A CRITICAL ASSESSMENT OF THE USE OF CAPITAL RATIOS IN A GROUP INSURANCE STRUCTURE FOR LOCAL OPERATIONAL DECISION-MAKING EFFECTIVENESS by Name Course Professor’s Name Institution Location of Institution Date Executive Summary The paper will make a valuation of the use of capital ratios in group structure for local operational decision making effectiveness. The paper will mainly focus on AIG Inc. which is a corporation whose headquarters are based in the United States. In addition, the paper will rely on the ratio analysis when making an analysis of AIG Company. Some of the ratios that will be used in the evaluation process include the operating efficiency ratios, the leverage ratios, the profitability ratios, the working capital ratios and the profitability ratio.
In the end, the paper will offer a detailed conclusion and recommendation that sums up the ideas that have been presented in the essay. Moreover, the paper will provide some of the methods that can be used by the organisation to enhance its performance. The essay can be relied upon by stakeholders when forming an opinion about AIG Company. Introduction Capital ratios are tools that help to evaluate the overall financial condition of any institutions. The ratios can be useful tools for making comparisons between various industries. The financial ratios enable the financial managers to spot the company’s trends and make necessary adjustments in an event that a business is not performing well.
Part 1 A Critical Assessment of the Use of Capital Ratios The performance assessment is based on judgement and observation: an evaluator observes a product or performance and makes a decision based on the quality. The company’s performance assessment comprises of event-driven and periodically scheduled assessments. Because the assessment is performed on regular basis either quarterly or annually they are critical in the international sustainability context. For any firm whether large, mid-sized and small it is critical for the stakeholder and management to know the weaknesses and strength of the business. The financial ratios being a performance assessment tool provides various answers to numerous questions that surround a business.
There are numerous financial ratios that can offer an overview of business performance. The performance assessment entails the valuation of financial data alongside other information to aid in the decision-making process. Tools of performance assessment for instance financial analysis can be used by respective institutions to gauge certain factors such as credit policies and the efficiency of operations and externally to evaluate the potential creditworthiness and potential investment of the borrowers (Bauman and Francis 2015). The analysts in the international business arena can draw the financial data from numerous sources. The sources of information include the business disclosures and financial reports. The annual report contains all the financial statements and disclosures that guide the stakeholders when making a decision about the company.
For tools of performance assessment such as ratio analysis to be reliable then they must be calculated using accurate and reliable financial information. Any sustainable business demands financial management and effective planning. The analysis of ratios remains to be a crucial management tool that ultimately improves the understanding of the financial trends and results over time. The management relies on the financial ratios to pinpoint the weaknesses and strength from which the initiatives and strategies can be formed. The business owners also rely on the financial ratios to measure the performance of the company against other companies. The ratios tend to reveal the interrelationship between numerous figures that in turn enable the analysts in making future projections about a business.
Through the financial ratios, an analysis can be made on the accounting information that is presented by a company which tends to be historical in nature. The observation of the business trends can be effective in forecasting, controlling and planning (Elliott 2017). The ratios play a critical role in making a comparison between the organisation’s present and past performance, while they also play a critical role in comparing one business with others in the industry. The financial ratios are just supplementary to the figures that have been extracted from the balance sheet and the income statement, but they provide a true story about a business. Through the financial statements, a business is able to perform better and find good prospects.
Part II AIG Ltd AIG Inc. is an international company AIG ltd was established in 1919 and up to now, it is one of the leading insurance company in the world. At the present, the organisation boasts of over 85 million clients that are distributed in more than 130 nations (About AIG Company 2018). The company’s core businesses entail consumer insurance and commercial insurance as well as other operations. The consumer insurance entails four modules: personal insurance, life insurance, group retirement and individual retirement.
