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Financial Modelling

FINANCIAL MODELLING 8

FinancialModelling

GradeCourse

Financialplanning requires all qualitative and quantitative approaches ofgauging financial success in a business. The use of financialmodelling is therefore one of the practical steps of indicating thelikely success of a given business portfolio in the coming periods.Financial modelling is the process in which real world perspectivesare developed through use of accounting and operational relationships(Musiela&amp Rutkowski, 2006).Financial modelling covers different finance related aspects that mayinclude analysis of available data, considering future performance,using available data to assist in decision making and outlining keyvariables for a business among others. This paper looks at theapplication of financial modelling especially in the Merchant Navyindustry through a chosen shipping company.

Inmerchant navy, financial modelling may be applicable in many ways.Merchant navy generally refers to all operations associated with theglobal commercial shipping sector. In modern merchant navy, companiesmay vary in many ways. However, a great distinction is drawn usingthe types of ships the companies operate in or their area ofspecialization in the industry. Container fleets, oil tankers, bulkcarriers and cruise liners are examples of the types of ships thatdetermine size or nature of company. With increase in global tradeand the supply chain becoming more complex, financial success isimportant for any company in the industry.

Modellingtherefore may be used to help management in decisions concerning thevolumes to be used for different sea routes, the associatedoperational costs and future cash flows. However, before embarking onthe case of selected company, it is important to understand the prosand cons of financial modelling.

Strengthsand Weakness of

Tobegin, financial modelling is beneficial for businesses in many waysmostly related to the presentations produced from this activity.First, financial models try to minimize risks associated withoperations and financing of business (Tankov,2004).Secondly, models are good tools for prediction of future financialperformance. Third, the tools of presentation used in modelling likecharts and spreadsheets are important for interpretation and quickdecision-making. Models are also good ways of providing consistentresults hence eliminating human error.

However,there are few weaknesses of financial modelling that must be noted.First, the use of models may require expert knowledge on spreadsheetsand other applications and therefore may not be easy to use (Tankov,2004).Secondly, models involving complex operations may not only bedifficult to perform but also time consuming.

Companybackground: Maersk Shipping Line

Maerskis one of the world’s largest shipping lines, which majorlyspecializes in container shipping across different destinations. Interms of history, A.P Moller, the conglomerate under which Maersk isa company in takes the name of a Danish freighter who founded thecompany in 1904. However, Maersk line began its global operations in1928, with the Asia and United States route being the first of itsoperations (Maersk Line, 2013). Today, Maersk line has grown tobecome one of the most successful and modern shipping company in theworld. The company transports general cargo that may includehazardous, dangerous or refrigerated cargo. This is made possiblethrough the company’s large fleet of more than 500 container linersable to handle a reported capacity of about 3.4 million TEU(twenty-foot equivalent units) (Maersk Line, 2013).

Withthe company’s capacity, its revenue has also continued to grow.According to the company’s financial report as of 2013, thecompany’s annual revenue stood at about 26.2 billion USD, with aresulting net profit of 1.5 billion USD (Maersk Line, 2013). As aresult, the company’s financial performance and growth strategy isundisputable in the merchant navy industry. This success has beenrecorded despite shifting levels of demand and supply that havesubstantially lowered the costs of freight in the global shippingindustry. The company’s return on investment however increased to7.4% in 2013 up from 2.3% in the previous year (2102) (Maersk Line,2013).

Thisrate is however below the company’s cost of capital. With a mixedperformance impacted a lot by the dynamics of the industry, thecompany will therefore need to absorb capacity as well as look intoother opportunities in the industry. This is because the merchantshipping industry relies a lot on economies of scale. As a result,the following section uses financial model to recommend alternativesfor the company.CaseStudy: of Maersk

Themain assumption of the model is that business will continue toimprove in other routes not currently plied by the company.Additionally, a £150,000 of equity finance is assumed for the model.For the alternative routes apart from its European, Asian andAmerican axis, a lot of trade volumes have continued to increase.These regions include southern Africa and Australian routes. As aresult, the company may get an opportunity of further absorbing itsidle capacity as a result of reduced trade volumes in itsconventional trade routes. With this shift, a projected increase inprofit at 3% from year two to three has been forecasted.

