international accounting and governance:modulo2"disclosure + financial statement analysis", Appunti di Analisi Di Bilancio E Principi Contabili

Scarica international accounting and governance:modulo2"disclosure + financial statement analysis" e più Appunti in PDF di Analisi Di Bilancio E Principi Contabili solo su Docsity! GOVERNANCE Lesson 2: Public company = listed company. Company name: - annual report. - Investor relation => you search for financial report/annual report. - Make sure they have followed IAS/IFRS regulations = you find this information in the Independent auditors' report. - Are they listed? Check in the link: https://www.borsaitaliana.it/borsa/azioni/listino-a- z.html?initial=A&lang=it - No bank, no insurance! - You should have these categories: - Could be a consolidated or separate financial statement. If there are both, choose the consolidated financial statement Accounting is divided into basic accounting and intermediate accounting. DISCLOSURE 1 Full disclosure principle Disclosure, in financial terms, basically refers to the action of making all relevant information about a business available to the public in a timely manner. The full disclosure principle states that all information should be included in an entity's financial statements that would affect a reader's understanding of those statements. The interpretation of this principle is highly judgmental, since the amount of information that can be provided is potentially massive. To reduce the amount of disclosure, it is customary to only disclose information about events that are likely to have a material impact on the entity's financial position or financial results. Full disclosure also means that you should always report existing accounting policies, as well as any changes to those policies (such as changing an asset valuation method) from the policies stated in the financials for a prior period. The IASB Conceptual Framework notes that while some useful information is best provided in the financial statements, some is best provided by other means. The full disclosure principle calls for financial reporting of any financial facts significant enough to influence the judgement of an informed reader. In some situations, the benefit of disclosure may be apparent but the costs uncertain. In other instances, the costs may be certain but the benefits of disclosure not as apparent. Reasons: - Complexity of the business environment → NOTES - Necessity for timely information → INTERIM - Accounting as a control and monitoring device → AUDITORS Two main purposes: - Add new information. - Explain where the information comes from. 2 aggregate. Notes schedules regarding such obligations provide addition information how about a company is financing its operations, the costs that it will bear in future periods, and the timing of future cash outflows. Financial statements must disclose for each of the five years following the date of the statements the aggregate amount of maturities and sinking fund requirements for all long term borrowings. - Equity holders’ claims (Crediti dei possessori di azioni) : many companies present in the body of the statement of the financial position information about equity securities (number of shares authorized, issued and outstanding and the par value for each type of security). Or companies may present such data in a note. Beyond that, a common equity note disclosure relates to contracts and senior securities outstanding that might affect the various claims of residual equity holders. - Changes in accounting policies : the profession defines various types of accounting changes and establishes guides for reporting each type. NB: -> INTANGIBLE ASSET How it’s measured? Its costs less any accumulated depreciation and accumulated impairment losses. What about intangible assets? Intangible assets need to be divided in: - Finite useful life = it’s measured at its cost, net of amortisation and impairment losses. - Indefinite useful life = impairment losses. Question 1 – notes. How much is the depreciation for the year? And the impairment loss? 1. You go to the notes. 2. Owned tangible assets. 3. Which information is included? We have the type of measurements that, depreciation rates (quantitative information =numbers). 4. Property, Plant, and Equipment [note number 9]. We have quantitative information. Everything that happens during a year, comparison of two year the current one and the last one. TANGIBLE ASSETS: Property, plant and equipment_ measurement after recognition After initial recognition, an item of PPE : - Shall be carried at its costs less any accumulated depreciation and any accumulated impairment losses; OR - whose fair value can be measured reliably shall be carried at a revalued amount, being its fair value at the date of the revaluation less any subsequent accumulated depreciation and subsequent accumulated impairment losses. Revaluations shall be made with sufficient 5 regularity to ensure that the carrying amount does not differ materially from that which would be determined using fair value at the end of the reporting period. Valuation of INTANGIBLE ASSETS →Amortization and not depreciation in intangible asset. →Difference between FINITE AND INDEFINITE. The accounting for an intangible asset is different if its useful life is finite or indefinite. After initial recognition: - an intangible asset with a finite useful life, in financial statement shall be carried at its cost less any accumulated amortisation and impairment losses; - an intangible asset with a indefinite useful life, in financial statement shall be carried at its cost less any impairment losses. Question 1.1 : In the notes to the financial statement related to property, plant and equipment which information is included? How much is the depreciation for the year? And the impairment loss? Explanatory notes: what rules the firm follows, what is the stock exchange. Owned tangible assets: what comes first o what comes second in the annual report can vary from the firm. “Property, plant and equipment are measured at cost, net of depreciation and net of any accumulated impairment, except for land which is not depreciated but is valued at cost net of any accumulated impairment.”: to remember readers on how to do the calculation. Information on the type of measurement that the manager has to use