Introduction
Any form of business organization needs financial resources to execute various activities undertaken. Such entities require funds for diverse reasons, including financing day-to-day operations, investing in new lines of business, supporting current expansion and future growth strategies among others. As such, organizations should clearly identify the purpose of finance. The general purposes for finance have been classified as revenue expenditure and capital expenditure. It is also imperative to recognize that financial needs of an organization could differ from needs of its competitors (Hofstrand 2013).
Factors, such as size and the type of business influence financial requirements. For instance, telecom firms are involved in capital-intensive ventures as opposed to retails that may need relative small capital. In most instances, a firm can get funds from either external sources or internal sources. In this assignment, two companies, Vodafone UK and BT both in the telecom industry and listed on the London Stock Exchange have been chosen for a comparative critical analysis with the focus on the following issues. It covers a brief history of Vodafone and BT Group plc, clearly identifies sources of external finance and potential considerations that the management takes into account before choosing a given type of finance. Finally, the assignment presents conclusion and recommendations on different capital structures of the two companies.
Context of the chosen companies
Vodafone Group
Vodafone Group was founded more than three decades ago. From a small mobile operator firm in the UK, the company has become a global brand and among the most respected telecom brands globally. Vodafone now operates across 27 countries while working with other partners in 48 other countries (Vodafone Group Plc 2014). Vodafone currently boasts of 434 million mobile subscribers and users spread across different countries globally. The company also offers other services beyond mobile, including fixed broadband services in various markers globally with more than nine million users. In the fiscal year 2014, the company generated ÂŁ38.85 billion as revenues, ÂŁ3.91 billion as operating income and ÂŁ9.12 billion as profit with total assets of 121.8 billion and total equity of ÂŁ70.80 billion supported with 92,812 employees.
BT Group Plc
The British multinational telecom firm provides its services across 170 countries globally. Established more than 46 years ago, BT today controls several big subsidiaries that serve various sectors, including private and public worldwide. BT offers telephony, subscription television and broadband services to more than 18 million users in the UK. In the recent past, the company announced its plans to buy EE Limited, a mobile phone network based in the UK. In the financial year 2014, the company generated ÂŁ 18.287 billion in revenue, ÂŁ 3.421 billion as operating income and profit of ÂŁ 2.018 billion. BT has about 87,800 employees.
The various external sources of finance available to BT and Vodafone
Vodafone and BT can get money from other external sources. External sources of finance could be individuals or institutions ready to offer assistance (Bragg 2010). The following external sources of funds would be considered for the two public listed companies.
Share capital
BT and Vodafone can raise funds through sales of shares to the public. Share capital is also referred to as equity capital because investors in the company shares are known as shareholders. Shareholders normally get dividends whenever a business makes profit. A company may limit its sharing offerings based on the targeted amount and the number of desired investors. The London Stock Exchange is a platform that provides an opportunity for public limited companies to trade their shares. Willing buyers and sellers trade freely.
Vodafone and BT often opted for share capital as the most appropriate source of funding because it is never repaid. Instead, investors only waits to get rewards when share prices rise and/or when the company makes profits and decides to pay dividends. Share capital does not attract any interests and, therefore, reduces interest expenses paid. It is imperative to recognize that shareholder structure changes once a company goes public. In fact, the owners may become minority as the new investors take control.
Debt capital
Vodafone and BT can also use loan capital or debt capital to gain access to finance. In most instances, corporations turn to financial institutions for funding. Debt capital is normally subjected to interests. Businesses have to negotiate for flexible repayment schedules (instalment) or arrange for a full settlement. Interests and principal are paid together with fixed or variable rates based on the available balance.
Debt capital is easily accessible and can be facilitated fast the required documents. However, financial institutions must evaluate financial statements from Vodafone and BT to ensure that they are financial healthy and, therefore, can meet their loan obligations. Business leverages the spread out repayment and reduces the burden of lump sum deposits. In addition, large corporations such as Vodafone and BT can enjoy extremely low rates because of large amounts they may wish to borrow at once. Debt capital does not affect shareholding structure of an organisation.
