Draft of Assessment two!
Step 1
Chapter 4: Analysing Financial Statements
Key Concepts and Key Questions
KC
The first thing that really got me thinking
was one of the quotes in the introduction by G.K. Chesterton. It’s incredibly
true that if you’re wrong about the past then how can you really expect to be
right. In the course I did last term, Principles of Accounting, this was so
evident to me and I can safely say that I always want to check that my
understand of the past is accurate so that decisions made for the future are
accurate. I often found that I would be completing tutorial questions and would
go through all of the 10 steps to complete that question, only to get to the
end and realise that my answer was wrong. This could have been so easily
avoided if I simply checked each equation was correct as I went along so that
the next one would be based upon a correct answer as well. My rush to complete
the question meant that each answer was built upon a faulty assumption, but
after making the same mistake a handful of times; by the end of the course I
was checking everything as I went along.
KQ
What are discounted cash flow (DCF) and free cash flow
(FCF)???
Throughout restating the financial statements of HKEx,
I learnt many things but one thing I haven’t gotten a grasp on is this cash
flow framework. I’m sure its just the name of the term I cant wrap my head
around but this is something I need to discuss with my peers and read further
into to hopefully better understand.
KC
Operating and financial activities was the most useful
concept in this chapter because it really helped me understand the terms and
the connections between them. It also helped me identify just how much
operating activities really do dominate and are pivotal to the company’s
success or failure. For me the concept of the kinder surprise egg being similar
to the operating and financial activities doesn’t quite fit. When I think about
a kinder surprise, I remember the overwhelming thoughts of wanting to eat the
chocolate but also to open up the toy. This was always a battle in my mind and
I would quite often attempt to do both at once. This is not in my opinion
similar to looking at financial statements. I feel that it is perhaps more
similar to ravioli; the outside doesn’t hold a lot of interest but the inside
(the operating activities) is what makes or breaks the dish.
I can see from my company that as they progressed and
took on more assets and made more money, they had a lot more liabilities which
went hand in hand with that which is definitely a balancing act for them.
I know that it can be said that they still made
billions of dollars regardless, but the variances between their assets and
liabilities was relatively small and definitely needs to be kept in check.
Their financial obligations on the other hand remain fairly steady, increasing
as their business does, with main differences being the acquisition of the
London Metal Exchange.
My personal budget at home would be similar in way
although perhaps categorized differently, but still has the set payments of
rent, internet, phone bill and Netflix. The things that can vary each week or
month and I actually pay very close attention to are things like food,
shopping, transport, random expenses. All of these things I can have great
impact on and if I don’t keep a good eye on my online banking, I could very
easily get myself into a lot of debt. For me, the former are my financial activities
and the latter are my operating activities.
KC
One of the steps in the study guide is restating the
financials, which involves finding a way to display the statements in
alternative way. A part of this is restating the cash of the company, but I must
decide somehow what portion is relevant in operations and what portion can go
in financial assets. Martin recommends that it should be about 0.5-1% of the
sales in the cash section of operational assets. Over the four years that my
assessment covers, the amount of cash is between 2-13 times the amount of
revenue for the corresponding years. Because there is such a large amount of
cash, I believe that it is not being actively used and there is also no
reference to the company taking on any large investments over the coming year
so it should be safe to allocate the other 99% to financial assets.
Overall I found this chapter very informative as it
gave almost a step by step guide to how the restatement is completed. Although,
I agree with what has been said that it definitely will vary for every single
company and so the assignment really requires the help of peers. For me when I
was reading through the chapter, I compared it with two of the exemplars and
the example martin gave and it helped me to related each section back to my own
company. Of course there was some differences that I needed help with from my
peers and then others that just took a lot of time to ponder, but I feel like
with this chapter was a great back bone to helping me understand each of the
terms and steps in this difficult process.
Step 2
I spent about three days looking at the assessment
sheet wondering what on earth that meant and why our first statement on the
financials wasn't good enough.
I know that this helps demonstrate our understanding
of the concepts and relationships between all the figures but it wasn't until I
actually started working on the restating that I understood why were completing
what seemed like a pointless task. Upon restating the financials, I started to
see things I never noticed last time. The biggest thing I noticed was that in
the way I presented the Statement of Financial Position initially it seemed
like as the years progressed that the company was making more and more money.
However, in restating this I have seen that they did indeed make more profit,
but their assets were almost outweighed by their liabilities. So in reality,
the company was better off in 2011 when they actually had the greatest amount
of assets and equity.
The greatest issue I faced with restating the
financials was continuing to develop my understanding of what each line on the
statements meant so I could restate these into different categories accurately.
Yet again in this assessment, I found that my greatest
help was my accounting dictionary and ensuring I completely understood each
term before I even moved a single line.
Along with my use of the accounting dictionary, the
study guide chapter 4.1 was especially useful in helping me identify terms that
I could use to restate the financials, such as the section on Economic Profit.
As mentioned in my KCQ’s, when allocating cash and
cash equivalents in the statement of financial position, I made the assumption
that based upon their report and goals for the coming year, that it was safe
for me to allocate only 1% of their cash to operating assets and the remainder
to financial assets.