make the calculation, the depreciation rates. So, qualitative and quantitative information. Information that give an explanation to other information, but also new data: “Depreciation is accounted for starting from the month in which the asset is available for use, or is potentially capable of providing the financial benefits associated with it. Depreciation is recognised on a monthly straight-line basis at rates that allow assets to be depreciated until the end of their useful life or, in the case of disposals, until the last month of use. Depreciation rates were as follows: The Group annually revises the expected useful life of property, plant and equipment. Buildings 3% - 10% Plants 7% - 20% Machinery 5% - 20% Equipment 10% - 33% Furniture 10% - 33% Motor vehicles 10% - 25%” Inside the financial position, you have the column “note”: note number 9, 10 etc is the note linked to the account, so you have an additional information about that account. You have, for instance, quantitative information: new purchase, sells: every that happens during the year. Every financial statement present column: you have representation of the current year and the previous year, to compare the two years. 6  Two information given by the notes: General information and the specific information given by the number of the note in the column “note”. How the manager calculates the depreciation and the impairment? Expenses of the year →depreciation. Cost – accumulated depreciation (made every year). Only in some years there is the impairment, for specific events, a firm bankrupt etc. Managers have to do the tests, then the tests can have two different results: 1) loss or 2) profit. If the value decrease → loss, increase → profit. Loss: is included in the income statement. Profit: cannot be included in the financial statement because the purpose of the test is to discover if the event brings to a loss in values. If it is a profit, it won’t be put in the financial position because it is just an idea of the manager, while the loss is always put, even if it is an hypothesis. Cost- accumulated depreciation – accumulate impairment  only in year with a specific year: usually cost-accumulated depreciation. IMPAIRMENT for PPE and INTANGIBLES are valued at: COST - ACCUMULATED DEPRECIATION - ACCUMULATED IMPAIRMENT. every year managers compute the expense of the year (depreciation) -> COST - ACCUMULATED DEPRECIATION. only in some years: only for specific events (bankrupt of a client, change in law, new technology) managers do IMPAIRMENT TEST the result of the test can be: - LOSS -> is included in the income statement - PROFIT -> cannot be included in the financial statement because the purpose of the test is to discover if the event brings to a loss in values. only in the year with a specific event, only in the year in which the test results in a loss = COST - ACCUMULATED DEPRECIATION - ACCUMULATED IMPAIRMENT only for INTANGIBLES WITH INDEFINITE LIFE (goodwill, brand) every year managers do IMPAIRMENT TEST BUT the result of the test can be: - LOSS -> is included in the income statement - PROFIT -> cannot be included in the financial statement because the purpose of the test is to discover if the event brings to a loss in values. only in the year in which the test results in a loss = 7 Lesson 3: “ the amortization method shall reflect the pattern in which the asset’s future economic benefitis are expected to be consumed by the entity (straight line method, the diminishing balance method and the unit o production method). Es. Building costs of 5000 euro (balance sheet), the manager has to do a calculation every year to do the amortization. Amortization method: 1) Straight 50000% B.S 10000 IS t; 10000 IS t+1 2) Diminish 50000 30000t; 10000 t + 1; 5000 3) Unit 50000 → 10 unit, more amortization when you have less unit. → 20 unit, 30000 t+1 Completely free for the manager on how to do the amortization, but a judgment in the notes has to be made “judgment and assumptions”, another decision is about “how much”→ how many years, with how much money should I start (it depends on the purposes). However, the manager has to give explanations about what he did, his decisions in the notes. Question 1.2 What are the accounting policies and the related assumptions made (method of depreciation, useful life) for PPE? Page 440, answer: straight line basis → “Depreciation is recognised on a monthly straight-line basis at rates that allow assets to be depreciated until the end of their useful life or, in the case of disposals, until the last month of use. + Useful life in percentages Question 1.4. What are the accounting policies and the related assumptions made (method of amortisation, useful life, definite or indefinite useful life) for intangibles? “Intangible assets refer to assets without an identifiable physical form, which are controlled by the Group and are capable of producing future economic benefits. Intangible assets with finite useful lives are measured at cost, net of amortisation and net of any accumulated impairment and 10 include costs for services provided by third parties. Amortisation is calculated on a straight-line basis and begins when the asset becomes available for use or is capable of operating in the manner intended by management, and ceases on the date when the asset is classified as held for sale or is de-recognised. Amortisation is calculated on a straight-line basis and begins when the asset becomes available for use or is capable of operating in the manner intended by management and ceases on the date when the asset is classified as held for sale or is de-recognised.” (pg.448) + Useful life in number of years: “the Metzeler Brand (useful life of 20 years) to the amount of euro 44,220 thousand included under the item “Concessions, licenses and trademarks – finite useful life”;  Customer relationships (useful life of 10-20 years) which mainly includes the value of commercial relationships for both the Original Equipment and Replacement channel” (Pagina 490) It can be different based on the company; it is not sure that the tangible and intangible’s policies and assumptions are the same. Notes include different types of disclosure: accounting policies. One for each account (line) in the balance sheet. 