This case discussed on the issue of choosing the most suitable performance measurement for MarineCorp Sdn. Bhd. and SURIA group of companies. MarineCorp is a wholly-owned subsidiary of SURIA group of companies. MarineCorp was the maritime solutions provider for SURIA; it regulates and enforces the Group’s policy on maritime activities, especially the vessel inspection and vetting on the vessels under SURIA. The company has two subsidiaries; the first one is Green Port Sdn. Bhd. which ran marine facilities and secondly is Sungai Emas Port Sdn. Bhd. which ran port facilities. In the case, Chief Financial Officer (CFO) of the company need to decide whether to pursue the old performance measurement or follows the order of the Chairman of SURIA group of companies.
The protagonist of this case is Hafiz Hashim who is the Chief Financial Officer (CFO) of MarineCorp Sdn. Bhd. He was appointed as CFO of MarineCorp since 2007. He was responsible for the financial management of MarineCorp and its two wholly-owned subsidiaries; Green Port Sdn. Bhd. and Sungai Emas Port Sdn. Bhd.
The first problem is the company and its two subsidiaries have difficulties in attracting and retaining marine professionals. This is because of the increasing competitiveness in the industry and its uncompetitive salary scale. Therefore, the company and its subsidiaries hired contract staffs to tackle this problem. However, this leads to increase in the manpower costs and preventing the company from expanding and exploiting new businesses.
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The second problem is the accounting treatment for dredging cost incurred by Green Port. The CFO, Hafiz Hashim had fully expensed the cost in the financial year it incurred. However, General Manager of the company, Anita Osman preferred the cost to be amortized in order to improve the profit of the subsidiary.
The third problem is related to the management of cash in the MarineCorp. As the CFO of the company, Hafiz preferred to give dividend payout since the company has excess of cash and currently there is no plan for the cash other than investing in funds. However, the General Manager, Lee Chong Way disagreed with the idea of dividend payout since it will not increase the profit of the company, instead he preferred to utilize the cash to generate interest income on their fund investments.
The fourth problem is the dilemma faced by Hafiz in ranking the financial performance of MarineCorp and its two subsidiaries. The Board has instructed him to evaluate and rank the financial performance of the companies. This ranking will significantly affect the opinions of the Board on the companies. Hafiz was in dilemma whether to use profit as the measurement or there is better performance indicator that can ensure fair evaluation on the three companies.
The main issue in this case is decision on the most suitable method to measure the performance of MarineCorp and its two subsidiaries. The president of the SURIA wants the SURIA group and all its subsidiaries and associated companies used Value Based Management (VBM) as their performance measurement. By using VBM system, the performance evaluation and appraisal of the employees would be linked to the performance of the company. In addition, through Value Based Management model, the value of a company would be measured by economic earnings. However, Hafiz belief that a company financial performance was linked to the investments made by its equity and debt holders where its profits would be compared with the investments expected returns based on the company’s cost of capital.
DESCRIPTION OF THE CASE EXHIBITS
Exhibit A was shown on the organizational structure of MarineCorp and its subsidiaries. As stated in this case the General Managers of the three companies which are MarineCorp, Sungai Emas and Green Port need to managed their respective companies and also responsible for their financial performances. Furthermore, the CEO of MarineCorp also the CEO for the other subsidiaries, he is responsible for the overall performance of the all subsidiaries. In addition, the appendix E presented the companies Income statements, from this appendix it shown that the Green Port has higher Net Profit after Tax rather than Sungai Emas Port and MarineCorp. The value that earn by Green Port is RM 27,370,609.
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Rank the companies in terms of their financial performance.
The companies can be rank based on various methods of financial performance such as economic earnings, net operating profit after tax, return on equity (ROE) and free cash flow.
1) MarineCorp Sdn. Bhd.
2) Sungai Emas Port Sdn. Bhd.
3) Green Port Sdn. Bhd.
Net operating profit after tax
1) Green Port Sdn. Bhd.