Theformula to be used for the forecast is as follows: Volumes moved intonnes*(1 + growth rate)nyears

Thefollowing table indicates the summary of expected growth in theunexploited areas by the company from year 2014 to 2016. Cost, sales,profit &amp loss, cash flow and balance sheet outlined in the excelfile.

&nbsp

Transported Volumes

Unit Cost

Total Revenue

Old region

8.8

2,500

22000

New region

5.6

3,000

16800

Assumed increases

&nbsp

&nbsp

&nbsp

&nbsp

Yr 1

Yr 2

Yr 3

Old region

&nbsp

2%

1.50%

New region

&nbsp

1.50%

3%

Revenue Projection

&nbsp

&nbsp

&nbsp

&nbsp

2014

2015

2016

Old region

22000

22440

22776.6

New region

16800

17052

17563.56

Reflection

Thesuccess of the model relies on the assumptions made in the process ofcomputing projecting revenues as indicated in the table above. First,sensitivity analysis is important for making a systematic review ofthe model assumptions (Grinblatt&amp Titman, 2002).Some of the rates used in the model are arbitrary and hence the needfor verification. For merchant shipping, the cost of doing businessrelies a lot on terminal costs and the costs of fuel consumption bydifferent vessels. All these costs may have a tendency of increasingthe expenditure hence reduction of net revenue. As a result, therevenue for new business within the third year might be influenced bythis eventuality.

Asa result, an increase say in the costs of fuel consumption for allvessels plying the new route may add to an average of .8% of thetotal revenue. Then, the newly revised total revenue will be derivedas follows: volumes moved in tonnes*(1 + (growth rate-decrease))nyears

=16800(1+(3-0.8)= 17169.6

Inthe same way, any form of increase in revenue growth may becalculated in the same fashion to revise the rates upwards. As aresult of new business, the total revenue for the company willtherefore be revenue from business in the old region added to revenuefrom new region’s business. For instance, in case of projectedrevenues above, the total revenue for Maersk line in year 3 will be(17563.56+22776.6) = 40340.16. This alone results in rise of revenuethat may match the costs of capital without depending on the worldtrade volume fluctuations.

Conclusionand Recommendation

Maerskline has shown leadership in the merchant navy industry judging byits financial estimates. However, the company continues to bevulnerable due to external business environmental factors. Fleetcapacity can be its main strength but may also be its maindisadvantage if capacity is not fully utilized. As a result, themodel has proposed the absorption of all existing capacity byengaging the idle resources to the unexploited sea routes that mayadd to the revenue of the business in the long run. To be able tosucceed in this however, Maersk must be able to cut on internaloperations for the new venture through majorly two ways. First,administrative costs should be reduced through use of the availablecapacity and hence reduction of costs associated with employment anddeployment of personnel. Secondly, the company should rely on massmarkets within the new trade routes in order to generate a lot ofvolumes being shipped and thereby increasing the marginal revenue forthe firm.

Bibliography

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

Grinblatt,M., &amp Titman, S. (2002) Financialmarkets and corporate strategy(Vol. 2). London: McGraw-Hill/Irwin.

MaerskLine, (2013) Annual Report 2013. Online accessed 26 Apr, 2014 fromhttp://investor.maersk.com/common/download/download.cfm?companyid=ABEA-3GG91Y&ampfileid=731491&ampfilekey=fb0012ef-15f0-4fda-80e0-d9a1b00b698e&ampfilename=Annual_Report_2013.pdfMusiela,M., &amp Rutkowski, M. (2006) Martingalemethods in financial modelling(Vol. 36). London: Springer.

Tankov,P. (2004) Financialmodelling with jump processes.Florida: CRC Press.