Intrinsic Nature of Commodity Business

Question: Discuss about the Intrinsic Nature of Commodity Business. Answer: Introduction The listed company on the ASX that has been chosen for the given analysis of role of CFO or Chief Financial Officer is BHP Billiton which is the one of the largest mining companies not only in Australia but globally. The company has mining assets which are present worldwide and also has presence across a host of minerals led by iron ore, coal, copper (BHP Billiton, 2015). Considering the intrinsic nature of commodity business and the fluctuating prices, it requires prudence on the part of CFO so as to ensure sustained performance by the company in an globally exceptionally dynamic and challenging environment. The given task focuses on highlighting the main responsibilities of the CFO for the selected company. Responsibilities of CFO The three key responsibilities that are associated with the CFO of this company are highlighted below. Capital Budgeting Since, BHP Billiton is a mining company, it always needs to be on the lookout for new mines that provide key minerals due to the depleting reserves of minerals and ores from the current mines. However, since the capital that the company has is typically limited, it requires prudent capital rationing on part of the company so as to ensure that money is invested only in those projects or mines which tend to deliver the highest returns for shareholders. However, this is easier said than done for mining projects because of the host of uncertainties associated with such projects (Brealey, Myers Allen, 2008). The gestation period of these projects is long and so are the capital costs specifically in terms of the dedicated rail infrastructure required to transfer the mining output along with the equipment used in mining. However, the commodity prices tend to change on a real time basis on the basis of the global factors which cannot be controlled by the company. The case in point is the cu rrent slowdown in China which has had an adverse impact on the profitability of the operations due to plummeting prices of key minerals (BHP Billiton, 2015). To add to the overall complexity is the political risk and government regulation since mining as a sector is highly sensitive to government policies related to licensing, royalty and taxation. As a result, of the above issues, the role of CFO is very significant in capital rationing. It is required that CFO guides the team of analysts so that an appropriate estimation of the long term prices can be forecasted for a particular mineral in the wake of the information available. One of the key aspects, where the CFO plays a critical role is in identifying the relevant factors that need to be considered by the analysts and those which are be ignored without compromising on the accuracy of the results obtained. This is imperative or else the parameters to be considered would be so immense that the underlying complexity would render it non-usable. A key tool which the CFO regularly deploys in this process is sensitivity analysis so that the focus could be brought on those factors which are the key determinants of the projects commercial success (Damodaran, 2008). Further, owing to the superior understanding of the CFO with regards to business and commodity markets, the CFO needs to provide critical inputs during the analysis of the projects which reflect his keen business acumen and ensures that the underlying risk is managed. One of the key mechanisms to ensure this is to estimate the underlying risk associated with a particular geography and political establishment which the CFO would be better placed to opine on based on previous experience and the same could determine the overall returns expected from such projects (Parrino Kidwell, 2011). While shortlisting the viable mining assets is just one step, the CFO then acts as one of the leaders in the negotiation process and the suitable valuation that should be given for acquisition for a particular mining asset. In this process, crucial decision needs to be taken particular with regards to financing and timing of acquisition considering the periodic nature of the commodity cycles which pose s additional challenges. However, in all such critical matters, the inputs from CFO provide to be a guiding light which ensures that interests of shareholders are preserved (Petty et. al., 2015) Preparation of Financial Statements For the given company, there is separation of the owners from the management which results in agency relation and hence information needs to be constantly provided to the owners so as to reflect on the performance in various segments so that the investors could take an informed view on the company (Drury, 2008). Besides, the company is listed on two exchanges i.e. London Stock Exchange and Australia Stock Exchange and need to fulfil the various reporting regulations that the exchanges impose along with the other regulatory agencies (BHP Billiton, 2015). Considering the wide span of operations which spread across geography, segments and currencies, this process needs to be done accurately while ensuring compliance with the applicable accounting standards that may be applicable in a given geography (Bhimani et. al., 2008). The CEO plays a critical role and acts as the chief coordinator so as to ensure that the financial statements are prepared in a timely manner and are in compliance with the various regulatory norms. The CEO also maintains connection with the internal audit committee so as to seek their inputs with regards to the key control risks that could be addressed through improvement in the processes. Further, considering the vast geographical spread of the operations of the company, determination of tax liability that may be payable in a particular geography and that which is payable in Australia is a pivotal matter and needs supervision and guidance from the CFO so as to ensure that compliance is achieved and the tax liabilities are kept at a minimum thereby providing highest returns to shareholders (Damodaran, 2008). With regards to audit of the financial statements and the various items, CFO acts as the chief coordinator which provides critical inputs in relation to formulation of the overa ll audit strategy and ensures that the external auditor are able to garner all the relevant information required in a