Acknowledgements
I would like to thank my teacher for giving me an opportunity to research and write on such an important topic. The research work has not only increased my knowledge in the area of financial management but has also enabled me to apply these techniques in practical decision making. I would also like to acknowledge all my friends and relatives who have supported me in this task. I specially acknowledge the authors, companies and websites used in the research for providing such extensive material for research.
Executive Summary
This essay explains the role of financial management in Nokia with reference to the historical, current and forecasted financial condition of the company. The financial planning, control and budgeting processes are explained with reference to the company. The financial analysis including ratio and trend analysis and vertical analysis has been performed using the financial statements of the company. The variance analysis is also performed using the budgeted and actual financial statements of the company. The forecasted financial statements of the company have been prepared for the next financial year. A capital spending project has been evaluated using the capital budgeting techniques including NPV, IRR and MIRR and the recommendations for the project have been stated.
Research Methodology
The objective of this essay is to present and evaluate the financial management structure of a company. The research approach used to address this presentation and evaluation is the quantitative approach. Information has been collected from various secondary sources for this essay The secondary sources used for this essay include the annual reports of the company for past five years, books on various topics related to financial management, journal articles and websites.
Information Background
The company selected for financial analysis is Nokia and the information related to the industry and company is given below:
Industry Background
Nokia is part of the mobile communications industry which is now one of the most rapidly growing industries in the world. The rapid evolution of technology in the past 50 years has increased the dependence of individuals and businesses on electronic and wireless communications including mobile phones. The industry includes multinational companies and giants like Motorola, Sony-Ericson and Samsung. The mobile phone industry is highly competitive and technology oriented. The companies in this industry continuously upgrade services or features in their products to gain competitive advantage.
Company Information
Nokia is almost a century and a half company with its roots in the paper, rubber and cable products. The company shifted to the mobile phone industry in 1968 and has been contributing to the industry ever since. During this time the people at Nokia have come up with a variety of innovations in the mobile communications area. The company is listed in various stock exchanges around the world including NYSE and NASDAQ. The company has six segments which are services and software, devices, markets, NAVTEQ and Nokia Siemens network. The company employs over 128,445 employees out of whom 39,350 employees are dedicated to research and development (Nokia).
Products and Services
The company has a wide array of products and services which it offers to a variety of customers across the globe. The devices unit of the company is responsible for the development and management of cellular phones. The services and software unit is responsible for internet services and software which include music, media, messaging services, games and maps.
Financial Management
Financial management involves the planning for future profitability and cash flows of an organization. The major objective of financial management is to assess the current financial condition of business and plan for the future accordingly. Financial management involves financial planning, financial controlling, budgeting, forecasting and making capital budgeting decisions based on various techniques. These functions of financial management help in achieving higher profitability and cash flows for the organization (Economy Watch). The financial management process involves the integrated efforts of the key personnel in an organization at various levels as shown in the diagram below.
Strategic and Financial Objectives
The strategic objectives of an organization include the overall goals of the organization such as dealing with competition, increasing the market share of the product and innovation in production. Financial objectives on the other hand include objectives such as profitability, share value maximization and target capital structure. Nokia put emphasis on both objectives in similar ways. The compensation of executives is linked with these objectives.
Nokia’s strategic objectives include purpose of business, scope of business, improvement and innovation in technology, increase in market share, increasing revenue from new products, retaining customers, quality and environmental success whereas the financial objectives include maximization of shareholders’ wealth, increasing revenue, operating income and cash flows of the company (Nokia). Though there are departments and segments in the organization but Nokia does not prepare financial documents and statements separately for each segment. The level selected for Nokia is the company as a whole and not a department of segment as no financial reports and statements are produced or published.
Financial Planning and Control
Financial Planning is a vital part of financial management and involves making plans for increasing future cash flows and profitability and includes six stages. Organizations rely on financial planning and control to make various important decisions. The first stage of the process is to forecast future financial statements and set standards for financial control. The second step involves the determination of funds required to implement the plan.
The third step involves the resources and sources of the funds required. In the forth step control systems are created which ensure the proper allocation of funds. Protocols for adjusting the formulated plan to changes are established in the fifth stage. The sixth and final step creates a compensation system for executives based on performance (Gup). Nokia follows the same pattern for planning and control and the implementation of the sixth stage has been clearly defined in the annual reports.
Control and Planning Calendar
Organizations plan their financial activities according to various time periods which are referred to as planning calendars. These calendars may depend on months, quarters or years and the planning is usually done on five year projections (PlanWare). Nokia follows quarterly planning for reporting and controlling purposes. The forecasted financial statements are compared with actual statements to reveal any variances and adjust these variances accordingly. The control mechanism works both for quarterly plans and yearly plans in Nokia at the same time. The financial statements are reviewed each quarter and each year with reference to forecasted and historical statements. At the end of a quarter targets are set for the next quarter and the same methodology is applied to yearly planning calendars.
