besides, preference stockholders are unable to earn any possible capital gains and extra dividend payments.
Warrant
Warrant is a derivative security that gives the holder the right but no obligation to purchase securities from the issuer at a specific price within certain time frame. It also entitles the holder to buy stock of the company that has been issued at a specified price, which is usually higher than the stock price at time of issue. Warrants are frequently attached to bonds or preferred stock as a "sweetener", allowing the issuer to pay lower interest rates or dividends. They can be used to enhance the yield of the bond, and make them more attractive to potential buyers. Warrants can also be used in private equity deals.
The warrant is appropriate to Sime Darby because it can protect the portfolio of the company. Put warrants allow the company to protect the value of its portfolio against the falls in the market or in particular shares. The warrant market also consider transparency, so the potential investors can see what is going on which means they can know that they are getting a fair deal or not or they are dealing at the best price the market has to offer. By using the warrant, this can help Sime Darby to diversify its portfolio. To deal in covered warrants, Sime Darby simply needs to ask their stockbroker, no new account is required.
Leasing
Leasing, like long-term debt, requires the firm to make a series of periodic, tax-deductible payment that may be fixed or variable. We can think of a lease as being comparable to secured long-term debt because in both cases there is an underlying asset tied to the firm's financial obligation. Leasing referred to as "off balance sheet" financing if a lease is not "capitalized" which means the holder does not own the asset at the end of the lease period.
Since Sime Darby is engaging successfully in various business industry, so it need many business assets such as machinery, land and trucks. It can lease these business assets from other company. An obvious advantage to lessee is its flexibility and convenience because leases are easier, quicker and require less documentation and simplifies bookkeeping for tax purpose. A leasing avoids many of the restrictive covenants that are usually included as part of a long-term loan. Requirements with respect to minimum net working capital, subsequent borrowing, business combinations, and so on are not generally found in a lease agreement. Besides, it can help Sime Darby Berhad save capital because it no needs to buy the asset and use the capital for other operating activities. Apart from this, by using leasing, Sime Darby Berhad can prevent the problems of technology changes.
Conclusion
According to the information that has been interpreted from Sime Darby Berhad's financial report, we have discovered that the company's source of finance basically comes from 2 major areas, which is from bank and other financial institution and also through issuance of shares. Such sources of finance are share capital, reserves, borrowings, trade payables and so on which is appropriate for a business that intends to invest in a project or expanding their business to raise financing in order for the objectives to be accomplished.
It is very important for a company to identify and evaluate which sources of finance are most appropriate to them. So the company would be benefited from the chosen sources of finance used. A company must also have a well-balance level between equity financing and debt financing because this is to maintain a healthy debt ratio so that the company's shareholder's interest and financial standing are protected.
Other than source of finance use by Sime Darby Berhad now, we suggested Sime Darby Berhad using Preference share, Warrant, Leasing to raise their capital. Preference share can avoid the danger of bankruptcy if earning is too low. Besides, if the company can't pay the dividend, it will postpone to next year. By the way, warrant can protect the portfolio of the Sime Darby Berhad and leasing can help Sime Darby Berhad save cost because no need use money to buy the assets. So, the alternative source of finance is very appropriate for Sime Darby Berhad to use.
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