Download How to read accounts

WITS
IJW
POWER
REPORTING WORKSHOP
SEPTEMBER 2007
Forensic Accounting LLP
Centre For Investigative Journalism
HOW TO READ ACCOUNTS
• Profit or Loss?
• Asset or Liability?
• Cash flow in or out?
• What’s in the small print?
• Who’s in charge?
Introduction
Objectives
De-mystifying accounts
•Provide a basic understanding of accounts
•Provide some pointers as to what you should look for
and where you should look
Understand the motivation and pressure for
earnings management
What’s your interest?
 Why are you looking at the accounts of this
particular company?
•Company is important local employer or has won local contracts
•Directors have political interest
•Company doing well but not clear why
•Something odd about the activities of the company or its directors
•Complex web of companies
•Is it safe to invest?
Where do you look?
Motivation
Private Companies
• Depress ‘Earnings’
Why? – Delay taxes
Hide data from competitors
and customers
Public Companies
• Enhance ‘Earnings’
Why? -“THE NUMBER”
Earnings per Share (EPS)
Impacts upon:
•performance bonuses
•stock options
•share price
Motivation – Public Companies
‘The Number’ is very important!
• Enron
• WorldCom
Failure to make ‘The Number’ can result in serious
embarrassment and loss of reputation.
Motivation
Yahoo shares
plummet after
missing targets
MEDIA
SHARES in Yahoo plunged more than
21 per cent in New York on the Nasdaq
after it revealed below-forecast secondquarter
sales and profits.
The internet company also reported
a setback in introducing technology
that would improve the profitability of
advertisements appearing in search
results as its seeks to keep pace with
rival Google. Yahoo posted a $164m
profit, or $0.11 per share, against Wall
Street forecasts of $0.12.
Google is due to post results later
today and Yahoo's below-forecast earnings
has prompted many analysts to
warn the sector maybe slowing.
Increase EPS
Court told of Ebbers' 'manipulation'
Bernie Ebbers, former chief
executive of WorldCom,
manipulated financial
results and lied repeatedly to
investors rather than admit
to the company's sagging
performance, a federal court
heard yesterday…..
…Mr Anders described an
evolving fraud, as Mr Ebbers
pressed lieutenants, including
Scott Sullivan, the company's
chief financial officer,
to "hit the numbers" each
quarter and meet Wall Street
expectations.
He said: "Bernie Ebbers
had a phrase he would use
over and over. It was called,
'hitting the number'. Every
time he told Scott Sullivan
that WorldCom had to 'hit
its number', he was directing
him to commit fraud.“…
HOW TO READ ACCOUNTS
• PROFIT OR LOSS
A Simple P & L a/c
£’000
Turnover
10,000
Cost of sales
(6,000)
Gross profit
4,000
Operating costs
Operating profit
(1,000)
3,000
Profit on disposal of asset
50
Income from investments
150
Interest payable
(100)
Profit before tax
3,100
Tax
(600)
Profit after tax
2,500
Dividend
Retained profit
(1,500)
1,000
PAGE 8
SASOL
• 2006 accounts
• Page 50
• Lots of lines but focus on main four
• Dividends given per share with listed companies.
Need to check how much dividend cost - see Cash
Flow statement or Note 45
HOW TO READ ACCOUNTS
• TOO BIG TO FAIL
A Simple Balance Sheet
Assets Employed
Capital Employed
Vodacom Group
• 2007 accounts
• Page 92
• Compare current assets and liabilities
HOW TO READ ACCOUNTS
• NO CASH NO BUSINESS
Cash Flow Statement
• Profit does not equal Cash
• Profit is the vanity. Cash is sanity…
“Cash is King”
A Simple Cash Flow Statement
£’000
Cash flows from operating activities
Cash generated from operations
Interest paid
Tax paid
Net cash from operating activities
250
(30)
(80)
Cash flows from investing activities
Purchase of PPE
Interest received
Dividends received
Net cash used in investing activities
(90)
40
25
Cash flows from financing activities
Proceeds from issue of share capital
Proceeds from long term borrowings
Dividends paid
Net cash used in financing activities
40
20
(70)
Net increase in cash and cash equivalents
Cash and cash equivalents at beginning of period
Cash and cash equivalents at end of period
140
(25)
(10)
105
90
195
Cash Flow Statement
 Is business generating net cash?
 Where are the company’s funds going, and why?
•
•
•
•
Working Capital
Re-invest in profitable opportunities
Loan repayments
Dividends
 Do cash flows support dividends?
 Companies usually go bust because they run out of
cash not because they run out of profit.
Jubilee Platinum
• 2006 accounts
• Page 31
• Cash from share issues
or loans - usual with
new
mining
companies
as
no
revenues
Growthpoint Properties
• 2006 accounts
• Page 39
• Less cash year on year
HOW TO READ ACCOUNTS
• THE SMALL PRINT
Notes to the Accounts
• The “small print” is always at the back of
the accounts or prospectus so worth reading
from the end forwards
• Gives clues as to what is hidden in the
figures.
• No point in reading the figures without
reading the small print.
Notes to the Accounts
• Directors remuneration
• Post balance sheet events
• Taxation
• Related Party Transactions
• Going Concern
• Exceptional items
• Ultimate ownership (UK only)
• Contingent liabilities
Remuneration
• The notes must disclose directors’ rewards:
– Basic salary/fees and possibly other benefits
– Performance related bonuses / share plans
– Share options
– Deferred Share Bonus Awards / other Deferred
Share Awards
ABSA Group
• 2006 Accounts
• Remuneration report
• Pages 33-43
Taxation
• The notes to the accounts must analyse the tax
charge/credit :
– Income or other company tax
– Deferred taxation
– Prior year’s charge
• The note will also show whether the company is paying the
full rate of tax or less because of tax breaks so perhaps not
a good corporate citizen.
