Analysis of Toyota’s Capital Structure
A Review of the Company’s Capital Structure and Major Issues
The capital structure is a company’s financial plan, showing the sources of capital and how the company mixes the various sources to ensure it becomes profitable. It comprises of the debt and equity securities that help to fund an organization (Zeitun & Tian, 2014). The capital structure represents the permanent sources of finance of a firm represented in long term debts and the preferred stock as well as the net worth of the company. Firms have different financial plans. However, it is imperative to take into account the various aspects that influence the financial plan of a company. Industries also have different capital structures that help to meet their financial needs. Institutions that finance companies have varied issues that they are concerned with, in the capital structure of a company. For instance, short-term creditors are concerned with the immediate payment of their debts, whereas long-term creditors are interested in ensuring that the business is financially sound. The paper analyzes the capital structure of Toyota Company, which is in the motor vehicle industry.
Toyota company strives towards maintaining major concepts in its strategy for growth, stability, and efficient financial strategies. Since Toyota’s value has a direct relationship to its capital structure, it is necessary to assess and analyze its capital structure to identify if it has an efficient and effective capital structure (Stock Analysis, n.d). The capital structure shows how Toyota company finances its operations by using different sources of funds to continue influencing the value of the company. For a capital structure to be efficient, it has to strike a balance between equity capital and debt capital to maximize the total capital of the firm. When a company has a strong and balanced capital, it manages to raise more funds at a reduced cost.
A Review of the Business and Financial Risks Related to the Company’s Capital Structure
Financial risks and business risks are some of the signs that investors have to consider while considering an investment. Financial risk is the ability of a company to manage its debt and financial leverage. In contrast, the business risk is the ability of a company to generate enough revenues to cover its operational expenses. Financial risk focuses on the sufficiency of a company to raise interest payments on financing or meet other debt-related obligations. Some of the factors that affect Toyota’s financial risk include changes in the interest rates and general changes in the amount of money that the company uses for debt financing.
While determining the financial risk that a company faces, financial managers use financial risk ratios such as debt to equity ratio, which helps in measuring the relative debt and the amount of money used in equity financing. Business risk is classified into two different categories, such as systematic and unsystematic risks (Waemustafa & Sukri, 2016). Systematic risk is the risk that affects all businesses which develop as a result of changes in economic conditions, political issues, and changes in market conditions. Toyota company may not have the ability to control the systematic business risks since the causes are beyond the control of the company. Nevertheless, their ability to manage and respond to changes in the economic environment will help them manage risks.
Unsystematic risks, on the other hand, relate to the specific risks that Toyota Company is likely to face in its operations. For instance, calling its vehicles from the market due to poor quality. Toyota Company can reduce its unsystematic risks by making good management decisions that help in the reduction of costs used in marketing and other operational expenses.
Capital Structure Analysis of Liquidity of Toyota Company
Toyota’s Performance of Current Ratio and Net Working Capital
The current ratio measures the ability of a firm to meet its short-term obligations. It compares the current assets and the current liabilities of a firm. In the year 2013, Toyota company had a current of 1.07, and this was one of the lowest current ratios recorded in five years. When comparing to the year 2010, Toyota company had a current ratio of 1.22. therefore, the current ratio of the company kept on decreasing between the years 2010 and 2013. The figure below shows how Toyota company has been performing in its liquidity.
Comparing the Current Ratio and the Net Working Capital
Analysis of a capital structure requires a comparison with other companies in the same industry. When comparing, Honda and General motors company had a current ratio of 1.3 in the year 2013. It shows that the two companies had a higher current ratio as compared to Toyota. The low current ration of Toyota implies that it kept increasing short-term debts and thus increased the company’s current liabilities. Toyota company has the least working capital as compared to Honda and General Motors. The difference indicates that Toyota’s liquidity has been affected by the company’s debt financing policy.
Solvency Ratios
- Debt to equity ratios
Toyota’s debt to equity ratio in the year 2013 was 1.2. checking it backward, one can note that the ratio kept decreasing from the tear 2009 to the year 2012, but the trend changed, and it started to rise again. The total debt to equity ratio in the automobile industry has been the same over the years. In comparison, the total debt to equity ratio of Honda has been the same as that of the industry. However, Toyota’s debt to equity ratio has been high as compared to other automobile companies.
- Long-Term Debt to Equity Ratio
Source: Toyota Global Site 2013 Annual Report
From the figure above, it is clear that there was a sharp decline in the long-term debt to equity ratio for Toyota Company between the years 2010 and 2012. The decline occurred as a result of the recall issue that Toyota had to undertake in the year 2010. The decline shows that Toyota company had started being conservative in using debt to finance its activities.
Industry Comparison
There is a decline in Toyota’s long-term debt between the years 2010 and 2012. Although it is experiencing this trend, Toyota company has remained at a higher position with high debt as compared to its competitors, as illustrated in the figure below.
