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Project objective and Coop program

Unfortunately what many students are facing is that the career life is different to academic life, but actually Coop program is a solution to help the students for the next level in their lives. This experience helps me to gain knowledge, skills and to be more powerful so that was an opportunity for me to apply the knowledge I got in my academic years into practice.

The purpose of this research is to identify the impact and the relation of tax on capital structure in a way that I express my study and how I applied this during my training program which helps me to gain an experience and knowledge.

Furthermore, the Coop Program was carried out in Naghi Group in head office Jamjoom, Jeddah I started the program on 6/1/2019 and is expected to end on 6/4/2019. As part of the program requirement this Research will be submit to the academic advisor (Ms. Khloud bajunied)

First chapter

Chapter (1) Interdiction

1.1 Saudi economy and vision 2030

Saudi Arabia is a country that is known and famous for its oil wealth, in 1951 the Arabian American Oil Company (Aramco) discovered the first offshore field in the Middle East, The discovery of oil changed the entire economic situation of Saudi Arabia, the economy has grown very strongly and they made plan to manage their income and expenses (Richard G, 1999). Saudi Arabia has been depending on oil as a source of income for many decades, oil accounts in Saudi is about 35-45% of the GDP. It is the source of 75-80% of its government revenues and 85-90% of its export revenues (AL-Tamimi, 2016), till recently Saudi Arabia’s oil has been dropped and the government started to look for new sources of income to help such as TAX and VAT to moving away from an oil-based economy, the dropping of oil prices around the world presents significant implication to the Saudi economy and over the time likely lead to slower growth It was the main catalyst for the development, the government adopted the policy with aim of ensuring the diversification of the income channels to minimize the impact oil prices on the economy (khashan, 2017) (Richard G, 1999). There are some reasons for this drop in oil price:

The Declined of oil Demand lead to weak economic activity, Strong US Dollar, oversupply of oil, and increased efficiency. However, after the dropped in 2016 the largest plan of Saudi Arabia announced which is VISION 2030 or known to be the long term economic blueprint for Saudi Arabia. It is a plan to decrease their use of dependence oil, expand the Saudi economy, becoming an investment powerhouse, and Increase the public services such as health and tourism. (Richard G, 1999)

1.2 FINANCE OVERVIEW

Finance is the management of money, there are three types of finance which are personal finance, public finance and corporate finance. Most of the finance concepts come from macroeconomics theories. Furthermore, finance has many activities such as borrowing, investing, budgeting, saving and forecasting. However, the goal of any firm is to maximizing the profit, market share, owner wealth and minimizing the costs. The five principle of finance are money has time value, risk requires a reward, market price is right, cash flow is what matters and conflict of interest. (McGraw-Hill)

However, Corporate finance deals with financial management decisions which are capital budgeting for long term investment, capital structure for how to pay the firm assets and which to use equity or debt and working capital management for day to day financing activities to increase the value of the company. (McGraw-Hill)

1.3 TAX Regime

It is a compulsory payment that supports cost of government without receipt any specific benefit, most of the countries have tax system it is not a fee because the tax payer will not receive specific product or service. On the other hand, it is different from fine or a penalty because it’s not intended to punish unacceptable behavior. The percentage rate of tax depends on tax type, every tax can be evaluated on standards.

· Sufficiency

· Convenient

· Efficiency

· Fairness

(abd El-moniem, 2011)

Tax objective

· Financial objective which is raising the governmental revenue to support its cost such as education

· Economical objective to provide exemptions for certain activates

· Social objective which is people with high income pay more while low income pay less.

(abd El-moniem, 2011)

TAX classification

Direct tax: is imposed directly on income or capital such as income tax	Indirect tax: imposed indirectly when the person use them such as sales tax
specific tax: imposed on each kind of income such as salaries tax	General tax: imposed on total income
personal tax: which is takes into consideration the circumstance of taxpayer	In kind tax: don’t take into consideration the circumstance of taxpayer
Income tax and Real Estate tax	Capital tax and Expenditure Taxes

(abd El-moniem, 2011)

Income tax

United states starting the income tax during the civil war in 1913 (terrell, 2004) Most of the countries imposed tax depend on the personal income if they earn high income so will pay high and if they earn low income will pay less. Furthermore, Income tax classified according to the tax base which is individual income tax imposed on net income from one or different source this type of tax will be under scheduler tax system and corporate income tax imposed on corporation’s net profit it will be under unified tax system, they report their business income and deduct the capital expenses and operating. (abd El-moniem, 2011)

