Liquidity refers to the speed and ease with which anasset can be converted to cash (Stephen A. Ross, et al., 1991).
It involvesplanning and controlling current assets and current liabilities in order toeliminate the risk of unable to meet the short term obligations and also canavoid the unnecessary investment in the company assets. When the business ismore liquid, it means that the company is reducing risk to the financialdistress, which is unable to pay their debts and not enough capital to buy thenecessity of the business. Therefore, liquidity is very important to a company.
However, liquid assets are generally less profitable to hold (Stephen A. Ross, et al., 1991). This is because wecan’t get any return from the liquid asset. For example, we can’t get anyreturn from the cash of the company. The terms profit and profitability are different.Profit is an absolute term whereas the term profitability is a concept .Profitsis the excess revenue that we get after deducted all the expenses.
According toLord Keynes, profit is the engine that drives the business enterprise. Profitis very important to a business because it is related to the growth of thecompany. In order to maximize the firm’s value, the very first thing is to getsufficient profit. Profitability means the ability of the company to get profitfrom all the business activities. Therefore, profitability is an importantyardstick for measuring the efficiency of the company. This is because when thecompany has greater efficiency, the company will generate more profit. Kuantan Flour Mills berhad has experienced eight yearsof profit loss which mean the company has loss profit since 2009.
From theannual report, the chairman’s statement stated that the loss profit incurredare mainly due to impairment loss on property, plant and equipment, impairmentloss on investment. Other than that, the company has a very low revenue in 2016because the company has decided to cease the operation due to the cash flowsituation and also the prolonged loss position. WorkingCapital ManagementWorking capital management involves current assets andcurrent liabilities. It can be defined as the working expenses that get blockedin current assets along the productive line of an enterprise (Titto Varghese, 2014). It also representhow well the company manage the account receivable and payable, cash andinventories. Current assets is the asset which relatively liquid and thoseasset can convert into cash within one year. Whereas current liabilities is theshort term obligation that the company need to pay back over the next 12months.
From working capital management, we can understand the relationshipbetween short term assets and short term liabilities of the company. It helpsus to make sure that the company able to operate its business and able tosatisfy the short term debt and the operating expenses. From the point of view as an investor, working capitalrepresents a safety cushion for providers of short-term funds of the companyand as such they view positively the availability of excessive levels ofworking capital and cash (M.A.Eljelly, 2004).However, when the working capital keep increasing, it might shows that thecompany has face some financial issues. This is because the assets that ownedby the company does not contribute to ROE (M.
A.Eljelly, 2004).Moreover, it also represents that the company do not utilize the assets andliabilities to generate more profit to the company. WorkingCapital Management versus Liquidity and Profitability IssueAs we can see the working capital of Kuantan Flour Millsberhad, its working capital is keep increasing from 2014 which is around RM1.
5million to RM2 million in 2016 and profit is declined drastically forconsecutive 8 years. It proves that even the company has enough of workingcapital but if they do not utilize it, it could be a risk to lead the companyexperience a loss profit and even worse condition. The working capitalmanagement play an important role in the successful of a company. When theworking capital management is no in an ideal level, the company would face highrisk to bankruptcy. Therefore, the company should have a proper balance betweenthe current assets and current liabilities in order to let the company operatetheir business well and also maintain their image among the industry as theyhave an ideal profit. Mergerand Acquisition IssueMerger and Acquisition activities involve a variety ofcomplexities and risks. It not only involves the target company but alsoinvolve the stakeholder of both company.
There are many reasons that companydecided to merger and acquisition. For example, the company wants to expandtheir business so they merge with others company to conquer the industry. Someof the company which face the financial distress, they decided to get help fromothers to achieve the company growths. Therefore, it is very important that thecorporate executives understand the motives of merger and acquisition and theconsequences after merger and acquisition.
