About the paper
The paper is commissioned to discuss the short-term debt scenario, foreign exchange risk management process and trends in the financial ratios of Arrow Electronics Limited. In order to achieve a desired outcome in the paper, we will comprehensively analyze the financial statements and accompanying notes provided in the latest annual report of the company, so released on 5th February, 2015.
Advantages and Disadvantages of sources of short-term finance
i) Bank Loans
Advantages:
No dilution of ownership
Tax advantages because of interest deductibility
No interference in managerial decisions
Option to opt for fixed or adjustable interest rate loans
Disadvantages:
High cost of debt
Obligation to pay timely interest and principal payments
High risk of bankruptcy and loss of corporate image in the event of non-payment
ii) Lines of Credit
Advantages:
No dilution of ownership
High flexibility over the use of funds allotted by the financial institution
Significant assistance to meet working capital needs
Disadvantages:
Requires the borrower to pay an upfront fee to obtain the line
Obligation to pay funds used on time or face high penal interest, compounded on a daily basis
iii) Commercial Paper
Advantages:
Term-based flexibility
Low borrowing cost
Disadvantages:
Limited eligibility
Reduced availability because of strict oversight of Security and Exchange Commission(SEC)
Income Statement
Balance Sheet
Sources of short-term debt
Referring to Note-6 of the financial statement we found that over the year, the amount of short-term debt has reduced drastically from $23,878 million to $13,454 million. The company has also disclosed that the entire amount of short-term borrowings was used exclusively for supporting working capital requirement at international locations. As for the sources of short-term debt, the company has disclosed that it has borrowed short-term funds from various countries and owes a revolving credit facility worth $1.5 million, which it uses for meeting working capital obligations. Apart from this, no information has been provided for the sources of short-term borrowings.
The weighted average interest rate of short term borrowings for 2014 was 3.8%.
Foreign Exchange Risk Management
Since Arrow Electronics Limited is a multinational entity, it is largely exposed to foreign exchange risk. However, it prudently managed the foreign exchange risk using foreign exchange based contracts such as, foreign exchange forward, options and swaps to mitigate the impact of foreign exchange risk. Important to note, these are the derivative contracts that are used by the company to hedge the respective foreign exchange at the time of purchase or sale of inventory by the company with payments to be made or received over a period of six month. Henceforth, in order to hedge their foreign exchange exposure and to avoid any foreign exchange associated risk, the company enters into foreign exchange contracts.
Tax Rate and after tax short-term debt rate
i) Effective Tax Rate: (Provision for tax rate/ Income before tax rate)
= 185/683
= 27.09%
ii) After tax short-term debt rate: Weighted before-tax short-term debt rate*(1-tax rate)
= 0.038*(1-0.2709)
= 2.77%
Trends in Working Capital Investment
For the purpose of evaluation of trends in the working capital investment of the company, we analyzed the investment in current assets and trends in current liabilities over the period of past two (2) years, and found the following results:
Referring to the above table, we witness that over the year the amount of working capital has reduced from $3284 million to $3195 million, a decrease of $89 million in the amount of working capital investment.
Financial Ratios
This section is attributed to the calculation of multiple financial ratios of Arrow Electronics Limited for the past three years and a relevant discussion of the trend analyzed. While the calculations can be accessed in the excel file attached to the report, the final outcome of each ratio sections follows hereunder:
-Liquidity Ratio
i) Current Ratio: Current Assets/ Current Liabilities
ii) Quick Ratio: Cash+ Receivables/ Current Liabilties
As noted from the above figures, the liquidity position of the company has witnessed a tidal trend over the past three years. As with the current ratio, the multiple surged higher in 2013 amid a higher proportionate increase in the current assets by 11.9% relative to 7.98% increase in the current liabilities. However, the trend took an opposite path during 2014 as the current ratio fell again to 1.55 with current liabilities increasing in higher proportion by 10. 11% relative to the current assets that increased by 5.21% only.
We even calculated the stringent liquidity measure of quick ratio and found the similar trend as during 2013, the ratio increased from 1.09 to 1.16 with a higher proportionate increase in cash and receivable position, the very next year it plummeted back to 1.10 with current liabilities increasing by 10.11% relative to 2.30% and 4.75% increase in the cash and receivable position, respectively.
-Profitability Ratios
i) Operating profit margin: Operating profit/ Revenue
ii) Return on Equity: Net Income/Total Equity
Referring to the above figures, we witness that over the years, the company has lost their hold on operating profit margins, although the trends do reveal signs of improvement during 2014. Beginning with the operating profit margin, during 2013, courtesy the increase in the proportion of operating expenses to revenue figures from 9.47% to 9.82%, the multiple fell from 3.94% to 3.25%. However, during 2014, the trend showed a marginal improvement as amid controlled operating cost structure and increase in revenue figures by 6.61%, the operating margin increased marginally from 3.25% to 3.35%.
We also analyzed the profitability of the company from the perspective of the equity shareholders and found that during 2013, the company failed to generate a sustainable momentum in the ROE multiple with the multiple decreasing from 12.70 % to 9.55% amid significant fall in the net profit figures by 21.35% while the shareholder equity continued to rise. However, the company managed to perform well during 2014 and the increase in net profit figures by 24.81% had a repercussion in the form of higher ROE multiple, so recorded at 11.99%.
Leverage Ratio
i) Debt-Equity Ratio: Total Debt/ Total Equity
ii) Financial Leverage: Total Assets/ Total Equity
iii) Times interest earned: Operating income/Interest expense
Leverage ratios provide us with the insight into the capital structure of the company and assist in evaluating the level of risk embedded in it. Referring to the above calculations we can see that during 2013, Arrow Electronics opted for high level of debt structure and the same is validated by the increasing trend in debt-equity ratio and financial leverage ratio. However, what may turn the analyst skeptical is the declining interest coverage ratio during 2013. It is considerable that during the time of increased reliance on debt borrowings, a decline in interest coverage ratio indicates impotency in the company’s ability to honor debt related obligations.
However, during 2014, while the company reduced its reliance on debt level, it also managed to increase its interest coverage ratio, thus neutralizing the whole situation, and confirming a sustainable solvency position altogether.
Asset Management Ratios
i) Inventory Turnover Ratio: Cost of goods sold/ Inventory
As the name implies, inventory turnover ratio indicates how well the management is able to formulate policies to speed up the inventory sales. Referring to the above figure, we notice a pessimistic trend with the inventory turnover ratio declining year-by-year. This indicates that it now takes more time for the company to sell its inventory, and hence the capital is tied up in the inventory level for a longer period of time.
Market based ratios
i) PE ratio: Year end price per share/ EPS
ii) Dividend Yield: Dividend per share/ Year end price per share
* Arrow Electronics Limited does not pay any dividend
PE ratio is one of the widely use market based ratio in the invest community to unearth the investment opportunity hidden in the stock and to judge the investors’ sentiments towards the future earning potential of the company. As noted from the above figures, during 2013, PE ratio of the company surged from 8.44 to 13.95 indicating towards strong expectations of the investor for the future growth potential of the company. However, although during 2014, company did recorded a strong growth in the net income figures, but still it could not stood well on the investor’s expectations and witnessed a resultant all in the PE ratio from 13.95 to 11.37.