The commercial insurance entails two modules special risk and property and liability and financial lines. The firm employs about 57000 persons that are distributed all over the globe. The institution generates a revenue that is estimated to be 64 billion from all these businesses that are distributed around the world, with about thirty percent of the revenue coming from outside Canada and the United States (About AIG Company 2018). AIG and its subsidiary firms have approximately 180 offices in the United States as 500 offices that are distributed in 70 countries. The organisation organises its operations in three major geographical regions: Africa, Middle East, Europe and Pacific/Asia (About AIG Company 2018). The company retails with its customer through career and independent direct consumer insurance, retail banks and insurance agents.
The organisation distributes its product every way possible from direct to consumers, banks, financial advisers, independent agents and specialty brokers. Financial Ratios The Liquidity Ratio The ratio lays focus on the available cash that can be used to manage the day to day business operations. The ratio basically measures the organisation’s ability to settle the short-term obligations with much ease and according to the already established agreement (Elliott 2017). The three common ratios include the current ratio, the cash ratio, and the quick ratio. A firm must ensure that it has enough funds to pay expenses, bills, and salaries on time. The failure by any firm to pay the loans can limit a company’s ability to access to future credit and therefore the ability to leverage growth and operations.
From the financial statements, AIG Inc. manages its liquidity prudently through stress testing, procedures and policies and risk committees (Horngren, Sundem, and Elliott 2014). The liquidity framework is mandated to manage the liquidity in the subsidiaries and parent company. Current Ratio The ratio measures how swiftly an institution can repay the current debts by the use of current asses.
The most desirable ratio is usually 2:1 (Bauman and Francis 2015). In an event that the ratio is below 1, it might indicate liquidity problems. A very high ratio, on the other hand, can indicate the institution holds too many assets that are not put to use. AIG Inc.
Current Ratio Current ratio 2017 2016 Current asset/Current liabilities 71148/282105=0.252 63029/275120=0.229 Source (Annual Report 2017) From the current ratio, the organisation does not have enough current assets to effectively pay the arrears when they fall due. The ratio indicates that the current assets exceed the liabilities a factor that is not desirable. For AG to be operating efficiently them the ratio must be above 2:1. The Cash Ratio The cash ratio estimates whether an institution has enough funds or cash to settle the current debts. In this case, the business should just hold enough funds to settle thee short-term obligations (Schonfeld ; Associates 2015). Having too little cash is considered ineffective because the institution will have limited funds to finance its day to day business processes.
On the other hand, holding too much cash is also at risk and indicates that an institution is ineffective in its cash management. Cash ratio 2017 2016 Cash/Current liabilities 2362/282105=0.00837 1868/275120=0.00679 Source (Annual Report 2017) AIG’s current ratio also indicates undesirable trend because current liabilities exceed the cash. The trend is risky because it raises suspicion on the company’s ability to repay the current arrears when they fall due. The ratio also shows that the company does not have enough cash to run its day to day business operations. The Quick Ratio The quick ratio estimates how well an institution can repay the arrears using current assets but after deducting the stock. The ideal quick ratio should be 1:1.
A ratio below this is risky because it shows that a business might not settle the arrears when they fall due. A higher ratio is also risky because it indicates that the business has many idle assets (Ciuhureanu 2017). Current ratio 2017 2016 Current asset-stock/Current liabilities (71148-0)/ 282105=0.252 63029/275120=0.229 Source (Annual Report 2017) The quick ratio indicates that AIG Inc. is operating below average. The ratio falls short of the required 1:1 threshold.
From the ratio, it is impossible for the company to repay its short-term debts by the use of the current assets when all the stocks have been eliminated. From the ratio, AIG is an undesirable or riskier avenue for investment. The Leverage Ratio The ratio reveals the extent to which an institution utilises the borrowed funds. The lenders will most often rely on this ratio to determine whether a company holds enough funds to repay the debt owed (Umurzakov 2017).
The leverage ratio is critical because AIG Inc. relies on both the debt and equity to finance and knowing the exact amount of debt held can be critical in identifying whether the firm can pay the debts as soon as they fall due. The Debt to Equity Ratio The ratio compares the capital invested by funders and owners, which entails the funds and the grand offered by the lenders. The lenders have more priorities when compared to the ordinary shareholders. The leverage ratio enables lenders to identify if there is any cushion to draw upon in the event of financial crisis.