Source: Toyota Global Site 2013 Annual Report
In the year 2013, Toyota’s company had a current ratio of 0.61 (Toyota Annual Report, 2013). When comparing the amount of long-term debt to equity ratio among other companies in the same industry, Toyota has borrowed three times more than Honda, which is one of its major competitors. With such information, it is clear that Toyota Company relies more on debt to finance its operations.
- Interest Coverage Ratio
Interest coverage ratios also help in the analysis of a company’s capital structure. It is calculated by dividing earnings before interest and tax by the total amount of interest that a company pays. When the ratio is small, then the company has a burden of the interest expense. A low-interest coverage ratio indicates that the company is not generating enough revenues to cover for its interest expenses, and therefore, there is a high chance that the company can become bankrupt. In the year 2013, Toyota’s interest coverage ratio was 72.2%, which is high in the industry. From the figure below, there is a rise in the trend of interest coverage ratio. However, between the years 2012 and 2013, there was a sharp rise from 28.51% to 72.2%. Therefore, Toyota was improving its interest coverage ratio, and it means that it did not have a high-interest burden.
Source: Toyota Global Site 2013 Annual Report
Comparing Interest Coverage Ratios
The graph below shows that the interest coverage ratio in the three companies fluctuates so much between the years 2009 and 2010—most of the companies in the automobile industry desire to keep their interest coverage ratios high. However, in the year 2013, Toyota had the highest interest coverage ratio as compared to other competitors, Honda and General Motors (Toyota Global Newsroom). The comparison also shows that Toyota has high-interest coverage and shows that it is financially fit and has less likelihood of becoming bankrupt.
Source; IBISWorld Industry Market Research. (2013)
- Long-Term Debt to Total Assets Ratio
Long-term debt to total assets ratio is a coverage ratio that helps to calculate a company’s leverage. The result of the ratio shows the percentage of a company’s assets that it has to liquidate for it to repay its long-term debt. It is calculated by dividing long-term debt by the total assets. In the year 2013, Toyota company had a ratio of 0.2 (IBISWorld Industry Market Research, 2013). This figure means that in every $1 of the company’s assets, there exist $ 0.2 long-term assets.
Comparison within the Industry
When comparing the long-term debt to total assets of Toyota and other companies in the same industry, it appears that Honda and Toyota have the same ratio, which has remained consistent at 0.2 (Toyota Annual Report, 2013). The comparison indicates that Both Toyota and Honda had $ 0.2 as long-term debt in every dollar of their assets. Therefore, it is possible to deduce that although Toyota relies on debt to finance its activities, it is not overleveraged. Toyota has a stable and reasonable leverage level.
Profitability Ratios
Return on Equity
Return on Equity measures the company’s profitability concerning the shareholder’s equity. Return on equity is calculated by dividing net income with the shareholder’s equity. In the year 2013, Toyota Company had a return on equity of 14.45% (Cheng et al., 2014). From the graph below, it is evident that the return on equity for Toyota Company kept improving, and the company realized a steady increase in the tear 2012, where the ROE rose from 2.72% to 14.45%.
Comparing return on equity with other companies
In comparison with other companies in the same industry, Toyota has a slightly low ROE. However, the drastic change in the ROE in the tear 2012 and 2013 is an indication that the company ventured into a lot of borrowing.
Return on assets
The return on assets (ROE) is a percentage that shows how a company is profitable and how it is using its assets to generate revenue. The ratio on the return of assets shows how the company utilizes its assets and also shows what the company can achieve using the assets that it controls. It is calculated by dividing net income with the total assets of the company. In the year 2013, Toyota Company had a return on assets of 5.06% (Toyota Annual Report, 2013). The company had a rising trend from the year 2009, as shown in the figure below. The growth of ROA increased rapidly in 2012 as it rose from 0.94 to 5.06. The return on equity and return on assets have the same trend. Therefore, it was an indication that Toyota Company was trying to improve its levels of return on equity and return on assets.
Source; IBISWorld Industry Market Research. (2013)
A comparison of return on assets shows that Toyota Company has a low ROA. The sharp increase of ROE and ROA shows a sharp increase in borrowing to finance its activities.
Analysis
From the discussion above, the long-term debt to equity ratio of the Toyota company has been declining. However, to find out if the company is overleveraged or not, a comparison of the debt to equity ratio will show the level of the company. From the analysis, it is clear that Toyota’s company is striving to achieve sustainability and enhance its competitiveness. However, if the financial markets collapse, Toyota is likely to collapse since it depends more on debt capital to finance its activities. Toyota company relies on debt financing, and the company borrows a lot to finance its activities. The profitability analysis shows that debt financing is one of the ways a company can raise more net income and reduce its interest expenses (Cheng et al., 2014). Therefore, the strategy that the Toyota company adopted is appropriate and efficient. Although the company is enjoying many profits, it needs to be cautious in its products to avoid recall of its cars, which not only reduces its profits but also affects its reputation. Embracing technology and developing hybrid products will enable Toyota company to have an efficient capital structure.
References
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