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Financial Modelling

FINANCIAL MODELLING 8

FinancialModelling

GradeCourse

Planningis an essential part of success for any operation, be it a project ora business entity. Financial planning is especially important forbusiness ventures, which are part of the wealth creating mechanismsof many investors today (Eric et al., 2011). However, since planninginvolves a lot of interrelated elements that contribute to orindicate performance levels of organizations, financial modelling hasbecome an important step towards informed financial decision making.Day (2001) gives different categories of activities that might beused to denote the process of financial modelling. They include datagathering, analysis, future performance forecasting, simulation ofall possible scenarios, identification of key influencers ofperformance and others. All these activities are aimed at ensuringthat the decision arrived at is the most accurate and suitable forbusinesses.

Applicabilityof financial modelling in various industries may be of key concern tomany businesses. This essay generally outlines the way in which thissystem may be applied in the merchant navy industry. This is donethrough a case examination of CMA CGM, which is one of the largestcontainer shipping companies in the world. First, it is important toindicate how financial modelling may generally apply to the merchantnavy sector. The industry is constituted of different companies thatdeal in different areas given that commercial shipping also involvesan array of products and mostly, services.

Inmerchant navy, financial modelling may be applied for projectportfolio management, fleet operations management, cost andefficiency focuses and new route ventures among other activitiesrelated to the financial performance of the sector. As trade volumescontinue to grow, shipping will continue to rely on sound financialestimation practices like the financial modelling system for quickdecision making. However, even as many companies are encouraged toadopt this system, it is important to examine some of the strengthsand weaknesses that exist with this type of financial analysis.

Strengthsand Weakness of the System

Firstand obviously, financial modelling presents the best way of gettinginsights on the likely future scenarios for a certain businessproject or venture. As a result, modelling can be said to be a goodtool for quick and informative decision making process (Charnes,2012).Modelling is also a good way of having prior knowledge on the likelyrisks that may be faced by a business and finding ways of eliminatingsuch risks. Models are also a good way of building accurateinformation out of possible assumptions made.

Onthe other hand, the system may have a few cons. For instance,financial modelling involves a process of interrogation through thedevelopment of related spreadsheets that contain the relevant data tobe analyzed (Charnes,2012).This actually requires that those involved are well trained or atleast capable of doing so. Secondly, time is also a factor that isimportant for any modelling exercise to be successful, especiallywhen a new model is being developed. Regardless of the weaknessesnoted, modelling relatively provides a quick option of an all roundfinancial analysis.

CMACGM: Overview

CMACGM is a global conglomerate in the commercial shipping sector,noticeably the third largest in capacity. The French Company mainlyoperates in maritime transportation of containerized cargo to andfrom different port destination of the world. Historically, CMA CGMwas founded by a French Jacques Saadé in the year 1978 initiallyoperating using a single ship. It is only in the year 1999 that thecompany’s full name was coined having merged with CompagnieGénérale Maritime (CGM). From the period, the company has grownthrough acquisitions, mergers and expansions to become the world’sforce in maritime transportation. To attest to this success, thecompany was named shipping company of the year in 2000.

Interms of finance, the company has continued to perform well in theindustry. As a result, the company posted revenue of 15.9 billion USDin 2013 down from the previous year’s revenue of 15.92 billion USD(CMA CGM, 2014). These massive gains in income show a slight declinebecause of a turbulent world economy that has affected trade volumesand freight rates. This is indicated in an increase of operationalcosts from 14.6 billion USD in 2012 to 14.8 billion in 2013. Successalready achieved, however has been as a result of the company’sambitious growth plans. For instance, the acquisition of CMA CGMMARCO POLO a vessel with a tonnage of about 16,000 TEUs (twenty-footequivalent units), has made the company benefit from economies ofscale that is important for revenue in the merchant navy industry.

However,given that operational expenses have been a problem for the companyeven as the key source of revenue, freight rates, continues todecline, it is important that the company remodels its financing tohelp in cost reduction where possible. A modelling case study belowoutlines how this objective may be achieved.

