International Finance Assignment: Analyzing Financial Environment of HSBC

Question

Task: You are required to prepare/submit an individual report on international finance assignment discussing the following:

Choose a Multinational Enterprise (MNE) listed on an internationally recognised Stock Exchange (including for example, London, Dublin, New York or Paris). You are required to:

a. Critically discuss two recent developments in the international financial environment which appear to have impacted on your chosen company’s recent performance and development. Analyze how these two developments are likely to impact on the company in the near future.

b. Discuss the following key elements of the MNE’s international financial and/or risk management strategy (and how they appear to have affected the financial performance of your chosen company):

• Sources of finance
• Dividend policy

c. With reference to your chosen Multinational Enterprise (and using the most recent annual report published), analyze the financial performance (in terms of profitability, liquidity, efficiency and investment) of the company in the two most recent consecutive financial periods (e.g. 2018/19 or 2019/20) using 8 different accounting ratios (prior year comparative figures will be available in the annual report).

Answer

1. Introduction to International Finance Assignment
Sir Thomas Sutherland established HSBC as a multinational investment bank back in the 18s. It is presently headquartered in England, United Kingdom. It deals in retail, corporate, investment, private banking, and credit cards, etc. As of 2020, it has approximately 2, 260, 59 employees. It had generated around 53.8 US billion dollars in 2018 and rose by 5.9% next financial year amounting to 55.4 US billion dollars. HSBC has 3,900 offices across 65 countries, and it stands for The Hong Kong and Shanghai Banking Corporation Limited. (Kynaston& Roberts, 2015)

2. New Developments in International Finance Market and how has it affected HSBC
2.1 Financial Aspects
The International Finance Sector has seen various developments recently where one of them is the use of Distributed Ledger Technology (DLT) to enhance trade functions. DLT can be used for reducing costs as it eliminated intermediaries, and allows seamless data sharing across the markets. HSBC has been continuously investing in this technology and finding ways to improve it since DLT reduces the efforts needed to maintain everything on paper providing spreadsheets in digital format and verifying information virtually. They also partnered with Singapore Exchange and a few holders to successfully launch a fully virtualized bond issuance with the exchange’s DLT enabled platform alongside the traditional pen and paper. Another development that was witnessed was cloud technology which is now becoming quite important for effective functioning and rational decision-making. HSBC became the first financial institution to its Corda service to Google Cloud, and hence claimed reduction of client on boarding costs and time. They now use fewer paper tokens and more digital certificates. By having around 40 million customers with approximately 240 petabytes of data, HSBC visions cloud computing as a means to enable personal customer experiences.

2.2 Financial Impacts
DLT reduced the settlement time from five to two days. HSBC now became the seventh largest bank in the world which decided to move assets worth 20 US billion dollars onto its digital vault, a move that will help the investors to work via decentralized applications regarding data, in the near future. This will help the bank to move more of its asset transaction lifecycle to ledger after a few years, reducing complexity, and saving time and money. It will cut costs that the bank had to put in on the middlemen engaging in immense paper work, and it will also help increase the client’s interest in the management of the bank’s activities. Since, HSBC implementing a Blockchain technology will be an in sync with the growing trends in the financial market; it will be highly significant for the company in the future.

In regards to cloud technology, HSBC has also been working on a new way to put all the data in its native format before it is used for analytics. Using cloud technology increased HSBC’s profits by 10% in 2019, and saved around 5 billion US dollars as cost savings.HSBC hence aims to direct their efforts to boosting capital and profits as this technology saves time via switching over to more strategic uses. This not only opens up new paths to safe future cloud migrations but also makes way for other large financial organizations to adopt the same. (Della &Gatti, 2014)

3. Dividend Policy and Sources of Finance
HSBC carries out three to four dividends every year that also includes special dividends. They declare the dividend in US dollars but they allow the use of UK Pounds Sterling, Hong Kong dollars. They also give the shareholders freedom to use any combination of all three. HSBC announced that it would make the interim dividend payment on 29th April, 2021 and the value would be US $ 0.15, i.e., 15 cents per share, despite HSBC suffering a 34% drop in their profits, they will be paying dividends. This decrease in profits, and decision to scrap dividend for that time lead to HSBC facing huge losses quarter after quarter reflecting its bad debt charges to go up to 13 US billion dollars. This also lead to low interest rates, and increased market volatility after which even after profit upbeats they decided to roll out dividends. In 2019, they rolled out a total of US $ 0.30 per share worth dividends but for the first time in such a long time, they had cancelled dividend pay-outs in 2020 that led to a miserable drop in their share prices. Pandemic might have affected their dividend pay-outs but they showed flexibility. By giving out dividends for 2021, HSBC‘s shareholders which are equivalent to 40% of their earnings will not be caught off-guard in the long-run because of higher pay-outs. HSBC decided that it would aim at keeping the dividend at 51 cents a share in the future. Earlier, HSBC used to use a scrip dividend alternative which they discontinued in 2021.