1. General part. 2. Specific notes with a number. Question 1.5. Are there intangibles with no amortization (expense of the year)? Which are these intangibles? Why? To evaluate equipment: historical cost – accumulated depreciation – accumulated impairment Accumulated depreciation, by IFRS, can be calculated with three methodologies (choice of the manager): 1. STRAIGHT 2. DIMISH 3. UNIT Answer: “Pursuant to IAS 36, goodwill is not subject to amortisation, but is tested for impairment annually, or more frequently if specific events or circumstances arise that may suggest an impairment.” (Pg. 492). “The Pirelli Brand, valued at euro 2,270,000 thousand is an intangible asset with an indefinite useful life, and as such is not subject to amortisation, but pursuant to IAS 36, is tested for impairment annually or more frequently, if specific events or circumstances arise that may suggest an impairment.” (pg. 493) 11 By theory it is not possible to do the amortization of goodwill. Lesson 4 EVALUATION OF INVENTORIES Recap: Inventories shall be measured at the lower of cost and net realisable value (Ias 2 par. 9). The cost of inventories shall comprise all costs of purchase, costs of conversion and other costs incurred in bringing the inventories to their present location and condition (Ias 2 par. 10). Net realizable value is the estimated selling price in the ordinary course of business less the estimated costs of completion and the estimated costs necessary to make the sale. (Ias 2 par. 6).  2 values: cost and the net realisable value (price of the market)  And the manager should choose the lower. He should show his choice in the notes and tell why. COST EVALUATION COSTS: ORDINARLY AND NOT ORDINARLY INTERCHANGEABLE 12 - or joint venture = the company A has the 50% of shares and there is only another shareholder with the other 50% of the reporting entity, or it is controlled, jointly controlled, or significantly influenced or managed by a person (manager, relative…) who is a related party. So which company do you include in the consolidated financial statement? You don’t include joint venture or associate. You include subsidiary of any type but it’s up to the manager to choose which type of subsidiary to include according to IFRS rules and he has to explain why. For example: you can’t include a company that is very small or if the company will be sold soon. When you write the consolidated financial statement, you take all the balance sheet of every company and sum them. IFRS tells you which are the parts that you can eliminate in order to avoid counting twice the transactions. recap on objective IFRS 10: key concepts IFRS 10 has the objective of setting standards for the preparation and presentation of consolidated financial statements for a group of entities under the control of a parent. IAS 27 Separate Financial Statements deal with presentation of separate financial statements. Related-party transactions is a transfer of resources, services or obligations between a reporting entity and a related party, regardless of whether a price is charged. Related party transactions are specific transactions that need to be considered specifically and differently from all the other transaction in the financial statement. A sale or purchase from outside (from a supplier or from a client or to a client) is an usual transaction that occur in a year. Instead, when there is a transaction with a related party, a party that is in a relation to the company, there could be some issue, so we need to have a special disclosure for all the transactions that are made with related parties. Transaction can significantly influence the policies and so it is important to make specific disclosure and also to show the motivation and the assumptions related to these transactions. Disclosure on Related-party transactions 15 In order to make adequate disclosure, companies should report the economic substance, rather than the legal form, of these transactions, specifying: - the nature of relationship (if the transaction is with a relative, or with a subsidiary…) - the amount of transaction and outstanding balances (mandatory to show it with numbers) - the Provision (fondi) for doubtful debts. - The expense recognized during the period in respect of bad or doubtful debts due from related parties. SCOPE OF CONSOLIDATION OR AREA OF CONSOLIDATION: is a part of the statement in which you have the list of the companies that are consolidated, but you don’t have to analyze them because we have to take into account the companies that are outside the consolidation area. Example_ What is a trade receivable? Pirelli sales to a client: TRANSACTION 3 April sales 20 units at 1000 euro to a client B. in the financial statement you put (recognition rule in the double entry bookkeeping): 20 * 100= 2000 euro as REVENUES FOR THE SALES (INCOME STATEMENT) and 2000 euro as trade receivable (crediti verso clienti), some money that Pirelli has to receive from the client (BALANCE SHEET). If on the 31st of Dec you don’t have the money, you will put it in resources- asset that has a connection with the future ( you will be paid in the future). RELATED PARTIES TRANSACTION Pirelli sales to a subsidiary/associate/manager…(not in the scope of consolidation) Question 2.1 Are there related-party transactions? Yes Question 2.2 If yes, who are the related PARTIES? pag 540 Related parties are - Associates - Joint venture - Single person: directors, key managers - Other: Aeolus Tyre and Prometeon : subsidiaries not consolidated Question 2.3 If included, how much is the amount of the transaction for the ordinary transaction of sales to clients / trade receivables? Da pag 540 (11 million in total prom subsidiary: 9.2 with associates and joint venture and 1.8 with other related parties) SUBSEQUENT EVENTS: EVENTS AFTER THE REPORTING PERIOD Notes to the financial statements should explain any significant financial events that took place after the formal statement of financial position date, but before the statements are authorized for issuance (hereafter referred to as the authorization date). These events are referred to as events after the reporting date or subsequent events. 