2) MarineCorp Sdn. Bhd.
3) Sungai Emas Sdn. Bhd.
Based on the ranking above, it demonstrates that there are differences in the ranking system among the companies. For this case the companies was measured by using different method. MarineCorp Sdn. Bhd was in the high rank when economic earnings were used as the method to measure the company performance while Green Port Sdn. Bhd was in the last rank and the Sungai Emas Port Sdn. Bhd. was in the second place. However, when net profit after tax was used to measure performance the Green Port was at the higher ranking and the MarineCorp Sdn. Bhd. at the second place. The Sungai Emas Sdn. Bhd. was at the last place because of they have the lowest net profit. The possible factor of the result might be because of the capital charges was higher than the net operating profit after tax (NOPAT) made by company. These companies’ financial performance also can measure through return on equity(ROE) and free cash flow. According to Investopedia return on equity (ROE) can be defined asthe amount of net income returned as a percentage of shareholders equity. Below are the calculationsof return on equity (ROE):
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ROE = Net Income/ Shareholder’s equity
MarineCorp Sdn Bhd = 15,348,792/ 13,233,036 = 1.16
Green Port Sdn Bhd = 27,370,609/ 463,779,574 = 0.06
Sungai Emas Port Sdn Bhd = 5,841,524/ 14,516,971 = 0.40
Based on the calculation above, it can be seen that the MarineCorp Sdn. Bhd. has the higher return on equity, while Green Port Sdn. Bhd. has the lowest return. The purpose of using this method to measures how many the shareholders earned for their investment in the company. In addition, the company’s financial performance also can be measure through the free cash flow because free cash flow shows the companies ability to generate the cash after put down the money required tomaintain or expand its asset base. Below is the free cash flow of the three companies:
MarineCorp Sdn. Bhd. = RM 11.11 Million
Green Port Sdn. Bhd. = RM 66.45 Million
Sungai Emas Port Sdn. Bhd. = RM 2.63 Million
From the example above it shows that Green Port Sdn. Bhd. has the higher cash flow rather than MarineCorp Sdn. Bhd. and Sungai Emas Port Sdn. Bhd. the reason to use this free cash flow as the financial performance because this free cash flow allows a company to pursue opportunities that enhance shareholder value. As a result, by using these two methods it would be fair to rank these three companies because when the company evaluate the performance based on the financial statement it not show the real performance of the company because profit operating after tax has the accrual basis. Besides that, MarineCorp is the holding company of Green Port and Sungai Emas Port; hence it would be unfair to rank these three companies through the net operating profit after tax and economic earnings. Furthermore, based on the return on equity and economic earnings results, Green Port was at the third place even though it ran the marine facilities itself. This is due to the highest liabilities incurred by Green Port. In addition, Green Port also bears high deferred tax liabilities.
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In your opinion, why are the GMs of Green Port Sdn Bhd and MarineCorp Sdn Bhd behaving in such manner? Should Hafiz follow their suggestion? The GMs of Green Port Sdn Bhd and MarineCorp Sdn Bhd behaving in such manner due to the evaluation of the company’s performance on those three companies that will be made by the CFO. The Chairman had requested the CFO to evaluate and rank those three companies which are MarineCorp, Greenport and Sungai Emas Port Sdn Bhd. The GMs would like to make sure their company shows good performance when company’s evaluation made. The rationale behind this target, the GMs requested to make some changes in method that used by CFO in calculate the financial statement. As a result, if the company generates more profit, their KPIs evaluation will be good and they will receive higher bonus while they can maintain their good reputation as the GMs of both companies. Based on the article, the GM of Green Port Sdn Bhd, Anita Osman, requested that changes be made to the dredging costs because Hafiz Hashim, the CFO of MarineCorp, had inappropriately calculated them. She suggested Hafiz to amortize the cost because it will improve the profits of the company.