CaseStudy

Forthe model, different assumptions based in reduction of operationalexpenses will be made, with the main one being that business isexpected to remain the same or improve in coming three years.Secondly, an equity finance of about £150,000 is available fromloaned sources and contributions. This finance will be used forinvestment in the cost reduction initiatives to be deployed in thecase. In the event that additional funding is needed, more funds willbe sought. For cost reduction for this model depends on lowering offuel consumption through plying of routes with good cargo volumes.With this shift, a projected increase in profit at 3% from year twoto three has been forecasted.

Theformula applicable for the model is: Total revenue = Total tonnagemoved *(1 + growth rate)nyears

Thefollowing table indicates the summary of expected growth in theunexploited areas by the company from year YR1 to YR3. Cost, sales,profit &amp loss, cash flow and balance sheet will be attachedseparately in an excel file.

&nbsp

Total Tonnage

Unit Cost

Total Revenue

Initial

6.8

2,500

17000

After cost reduction

7.9

3,000

23700

Expected increases

&nbsp

&nbsp

&nbsp

&nbsp

Yr 1

Yr 2

Yr 3

Initial

&nbsp-

2%

1.50%

After cost reduction

&nbsp-

1.50%

3%

Revenue Forecast

&nbsp

&nbsp

&nbsp

&nbsp

2014

2015

2016

Initial

17000

17340

17600.1

After cost reduction

23700

24055.5

24777.165

Reflections

Thereare many issues that must be taken care of in a financial model likein the above case. First, it is important for the relationshipbetween the variables to be analyzed (Krishnaet al, 2007).In this case, a sensitivity analysis is conducted to determine thecorrelation between reduction of costs and increased revenue for theshipping company. For instance, a simple test will be to reduce themaintenance costs by a half. If the costs of maintenance is say $50per trip and that the vessel plies the same route 4 times a month,total expense will be $200. If the expected revenue in the month is$1000, the reduction will be as follows

NetRevenue = Gross revenue – costs

Initialcosts – reduced costs= 200-(0.5*200) = $100

Revenue= 1000-100 = $900

Change= (900-800)/1000 =10% increase

However,shipping revenue may also depend on other cost factors like cost ofpaying workers, terminal costs and the costs of fuel consumption.Trade volumes may also fluctuate according to seasonal changes.

Conclusionand Recommendation

CMACGM has been a force in the merchant navy industry judging by itsambitious expansion program. Even though revenue decrease has beenthere, it is minimal compared to that of other industry operators.However, the company still need to check on its operational expensesif it will curb the reductions of revenue. The shipping sector issensitive to the global economy since it depends a lot on oil prices,regional stability and trade volumes of merchandise.

Withthis in mind, the proposed model has gone for cost reduction that islikely to add to revenue boost through saving for the company. Tosuccessfully achieve this objective, CMA CGM must however, be able toreduce its operational expenses even further than the model proposes.This can be through sourcing for cost effective bunker and spareresources available in the market. Secondly, the company shouldembrace outsourcing in the areas of management and port operations tobe able to save on costs associated with currency and inflationarypressures.

Bibliography

Charnes,J. (2012) Financialmodelling with crystal ball and excel.Hoboken: John Wiley &amp Sons.

CMACGM, (2014) AnnualReport 2013.[Online] Available at:http://www.cma-cgm.com/static/Finance/PDFFinancialRelease/2013%20-%20Q4%20-%20Annual%20Report.pdf(accessed 26 Apr, 2014)

Day,A. (2001) Mastering in Microsoft Excel: A practitioner`s guide toapplied corporate finance (2ndEdition). New Jersey: FT Press

EricW et al., (2011) Managerialaccounting for managers.Burr Ridge: McGraw-Hill Higher Education.

Krishna,G. et al. (2007) Businessanalysis and valuation: text and cases.London: Cengage Learning EMEA