Kuantan Flour Mills berhad are facing merger andacquisition issue. This is because the company has experienced 8 years ofprofit loss and the corporate executives decided to restructure the company sothat the financial performance will be improved. Felcra berhad is looking tobuy a stake in Kuantan Flour Mills berhad which under a reverse takeover. Thisnews has been spread through to all of the investors. It leads to the shareprice of the company goes up dramatically from four cents to eight cents andthe share price goes up until twenty four cents. However, Felcra berhad hasretracted interest to Kuantan Flour Mills berhad without any official replyfrom Felcra. After the retraction of interest of Felcra berhad, Lotus EssentialSdn. Bhd.
has become the white knight of Kuantan Flour Mills berhad. This isbecause shareholder of Lotus Essential Sdn Bhd has become the placementinvestor of Kuantan Flour Mills. Kuantan Flour Mills signed a memorandum ofunderstanding with Lotus Essential Sdn Bhd which related with the manufacturingand provision of flour milling activities. CorporateRestructuring TheoryAccording to Edward and Harbir, restructuring canencompass a broad range of transactions including selling lines of business ormaking significant acquisitions, changing capital structure through infusion ofhigh levels of debt and changing the internal organization of the firm. As weknow most of the time the company decided to get mergers and acquisitionbecause they want to expand their business. However, corporate restructuring isusually used in reference to ways that companies get smaller by sellingsplitting off or shedding operating assets (Clayman, et al., 2012). Divestitureoccurred when the company decided to sell, liquidate or spin off its subsidiary(Clayman, et al.
, 2012). Corporaterestructure causes radical changes in company business operation and also thefinancial structure. When the company use financial restructuring strategy,it means that they will makes changes on the capital structure. It actuallywill increase the firm value by taking cash out of manager’s hands andreturning it to shareholders (Bethel & Liebeskind, 1993).
According toJensen, financial restructuring not only reduce the ability of manager to overexpand and over diversify the firm but also force the manager to increase theiroperating efficiency and also sell off all the unprofitable business. As weknow, the excessive cash is not good for the company. Therefore, when thecompany sell off the unprofitable business and get the excess amount of cash,the manager can use the cash to pay dividends and also issue more new debt tothe company so that the company has more funds to generate the company profit.
Another restructuring is portfolio restructuring,which involves changes in the size and the mix of business of diversifiedfirms. It allows the company to focus the core business and raise more fundneeded from the business. According to Bowman and Singh, most of the largefirms in United States restructured their portfolio in some way because theywant to reduce the unrelated diversification and focus on their firm’s businessportfolios around core capabilities (Bethel & Liebeskind, 1993). When thediversification is reversed, it actually will increase the company value.
Thisis because when the company down size within the line of business, it actuallycut down the unnecessary cost for example the company is cut back the laborcost and also the operating cost of the diversified business. Mergerand Acquisition Issue versus Corporate Restructuring TheoryKuantan Flour Mills berhad is facing merger andacquisition problem therefore they want to restructure their company since thecompany experienced a very long period of profit loss. It really takes time topropose a restructuring plan. Kuantan Flour Mills berhad use a lot of time toprepare the restructuring plan because it has a lot of issues that need todiscuss and have a mutual agreement with both company. As we know LotusEssential Sdn Bhd become the placement investor of Kuantan Flour Mills berhad.In this matter, Lotus Essential Sdn Bhd cannot make the decision by itself butit needs to go through all the shareholder of the company so do the KuantanFlour Mills berhad. From the theory, we know that restructuring is related withthe financial restructuring. It this case, it has been proved the theory.
Whenthe Lotus Essential Sdn Bhd become one of the owner of Kuantan Flour Millsberhad, the financial structure and operating structure has been changed. Itstarted to get equity fund raising exercise with a right issue and specialissue of its share and also collaborate with Lotus to carry the businessoperation. From this case, we understand that corporate restructuring is notonly downsize or sell off the company but also give a chance to the company tosurvive by changing the financial structure and also the operating structure ofthe company in order to get more profit and also increase the value of thecompany. LeverageIssueLeverage is the use of fixed costs in a company’s coststructure (Clayman, et al., 2012). The fixed operatingcosts create operating leverage while the fixed financial costs createfinancial leverage.