Application of tax and zakat

Only the non-Saudi investor are subject for income tax and the Saudi are subject for Zakat even the citizens of gulf cooperation council countries (GCC) are treaded as Saudis. Although, if the company owned by both Saudi and non-Saudi interest so the portion of taxable income of non-Saudi is subject to income tax. Moreover, the income tax rate is 20% of the net profit. (GAZT, 2019) (KPMG, 2017)

1.4 VAT in the world

1.5 Current VAT developments in Saudi Arabia

While Saudi Arabia moving away from oil based economy starting to look for additional revenue which is Value added tax (VAT) is the new tax system, it is a consumption tax and is collected on business transaction and importing, there are many complexities and exceptions. Saudi Arabia imposed VAT on January 1, 2018, it’s applied in more than 160 countries around the world at varying rates. Tax rate in Saudi Arabia is 5%. (GAZT, 2019) Moreover, VAT is different to sales tax because it’s imposed on the addition of product value not total value (abd El-moniem, 2011).There are penalties for error in tax calculation, failure to register and failure to pay tax when due etc… (KPMG, 2017) (abd El-moniem, 2011)

In additional, VAT is indirect tax imposed on the increase of product value at each stage of supply chain from the producer until it reach the final consumer so in the end final consumer will borne the VAT. However, businesses pay the governments vat by collecting it from their customer’s purchases and refund the vat to their suppliers. (GAZT, 2019)(KPMG, 2017)

VAT Transactions

Figure 1

(GAZT, 2019)

Figure (2) showing VAT invoice

Figure 2

(KPMG, 2017)

Figure (3) showing VAT return

Figure 3

(KPMG, 2017)

1.6 CAPITAL STRUCTURE

Capital structure referred to how the firms financing its growth and operation by using different source of funds, also it can be a combination between long term debt, short term debt, preferred equity and common equity. Business activities must be financed to support their fixed assets because without finance the businesses could not exist. On the other hand, capital of the firm is categorized into equity and debt. However, usually firms that is financed by debt has more aggressive capital structure and high leverage ratio so that lead to high growth rate while the firm that finance its assets with equity has lower leverage ratio and conservative capital structure lead to lower growth rate. Using debt could be the primary source of firm growth even if it risky or could be a trouble paying to debtors and it will lead to financial distress. Since the equity is more expensive than debt so most of the firms like to issue debt to take tax advantages. Moreover, firm use Debt to equity ratio to compare capital structure. The goal of any firm is to find the maximum optimal equity and debt. (kenton, 2018). Once firms use debt to finance its assets will become more riskier and investor require higher return while the increasing in the cost of equity will reducing the benefit of tax shield (theorem)

Figure 4

Figure (4) showing the financing source (Delia)

1.7 THE RELATION BETWEEN CAPITAL STRUCTURE AND TAX

The firm capital structure determines by taxes, agency cost, firm product and input market strategies and cost of financial distress. The relation between tax and capital structure is subject to theoretical analysis that is specify the relations through corporate tax rate, non-debt tax shield, optimal capital structure and personal tax rate. On the other hand, to analyze the firm’s capital structure is necessary to identifying the financing source that the firm uses in financing its assets. So the financing source used in order to finance the firm’s current assets, current liability and fixed assets. However,

Corporate tax rate is the company income tax makes debt more attractive than equity in financing the company due to the deduction of the interest rate which will lead to decrease in the cost of capital (Miller, 1963) (McGraw-Hill)

1.8 Background about Naghi Group

Naghi Group is one of the biggest company in Saudi Arabia, they start their journey in 1911 the business founded by Youssef Naghi. Nowadays, naghi Group has more than 15000 employees working across the kingdom. Naghi headquarters is based in Jeddah. However, Youssef Naghi starts as distributor for several products, over the year naghi’s name become synonymous as major player in the market because of the different sector he works on. In other words, he has an umbrella of companies covering diversified groups which are Arabian food and supplies such as Fuddruckers and chili’s restaurants , cigalah, vehicles and electronic distribution and each of this groups managed by one of his sons. Moreover, each operating sector has extremely covers large number of brands and services they are trying to expand and invest in more things not only locally even in the Middle East. Moreover, their operation is widespread throughout Saudi Arabia (naghi)

Mohammed Yousef Naghi Motors Company is a company under Naghi Group. he starts as official importer and distributor for the luxury cars which is BMW Automobiles in Saudi Arabia then he expand and import many others cars such as Rolls Royce, jaguar, land rover, mini copper later on he imports economic vehicles such as Hyundai and ford. The operation also, include schools transportation contracts and city transportation service for Hajj/Umrah Moreover, he is an exporter for china.

