Assignment
Word Limit: 2,000 words plus Appendices
Details: Publicly listed companies are currently receiving considerable press coverage frequently linked to factors relating to their financial statements. They produce annual reports for the use of a range of interested parties, including existing and potential shareholders, suppliers, financiers, and regulatory authorities. Annual reports convey primarily financially-oriented information that is intended to shed light on organizational performance from a financial perspective. However, their utility is being questioned. Recent evidence suggests that annual reports may mask what may be otherwise considered to be the "true" state of affairs of a firm. With this in mind, financial statements may need to be read with care. Hence it is important that they are evaluated critically.
Variability in the prices of shares listed on stock exchanges around the world continues unabated. Some of that variability has been due to concerns relating to the degree of financial leverage used by organizations, liabilities classified as non-current rather than current, difficulties associated with raising capital, and the extent of opaqueness of corporate structures as well as the nature and magnitude of debt reported in financial statements. Some investors are increasingly hesitant to buy stock as a result of these concerns. Other investors have lost their life savings in collapsed companies.
Required: Obtain the annual reports of the two ASX listed companies of BHP Billiton (https://www.bhpbilliton.com/home/investors/reports/Pages/default.aspx) and Rio Tinto Limited (https://www.riotinto.com/investors/results-and-reports2146.aspx) for the period 2012 to 2014 inclusive. Reports can be downloaded from the corporate websites.
Evaluate the annual reports from the perspective of investors in the firms. Prepare trend analyses, common size statements and financial ratio analyses for a minimum of three years for the organizations and evaluate them for their information content. Assess whether the reports provide any red flags that may have provided signals of impending financial difficulties. Comment also on the qualitative and non-financial information contained in the reports and assess the extent to which that information facilitates a clearer understanding of the companies' financial operations. Evaluate the notes to the accounts for information that may influence the manner in which the reported financial data may be interpreted. Finally, comment on the utility of annual reports and financial statement analysis in terms of their capacity to inform the decisionmaking processes of investors in these two companies.
Suggested Structure
1.0 Introduction
• What you are going to do
• Why are you doing it
• How you are doing it - brief overview of assignment
2.0 Body
2.1 COMPANY BACKGROUND
• Brief introduction about company and what it does
2.2 FINANCIAL STATEMENT ANALYSIS
2.2.1 COMPANY PERFORMANCE and POSITION
TREND ANALYSIS
• P + L -
- Discuss how the companies have performed over time.
- Include chart to compare; sales, COGS, Expenses and Net Profit as a % - Compare with the other company and industry averages
• B/Sheet
- Discuss how companies have grown or contracted over time - Compare with the other company and industry averages.
2.2.2 COMMON SIZE STATEMENTS
• P + L
- Discuss how companies have improved performance relative to sales (i.e. internal efficiencies)
- Compare to the other company and industry averages
• B/Sheet
- Discuss structure of company
- Discuss how financed etc
- Compare with the other company and industry averages.
2.2.3 RATIO ANALYSIS
• Profitability
• Efficiency
• Liquidity
• Stability
• Investment
• Cash
- Discuss what each group of ratios measures
- Include table with ratios (see below)
- Discuss the impact on company and how it would affect your investment decision
- Discuss whether good or bad
- Compare with the other company, ‘rules of thumb' and industry averages
NB. All of the above discussion points and comparisons are to be applied for all the ratios listed above in bold.
2.3 ACCOUNTING TREATMENTS AND METHODS USED
• Discuss any changes or problems that will/may occur as a result of the methods/treatments the company used and how it would change your analysis.
• What would the difference be if the company used a different method/rate etc?
• Important, this is where we try to see what games the companies have played.
2.4 USEFULNESS OF INFORMATION PROVIDED
• General Purpose Financial Statements (GPFS) are prepared for users to make decisions about the allocation of scarce resources
• Discuss how well information was presented
• Discuss how easy it is to use information given
• Discuss if information was hidden/buried in the reports
• What should be included
2.5 LIMITATIONS OF FSA
• Historic data
• Lack of information/disclosure
• Year end not typical
• Data not comparable - A/C methods, size & diversity
• Hidden supplementary information
3.0 Conclusion
• Summary of what you did
• Summary of results
• Implications
• Where to next/further research
General Comments
Appendices should be used for financial statements, trend statements, common-size statements and ratio calculations.