It also can be defined as the mixed between the fixed costas variable cost. It is very important because it will help a company to driveup the profit and also maximize the firm value. Other than that, it also veryhelpful in forecasting the cash flow. However, leverage will increase thevolatility of the company’s earnings and the cash flow at the same time it willincrease the risk of the company, which include credit risk, business risk andso on. There are two types of leverage which are operating leverage andfinancial leverage. We can measure the degree of operating leverage by usingthe percentage change of operating profit divided by the percentage change inunit sold.
The financial leverage is related with the financial cost. Accordingto Brigham and Ehrhardt (2008), financial leverage is the portion of a firm’sassets financed with debt instead of equity. From the article, we also know thatthe use of debt or financial leverage concentrates the firm’s business risk onits stockholders because the debt holders who received fixed interest payments,bear none of the business risk (Cekrezi, 2013). Kuantan Flour Mills berhad has an issue which relatedwith imbalance of debt and equity. From the financial statement, we know thatthere are too much of current liability to the company and the total equitydeclined drastically until have a negative value of total equity. Due to thecompany facing the negative value of equity, the company have to use debt tooperate the business.
In this condition, the company almost facing bankruptcybecause it has too much of debt and unable to repay it. The negative value oftotal equity is due to the poor financial performance and also the resignationof director. Trade-offTheoryIn this imperfect market, companies try to get thebest, the optimal and value-maximizing debt to equity ratio by traded off theadvantages of debt to the disadvantages of debt. It is normal to a firm to seta target debt-to equity ratio so that they have a motivation to move forwardsand achieve the target. According to Anila Cekrezi, the trade-off theory is adevelopment of Modigliani and Miller theorem but taking consideration theeffects of taxes and bankruptcy costs (Cekrezi, 2013). As we know, there are two componentsto form a capital structure which are debt and equity. This theory is focus onthe advantages of debt which in an optimal level to maximize the value of thefirm.
In other words, this theory stated that companies have an incentive toturn to debt as the generation of annual profits allows benefiting from thedebt tax shields (Serrasquiero & Ana, 2012). The most importantgoal of this theory is the company choose the suitable funding method whichfund by using combination of debt and equity without depends on single source.Based on the theory, there is an advantage when the company choose the debtfinancing because of the tax shield. However, it is the cost which the companyhave to pay is the interest payment. According to Brealey and Myers, financialmanagers often think of the firm’s debt-equity decision as a trade-off betweeninterest tax shield and the costs of financial distress (Cekrezi, 2013). In other words, when the companyunable to repay the obligation, it would be the cost of financial distress andit could be a possibility of bankruptcy to the company. Therefore, the companies which are stable on handlingdebt, have tangible assets and plenty of taxable income should use the debtfinancing to shield out the tax and get a high target debt ratio.
On the otherhand, the companies which have less profit or have a loss profit, they shouldrely on the equity financing so that they can minimize the possibility ofbankruptcy which due to unable to pay back the debt. LeverageIssue versus Trade-off TheoryKuantan Flour Mills berhad is listed in pn17 since2015. This is due to the shareholders’ equity of the company is less than 25%or less of the paid-up capital. Apparently, the company has facing leverageissue which having the high debt and negative value of equity. From the theory,we know that the company should use the optimal capital structure so that thecompany can maximize the value of the company. However, Kuantan Flour Millsberhad seems like imbalance in the capital structure. As we know, it has facingthe eight years of loss profit. We can said that the company is unprofitable.
Based on the theory, the firm which is unprofitable should use the equityfinancing to operate their business so that it can minimize the risk ofbankruptcy. To overcome and minimize the possibility of bankruptcy, the firmshould balance up the capital structure. The company should lower down the debtlevel so that the company no need to pay more interest of the debt. On theother hand, they need to raise fund from the shareholders so that it canbalance up the capital structure at the same time it also can increase the firmvalue.
Therefore, in order to maximize the value and minimize the risk ofKuantan Flour Mills berhad, the company should get an optimal capital structureso that they have a target to move towards until they get the desired debt toequity ratio. .