New Conservative Financial Framework Essay Example Pdf

BP is undertaking a conservative financial framework which they think flexible to execute strategy and programs while remaining resilient to the inherent risk of the business. The conservative capital structure is demonstrated in the table shows that in approximately 68% of the source of funds come from internal capital injected by the shareholders in 2010. The significant drop from 74.6% in 2009 is explained by the debt increment and liquidity problems in resolving the oil spill issue in the Gulf of Mexico. In effort to maintain a significant liquidity buffer, BP intends to reduce their net debt ratio to within a range of 10-20% from the previous target of 20-30%. The Gulf of Mexico oil spill catastrophe has poses a serious reputational damage on BP as well as its financials. Following the incident, the group was required to make substantial cash payments and compensation in relation to the oil spill. BP has established a trust fund of $ 20 billion to satisfy legitimate claims by parties affected (government, business and individual) and restore the damaged environment which is to be funded over the period to the end of financial year 2013. Besides, to increase the company’s cash resources, the company has sold off up to $ 30 billion of assets to meet its financial obligation after taking a pre-tax charge of $ 40.9 billion in relation to the accident.

Statistics of BP’s business performance

2010 2009 Capital Structure Debt 32.3% Debt 25.4% Equity 67.7% Equity 74.6% Net Debt Ratio 21.0% 20.0% Current Ratio 1.15 1.14 Capital Expenditure $ 18,421 million $ 20,650 million There is a significant decrease in capital expenditure from $ 20,650 million in 2009 to $ 18,421 million in 2010 attributed to the loss suffered from the oil spill incident. However, the group further enhance its position through mergers and acquisition activities for long term growth. The funding of increased capital expenditure and acquisition was achieved by the disposal of assets of $ 17 billion in 2010 as well as supported by the internal resources, bringing the net investment decreased to $ 3,960 million in 2010 from $ 18,133 million in 2009. The disposal proceeds may lower the group’s debt level while sustaining a liquid position to remain competitive among the peers. Apart from that, they have cut back on discretionary capital spending and secured additional credit lines. The board of BP has taken a bold measure to cancel three dividend payments in 2010 to protect the company and secure its long-term future and would recommence in 2011. Financing Activities The group finance operations with US dollar debt, or by using currency swap when funds have been raised in currencies other than US dollars. The group finance debt at 31 December 2010 was recorded at $ 45.3 billion ($ 34.6 billion in 2009). Of the total amount, $ 14.6 billion is classified as short term debt ($ 9.1 billion in 2009). BP has financed its short term obligations through the issuing of commercial papers in US and Europe to provide flexibility. BP maintains a strong cash position to ensure that the firm always has the flexibility to meet future financial obligations and reflects a prudent approach in managing company’s liquidity requirement. Cash balances are pooled centrally and cash surpluses are deposited with highly reputable banks and invested in money market funds with short maturities to ensure availability. At 31 December 2010, the group has a balance of undrawn committed borrowing facilities of $ 12.5 billion ($ 5 billion in 2009) which is made up of $ 5.3 billion of standby facilities and $ 7.2 billion of 364-days facilities. Following the Gulf of Mexico oil spill, Moody’s Investors Service and Standard & Poor’s (S&P) downgraded the group’s long term credit ratings from stable outlook to negative outlook. The announcement shod the confidence of the investors in BP’s US Industrial Revenue/ Municipal bonds and in bonds related with long term gas supply contracts. They exercised the options to tender the bonds for repayment and the group has to fork out $ 4 billion to repay the investors, with BP either holding or retiring the bonds. In response to that, BP secured additional bank links totalling $ 12 billion and announced the momentary deferral of quarterly dividend payments. Besides, $ 17 billion was raised through the disposable program in 2010 and another $ 4.6 billion was raised during the third quarter from syndicated bank loans backed by future crude oil sales over a five year period. Bonds worth $ 6.25 billion with maturities between four and ten years were issued in US and European capital market. The group has in place a European Debt Issuance Program (DIP) of which the group may raise up to $ 20 billion of short-term debt with maturities of one month or longer. Besides, the group has also in place an unlimited US Shelf Registration which allows similar financing as DIP. Financial Risks Management The group is exposed to a number of financial arising from the nature of business such as market risk from volatility of commodity prices, foreign exchange rate fluctuations, interest rate risks, credit risks and liquidity risks. Financial risk committee (GFRC) was established to act as the advisor for the group chief financial officer (CFO) who oversees the management of the aforementioned risks. It also plays its role as an advisory body which formulate the financial risk governance framework for the company. Market risk and commodity price risk are the uncertainty arising from the volatility of market price movements and their impact on future performance of the business. These risks are deemed to be the most concerned for BP as their business performance depends on the prices of commodity instruments: oil, natural gas and power. Value-at-risk techniques are used to measure market risk while price risk is hedge by using oil and natural gas swap, options and futures. The group uses derivatives financial instruments to hedge against the exposure of foreign currency exchange rates, interest rates and commodity prices. The basic hedge strategies against the foreign exchange rate exposure undertaken by the group are currency forwards, futures and cylinders. The group aims to keep the 12-month foreign currency value at risk below $ 200 million and the foreign currency value at risk was $ 81 million at 31 December 2010, far below the threshold level. Some measures taken to mitigate credit exposure are netting arrangement, credit support agreements that require the counterparty to provide collateral, take up credit insurance and other risk transfer instruments. To avoid concentration risks and ensure that cash is well diversified, more than 80% of the group’s cash and equivalents balance was deposited with financial institutions rated A+ or higher at 31 December 2010.

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