Budget and Budgeting Approaches
The term budget is referred to the estimation of revenues and expenses of a future period. From and organization’s view point it is the activity performed by management to evaluate future financial conditions with reference to inflows and outflows (About.com). There are various approaches to budgeting which depend on the time period, forecast values, forecasting process and setting goals in an organization. According to the time period the traditional approach to budgeting is a fixed budget which is based on a specific time period while the alternative approach is a rolling budget where the time period keeps changing.
The traditional budgeting approach with reference to forecast values is a static budget where the values are not changed over the life of the budget whereas in the alternative flexible budgeting approach the revenues and expenses are adjusted over a period of time.
The forecasting process is also used in budgeting process in which the traditional approach is incremental budgeting where budgets are made using historical data whereas in the alternative approach of zero based budgeting the budget is prepared from scratch. The traditional budgeting approach in goal setting is top own approach where the goals and budgets are set by the upper management whereas in the bottom up alternative approach the budgets are set by the people responsible for achieving budget goals (Harvard Business School).
Budgeting in Nokia
Although many companies implement various budgeting approaches at various levels and units, there is a budgeting approach which reflects the overall company policy. In Nokia the incremental budgeting approach to prepare budgets for its quarterly and yearly planning calendars is applied. The top down approach is used in the management system for setting goals in various segments and departments.
This is the overall budgeting approach for the company and the specific approaches used in many units or segments may vary. The master budget of a company is the overall estimate of income and expenditure of the company and comprises of various smaller budgets including a cash budget, material budget, overhead budget and sales budget. Nokia manages its worldwide value chain with highly integrated management accounting systems.
The company prepares budgets related to production, sales, research and development and cash. Nokia also focuses on specific targets of business units and units are required to prepare targets for sales, production, customer services, operative efficiency, and cost efficiency. The upper management of the company also sets targets for the company as a whole for sales and production (Laitinen and Leppnen).
Financial Analysis
Comparative Financial Statements
The comparative financial statements of the company are included in Appendix 1.
Ratio Analysis
The ratios for Nokia are calculated in four different categories of Profitability, efficiency, liquidity and investment and are provided in the following table. The ratios have been calculated by applying the standard formulas available (Rao). The profitability ratios indicate the high profitability of Nokia as the Return on Assets is 10% and Return on Equity is 27.5%. A profit margin ratio of 8% indicates that the company is earning 8% on its sales annually.
The market price for Nokia on Jun 19 was $14.67 (Yahoo! Finance) which is a very good bargain at earnings per share of €1.07 which translates into $1.48. The turnover or efficiency ratios indicate how efficient a company is in managing various assets such as inventory, receivables, fixed assets and total assets. The inventory and receivables turnover are 12.32 and 4.91 times respectively. This indicates that the inventory is converted into finished goods and sold off at least 12 times in a year which averages to once a month. The receivable turnover on the other hand indicates that the receivables are converted into cash approximately 5 times a year.
The fixed assets and total assets turnover are quite low as compared to the industry at 3.36 and 1.28 times respectively. The table also includes liquidity ratios which indicate the solvency of a company and its ability to meet short term obligations. The current ratio for Nokia is 1.2 which is higher than 1 and indicates suitable liquidity for the company and the short term assets and liabilities have been managed efficiently. The quick ratio for the company is 1.08 which is also higher than 1 and reflects the ability of the company to meet obligations with liquid assets such as cash, marketable securities and receivables.
The Net Working Capital of the firm is at €4,115 million which indicates that the company has a fair amount of working capital to finance its current business operations. The operating ratio at 2.58 also indicates the efficient operations of the company. The investment ratios help investors in analyzing investment options in a company. The EPS of 1.07 already mentioned is quite attractive for investors. The price earnings ratio is at 10.37 and the dividend yield is at 3.60%. The debt to equity ratio is at 14% which reflects the relationship between the debt and equity of the company.
Horizontal Analysis
The horizontal analysis is the comparison of two or three years of the financial statements values or the financial ratios of an organization (Investopedia). The table in appendix 2 shows the horizontal analysis for Nokia for 2007 and 2008 with the percentage change of each amount in 2008. The most significant changes in the income statement can be noted in the other expenses and financial income and expenses. The net sales of the company have reduced by 0.68% while the cost of sales also decreased by 1.31%.
Other income has shown a sharp decline of 81.83% whereas other expenses have shown a significant increase of 181.84% which has caused the operating profit to decrease by 37.81%. Another considerable change in the income statement is reflected in financial income and expenses which were €239 in 2007 and dropped by 100.84% to €-2. All these changes have a combined effect on the net profit of the company which shows a reduction of 44.65% in 2008. Horizontal analysis is also applied to the balance sheet of the company. There are more than a few values which have changed considerably on 2008 due to various reasons.