16 Period of the financial statement: 12 months (common from January to December) and it’s updated day by day with double bookkeeping ( accounted both in the balance sheet and the income stat.). It takes months to account it and create the financial statement so IFRS gives you time until March/May of the following year to create all the 500/600 pages. This work is made by 5 people circa. Their work is controlled by auditing since June and it should be approved by shareholders meeting that approve it before publishing it online. So what happens after the 31st of December is called Subsequent Event Period. If something happens after the 31st of December and it’s relevant for the company you should write an additional disclosure to the financial statement but not including numbers. (ex. Covid that happened in March). Notes to the FS should explain any significant events that took place after the formal statement of financial position date, but before the statements are authorized for issuance (the authorization date). These events are referred to as events after the reporting date or subsequent events. Time periods for subsequent events: 1. Financial Statement Period (ex. 01.01.2019 – 31.12.2019) 2. Subsequent Events period (ex. 31.12.2019 – 03.03.2020 - date of the authorization). So, during the period between the statement of financial position date and its authorization date, important transactions or other event may occur that materially affect the company’s financial position or operating situation. Two types of events or transactions occurring after the statement of financial position date may have a material effect on the financial statements or may need disclosure so that readers interpret these statements accurately: Subsequent events can be of two types: 1. events that provide additional evidence about conditions that existed at the statement of financial position date (ex. Results of a legal issue, such as a class action). These events are referred to as adjusted subsequent events and require adjustments to the financial statements. 2. events that provide evidence about conditions that did not exist at the statement of financial position date (example Covid-19). These events are referred to as non-adjusted subsequent events and do not require adjustments of the Financial statement. 17 disclosing the Brazilian operations. Caterpillar's failure to include information about Brazil left investors with an incomplete picture of the company's financial results and denied investors the opportunity to see the company “through the eyes of management.” Basic Principles of IFRS: Financial statements can be disaggregated in several ways. IFRS requires that general purpose financial statements include selected information on a single basis of segmentations. Thus, a company can meet the segmented reporting objective by providing financial statements segmented based on how the company’s operations are managed. The method chosen is referred to as the management approach. The management approach reflects how management segments the company for making operating decisions. The segments are evident from the components of the company’s organization structure. These components are called operating segments. The segments are evident from the components of the company’s organization structure. If you decide to divide by products, it is not possible that you divide also by geography, by customers and this would be too much. IFRS requires you to choose just one of the possibilities of the segmentation and the manager chose the one that followed the management approach. A management approach/accounting is the accounting made inside the company , the manager prepares and make information also calculation for data that just stay in the company and they do not give this information to the public. management approach: financial statement accounting (info for outside) + management accounting (info from inside and for inside the company). IDENTIFYING OPERATING SEGMENTS An operating segment is a component of an enterprise: a. That engages in business activities from which it earns revenues and incurs expenses. b. Whose operating results are regularly reviewed by the company’s chief operating decision maker. c. For which discrete financial information is available. Companies may aggregate information about two or more operating segments only if the segments have the same basic characteristics in each of the following area: - The nature of the products and services provided. - The nature of the production process. - The type or class of customer. - The methods of product and service distribution. - If applicable, the nature of the regulatory environment. After the company decides on the possible segments for disclosure, it makes a quantitative materiality test. This test determines whether the segment is significant enough. 20 An operating segment is deemed significant and therefore a reportable segment if it satisfies one or more of the following quantitative thresholds. - Its revenue is 10 percent or more of the combined revenue of all the company’s operating segments. - The absolute amount of its profit or loss is 10 percent or more of the greater, in absolute amount, of (a) the combined operating profit of all operating segments that did not incur a loss, or (b) the combined loss of all operating segments that did report a loss. - Its identifiable assets are 10 percent or more of the combined assets of all operating segments. In applying these tests, the company must consider two additional factors. - Segment data must explain a significant portion of the company’s business. Specifically, the segmented results must equal or exceed 75 percent of the combined sales to unaffiliated customers for the entire company. - The IASB decided that 10 is a reasonable upper limit for the number of segments that a company must disclose. The accounting principles that companies use for segment disclosure do not need to be the same as the principles used to prepare the consolidated statements. This flexibility is due to the fact that it would be very difficult to prepare segment information in accordance with some IFRS. IASB requires that an enterprise report the following. - General information about operating segments. - Segment profit and loss and related information (some info of part of income statement). - Segment assets and liabilities (some info of part of balance sheet). - Reconciliations to the total: sum of data of the segments - Information about products and services and geographic areas. - If 10 percent or more of company revenue is derived from a single customer (you need to do a special disclosure about this customer), disclose revenue from each such customer by segment. segment reporting: disclosure for IFRS wants data to be divided by segments. One single segments means NO DIVISION of data and there is no segment disclosure. Because one segment is one firm. SEGMENT disclosure Question 4.1 What are the criteria used to identify segments (geography, legal, products/services, size)? Is the director c using the management approach? Answer : Pag 485. There is not a segment reporting disclosure. Question 4.2 If the segment reporting is not disclosed, why not? (based on thresholds of IASB) Answer : Is not disclosed because it doesn’t respect the IFRS but Pirelli decided to give a voluntary disclosure. 