SASOL
• 2006 ACCOUNTS • Note 9, Page 146
• Holding company Sasol Limited pays 0.5%
instead of normal 29%
• Reason given - exempt income
• Sasol group of companies pays more than 29%
• Note 34, Pages 105-6, Note 23, Page 100
Post Balance Sheet Events
The note will include:
• Events since the financial year end but before the accounts
were signed - usually a gap of several months
• If material, the nature and potential financial impact.
Anglo American Corporation
• 2006 accounts
• Note 39, Page 124
• Usually found at the end of the notes but
can also be in the Directors’ report at the
beginning of the annual report
Related Party Transactions
• The company’s financial position and results may
be affected by material transactions involving
related parties.
• Relationships between parents and subsidiaries
must be disclosed.
• Disclosure of transactions between related parties
such as directors or families:
– The nature of the relationship
– Information regarding the transactions
– Outstanding balances
Cape Diamonds
• 2006 accounts
• Note 24, Pages 31-32
• Series of transactions between company and
directors/shareholders
• Such deals always worth checking - are they at
arms-length or is the company/shareholders losing
out
Growthpoint Properties
• 2006 accounts
• Note 34, Page 68-9
• Series of deals with significant shareholder
Investec which is also banker and business partner
• Who gains most?
Going Concern (1)
• Financial statements are prepared on the basis that
the entity will continue for the foreseeable future if necessary with the backing of a director or
shareholder.
• The company has no intention or need to liquidate
the company
• The company has no intention or need to curtail
materially the scale of its operations
• Management must look up to 12 months from the
balance sheet date
Going Concern (2)
Sendo Holdings Plc
Exceptional Items
• Material gains or losses which arise outside of
normal business activity and
are therefore
required to be disclosed separately. The note must
give:
– A break down of each separate exceptional item, either
individually or as an aggregate of items of a similar
type.
– An adequate description of each exceptional item so
it’s nature can be understood
De Beers
• 2006 accounts
• Page 7 - special items
• Explained on page 9
• Special or exceptional items should not happen
again.
• Look closely at a company where exceptional
items seem to happen every year
Ultimate Ownership (1)
• A UK company must disclose its parent company
and, if different, the ultimate controlling party.
• If neither the company’s parent nor the ultimate
controlling party produces financial statements
available for public use, the name of the next most
senior parent that does so shall also be disclosed.
• Note that in some cases, the controlling party may
not be the ultimate beneficiary
Ultimate Ownership (2)
Wockhardt UK Ltd
Contingent Liabilities
• A contingent liability is essentially:
– A possible or present obligation stemming from
something that has happened in the past.
• A contingent liability is disclosed by way of a
note to the accounts. This note should contain:
– A brief description of the nature of the liability
– Estimate of the financial impact
– An indication of the uncertainties involved
– Possibility of any reimbursement
SASOL
• 2006 Accounts
• Notes 49(3);49(4);49(5);49(6)
• Litigation, regulatory action and other bad stuff
usually make up contingent liabilities.
• A company will often say it will win until it does
not and has to make a big provision for the bill
Auditors’ Report (1)
 Clean or unqualified opinion
 Qualified opinion
 Explanation of qualification
 Going concern qualification
The duty of the auditor is to report to members whether the
financial statements of the company have been properly
prepared in accordance with the Companies Act.
Auditors’ Report (3)
Sendo Holdings plc
Independent auditors?
• Anglo American
• Accounts 2006
• Note 4, Page 99
• Deloitte & Touche fees for audit twice fees for tax
and consultancy
• Independence threatened if audit fees much less
than fees from consultancy
Re-cap
1.
Earnings are not the be all and end all.
2.
Quality of assets not just quantity.
3.
Cash is King.
4.
What is happening to the cash?
5.
“The Devil is in the detail”.
HOW TO READ ACCOUNTS
• ANY THE WISER?
Investment Opportunity
Company A – P&L
Share capital
Company B – P&L
10 million
Share capital
£’000
Turnover
Costs
5,000
(2,000)
10 million
£’000
Turnover
Costs
5,000
(2,500)
Profit/Earnings
3,000
Profit/Earnings
2,500
EPS
£0.30
EPS
£0.25
Where would you investCompany
yourB -£100?
Balance Sheet
Company A - Balance Sheet
£’000
£’000
Fixed Assets
6,000
Fixed Assets
7,500
Stock
4,000
Stock
2,500
Trade Debtors
15,000
Trade Debtors
1,500
Cash
8,500
Cash
100
Creditors
(7,600)
Creditors
(2,500)
Net Assets
17,500
Net Assets
17,500
Who are the directors?
• Business background
• Don’t rely on the official version
• Check what happened before
Equator Exploration
• 2005 accounts
• Chief executive Wade Cherwayko
• Abacan Resources
• Promised much in Nigeria, delivered little
• Equator = Abacan 2
• Déjà vu all over again
Financial Check-up (1)
Have the auditors expressed any concerns ?
Check the Auditors Report
How independent are they if they are paid more for non-audit work?
Check the Operating Profit Note
How much debt does the company have, and what is the nature of the debt?
Review the Balance Sheet and Long Term/Short Term Creditors Notes
Is the company generating cash? If so, what is it doing with the money?
Review the Cash Flow Statement
Financial Check-up (2)
What is the management’s previous history?
Review Company Prospectus and public records
What is the level of directors’ remuneration?
Review Notes on Directors
Have there been any related party transaction?
Review Related Party Transactions Note
What has happened since the financial year ended?
Review the Post Balance Sheet Events Note
Forensic Accounting LLP
Centre For Investigative Journalism
2007