The path of stock buy-backs, smooth or rough?

Posted on by Future's Management

share-buybacks

Author : Konstantina Karatzoudi

Post financial crisis and many companies are considering going for stock buy-backs while some others have already evaluated it and have taken this path. Companies through repurchase programs or buyback plans repurchase their outstanding shares in order to reduce the number of shares in the market. They want either to increase the value of shares that are still available or to eliminate the threats by shareholders who may want a controlling stake. Stock buybacks allows companies to invest in themselves, usually because management thinks the company’s shares are undervalued.

A stock buy-back can improve several financial ratios. For example, it can reduce that total assets of a company and as a result, its return on assets and return on equity are improved. Reducing the number of outstanding shares means that earnings per share, revenue and cash flow grow more quickly. Additionally, if a company pays the same amount of dividends to its shareholders and the total number of shares decreases, then each shareholder will receive a larger annual dividend. Many companies believe that it is an effective method to increase the stock prices, to raise the demand for their stock on the open market and to show investors that the company has enough resources set aside in case of emergencies or financial distress.  It indicates a favorable attitude towards shareholders and company’s ability to generate profits used to buy back outstanding shares. Using up excess cash just sitting in an account can lift the overall performance of a company and keep itself from becoming a takeover target.

But is the path of stock buyback so smooth? Probably not. Excess cash spent to buy back shares is recourses that cannot be used on any other purpose. There is always the lost opportunity to use the available resources in more productive activities that can create value to the company. Furthermore, it can signal to investors that the company lacks worthwhile uses for its resources. In cases where the stock payback has not been evaluated as the best use of capital for a company, paying additional dividends to shareholders can be a risky decision. It can return control to shareholders, as shareholders have always the right to reinvest in additional shares. In addition, paying additional annual dividends to shareholders can have tax implications for them, as dividend payments are taxed as ordinary income in the year they are received. Moreover, if companies pursue payback programs during bull markets and halt paybacks when the stock starts to decline, this strategy creates a false signal that improved earnings are not driven by organic sales growth and thereby destroying investors’ value.

So, is this the best path to go? It is expected that companies’ target is to return cash to their investors either by regular dividend payments or by using stock repurchasing programs. Stock repurchasing is a good weapon for a company to make this target real but under the condition that it does not turn this weapon towards itself. That is to say, not reinvesting excess cash to alternative investments or activities that could increase their capabilities and make the company more competitive in its industry and more attractive to investors.

 

References

Balchunas, E. (2014). The Pros and Cons of Buying Buyback ETFs. Bloomberg.

Lazonick, W. (2014). Profits without Prosperity. Harvard Business Review.

Merritt, C. Advantages & Disadvantages of Buying Back Your Own Stock. eHow.

Nath, T. (2016, April 28). Stock Buybacks: Their Benefits and Drawbacks. NASDAQ. Tice, C. The Pros and Cons of Stock Buybacks for Investors. All Business.

Tyler (2008, June 23). Stock Buybacks: Who Benefits The Most? Dividend Money.

Short-term debt as permanent capital

Posted on by Future's Management

corporate_debt

 

Author : Konstantina Karatzoudi

Short-term debt or current liabilities are a company’s obligations that require payment within one year or within the operating cycle, if this is shorter. This short-term debt can be used as funding to match the terms of a specific project or in cases of unmatched funding, the maturity and duration of the debt do not match the funding requirements of a specific project. The most common situation is that companies prefer that funding be matched to ensure funding availability throughout their projects. Matching principle is a standard theory of finance, which states that firms should finance their short-term assets with short-term liabilities and long-term needs with long-term capital.

The method of using short-term debt to finance long-term assets can be an attractive option, especially during economic crises, as short-term debt is more readily available and is offered at variable interest rates determined by the market. It is mostly attractive to small companies that more possibly face difficulties in raising long-term capital and thus, they turn to more viable funding alternatives. Using the option to finance its long-term projects, a company does not have any other choice than to fully utilize the resources available, as it must pay back the debt and interest to its creditors.