21 Question 4.3 What is the information about each segment provided? Are there data of income statement? Data on assets and liabilities? Is there a reconciliation? Answer: Yes info about income statement (revenues). Yes data on assets (PPE) of balance sheet. Question 4.4 What is the number of segments disclosed? Is it lower than the maximum number allowed by IFRS? INTERIM REPORTS Another source of information for the investor is the interim reports. Interim reports cover periods of less than one year. The securities exchanged, market regulators, and the accounting profession have an active interest in the presentation of interim information. An interim report can start any month, depending on the choices of the business. Example to understand: - Transaction: sales of 10 units at 100 euro each (20th November) - Clients receive the units on 20 November - Pay 1000 euro on 15 January - Accrual accounting (this is the one IFRS uses): revenue 1000 written in November ( when there is the invoice, ratei-risconti, revenues unit delivery) – income statement in the period - Cash accounting (used in Italy): cash movement 1000 euro in January (income declaration) - Now we imagine that there is a Manager report for 3 months from Jan to March - Transaction: sales of 10 units at 100 euro each (20th November) - Clients receive the units on 20 March - Pay 1000 euro on 15 April - Accrual accounting: revenue 1000 in March IFRS requires companies to follow the discrete approach. - Treat each interim period as a separate accounting period. - Follow the principles for deferrals and accruals used for annual reports. - Report accounting transactions as they occur, and expense recognition should not change with the period of time covered. All the accounting numbers that are inside the scheme of financial statement have to follow an accrual accounting principle and you cannot follow a cash basis principal. For example, when a company makes a sale, the company performed the services and then it will receive the cash for this service in the next interim. The cash movement (the movement in the bank account) is in the next period but the service you have done occurs in this. So, if you follow the accrual accounting the company should put the revenue of this service in this financial statement, if you follow the cash accounting you have to put the revenue in the next period because the cash is moving in the next period. 22 MANAGEMENT’S REPORT Also called management commentary/director report. It is an additional disclosure, not inside the FS. Management commentary helps in the interpretation of the financial position, financial performance, and cash flows of a company. Such a report may include a review of the: - main factors and influences determining financial performance; - company’s sources of funding and its targeted ratio of liabilities to equity; - company’s resources not recognized in the statement of financial position in accordance with IFRS. The management commentary also provides an opportunity to understand management's objectives and its strategies for achieving those objectives (all the information related to accounting are information related to the past). Users of financial reports, in their capacity as capital providers, routinely use the type of information provided in management commentary as a tool for evaluating an entity's prospects and its general risks, as well as the success of management's strategies for achieving its stated objectives. Management commentary encompasses reporting that is described in various jurisdictions as management's discussion and analysis (MD&A), operating and financial review (OFR), or management's report. Risk factors – Management of risks: for internal controls to be effective, the Group needs to be able to identify and assess the risks to which it is subject, namely the possible occurrence of an event whose consequences could affect the company’s human capital, assets, environment, goals, together with its activity, financial condition, financial results (or its ability to achieve its goals) or reputation. These risks are identified by means of a continuous process, taking into account the changes in the Group’s external environment together with the organizational changes rendered necessary by the evolving nature of it markets and the macroeconomic environment. This process is overseen by the Finance division and the Legal Affairs department, with input from all Group operating and corporate departments. Management Discussion and Analysis: RISK FACTORS-MANAGEMENT OF RISKS This chapter describes the main risks facing the company with regard to the specific characteristics of its business, of its structure and its organization, of its strategy and its business model. It further describes how the company manages and prevents these risks, depending on their nature. The chapter has been organized to identify risk factors specific to the Group. They have been arranged by order of priority, according to whether they are of high, secondary, or low importance. Risks in 2015 were more or less identical to those described in the Management Discussion. Identification of Risks 25 For internal controls to be effective, the Group needs to be able to identify and assess the risks to which it is subject, namely the possible occurrence of an event whose consequences could affect the company's human capital, assets, environment, goals, together with its activity, financial condition, financial results (or its ability to achieve its goals) or reputation. These risks are identified by means of a