However, Their Mission is trying as much as possible to cover all types of cars and to expand more and more so that is his competitive advantage in the marketplace.

(naghi)

Second Chapter

Chapter two: literature review methodology

2.1Research problem

What is the impact of TAX and VAT on capital structure?

What is the relation between TAX and capital structure?

To answer these questions I used naghi’s financial statements to do financial analysis and correlation, and I will analyze the effect through it.

Elsevier B.V. (2015) Showing the relationship between capital structure and financial performance in 196 Romanian companies, The analysis made based on cross sectional regression at the end that lead to indicate that Romanian companies performance is higher when they avoid debt and operate based on equity. (B.V, 2015)

Drik Hackbarth and Bin Zhou (2018), they showing the effect of new tax law on capital structure and cost of capital from the U.S historical experience. However, corporate tax was 30 over the past century then increased from 10% to 52% between 1920 and 1950 so they investigate that no significant time series relation between debt, common equity and taxes, margin. Furthermore, the relationship between effective tax rate and debt ration based on trade off theory. However, the rise on tax rate will increase the tax benefit of debt so the shareholder will borrow more also, they are showing the impact of financial leverage on cost of capital. (zhou, 2018)

C J Arene and S 0 Ndomadu(1997), Nigeria country was using sales tax then in 1997 they introduced the new tax system on consumption which is VAT. The aim of VAT was to reducing the incidence on taxpayer. However, in this research they investigate the relationship between VAT and Capital structure on Nigeria based on regression and financial statement that result on the increase on the price by VAT that responsible to reduce consumption capacity. So they study investigate the imposition of VAT has reduced the quantity and rate consumption of the goods. (Ndomadu, 1997)

Methodology

The study was conducted for naghi group only on motors sector, it refers to a period of five years 2014 to 2018 which is before and after applying. Furthermore, was generated the data directly from naghi motors company finance department.

However, I used financial statement to investigate the effect of VAT on capital structure and to evaluate Naghi’s company performance before and after applying VAT on Saudi Arabia through the popular way to of analyzing financial statement which is fundamental analysis and correlation coefficient. (McGraw-Hill)

2.2 Fundamental financial analysis

Ratio analysis is comparison between variables

Financial ratio are conducted in order to evaluate the company performance as follow

· Liquidity ratio

· Leverage solvency ratio

· Profitability ratio

· Efficiency ratio

(McGraw-Hill)

· Liquidity ratio

This ratio evaluate the firm ability to meet short term debt obligations also, it measure the company ability and how easily can convert its assets into cash. Liquidity ratio contain current ratio, cash ratio, quick ratio and net working capital however, the high liquid is not always sign for company good financial health. (McGraw-Hill)

· Leverage solvency ratio

This ratio evaluates the firm’s ability to meet its long term obligations. Furthermore, solvency ratios are used to calculate if the firm’s cash flow enough to meet short and long term liabilities. However, the lower firm’s solvency ratio the greater chance of default on its debt obligation. It contains total debt ratio, debt to equity ratio, equity multiplier and long term debt ratio. (McGraw-Hill)

· Profitability ratio

This ratio evaluate the firm ability to generate profit, it shows how well a company utilizes its assets to produce profit. Furthermore, it contains margin ratio, operating ratio return on assets and return on equity. A higher profitability ratio means that firm is performing well by generating cash flow, revenue and profit (McGraw-Hill)

· Efficiency ratio

This ratio uses to analyze the firm internal uses of liabilities and assets also, efficiency ratio work in hand with profitability ratio. On the other word, it measures the firm’s ability to use its assets to manage its liability effectively. Efficiency ratio contains turnover ratios which are assets turnover, inventory turnover and receivable turnover. (McGraw-Hill)

2.3 Correlation coefficient

It’s a statistical relationship between variables that measure the strength between the two series number. On other word, it measure the degree of correlation so if two variables are moving in the same direction and equal to +1.0 that positive correlation while if they are moving in opposite direction and equal -1.0 that negative correlation. If the variable shows no relationship to each other that mean uncorrelated so it’s equal to 0. On the other hand, if the correlation coefficient greater than 1 or less than 1 the measurement is not correct. (Scott B. Smart)