However, numerous companies had to deal with a trouble situation after having used the easy availability of short-term lines of credit, especially when they purchased assets, such as equipment with money borrowed from short-term loans, without matching the terms of the loan with the life of the asset. Companies should evaluate the risks involved and when those risks become excessive, before they make the decision to finance long-term assets with short-term debt. In case businesses violate the matching principle, they run three serious risks. Firstly, the interest rate risk, which can easily be higher at the time of loan renewal. Usually, working capital agreements involve floating interest rate instead of a fixed one. The exposure of companies to high and fluctuating interest rates can seriously affect their survival, especially the survival of small companies. Secondly, as companies heavily rely on working capital loans, they should consider the possibility of an arrangement termination, if the lender decides about it. In this case, companies should have alternative resources to turn to ensure available funding for their operations. Thirdly, it is possible that lenders insist on revised terms in the agreements, for example, requiring more security, personal guarantees or higher charges. If these changes coincide with an unfavorable economic situation, as the financial crisis during the last years, this can result in difficult times for the companies, hindering them from meeting their obligations.

Therefore, achieving the goals of corporate finance requires appropriate financing of any business investment. It is critical that interest expenses never exceed the net operating income margin. This situation must be avoided, as it is a negative leverage. Management should try to match as closely as possible, the short-term or long-term debt financing with the assets that are financed in terms of timing and cash flows.

This can lead to a healthy business.

References
Berkus, D. (2011, March 21). Never use short-term borrowing to cover long-term debt. Berkonomics.
Fosberg, R. H. (2008). Determinants of short-term financing. William Paterson University.
Koch, KJ. (2013, March 22). Discussion on Short Term Debt as a source of “permanent” assets. Thin.KJ.et
Viscione, J. A. (1986, March). How long should you borrow short term? Harvard Business Review.

Hipp hipp hurra gratulerer med dagen Norway!

Posted on by Future's Management

17 mai“Need to learn more? Click the photo”

Congratulations to Norway for its National Day!

Today, 17th of May, Norway celebrates its National Day the Norwegian Constitution Day or simply ”Syttende mai” (seventeenth May), ”Nasjonaldagen” (The National Day), or ”Grunnlovsdagen” (The Constitution Day), as the day is referred to among Norwegians.

Norway celebrates today the signing of its Constitution at Eidsvoll on May 17 in the year 1814. The Constitution declared Norway to be an independent kingdom in an attempt to avoid being ceded to Sweden after the defeat in the Napoleonic wars. Originally the day was focused only on the Constitution but after 1905, the focus was directed also to the royal family.

”Hipp hipp hurra” is a rejoicing, an expression of joy and exuberance used by people this day, so let’s exclaim Hipp hipp hurra for Democracy!

 

Business Continuity Management – What is the trend?

Posted on by Future's Management

Business-Cont-Mgt_sized

Author : Konstantina Karatzoudi

The adoption of business continuity management by companies is becoming more and more a necessity during the last years. It is a crucial parameter to achieve the resilience of a business organization as it improves the management’s capability to identify potential impacts that threaten a business organization and provide a framework for protecting the interests of stakeholders, reputation and value-creating activities.

Although the increasing necessity and the importance of having an emergency response plan, there are still many businesses that resist implementing the above procedures. Most of businesses can argue about their decision of not implementing preparedness planning focusing on the fact that their organization rarely suffers from disruptive events and they are able to deal with the disruption when it occurs, most actual approach for small private organizations. However, their arguments do not end here. Many businesses do not place the business continuity as a top priority. They can even argue that continuity issues have been already covered by other plans inside the organization, showing that they do not perceive the business preparedness as a separate procedure that needs a separate planning. Consequently, they do not realize the benefits gained by implementing a preparedness planning. Another reason is the lack of expertise. This means that companies lacking expertise need to allocate budget resources for implement emergency plans, an investment that is considered too expensive by the senior management. Or the reason can be simpler, the senior management is just not interested in implementing preparedness planning as this is defined by the culture of the organization.

So, is it a challenge to convince the senior management to make the necessary investment?

In my opinion, the key element here can be the projection of benefits that other businesses have experienced (financial and non-financial) after implementing a preparedness planning. According to surveys, managers in organizations that have activated business continuity plans have reported numerous benefits gained by this implementation. The reported benefits were, among others, that the preparedness enabled the organizations to return to normal operations more quickly than otherwise, the cost of developing a preparedness planning is covered by the benefits that the organization brings, it effectively reduced the impact of the disruption event, it enabled the continued delivery of services to customers without interruption, it effectively supported the employees after recovery and contributed to personal and family resilience of employees, a critical factor for business continuity.

In short, someone can argument in favor of preparedness planning that can overcome its costs of implementation in long-term, as it can improve the business resilience, can effectively protect the business reputation, can allow meeting customer requirements without interruption, can ensure fulfillment of regulatory requirements and can, in general, improve understanding of risk to organization, all factors that can provide a competitive advantage to organizations with preparedness planning.

Do you need more reasons to decide in favor of Business Continuity Management?