HSBC receives its funding from depositors; they borrow money from them and give them an interest rate, which is similar to depositors depositing their money with the bank. It also lends money and charges a high-interest rate. The base rate for 2021 is 7.09% per annum for HSBC w.e.f. 1.02.21. They also charge service fees and receive money from retail tie-ups. Their main source of financing being deposits, HSBC witnessed a peak in their digital deposits during the pandemic. The average digital deposits increased by 30%. This for the company meant that it stands upright among those competitors who do not offer digital deposit features in addition to the traditional cheque system. They also extended their limit allowing customers to scan and upload cheques worth 1,234 US dollars. The deposits increased to $20 billion, but the profit for the bank fell down by 30/5 amounting to 6.1 US billion dollars. The revenue for the third quarter in 2020 was also 11% lower than before.(HSBC, 2019)

4. Profitability Ratios
This measures the efficiency of the company, and its ability to generate revenue. (Lesakova, 2007)

4.1 Return on Capital Employed (ROCE):
This assesses the capacity to produce profits from the invested capital, and is calculated as:
(Operating Profit / Capital Employed) * 100

Capital Employed = Share Capital + Lon-Term Debt + Retained Earnings
2019: 10,319 + 136,679 = 146,998
2018: 10,180 + 138,191 = 148,371

Explanation:
A high ROCE suggests that the company is doing well by making proper use of its resources. A ROCE of 10% is considered stable but it keeps varying depending on the industry, and banks can maintain around 18% or a percentage that is double their current interest rates. Here, the ROCE for HSBC decreased from 11.7% to 7.4%.

4.2 Return on Assets (RoA):
It helps the manager understand optimal usage of assets, and is calculated as:
(Net Profit / Total Assets) * 100

Explanation:
There is no metric for a bad or a good Return on Assets but for banks any percentage above 1% have been a good indicator for the banks as it suggests that they have been squeezing out profits out of their invested capital. Many large banks seem to have a lower ratio.

5. Efficiency Ratios:
This assessesthe company’s assets’ potential to produce revenue. (Hays, Lurgio, & Gilbert, 2009)

5.1 Accounts Receivable Turnover Ratio:
This measures the company’s efficacy in fetching money from those who owe to it, and it is found by:

Cost of Goods Sold (COGS) / Average Inventory

Net Credit Sales=
Since banks do not have any net credit sales, they have interest income.

Average Accounts Receivable=
(Accounts Receivable at the end + beginning) / 2
2019: (4,956 + 5,787) / 2 = 5,372
2018: (6,441 + 6,441) / 2 = 6,441

The average number of days taken to collect payment from debtors:
Transforming the ratio into days outstanding can be done by:
One-year: 365 / Accounts Receivable Turnover Ratio
2019: 365 / 10.2 = 36
2018: 365 / 7.8 = 47

Explanation:
A ratio of 7.8 is perfect, and has more value but a ratio of 10 and above states that the company is lagging behind its competitors. Here, if the credit days are 30, then the bank is improving its collection efforts, and if it is 60, then it’s quite ahead of it.

5.2 Accounts Payable Turnover Ratio
This measures the number of times the company stands able to clear off its creditors’ amount, and is calculated as:

Net Credit Purchases / Average Accounts Payable

Net Credit Purchases=
Cost of Goods Sold + Ending Inventory Balance - Starting Inventory Balance Since banks do not have any COGS, they have cost of interest, i.e., interest expense.

Average Accounts Payable=
(Accounts Payable at the end + beginning) / 2
2019: (4,817 + 5,641) / 2 = 5,229
2018: (8,750 + 8,750) / 2 = 8,750

The average number of days taken to give payment to creditors:
Transforming the ratio into days outstanding can be done by:
One-year: 365 / Accounts Payable Turnover Ratio
2019: 365 / 4.6 = 79
2018: 365 / 2.2 = 166

Explanation:
A low accounts payable turnover ratio states that the company makes transactions mostly on credit, which is not applicable for HSBC in 2019.Days Payable Outstanding for the bank has reduced as compared to 2018. Hence, it states that the bank doesn’t delay payments.