continuous process, taking into account the changes in the Group's external environment together with the organizational changes rendered necessary by the evolving nature of its markets and the macroeconomic environment. This process is overseen by the Finance division and the Legal Affairs department, with input from all Group operating and corporate departments. As in previous years, the Audit Committee has reviewed risks liable to have a significant adverse impact on the company's human capital, assets, environment, goals, together with its activity, financial condition, or financial results (or its ability to achieve its goals), or reputation, and considers that there are no other significant risks than the ones discussed below. The key factor protecting the Group against macroeconomic environment risks I its business model, and in particular: Economic and Operational Risks Specific to the Company's Business Lectra designs, produces, and markets full-line technological solutions-comprising software, CAD/CAM equipment, and associated services-specifically designed for industries that use large volumes of fabrics, leather, technical textiles, and composite materials. It addresses a broad array of major global markets, including fashion and apparel, automotive (car seats and interiors, airbags), furniture and a wide variety of other industries, such as aeronautical, marine industries and wind power. Market Risks Because of its international presence, foreign exchange risk is the principal market risk to which the Group is exposed. It is Group policy to manage these risks conservatively, refraining from any form of speculation, by means of hedging instruments. Customer Dependency Risks Each year, revenues from new systems, accounting for 42% of total revenues in 2015, are generated by around 1,600 customers and comprise both sales to new customers and extensions or the renewal of existing customers' installed bases. Revenues from recurring contracts, accounting for 33% of 2015 total revenues, are generated around 6,000 customers. Finally, sales of consumables and spare parts, which account for 25% of 2015 total revenues, are generated on a large proportion of the installed base of more than 6,000 cutters. These figures are more or less identical to those for 2014. There is thus no material risk of dependence on any particular customer or group of customers, as no individual customer represented more than 7% of consolidated revenues over the last 3-year 26 period 2013-2015, and the company's 10 largest customers represented less than 20% of revenues combined, and the top 20 customers less than 25%. Example in pirelli Question 7.3 What is the information given on risks in the management commentary? (Example Pirelli) Pirelli shows risks divided into three categories: 1. External (occur outside the sphere of influence of the company. Includes risks related to macroeconomic trends, evolution of demand, competitor strategies, technological innovation, introduction of new regulations, country-specific risks financial, security related, political, environmental- as well as impacts linked to climate change). In Pirelli’s financial report, these risks are risks associated with general economic conditions and specific countries (Argentina, Brazil, Mexico and Russia); risks related to Brexit, Covid-19 and to changes in demand (in the middle and long term). Then there are risks related to climate change, to price trends and availability of raw materials, and to competition. 2. Strategic (related to marketing, managing and strategies of the company. Typical for a specific business sector of which the proper management is a source of competitive advantage or (on the contrary) the cause for the failure to achieve financial objectives. Includes risks linked to markets, to product innovation and development, to human resources, to raw material costs, production processes, and financial risks connected to M&A operations). In Pirelli’s Financial report, we can find in this section exchange rate risk, liquidity risk, credit risk, interest rate risk (variability important when calculating fair value or in relation to future cash flows of financial assets or liabilities), price risk associated with financial assets, and risks associated with human resources. Important distinction: - liquidity risk: risk of insufficient available financial resources to meet the financial and commercial obligations (SFP, liabilities) within the terms and deadlines established, - credit risk: exposure to potential losses resulting from the non-fulfilment of the commercial and financial obligation undertaken by counter parties. 3. Operational (generated by the organization and corporate processes, whose occurrence does not result in any competitive advantage. Includes information technology, business interruption, legal & compliance, health, safety, environment, and security risks). In Pirelli’s Financial report, there are risks related to environmental issues, employee health and safety risks, defective product risk, litigation risks, personal data processing risks, risks related to information systems and network infrastructure, risks relative business interruption and to the financial reporting process. Next, there are reputational risks and risks related to corporate social and environmental responsibility, business ethics and third-party audits. 27 3. Circumstances now change so rapidly that historical information is no longer adequate for prediction. Arguments against requiring published forecasts: 1. No one can foretell the future. Therefore, forecasts will inevitably be wrong. Worse, they may mislead if they convey an impression of precision about the future. 2. Companies may strive only to meet their published forecasts, thereby failing to produce results that are in the shareholders' best interest. 3. If forecasts prove inaccurate, there will be recriminations and probably legal actions. 