Debt to Equity 2017 2016 Total Debts/Equity 432,593/ 65,708=6.58 421,406/ 76,858=5.48 Source (Annual Report 2017) The debt to equity ratio indicates that AIG is highly geared. This men’s that the organisation is financed more than equity. In addition, the ratio increased from 5.48 in 2016 to 6.58 in 2017. The trend is adverse because the organisation will spend huge sums of money servicing debts.
The ratio might scare away potential investors and the business might not have adequate funds to finance operations in future. The Debt to Asset Ratio The debt to asset ratio assesses a link between the debts that are held by an organised and its assets. For the ratio to be desirable then a business should have more assets when compared to the debts that are held (Islam 2014). The ratio also measures the exact amount of debt that is used to finance the debts of a company. The debt to asset ratio 2017 2016 Debt/Total assets 282105/ 498301=0.56 275120/498264=0.55 Source (Annual Report 2017) The ratio indicates the organisation is financed by more debts relative to equity.
The ratio is below one an indicator that AIG can repay its obligations by selling some of the assets. The ratio also improved from 0.55 in 2016 to 0.56 in 2017 an indicator that the company’s asset base improved. Debt to Capital The ratio compares an organisation’s total debt held to its capital. In other words, the ratio can indicate the percentage of debt a firm can use to finance the operations when compared to the capital held (Du 2017).
Debt to Capital 2017 2016 Total debt / Capital (debt-equity) 282105/(282105+65708)=0.811 275120/(282105+76858)=0.766 Source (Annual Report 2017) The debt to capital ratio indicates that the sum of liabilities exceeds the debts that are held by the company. The ratio is also below 1 implying that the level of debt is manageable and AIG is considered to be less risky. In an event that a firm is financed by more debt more funds are always directed to debt servicing a factor that will reduce the amount of money to be paid to ordinary shareholders. Profitability Ratio The ratio measures the business’s ability to raise revenue relative to other overheads and other costs. For the company to be desirable a company must have more profits relative to the expenses or the firm must have a rising ratio from the previous period. Gross Profit Margin Ratio The ratio highlights the financial health of an organisation as it reveals the amount of money that is left for over from the revenues after accounting for the cost of goods sold (Azzali and Mazza 2014).
A company with a higher or rising gross margin ratio is taken to be desirable. Gross profit margin 2017 2016 Gross profit/Sales 6849/ 49520=0.13 5236/ 52367=0.09 Source (Annual Report 2017) The company’s gross profit margin increased from 0.09 in 2016 to 0.13 in 2017. The rise is an indicator of the amount of money that is left after deducting the cost of goods sold is rising. The rise also indicates that the management is becoming efficient in the management of the gross profit. Operating Profit Margin Ratio The ratio reveals the amount of revenue that is left after deducting the variable costs, for instance, raw material and wages. The ratio is also expressed as a percentage of sales and it shows the ability of an institution to control the expenses and costs associated with the business operations.
The ratio is vital to the investors and creditors because it enables them to who how profitable an institution is. Operating profit margin ratio 2017 2016 Operating Income/Revenue 2561/ 49520=0.05 715/ 52367=0.01 Source (Annual Report, 2017, p.167) AIG operating income increased from 0.01 in 2016 to 0.05 in 2017. The rise is an indicator that the company’s operating income is increasing which is a positive trend. The ratio indicates AIG’s management is increasingly becoming effective in the management of expenses that result from the business operations. The Net Profit Margin The ratio shows how much profit is left after all expenses have been deducted. The higher the ratio the more profitable and organisation is (Florou, Morricone, and Pope 2017).
The ratio can show the amount of revenue that an organisation can extract the total revenue. The ratio can indicate the general success of a particular business. When the ratio is high it indicates that the business has priced its commodities effectively. The net profit margin 2017 2016 Net profit/Sales – 6084/ 49520=-0.12 – 849/ 52367=-0.03 Source (Annual Report 2017) AIG Company generated losses in the two years. Amount of losses seems to be rising.