6. Liquidity Ratios:
It helps the company understand its ability to pay off all the debts specifically short-term in nature along with cash needs that might arise unexpectedly (DeYoung& Jang, 2014).

6.1 Quick Ratio:
It is also called the Acid-Test Ratio, and it measures if the company can pay off its financial obligations with its assets excluding its inventories. It is calculated as follows:

Quick Assets, i.e., (Current Assets – Inventories) / Current Liabilities

There are no inventories for a banking company, hence 0.

Explanation:
Traditionally, this ratio should ideally be 1:1. Here. HSBC has been maintaining a ratio higher than 1:1 in both years; hence it states that the company has a good financial health. But, the same has been decreased in 2019 as compared to 2018. A low quick ratio would have suggested that the company will be facing issues while paying off the debts.

6.2 Operating Cash Flow Ratio
This ratio tells if a company’s normal business operations are enough to cover liabilities.

The formula for the same is:
Operating Cash Flow / Current Liabilities

Explanation:
Investors, creditors, and other analysts always prefer a ratio that is above 1.0 because it shows that even after the company has paid all the liabilities, it will have some amount left. But, here HSBC has been maintaining a ratio less than the traditional or the ideal one. It shows that HSBC might need external financing for its capital.

6.3 Current Ratio
This Working Capital ratio, measuring the ability to pay the debts with current assets, and is found by the following formula:

Current Assets / Current Liabilities

Explanation:
An ideal current ratio stays between 1-1.2. Here, the current ratio for 2018 has been 1.8. A ratio of 1.5 and above means that the company has not been using its resources effectively but in 2019, it comes to 1.4 which shows that the company is very likely to pay back its creditors within the given period.

7. Investment Ratios:
These ratios measure gains and investments generated, that eventually helps the management, investors, and analysts to understand the company’s position. (Khan, Islam, & Adnan, 2014)

7.1 Earnings per Share (EPS):
This helps the company to measure how much amount of money it makes per share of stock. It is also used to measure corporate value.

Explanation:
There is no good or bad EPS, it is considered as the best measure to understand a share’s price. However, a higher EPS would suggest the investors to invest more because of the higher value of the company that might eventually lead to profits.

8. Conclusion
HSBC has been having great financial performance over the past few years. After analysing the dividend policy, and the liquidity, efficiency, profitability, and investment capabilities of the bank, it can be concluded that HSBC is very good for customers as it offers competitive interest rates, there are seamless transactions

9. References
About HSBC, available at:
Kynaston, D., & Roberts, R. (2015). The lion wakes: a modern history of HSBC. Profile Books.. (Last Accessed: 24th March, 2021)

International Finance Markets available at: Della Croce, R., &Gatti, S. (2014). Financing infrastructure–International trends. OECD Journal: Financial Market Trends, 2014(1), 123-138. (Last Accessed: 24th March, 2021)

HSBC Dividend Policy available at:
(Last Accessed: 24th March, 2021)

HSBC Shareholders Reports, available at:
(Last Accessed: 24th March, 2021)

HSBCAnnual Report, 2018, available at:
(Last Accessed: 24th March, 2021)

HSBC Annual Report, 2019, available at:
(Last Accessed: 24th March, 2021)

Financial Ratios for banks, available at:
Murthy, Y., &Sree, R. (2003).A study on financial ratios of major commercial banks. Research Studies, College of Banking & Financial Studies, Sultanate of Oman, 3(2), 490-505. (Last Accessed: 24th March, 2021)

Liquidity Ratios, available at:
DeYoung, R., & Jang, K. Y. (2016). Do banks actively manage their liquidity?. Journal of Banking & Finance, 66, 143-161. (Last Accessed: 24th March, 2021)

Profitability Ratios, available at:
Lesakova, L. (2007, June). Uses and limitations of profitability ratio analysis in managerial practice.In International Conference on Management, Enterprise and Benchmarking (pp. 1-2).(Last Accessed: 24th March, 2021)

Efficiency Ratios, available at:
Hays, F. H., De Lurgio, S. A., & Gilbert, A. H. (2009). Efficiency ratios and community bank performance. Journal of Finance and Accountancy, 1(1), 1-15. (Last Accessed: 24th March, 2021)

Earningsper Share, available at:

Khan, T. R., Islam, M., Choudhury, T. T., & Adnan, A. M. (2014). How earning per share (EPS) affects on share price and firm value. (Last Accessed: 24th March, 2021)