COURSE WORK 2

NAME: MD. SAKIB RAHMAN

ID: 100471212

MODULE NAME:
FINANCIAL STRATEGY
MODULE CODE: 6AG522
TRIMESTER: T1 AUTUMN
2018
SUBMISSION DATE:
 Course work 2

1) (a) Appraise Engie’s capital structure using the tools discussed in the module.

Answer:

Capital structure of the Engie’s on the basis of financial tools can be reviewed as:
i. Debt-Equity Ratio
ii. Equity Ratio: Shareholders Equity/ Total capital employed
iii. Debt Ratio: Total Debt/ Total Capital employed

As per the capital structure given in the sheet, we can review and determine the effectiveness of
the capital structure of the company.

As per the table, the total structure of company is:

Particulars 2017 2016

Equity 42,577 45,447

Total Non current
liabilities 52,960 55,461
Current Liabilities 54,795 57,591

Capital employed 95,537 100,908

Now we can evaluate and appraise capital structure on the basis of the financial ratio’s as we
explained above.

Debt Equity Ratio 2.53 2.49

Equity Ratio 0.45 0.45

Debt Ratio 1.13 1.12

Debt equity ratio: A debt equity ratio simply illustrates that a company’s liquidity. So suppose a
company is in higher debt then the working capital of the company will be reduced and the
business of the company may lead to downside. But if the other side the equity is higher than the
return to the shareholders will be given on the profit portion and can also be debarred for some
period. So, a debt equity ratio helps to understand the viability of the future.

As per the above table, the debt equity ratio of the company in 2016 was 2.49 and which is even
higher in 2017 to 2.53 which means that the company is been overburden with debt. In case of
solvency the company may liquidate and have to repay the funds of the debt holders.

Equity Ratio: It shows that the contribution of the equity holders in the total capital structure of
the company. Where the capital structure means that the company overall fund management and
the source for funding of capital expenditure and planning. So, equity ratio states the owner’s
fund and should be higher to 1. But as shown in the above table, the equity ratio in the total
capital is 0.45, which means that not even 50% contribution to total capital employed by the
company. This tells you that the company has financed 45% of its assets with shareholder equity,
meaning that 65% is debt funded.

Debt Ratio: This ratio shows that how much cash has been carried in terms of loans from the
different sources. If the debt ratio is higher than the other sources then the company should
monitor and find the factors to reduce the same. Currently the ratio is 1.13 which should be less
than 1. This ratio illustrates the higher interest liability of the company in terms of short and long
term.

1. b.) Critically evaluate theoretical advantages and disadvantages of the company’s capital
structure with regards to the debt and equity structure of the business. How these advantages and
disadvantages apply to the specific company? Your answer must be accompanied by significant
evidence from the literature
Answer 1b:

Capital structure should not be governed by one and should also not be over flow from one
source. Capital structure should be balance in terms of long term/ short term, it should be source
via Equity/Debt funds, it should be source from different ideas like, bonds, debentures, deposits
and can also be in nature of different rates.

So, theoretically the advantage and disadvantage of capital structure are as follows:

Advantage:

- The existing shareholders are allowed to take the higher share as the debt financing in the
company is higher than equity. So the existing shareholders get the higher benefit.
- A less members in board will help Engie to make a good strategic decision vs.
intervention of more shareholders
- Although the debt liability of the company is higher but it is subject to the repayment
period, i.e. once it is been paid then there is no obligation;
- Interest rate is less than the expected return of the company , which may be at any
number of percentage in the profit for the company;
- The interest expense is also an expense subject to tax so it is benefit for the company to
show the financial movement.

Disadvantage:

- Since the company is higher in debt funds so the company has a burden to pay monthly
instalment payments even if the cash flow doesn’t allow;
- If the instalments are not paid then the company can face the penalty clause with the
stakeholders and even solvency can be challenged;
- Since the debt ratio is higher so the company will always be treated at higher risk at any
moment of time;
- Debt will not allow the company to take decision for expansion or any progress for the
company as the reserves will be given to the debt holders vs. the strategy for expansion

As per the above description the advantage and disadvantage of the company will be specific to
Engie’s capital structure as it is more driven by debt financing than the equity finance structure.
So, if it could have been equity structured the definition could have been changed.
2) (a.) Assess the above company from a short-term financing perspective and comment on the
application of the matching principle. What conclusions can you draw, how are they linked with
the academic literature?

Answer 2a:

As per the table below:

Particulars 2017 2016

Equity 42,577 45,447

Total Non current
liabilities 52,960 55,461
Current Liabilities 54,795 57,591

Capital employed 95,537 100,908

The company debt structure is higher in terms of short term. The debt equity ratio is 2.53 which
means that the company is already been structured in the terms of the debt and the overall ratio
of the debt ratio to the capital employed is 1.13 which means that company is already in higher
debt position and which should be reduced to the extend which will balance with the standard
capital structure. The scenario where short term financing should be introduced can be seen
when the long term can be reduced and the current liabilities can be introduced to fund for the
working capital. The company should plan a way where the project should be focused by the
reserve of the company or the other funds vs. the long term loans. The current financing can help
the company to plan for higher business and this can help to increase the surplus for the
company.

In this scenario the matching principle states that the accrued interest revenue and the expense
should be recorded in the books at the end of the period. And the return should be taken only on
realization. The expenses are in the nature of the interest payable for the short term funding and
the realization cost. When the returns are in the process of realization from such funding then the
company should book such expense only when the realization in banks or the proof of return is
been backed off.
As the Engie’s capital structure shows that it is already has huge sources from debt so it can be
planned to move to short term financing but then it first have to reduce the long term finance and
on the repayment of the same then company should take the loan only for the short term working
capital or the project driven so that the repayment will not be long and the commitment can be
fulfilled.

2b) Critically evaluate the potential advantages and disadvantages of the Engie’s strategy around
the working capital and backup your answer with significant evidence from the literature

Answer 2b:

Working capital of the company means, current assets should be higher than the current
liabilities. From the financials of the Engie’s the working capital of the company is:

Particulars 2017 2016

Current Assets 58,161 59,595

Current
Liabilities 54,795 57,591

Working capital 3,366 2,004

The working capital of the company is in positive which means that despite the higher ratio the
working capital of the company is in positive side.

The advantage and disadvantage to this will be:

Advantage:

- The company short term liquidity is payable on time and solvency cannot be challenged;
- The company is able to repay their current obligation and can generate good reserves
from the positive cash flow;
- Short term interest rates are lower than higher so as there is less influence of liabilities so
they can pay them on time;
 - The company is getting loans easily due to better working capital
- Goodwill of the company has been maintained.

Disadvantage:

- The company is operating on the higher long term loans which means that the company’s
working capital can be challenged in the near future;
- The current working capital cannot be financed for the long term projects so instead of
using the money for the new project, the company should be bring in other financial
plans.
- The stakeholders can see that the working capital is in positive so the demand of the
return can be there and long term returns can be on higher rate.
- The funds are not being utilized properly so no return is gained.

So, as per the above points, it can be seen that the company is operating in a debt module so they
should be focusing on increasing working capital so to survive in the business.
References:

1. Academia.edu, 2018, “Advantage & disadvantage of capital structure”, Available from:

https://www.academia.edu/30802722/Advantage_and_Disadvantages_of_a_Capital_Stru
cture
2. Fundamentalof accounting, 2018, “Capital structure ratios”, Available from:
https://www.fundamentalsofaccounting.org/capital-structure-ratios/