The goodwill of the company depicts change of 352.10% which is primarily due to the recording of NAVTEQ goodwill. Other intangible assets show an increase of 65.95% while the investment in associated companies has fallen by 70.46%/. The long term loans receivable amount shows a sharp increase of 170% and the total non-current assets have increased by 81.96%. In the current-assets section of the balance sheet other financial assets show an enormous increase of 332.64% while available for sale investments show a decrease of 74.06%. The total current assets have reduced by 16.47% and the total assets have increased by 5.27%.
In the shareholders’ equity and liabilities section of the balance sheet the translation differences have decreased by 309.20% while fair value and other reserves have increased by169.57%. The long term interest bearing liabilities have also increased considerably by 324.14% and the total non-current liabilities have increased by 111.44%. The short term borrowings and other financial liabilities show have increased in 2008 by 401.12% and 402.17% respectively
Vertical Analysis
Vertical analysis involves and shows the relationship among the different values in the financial statements of the company. The values in the income statement are usually expressed as a percentage of sales while the values in the balance sheet are expressed as percentage of total assets (Business Dictionary). The highest percentage amount with respect to sales for Nokia is its cost of sales which is 65.74% leaving the gross profit at 34.26% of sales. The research and development expenses are 11.77% of sales while selling and marketing expenses are 8.64% of sales. The operating profit of the company is 9.79% and the profit before tax is 9.8%.
The net income of Nokia is 7.86% of net sales. The vertical analysis has also been carried out on the balance sheet of the company. The goodwill of the company is 15.81% of the total assets while the total non-current assets are 38.18%. In the current assets section the accounts receivable are 23.86% while prepaid expenses and accrued income are 11.46%. The total current assets are 61.82% of the total assets. The retained earnings are 29.54% of total assets whereas the total shareholders’ equity is 41.71% of total assets. The non-current liabilities are 6.86% of total assets while accounts payable and accrued expenses are 13.2% and 17.74% of total assets respectively. The total liabilities of the company are 58.29% of the total assets.
Budgetary Control
Budgetary control is a method used to control the outcome of actual results as compared to estimated budgets. The variance analysis is carried out by comparing the budgeted values with the actual values and any variances are calculated to make any changes necessary to the actual performance. The performance of individuals working to achieve the budgets is also appraised using the budgetary control procedure (Food and Agriculture Organization of The United Nations). The budgeted income statement has been prepared by applying a growth rate of 10% as indicated in the 2007 annual report of Nokia (Nokia).
The budgeted sales for 2008 were €56,164 while the actual sales were €50,710 with an adverse variance of €5,454 million. This means the sales target has not been achieved and the main reason is the overall decline of the mobile phone industry. The budgeted cost of sales were €37,159 and actual were €33,333 with a favorable variance of 3,822 million. The main reason for the decline in the cost of sales is the decline in sales of the corresponding period.
The gross profit is also lower than the budgeted amount and has a variance of €1,632 million because of the decline in sales. The operating profit of the business quite low as the budgeted amount was €8,784 and the actual is €4,966 which leads to a variance of €3,818. The net income of the company was budgeted to be €7,926 million while the actual net income is €3,988 with a variance of €3,938 million which is variance of almost 50%. The adverse variances can be reduced by increasing sales of the company and decreasing the relevant expenses.
Financial Forecasts for Next Year
Financial forecasting has been done by preparing the pro-forma financial statements for 2009. The statements have been prepared by a growth rate of 12% which is the compounded annual growth rate. The compounded annual growth rate has been calculated by through the actual growth rates of the last five years from 2004-2008. The forecasted financial statements appear in appendix 4.
Capital Investment Appraisal
Nokia acquired NAVTEQ in July 2008 at a total cost of €5,342 million with cash payment of €2,772 million and debt issue of €2,539 million with other acquisition costs of €31 million (Nokia). Although the company has already acquired NAVTEQ, the model has been taken to evaluate the investment option. The expected cash outflow of €2,772 million has been taken from the annual report while the cash inflow for the first year has been estimated through the operating loss amount of €153 million.
This loss is reported after depreciation and amortization of €238 million and capital expenditures of €18 million. The depreciation and amortization have been added back to the operating loss amount and the capital expenditures are deducted to arrive at €373 million in the first year. The cash inflows have been adjusted with an estimated 5% growth rate.
Cost – Benefit Analysis
Cost-Benefit Analysis is carried out to evaluate the financial benefits of a project or asset. It involves the comparison of the cost and income from a project and provides a quantitative analysis of a project (Mind Tools). The cost of the project is €2,772 million which is recovered after 6 years which is good for Nokia as it would not only have competitive advantage but could push its cash flows much higher with this advantage. The focus of the company is more on the services it can offer after the acquisition of NAVTEQ but it will also benefit from the cash flows of NAVTEQ.