prompt manner thereby ensuring that the incidence of misrepresentation in the financial statements is reduced and also the audit quality is enhanced (Seal, Garrison Noreen, 2012). Corporate Strategy Control Every business has a vision and it is imperative that the corporate strategy in place to achieve this should be viable and optimum. One of the crucial members in regards of the strategy formulation for the near future is the CFO as every action or strategy has financial implications which the CFO is in the best position to comment on owing to his experience and his financial acumen. In this case, decisions may be required to be taken with regards to the minerals that the company should focus on going ahead taking into consideration the likely demand supply mismatch for the same (Brealey, Myers Allen, 2008). Further, certain strategic acquisitions of mining assets or mining companies may be required to be taken which should be aligned with the overall strategy. Also, CFO is in the position to comment on the availability of financial resources and the likely sources to garner more if required based on which the board may finalise strategic priorities for the company (Brigham Ehrhardt , 2013). Further, the CFO tends to outline the various financial benchmarks based on industry standards that aid in the overall control process. The performance of the key executives, operations is compared with these objectives and milestones. An additional tool which ensures the same is budget and this represents the priorities of the business and the CFO plays a critical role in reviewing and authorising the same. The CFO tends to allocate money for those projects which are considered to be pivotal for the company and tends to limit finances in areas that are relatively not significant. Besides, the financing needs arising from any shortfall of the requisite capital is also managed by the CFO along with the support of the financial managers (Bhimani et. al., 2008). Conclusion and Significance The critical role that the CFO plays in the functioning of the company is apparent from some of the key responsibilities that have been outlined above. The CFO ensures that the vision and mission of the company is aptly reflected in the corporate strategy which defines the key priority areas. Once these key priority areas are defined, the CFO defines the various financial milestones and key benchmarks that aid in the performance evaluation from time to time. This process is intrinsically dynamic especially since the mining business has exposure to a plethora of external risk. The various requisite resources are allocated based on the financial priorities and the budget (Brigham Ehrhardt, 2013). Also, to ensure that the growth is sustained, the capital is diverted into acquisition of fresh mining assets that would deliver superior value to the stakeholders. This typically requires a great deal of foresight and business acumen on the CFOs end considering the cost implications and also the gestation period, (Bhimani et. al., 2008). Finally, the performance of the company is reported to the various internal and external stakeholders so as to minimise agency costs and also be in compliance with the applicable regulations (Drury, 2008). For better understanding and analysis of the statement extended, the first step is to introduce the concept of efficient markets which is captured by the concept of Efficient Market Hypothesis (EMH). There are three forms of efficiency in market that this hypothesis advocates. The first is market efficiency in the weak form which advocates the random movement of the stock price and therefore dismisses any utility of predicting stock price movement patterns by deploying technical analysis (Petty et. al., 2015). The second is market efficiency in the semi-strong form which advocates that the stock price adjustment process to any information that enters the market is so swift that no opportunity is provided with regards to initiating trades based on this information, thus reflecting poorly on the utility of fundamental analysis (Damodaran, 2008). The third is market efficiency in the strong form which advocates that all the information at all times is reflected in the actual market pric e and deviations from the intrinsic price are essentially very short lived due to self-correcting mechanism in the efficient markets (Brealey, Myers Allen, 2008). In the markets that tend to adhere to the above features, the pension fund manager need not engage in active portfolio management as trades cannot be initiated based on information or price pattern since the past prices are not a faithful representation of future trends. Further, the stock specific information about the stocks that are included in the portfolio is also not required as trades cannot be initiated without the impact of new information already been captured. Thus, in such an idealistic situation, for a moment it may seem that the given statement is true (Parrino Kidwell, 2011). It is imperative to consider that there are two variants of risk for an investor with exposure to the stock market. One of these is systematic risk which refers to the general market risk and cannot be avoided through any means. However, the unsystematic risk is manageable if the investor tends to diversify the portfolio in a prudent manner. Therefore, it is imperative that the manager of a pension fund should aim to choose a portfolio which reduces the exposure to unsystematic risk. Additionally, the key purpose of an investor who avails pension fund is to ensure that a regular stream of income is received while the preservation of capital is ensured. As a result, the likely choices for inclusion in such a portfolio would be large cap stocks which tend to exhibit less volatility in price and simultaneously offer a smooth and assured income from dividends.(Petty et. al, 2015). Hence, in the event of random choices being made by the manager of pension fund, there is the risk of the po rtfolio not being diversified and hence having unsystematic risk. Also, the selected stocks may not be suitable for the risk appetite and requirements of the users. As a result, it is appropriate that even when the market may be efficient, then also the random selection of stocks using a pin is not justified (Damodaran, 2008). 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