4. Disclosure of forecasts will be detrimental to organizations because forecasts will inform competitors (foreign and domestic), as well as investors. Fine ppt disclosure LESSON 8 FINANCIAL STATEMENT ANALYSIS : RATIOS AND PERCENTAGES (7.2 BOOK CHAPTER) The final stage of exploring accounting is the interpretation of financial statements. A vital part of the analysis of financial statements is to be aware of their weaknesses. Financial ratio analysis consists in using relationships among financial statement accounts to gauge the financial condition and performance of a company. A number in isolation is not very helpful, comparison is key. There are no “absolute rules” on how to define the ratio. A ratio is a number divided by another number: for effective comparison in practice, a number of years’ results need to be taken together, preferably five or more. However, the more years are considered, the greater the risk of changes in the accounting policies used over the period. Common size analysis Techniques of ratio analysis - Time-series analysis: comparing a firm’s rations across time o Facilitates the identification of changes in performance and the detection of the underlying causes, such as: a. Has the firm made a significant change in its product, geographic, or customer mix? b. Has the firm made a major acquisition or divestiture? c. Has the firm changed its methods of accounting over time? d. Are there any unusual or nonrecurring that impair a comparable analysis of financial results across? 30 - Cross-sectional analysis: comparing a firm’s ration of comparable firms o Facilitates the identification of differences in performance and the detection of the underlying causes. The following steps are required: a. Definition of the industry b. Calculation of industry leverage c. Distribution o rations around the mean d. Definition of financial statement rations Three Caveats of ratio analysis We need to build a systems of ratios (i.e ratio tree) where ratios are connected by cause-and- effect relationships. There is no generally accepted set of rules for computing ratios. Ratios do not provide answers, they just help direct you in your search for answers. 7.3 PROFIT RATIOS GROSS PROFIT MARGIN: the gross profit is the difference between the value of the sales and the cost of sales (called costs of the goods sold). The gross profit margin is an indication of the extra inflow from an extra unit of sales. Gross profit margin = Gross Profit / Sales 1. SALES ≠ Total revenues 2. Gross profit = Sales – Cost of sales 3. Cost of sales or Cost Of Goods Sold (COGS) = Purchase– Discount/Returns – Variation of inventory 4. EBITDA ≠ Gross profit E EBITDA = earnings before interest, tax, depreciation and amortization (thus it includes also cost of personnel, services, other …) 31 An alternative way to consider this is to relate the gross profit to the cost of goods sold, thus giving the mark-up as a percentage of cost. Using such a mark-up might well be the way in which the business manager decided upon the selling price. The calculation of the mark-up is as follows: For Bread Co. the gross profit margin has fallen since the previous year. Some of the possible reasons for this are obvious. For instance, the selling price may have been deliberately lowered or the cost of goods sold may have increased but a decision made not to increase selling prices correspondingly. Alternatively the mix of sales may have altered, with an increase in the proportion of low-margin goods. REVENUES Revenues include: sales and other type of revenues. If the income statement does not provide the detail, you can find the information in the NOTES to the financial statement. In some firms, revenues are only sales. Thus, it is possible to use total revenues in the ratios that use sales. In some other firms, you have to select sales from raw materials and goods. COST OF SALES 32 the balance sheet. Possibilities include considering total assets, net assets (i.e. assets minus liabilities) or non-current assets alone. These could be related to, for example, sales, gross profit, net profit or net operating profit. Using net profit or net operating profit gives an indication of the rate of return being generated through the use of the assets. o Sales / Fixed Assets o Sales / Net Assets o Sales / Total Assets o Net Profit / Fixed Assets Net Profit / Net Assets o Net Profit / Total Assets NET OPERATING PROFIT MARGIN Ratio preparation is a pragmatic business. It is, of course, possible to calculate a ratio that is ‘wrong’ in the sense of being defined or calculated in an illogical manner. Even so, once that hurdle has been overcome, there is still no list of ‘right’ ratios. For example, in the above discussion, the debenture interest was treated as just another expense. However, depending on the purpose of the analysis, it may be more helpful to view the debenture interest as different and separate from the other expenses, on the grounds that it is concerned with the financing structure rather than with the operation of the business. This leads to the idea of calculating the percentage of net operating profit to sales, i.e. taking the profit before deduction of the debenture interest. Then we would have: GEARING: LEVERAGE The relationship between equity and long-term borrowings is known as the gearing (or leverage) of the financial structure. There are two common ways of calculating a gearing ratio: (a) compare the debt (i.e. long-term borrowings) with the equity; or (b) compare the debt with the capital employed (i.e. equity plus debt). Formulae for the two gearing ratios are: DEBT = long term liabilities + current liabilities = total assets – total equity EQUITY + DEBT = TOTAL ASSETS High leverage= – High interest expense to pay (can bring to bankrupt) = debt should be always legally paid (interest) while equity can be paid when the company decides (dividend). Help the business if ROA can cover this cost - RETURN ON EQUITY ROE 35 A further approach to investigating the relationship between returns and the resources employed to create them is to consider the sources of finance on the other side of the balance sheet. This is probably the most interesting approach, because it enables analysts to focus on various subsets of the total finance being provided and to consider the return generated for that particular subset and its providers. Several different ratios are now considered. Return on equity relates the return made for the shareholders with the finance made available by the shareholders. It can be calculated either before tax deductions or after them and it may well be useful to do both. If the issue to be explored is the return potentially available for distribution to shareholders, then clearly the aftertax