This decision altered my spread sheet dramatically,
going from having net operating assets for the four years in their billions, to
multi billion dollar negatives.
The final step that I found incredibly difficult was
calculating and allocating the tax expenses and benefits. I started by
determining the tax rate of 16.5% and then working out the equation that I
would need to use to calculate the tax benefit and where this would fit in the
restated income statement. My first obstacle was determining what my financial
income versus financial expenses was and realized that my company as far as I
could see, had no financial income and so multiplying the financial expenses by
the tax rate and determining the tax benefit for each year did the calculation.
Step 3
In this step I identified three services that
Hong Kong Exchanges provide which are the following various stocks; Cathay
Pacific Air, Emperor E Hotel and China Infrastructure Investments. I attempted
to find three securities that are quite different from each other with cost
price and amount available.
I have calculated the selling price based
upon the nominal value on the given day I was researching, which is set for the
life of the stock.
Cathay Pacific Air 00293 – 13.1 HKD
Emperor E Hotel 00296 – 1.43 HKD
China Infrastructure Investments 00600 –
0.091
To calculate the variable costs, I found an
annual listing fee, which is charged, based upon the nominal value of
securities listed on the exchange. I
found the individual annual fee for each and then divided that by the number of
securities listed.
Cathay Pacific Air 00293
Annual listing fee – 198,000
/ Securities – 3,933,844,572
= 0.00005 HKD
Emperor E Hotel 00296
Annual listing fee – 541,000
/ Securities – 1,302,545,296
= 0.00042 HKD
China Infrastructure Investments 00600 –
Annual listing fee – 198,000
/ Securities – 4,269,910,510
= 0.00005 HKD
The final step in this process was to
calculate the contribution margin. Subtracting all variable costs from the
selling price gave me the contribution margin, which gave me the amount left
over to pay for fixed costs and then resulting in a profit or loss.
Cathay Pacific Air 00293
Selling Price – 13.1
-
Variable Costs – 0.00005
=13.09995
HKD
Emperor E Hotel 00296
Selling Price – 1.43
-
Variable Costs – 0.00042
=1.42958 HKD
China Infrastructure Investments 00600 –
Selling Price – 0.091
-
Variable Costs – 0.00005
=0.09095 HKD
When I was searching through what seemed like
endless lists of securities held by HKEx, I was looking for three different
ones with different prices and amounts of shares held and different services.
It was very surprising to me that the variable cost for Cathay Pacific, which
had the highest selling prices, and China Infrastructure that had the lowest
selling prices, both shared the exact same variable costs. This was because the
cheaper stocks were in much higher supply and so balanced out with the costs of
Cathay with their higher cost but limited supply stocks.
HKEx has so many products but one of the most
challenging things I found in my search for the three securities I would use,
was finding one that had all of their costs and prices listed only in Hong Kong
dollars (HKD). There were so many securities that would display various aspects
in Renminbi (RMB) and others in HKD but I chose to use securities that simply
deal with HKD as most of this assignment deals with that currency. The
multitude of currencies is of constant concern to HKEx as one of the major
goals of the company is to help internationalize the RMB currency so that
trading is easier and can be open to all markets. This constraint has been
addressed in the last four years of the annual reports and each year they have
reported that they are edging closer and opening up their market outreach
further with a prime example of this being the Hong Kong – Shanghai Connect as
addressed in Assessment one.
The variable cost that is most likely the largest
contributor but was too difficult for me to accurately calculate was Labour. I
attempted for quite a few hours to identify how I could calculate the labour
hours and fees associated with the securities I was analysing but found that
due to the large amount of products offered, the foreign country’s wages
agreements and all of their rewarding systems in place, my estimate could never
have been accurate. I believe that although I am only a student studying
accounting, that this could possibly be a constraint upon the company as it
would be difficult to identify the wages cost associated with their stock
sales. This is especially important, as this cost was always the largest
operating expense for the last four years.
There was another reason why I decided to use
the annual fees for my variable cost instead of wages and that is because it is
my assumption that this cost would be inclusive in the annual fees. The annual
fees referred to are the sole cost to the company listing with HKEx and so
should include all costs in this such as staff costs, implementation costs of
adding them into the system and maintenance as well as any other sundries
involved. I’m sure this fee probably
allows for a small profit in there but was the most accurate piece of information
I could use to calculate the variable costs and then onto the contribution
margin.
As mention in Chapter 8.2 of the study guide,
the contribution margin is one of the key equations in accounting as it can
help to make decisions about how the company is progressing and which products
are performing or underperforming. For example, I can see that all three of the
products I chose do have a positive contribution margin and despite the Emporer
E Hotel having the highest variable costs, all three products selling price are
in line with their contribution margins.
|
|
Cathay Pacific Air - 00293
|
Emperor E Hotel - 00296
|
China Infrastructure
Investments - 00600
|
|
Selling Price
|
13.1
|
1.43
|
0.091
|
|
Variable Cost
|
0.00005
|
0.00042
|
0.00005
|
|
Contribution Margin
|
13.09995
|
1.42958
|
0.09095
|
*All Hong Kong Dollars