Risk Analysis
Risk analysis is the process of identifying risks related to company or any part of that company. The risks are identified and any procedures that can be implemented to reduce these risks are evaluated. Risk analysis entails the identification of the nature and level of risks (Olson and Wu). The risks associated with NAVTEQ for Nokia generally comprise of the general risks related to Nokia as a whole. The risks for Nokia involving NAVTEQ include financial risks like market risk, credit risk and liquidity risk.
Sensitivity Analysis
Sensitivity analysis of a project identifies the sensitivity of that project’s NPV to changing variables (Dicuss Economics). Sensitivity of NPV in this particular project is analyzed by changing the growth rates of the cash inflows. The graph represents the changing values of NPV with reference to the change in the growth rate applied for the calculation o NPV. As the growth rate for the cash flows increases so does the NPV for the project in these different scenarios.
Recommendations
The capital budgeting model implies that the NPV of the project is €71.12 million which is positive and the project should be accepted. The IRR for the project is 12%, the MIRR is 10% and the ARR is 38% which is quite attractive for an investment. The simple payback period is though between 6 to 7 years the discounted payback period is 10 years which means the investment in the project will be recovered in 10 years. It was mentioned earlier that Nokia purchased NAVTEQ for future benefits rather than short term benefits which would help the company in value addition and increase the quality of service provided to customers.
Financial Review
The actual, budgeted and forecasted financial statements of Nokia were reviewed to analyze the financial management policies and procedures being implemented in the company. The overall financial management process in the company is quite efficient as the financial ratios are quite healthy and the future outlook for the company is positive.
Budgeting Process
The budgeting process used in Nokia implements the incremental budgeting approach which compares the previous results with current results to prepare budgets or forecasts. The top down approach is also implemented to set targets all units in the company. The focus items of the company budget are sales, production, operative efficiency and cost efficiency. The budgeting process of the company is supported by its management accounting system.
The budgeting process in Nokia enables employees to clearly understand the required goals and objectives. The decisions which have to be made and the level and nature of risk taken can be identified through the budget. The budgets are prepared in line with market trends in the communication sector. The company should follow the ongoing budgeting process in order to meet market competition and changing market trends.
Review of Actual Financial Results
Ratio analysis, trend analysis and vertical analysis of the firm indicate a positive outlook for the company. The profitability ratios indicate that the company has managed to keep the company quite profitable as the ROE is 27.5%, the profit margin is 8% and the earning per share is 1.07. The company is also quite efficient in managing its assets as the inventory turnover ratio is 12.32 and the receivable turnover ratio is 4.91. The company can pay-off its short term liabilities as the current and quick ratios are 1.2 and 1.08 respectively and both are higher than 1 which is a standard for these ratios. The investment options in the company are quite healthy as well as the price earnings ratio is 10.37 and the dividend yield is 3.60%.
Analysis of Forecasted Financial Statements
The forecasted financial statements of Nokia provide information for the next financial year which can be analyzed to evaluate the profitability of the company. With an expected growth rate of 12 % the company has a forecasted sales level of €56,795 million and a net income of €4,467 in 2009. The company requires a sales level above €52,500 to achieve profits. If the actual sales in 2009 are below this level the company would not be able to break even and would report a net loss. The balance sheet provides the forecasted levels for assets liabilities and shareholders’ equity in 2009 while the cash flow statement reflects the expected inflow and outflow of the company in 2009.
Evaluation of Capital Investment Appraisal
The capital budgeting techniques applied to the already acquired NAVTEQ company model suggest that the project should be accepted by Nokia which in fact has already been acquired by Nokia. The NPV of the project was positive with IRR and MIRR 12% and 10% respectively. Though the discounted payback period is 10 years the project should still be accepted as it increases the overall value of the firm in terms of customer service and increased market share. Nokia can now offer additional value added services to its consumers such as digital mapping and this can be used to increase the sales volume of the company thus increasing the cash flows and decreasing the payback period.
Conclusion
The financial management tools and techniques can be applied to any organization to evaluate the overall financial structure with specific details as well. The financial management and budgetary control framework of Nokia is evaluated with capital budgeting techniques and forecasted financial statements. The actual results of the company have been compared with the budgeted estimates to calculate any significant variances.
It is concluded that the financial management procedure is not only comprehensive in company analysis but it provides guidelines and recommendations for investments, capital spending and budgetary control. Financial management enables a person or company to identify what resources are required and what ways are sources are available to finance these resources. Various other tools and techniques which have not been applied here are used to enhance company evaluation.
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