Figure 5 shows correlation coefficient relationship between variables

Figure 5

Third chapter

Chapter three: Data analysis

Result and findings

3.1 Fundamental analysis

· Liquidity ratio

Ratio	Naghi Group (Motors)
	2014	2015	2016	2017	2018
Current ratio	1 Times	0.84 Times	0.81 Times	0.82 Times	1 Times
Quick ratio	0.47 Times	0.36 Times	1.03 Times	0.26 Times	0.36 Times
Cash ratio	0.17 Times	0.12 Times	0.10 Times	0.11 Times	0.16 Times

Current ratio analysis

The 1 in year 2014 and 2018 indicates that Naghi’s company does not have liquidity problems that’s mean the current assets is higher than current liabilities compared with the others years. Moreover, the declined in 2015, 2016 and 2017 it is not necessarily a bad indicator they might using their current assets to reduce long term debt. However, when this ratio is equal or exceeds one that’s mean is capable of covering its short term obligations to cover its liabilities. On the other hand, the reason of declining could be referred to an increased in short term debt or decrease in current assets. Since there was increasing in 2018 current ratio doesn’t affected by applying the VAT

Quick ratio

The highest ratio was in 2016 is 1.03 that indicates Naghi’s company was financially securing to meet its short term debt as compared with other years. Furthermore in 2014, 2015, 2017 and 2018 was not liquid enough that’s mean they don’t have enough liquid assets to cover current liabilities.

Cash ratio

The cash ratio was declining from 2014 to 2016 that’s means they have insufficient cash to pay off its current debt. However, in all years was less than 1 so the current liabilities that exceed the available cash so they have incapable of covering their current liabilities using its cash. On the other hand, I think Naghi’s company need more than its cash reserves to pay its current debt.

· 3.2 Long term solvency ratio

Ratio	Naghi Group (Motors)
	2014	2015	2016	2017	2018
Total debt ratio	64%	70%	68%	68%	67%
Debt/Equity ratio	1.77 Times	2.36 Times	2.12 Times	2.18 Times	2.12 Times
Equity multiplier ratio	2.74	3.34	3.10	3.15	3.08

Total debt ratio

The ratio of the year 2016 and 2017 were the same, but it was the highest in 2015 that is 70% which indicates that 70% of total assets were financed by Long Term debt. The higher the debt ratio is, the higher the risk will be for the company therefore requiring higher return on its assets. The same ratio improved in the year 2018 reducing the risk for the company. However, until the rate is below 100%, this means that the company can always settle its liabilities by liquidating its assets. Furthermore the lower the ratio is, the better it is for the company’s going concern and also it would be able to secure new financing at a lower interest rate from banks.

Debt/Equity ratio

The ratio in 2016 and 2018 were the same, but the highest were in 2015 however, naghi’s company has high D/E ratio which is considered to be unhealthy company. However, the ratio in 2014 seems they have almost debt similar to equity. In General naghi’s company has aggressive in financing its growth in debt. Always if the company has high D/E ratio has high risk.

Equity multiplier ratio

Naghi’s company has high financial laverage. Furthermore they have huge debt so they are dependent on debt financing.

Financing source

Internal

Reinvested profit

Deprecitation

External

Debt

Equity

2014 Naghi's current ratio 1 2015 Naghi's current ratio 0.84 2016 Naghi's current ratio 0.81 2017 Naghi's current ratio 0.82 2018 Naghi's current ratio 1 2014 Naghi's quick ratio 0.47 2015 Naghi's quick ratio 0.36 2016 Naghi's quick ratio 1.03 2017 Naghi's quick ratio 0.26 2018 Naghi's quick ratio 0.36 2014 Naghi's cash ratio 0.17 2015 Naghi's cash ratio 0.12 2016 Naghi's cash ratio 0.1 2017 Naghi's cash ratio 0.11 2018 Naghi's cash ratio 0.16 2014 Naghi's total debt ratio 0.64 2015 Naghi's total debt ratio 0.7 2016 Naghi's total debt ratio 0.68 2017 Naghi's total debt ratio 0.68 2018 Naghi's total debt ratio 0.67 2014 Naghi's debt/equity ratio 1.77 2015 Naghi's debt/equity ratio 2.36 2016 Naghi's debt/equity ratio 2.12 2017 Naghi's debt/equity ratio 2.1800000000000002 2018 Naghi's debt/equity ratio 2.12 2014 Naghi's equity multiplier ratio 2.74 2015 Naghi's equity multiplier ratio 3.34 2016 Naghi's equity multiplier ratio 3.1 2017 Naghi's equity multiplier ratio 2.15 2018 Naghi's equity multiplier ratio 3.08