Debt capital, however, may present some serious challenges especially if the business is not profitable. The lender must always strive to recover the loan. In some instances, collateral is required as security while interest rates may increase often because of market dynamics.
Overdraft
BT and Vodafone can also use overdraft to access finance. In this case, a company arranges with a financial institution to withdraw more money than the available balance. Overdrafts have ceiling limits, and they attract interests. Companies that exceed the limit are most likely to be fined through increased interest rates.
Overdrafts allow a firm to gain immediate access to finance whenever it needs to spend more money than what is currently available. Consequently, firms can easily meet their short-term obligations. Overdraft is simple to set and manage.
Overdraft could be cheaper relative to loans. However, financial institutions expect their customers to pay back overdraft within the month. In addition, they may also attract significantly high interest rates.
Trade Credit
Vodafone and BT can also use trade credit to run their operations. The arrangement ensures that they can get goods and services and then pay at later date. Trade credit does not involve the use of cash when trading takes place. Instead, the buyer may get up to 180 days to pay. This form of arrangement allows organisations to increase their cash flow and trade with it before they can pay. Trade credit does not attract any form of interests for the credit period.
However, organisations that use this form of finance are not qualified to receive any discounts because they do not pay cash. Further, any delays after the period has elapsed could lead to poor relationships with suppliers.
Grant
In some instances, governments, donor foundations, trust or any other organisations may offer grants to businesses. Proposals are required from the business to get grants. Governments, for instance, may offer grants for organisations to facilitate investments in specific areas.
The UK Government, for instance, offered ÂŁ1.2 billion to BT Group to develop rural broadband (Curtis 2014). Other competitors such as Vodafone, EE, and Three protested that it would create a quasi-monopolistic position for BT, and it would end up owning broadband assets created with public money.
Grants are usually not repaid, but they may have specific conditions.
Leasing
This option is also available for Vodafone and BT to explore. They can strike a deal with the leasing firm to acquire or use specific assets for a given period. Hence, they can use such assets without cash purchase, but make reasonable periodic leasing fees.
The possible considerations taken into account by their respective management when choosing the type of finance
Vodafone, for instance, has a net debt for the fiscal year 2015. This debt consists of the following:
- Short-term borrowings: commercial paper, bonds, put options over non-controlling interests, bank loans, and other short-term borrowing.
- Long-term borrowings, which is made up of put options over non-controlling interests, bonds, loans and other long-term borrowings.
- Other financial instruments (Vodafone Group Plc 2015).
BT Group plc also has net debt made up of loans and other borrowings (BT Group plc, 2015). In addition, operating lease, equity and credit facilities are typical to both companies. Vodafone and BT must consider several factors when making decision on the type finance.
Purpose
Vodafone and BT must determine the purpose of funds to meet their specific needs. For instance, BT may seek for funds to acquire EE, invest in broadband expansion and acquire other long-term assets. Vodafone may also seek for funds to drive its expansion and acquisition strategies while investing in long-term assets (Parrot 2011).
Cost
Both companies use bank loans to fund their operations. However, there are cost consideration in form interests, administration costs and other expenses incurred when finance is processed, which they must evaluate. BT has landed free grant from the UK Government to develop broadband.
Industry position
BT and Vodafone are large players in the global telecommunication sector. Being public firms, they have multiple sources of finance. Their current statements show total equity, loans from banks, leases, put options and bonds among others. These sources may not be available to small, sole traders. Given their position in the industry, these firms can negotiate for extremely low interest rates.
Capital needed
BT and Vodafone rely on short-term loans to meet their short-term obligations. Consequently, they use commercial paper, bonds, put options over non-controlling interests, bank loans, and other short-term borrowing. On the other hand, these giant companies also rely on long-term finance consisting mainly of bank loans and other long-term borrowing arrangements to raise large amount necessary to fund capital-intensive investments.