From the ratio, it is indicative that the organisation has overpriced its commodities and the strategies that have been put forth are not yielding positive results. The management should cut down on the expenses if it aims at increasing the profit that is generated. Operating Returns The operating margin measures the amount of profit that a business raise. Asset Turnover Ratio The ratio measures the amount of revenue that a company’s assets generate (Lambert 2017). A higher ratio will mean that the assets are being utilised efficiently to generate sales while a lower ratio implies that the business is holding more assets or they are simply being underutilised. Asset Turnover Ratio Asset turnover ratio 2017 2016 Sales/Assets 71148/ 49520=1.44 52367/63029=0.83 Source (Annual Report 2017) From the ratio AIG is underutilising is assets.
In 2016 the total revenue assets exceeded the total revue which is a poor indicator as it shows that either the company holding many unnecessary assets or they are simply being underutilised. In 2017 the number of sales generated by the assets increased to 71148 which is still low. The Return on Equity The ratio indicates the amount of profit that each unit of capital that invested in an organisation generates (Wagenhofer 2016). The ratio can offer a glimpse of how the management is using the finances to generate revenue.
A higher ratio can indicate that the company is generating more revenue for the ordinary shareholders. In contrast, a decline in return on equity can mean that the management is making poor decisions with regard to investments. Return on Equity 2017 2016 Net income/Total equity -6084/ 65708=-0.093 -849/ 76858=-0.011 Source (Annual Report 2017) The ratio indicates that AIG is performing poorly in terms of generating profit to the ordinary shareholders. In 2016 the company generated a net loss of 0.011 on each unit capital available in the organisation.
In 2017 the net loss on each unit of the stock increased further to 0.093. From the ratio, it is true that the policies put forth by the management have failed to yield the anticipated results. The Working Capital Ratio The ratio measures if a business has enough money to fund the day to day business operation of a business. A higher ratio means that a company has enough funds to finance the operations.
The Account Receivable Ratio The ratio indicates the number of times a company collects the debts. The ratio also measures also indicates the efficiency at which the management can give debts and later on retrieve them (Easton 2016). A low account receivable ratio can show that a firm has too many bad debts. Account Receivable 2017 2016 Sales/Account receivable 49520/0=49520 52367/0=52367 Source (Annual Report 2017) The ratio indicates that the business does not operate on credit basis because it lacks the account receivables. The ratio also indicates that the business receives all the cash from the clients. The strategy is appropriate because the chances of bad debts are reduced.
Recommendation The financial statement indicates that the company’s revenue has been declining in the past two years. The revenue declined by 11 percent to 52.4 billion dollars in 2016. The decline was as a result of deterioration in the policy fees, premiums, as well as the net, realised capital losses. The cash flow statement also indicated a declining by over 17 percent to 2.4 billion dollars. The decline was because of the net losses over the years. To change the declining trend the company should dispose of all the assets that do not generate any revenue.
The asset to sales ratio indicates that the business holds excess assets that do not contribute to profit generation. The company should dispose of assets that do not contribute to its profits. Going forward the company’s main objective should enhance the returns on equity by improving the operations efficiency and legal entity structure. The company must also improve the business portfolio by improving data analytics to provide better underwriting and pricing.
The company should also focus on expanding in the growing markets such as China if it aims a growing its revenue. The company can intensification revenue base by increasing the number of mergers. The acquisitions should main target the emerging markets as this will give the firm a quicker chance to grow. In addition, AIG should stop relying on debt to finance operations because they increase the costs. The management should always be receptive to change in the market as this will give the company the opportunity to grow.
The company can expand the current utilisation of insurance to improve the capital efficiencies. It is also important to narrow the geographical footprints while at the same time improving the global capabilities. At the moment the company’s ability to raise more profit to the ordinary shareholders is governed by two main factors: meeting regulatory capital requirements and managing the creditworthiness. References Aig.co.ke. (2018). About Us – Insurance from AIG in Kenya.
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