position has to be taken. However, the deduction of tax is a distortion when investigating the efficiency of management in organising the operations of the business is required or when comparing ROE with rates of return on other sources of finance. In such cases, before-tax returns may be more useful. The formula for return on equity is: INTERPRETATION PROFITABILITY RATIOS In Pirelli (QUESTION 2.3 AND 2.2) 2022 ROE 8% ROA 5% LEVERAGE 61% for 100 euro of total, 61 is debt and 39 is equity Gearing effect Choosing the two ratios that measure the leverage and the return on equity and analysing them, does the firm use the gearing to increase the profitability of the firm in year t? Is this strategy changed in year t compared to year t-1? Yes in year t, Pirelli uses Debts (61%) to increase profitability for shareholders (8%) In timeseries analysis there is a decrease in Debts (from 64% to 61%), but the profitability for shareholders increases from 6% to 8%. Decreasing debts is a good idea because there are costly (interest expenses to pay), anyway Pirelli doesn’t have to eliminate completely debts. Debts help to run the business (gearing) also in t-1 2021 - ROE 6% - ROA 4% - LEVERAGE 64% - ROA 5% 36 - ASSET TURNOVER 46% (Quantities) PROFIT MARGIN 11% (prices ) - ROA 4% - ASSET TURNOVER 38% (Quantities) PROFIT MARGIN 10% (prices ) Strategies on quantities 7.5 LIQUIDITY RATIOS Liquidity ratios indicate a company’s ability to pay short-term debts. They focus on current assets and current liabilities. (you find all the data for these ratios in consolidate balance sheet also known as consolidated statement of financial position) Each ratio shows the extent to which the particular definition of ‘short-term assets’ chosen would allow the repayment of the short-term liabilities in existence at that date. The shorter the term considered, the more prudent, pessimistic or safe is the approach adopted. Three types of analysis: 1. CASH RATIO (being able to pay only cash) CASH + MARKETABLE SECURITIES = CASH AND CASH EQUIVALENTS 2. Current Ratio (or working capital ratio) = Current Assets / Current Liabilities - number of Euros of current assets for each Euro of current liabilities - Need to balance liquidity and investments for avoiding over conservative approach It includes inventory, account receivable and inventory Working Capital = Current Assets – Current Liabilities Current assets include those assets that a company expects to convert into cash within the next operating cycle, which is typically a year Current liabilities : those liabilities that come due within the next year. An excess of current over current liabilities in known as working capital. NB liabilities: - Non current (usually) = employees benefits, provisions, deferred tax, debt - Current (usually) = trade payable, current tax - For the "other liabilities", if you do not have information in the balance sheet, you should go in the NOTES 37 Acronyms: SALES+INVENTORY-PAYBLES= DAYS CASH CONVERSION (number of day a firm need to have cash) Number of days that in average are necessary to collect cash from debtors, to sell goods in inventory and to pay cash to creditors. If the collection and sales of inventory takes longer than the payment period, the firm has to think to change the funds management In pirelli: - trade creditors(account/trade payables): 1973 - cost of sales (is negative but we use it positive in ratios): 2207 - ratio: 1973/2207 * 365= 326 days In Pirelli - inventory: 1458 - cost of good sold: 2207 - ratio: 1458/2207 * 365= 241 days In pirelli: - trade debtors(account/trade receivables): 636 - sales: 6427 - ratio: 636/ 6427 * 365= 36 days LESSON 10 7.9 SOME GENERAL ISSUES ABOUT RATIOS RELATIONSHIPS BETWEEN RATIOS Pyramid of ratios (levels 1–2) NOTE: THE COURSE DOES NOT COVER LEVEL 3 AND 4 Learning objectives: - Explain the roe drivers with a system (not a list) of ratios - Understand how financial leverage affect ROE 40 - Understand the difference between ROA and RNOA Pyramid of ratios level (1st and 2nd level) The pyramid can be extended to a further level by comparing Example: Same total asset Company A has 500 debts and 500 equity company B has 800 debts and 200 equity higher debts don’t means a worst situation (Debt is not evil) for both companies different financial leverage (FLEV) ROE is higher than ROCE, if: - Firm has financial leverage - ROCE > Cost of debts BUT Higher leverage generally suggests greater financial risk, which makes more expensive the cost of capital. Companies with stronger ROCE can afford more leverage. 41 A system of ratio instead of a list of ratio facilitates the evaluation of ROE emphasizing the cause and effect relations among ratios. Ratio analysis does not provide answers, it just helps guide you in your search for answers, Ratios should be interpreted in the context of the firm’s business environment. ROA: asset turnover * Profit margin Asset turnover= Sales / total assets Profit margin = net operating profit / sales Profit= EBIT or operating profit (it’s not the net profit) +EBIT net profit + taxes + interests expenses LESSON 11 Interpretation for Pirelli Profitability : (question 2.1 and 2.6) Choosing one ratio over time, answer at the following question: Has the operating profitability increased in year t compared to year t-1? ROA from 4% to 5% Choosing one ratio answer at the following question: given that the capability to turn sales in gross profit in a competitor is 60%, is this capability higher in the firm analysed based on a time series analysis and on a cross sectional analysis? Time series analysis (comparison t and t-1) from 68 to 66, usually higher than othe profitability Cross sectional analysis (comparison of Pirelli and competitor) 66% higher than 60% Nb gross profit only from sales and purchase (no salaries, no depreciation, there arenot other expense) INTEREPRETATION FOR LIQUIDITY RATIOS Example Questions 2.5 Choosing the three ratios measuring liquidity and comparing them, answer at the following questions: Is the company more liquid over time considering all assets that it expects to convert into cash within a short term? Is the lower/higher liquidity caused by inventory? Is the company more liquid over time considering only cash? The main point is to know if the liquidity is caused by inventory or by cash. THREE RATIO MEASURING LIQUIDITY: 42