However, you can use charts, figures or tables in the body of your assignment to emphasise certain points. For example:
LIQUIDITY RATIOS
These ratios focus on working capital and are used to determine a company's ability to convert assets to cash such that it is able to pay liabilities as and when they fall due. Liquidity Ratios include the Current and Quick Ratios.
2009 2010 2011
Current Ratio -Your Company
- Ind. Average 2.0:1.0
2.0:1.0 2.2:1.0
2.1:1.0 2.4:1.0
2.2:1.0
Quick Ratio - Your Company
- Other Company 1.0:1.0 1.0:1.0 1.2:1.0 1.1:1.0 1.4:1.0 1.2:1.0
Table 1: Company Liquidity Ratio and Comparatives
Current Ratio
The Current Ratio measures a company's ability to ....
As you can see from Table 1 above, the Current Ratio has increased from 2:1 in 2009 to 2.4:1 in 2011. The ability of the company to pay its short term debts has improved and is better than the Industry Average, which only increased from 2:1 in 2009 to 2.2:1 in 2011 etc.
Note - Look behind the numbers and tell the story. Ask why they are telling you what they say. The "whats" are only the first step. Real insight comes only from the "whys". Avoid "elevator" analysis: "Sales went up, profits went down" means little without an explanation of the reasons. You may find the caution flags (see end of assignment) useful. Generally, individual ratios are not viewed in isolation. One ratio may help to support the results of another ratio.
Checklist of Caution Flags
Adapted from Understanding the Corporate Annual Report Nuts, Bolts, and a Few Loose
Screws (Fraser and Ormiston 2003)
Below is an abbreviated list of caution flags you may like to consider when preparing your financial statement analysis.
CAUTION FLAGS - INCOME STATEMENT
• Revenue and profit growing at substantially different rates or moving in opposite directions
• Large, unexplained reductions in discretionary items such as advertising, research and development
• Profit margins shrinking or growing dramatically or moving in opposite directions
• Taking large, one-time (special) charges against earnings
• Changing accounting estimates and assumptions
CAUTION FLAGS - BALANCE SHEET
• Reductions in the allowance for doubtful accounts when accounts receivable are increasing
• Sales and receivables growing at substantially different rates or moving in opposite directions
• Sales and inventories growing at substantially different rates or moving in opposite directions
• Excessive use of -other- for material, unexplained items
• Borrowings growing faster than assets being financed; debt rising when assets are decreasing
CAUTION FLAGS - STATEMENT OF CASH FLOWS
• Failure to generate cash from operating activities
• Large fluctuations in cash flow from operating activities over time
• Net profit and cash flow from operations not tracking closely
• Net profit and cash flow from operations moving in different directions
• Positive cash flow from investing activities because company is selling off assets to generate cash
• Positive cash flow from financing activities for several periods - possibly indicating borrowing needed to offset lack of internal cash generation
• Company highlights cash flow in shareholders' letter, especially in same paragraph discussing falling stock price
CAUTION FLAGS - COMPREHENSIVE ANALYSIS
• Changes in top company management
• Key financial ratios indicating deteriorating trends and/or weaknesses relative to industry competitors
• Cash flow from operations declining, negative, volatile, or not tracking with net income
• Lack of profitability in key operating areas
• Price to earnings ratio low relative to competitors
• Firm's earnings less than after-tax cost of debt
• Declining operating profits when debt is rising
Presentation of Report
• Your presentation should take the form of a formal report (see structure above). You do not need to include a letter of transmittal or a glossary.
• Your report must be typed and your discussion should be about 2000 words.
• Your calculations including numbers and formulae of ratios must be included in the appendix.
• It is expected that your report will be referenced where appropriate (Harvard method - no footnotes).
• Do not include definitions of ratios in your paper. It is expected that the reader understands ratios.
• You should include graphs in your discussion.
• No two assignments should have the same wording. Superficial changes will be picked up and dealt with accordingly.
• You must keep an electronic copy of your assignment and be prepared to hand up another copy if necessary.