The ease of obtaining the finance
Management often consider how easy it is obtain facilities from a given institution. In addition, managers also consider how easily they can switch sources or leverage various sources to get finance. In most instances, organisations will need more than a single source of finance to run their operations. The need for more funds may be triggered by changes in the business environment. For example, increased demands may make an organisation to seek for additional funds to meet such demands.
In addition, managers also consider other internal or external factors to determine the best finance option available. The operating environment for the business should favourable to support investment. For instance, economic potential of BT and Vodafone has a profound impact of the type of finance. These two companies are the leading telecoms in the UK and other parts of the world. Besides, they are currently expanding and acquiring new firms rapidly. They demonstrate greater growth potential as well as increased profitability. Hence, they are most likely to have several financing options.
Vodafone and BT are mature firms. That is, they have been in the industry for several years and can find lenders than start-ups. This implies that managers of these two communications firms are faced with many sources of finance and, therefore, they must exercise robust financial knowledge when making borrowing decisions (Bourne, Franco, & Wilkes 2003).
These companies are also most likely to assess their asset base because creditors often use such pieces of information to make lending decisions. Financial institutions prefer companies with tangible assets, which they consider as long-term security. Managers also need to weight their options based on debt and equity.
Market conditions
It is imperative for managers to account for other external factors beyond their control when choosing finance type. An increment in the rate of interest, foreign currencies or inflation usually influences consumer behaviours. Such conditions influence businesses when seeking for finance. For instance, Vodafone and BT would strive to avoid any bank loans during high interest rate seasons. Such tough market conditions often lead to a choice between equity or debt finance.
Factors such as profitability and risks associated with the type of finance are considered. For instance, managers would consider debts if they require more returns and increasing shareholders’ returns. At the same time, debt allows business owners to maintain their control over an organisation. However, debts expose a company to increased financial risk. Conversely, a firm may opt for equity by issuing stock to spread risk, limit returns and establish business control.
Conclusion and recommendations
It is imperative to recognise that companies have diverse sources of external finance. At the same time, managers should understand important consideration for the type of finance. Armed with such information, they can make the best financial decisions by leveraging internal sources and external ones while avoiding risks, focusing on profitability and owners’ control interests.
The best recommendation for both companies should be based on Debt Equity Ratio or gearing that captures their capital structure (Drake & Fabozzi 2012). BT’s debt to equity ratio is 1 (808/808), indicating that the firm has taken debt that is growing steadily and therefore could increase its risk. The debt ratio for Vodafone is 0.81 (54,840/ 67,733), indicating that it has taken relatively high debt and therefore increasing its risk. This ratio demonstrates both financial risks and capital structure of an organization. In both cases, external sources of finance would bear more risk in Vodafone and BT relative to their shareholders. These companies should consider using internal sources of capital to fund their aggressive expansion and acquisition. The ratios should be generally low to reduce risks.
Reference List
Bourne, M, Franco, M & Wilkes, J. 2003. ‘Corporate performance management’, Measuring Business Excellence, vol. 7, no. 3, pp. 15-21.
Bragg, M. 2010. Accounting Best Practices, 6th edn, John Wiley & Sons, London.
BT Group plc. 2015. Annual Report 2015. Web.
Curtis, S 2014. UK government allocates ÂŁ250m rural broadband funding, Telegraph. Web.
Drake, P & Fabozzi, J 2012, Analysis of Financial Statements, 3rd edn, John Wiley & Sons, New York.
Hofstrand, D. 2013. Types and Sources of Financing for Start-up Businesses. Web.
Parrot, W. 2011. Analysing the suitability of financing alternatives. Web.
Vodafone Group Plc. 2014. Annual Report 2014. Web.
Vodafone Group Plc. 2015. Vodafone announces results for the year ended 31 March 2015. Web.