By amortizing the dredging costs, the costs will not fully expense in the financial year it incurred. Due to that, the dredging costs will not give big impact to the financial statement during the year it incurred. This cost can be treated same as the pension cost. The pension cost also had been amortized based on the estimation year of employment. If the company fully expenses the cost in the financial year it incurred, the financial statement during that year will show the higher cost incurred and the profit of the company will look lower. In addition, the main purpose of dredging is to clearing the navigating channels for vessels of the port, so it affects the value of the port if the dredging maintenance not be conducted. Thus, Green Port will have a positive value for economic earnings if 25 million is amortized in five years which is five million per year. In addition, the treatment of dredging costs can be related to MFRS 116 if the costs are assumed as capital expenditure that is used on maintaining the fixed assets. The fixed assets are used in generating the income for the company. Under MFRS 116, there is the explanation about the costs that incurred in maintaining the fixed assets.
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Some company decided not to pay the dividend payout because they afraid that they do not able to do so on next financial year. Commonly practices that the company is used to pay the dividend to their shareholders need continuously pay the dividend at the same rate as previous years or more. The reason is if they do not able to pay dividend on next financial year, it shows that the company had conflicts or problems in terms of their reputation. Due to this perception, MarineCorp wants to ensure that their company’s reputation is maintained and does not turn bad. Therefore, the GM of MarineCorp, Lee Chong Way, wants to utilize the cash to generate interest income on their fund investments. Besides, payment of the dividend will not give positive effect to financial performance. However, MarineCorp may give the special dividend to the shareholders for the reason that to make the shareholders happy and to fulfil the standard of maximizing the shareholders wealth.
Besides that, the company can pay the dividend to the shareholders in term of non-cash such as issuing shares. That action initially can give more wealth to them especially to the long term shareholders when the share price increases in future. As a conclusion, Hafiz should follow their suggestion due to seek of improvement on the financial performance of the company and the methods that chosen by the both GMs are not against the ethical of accounting. In terms of dredging costs matter, the usage of the expenses not wholly used during the year it incurred. Thus, amortizing the cost is appropriate action to take. In terms of dividend payout, the payment of dividend not only using cash basis. The company can pay the dividend using another way such as issuing shares.
What actions can be taken to improve the future performance of MarineCorp and its two subsidiaries? Prepare a report of your recommendations to be presented to the Chairman of the Board.
We have outlined three suggestions to improve the performance of the company. Since the industry is becoming more competitive, therefore it is a necessity for the company to develop its competitive strengths.
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The first suggestion is to revise the salary and incentives for the employees. MarineCorp and its two subsidiaries recognized human capital as their main asset; however the current salary scale is uncompetitive as compared to other players in the industry. Therefore, the companies should revise its salary in order to attract more marine professionals into the companies. Other than that, there is an issue of retaining the marine professionals in the company. Thus, the companies should provide attractive incentives to the employees. Among the incentives that can be provided is Employees Share Option Scheme. This scheme will increase the motivation of the employees to be more productive and generate more profit to the companies.
The second suggestion is related to the cash reserved in the companies. Based on the current and past performances of the companies, they are able to generate a huge free cash flow every year. Thus, the companies have the capability to expand its business and invest in other businesses. The companies may expand and improve the facilities in ports from time to time to ensure they provide better services to their customers. Other than that, the companies may invest in other businesses, whether it is related or unrelated. By investing in related businesses, the companies can strengthen its position in the industry such as investing in businesses related to port maintenance.
The third suggestion is the companies should pursue the purpose beyond the profit by implementing the triple bottom lines; the concerns on the social, economic performance and environmental. In the aspect of social, the companies may provide scholarships to the local community and employees to continue their educations. The scholarship holders later will work with the companies, thus the companies are able to tackle the problem of shortage of qualified manpower. In the aspect of economic, the companies should focus to maximize the wealth of shareholders by maintaining and improving their financial performances. In the aspect of environmental, the companies should ensure their standard operating policy and procedures (SOPP) do not harm the surrounding environment. The companies should remember the cost of prevention is always cheaper than the cost of correcting a mistake done on the environment.