Analyzing financial statments

Chapter four and assignment two have been very challenging for me.  I've definitely had some 'uh-ha' moments but I'm not confident my spreadsheet is correct.

Re-stating financial statements

Uh-ha moment #1
K + S Group have corrected their 31 December 2012 balance. I found a discrepancy between the 31 December 2012 figures reported in the 2012 and 2013 statements. The 31 December balance in the 2012 report is 3473.7. In the 2013 report this is reported as 3390.03. I have elected to use the later version as it matches with the opening balance for 2013.

Uh-ha moment #2
I had a good laugh while re-stating my Income statement. This definitely gave me the most hell. For some reason I thought Gross Profit and Cost of sales equals Revenues... I quickly realized that Revenue minus Cost of sales equals Gross Profit. Had a good giggle at that.

After that initial break through I realized that the K + S Group Income Statement was broken into specific sections already. Once the Gross Profit was calculated additional expenses and income were added until Earnings before income taxes was calculated. The operating and financial taxes were grouped together but then split into continued and discontinued operations. I'm quite sure my tax calculation is incorrect but I've run out of time to try and figure out what I've missed here.

KCQ: What is the difference between Comprehensive income and Net income?

My Comprehensive income statement contained both of these figures which sent my head spinning. Don't these both mean total? There are many different kinds of totals in accounting. Lol. It was only by grabbing a calculator and doing some figures that I realized Comprehensive income is Net income + Other earnings after taxes.

Total other operating comprehensive income does not add up to Other earnings after taxes. There's 30 missing from somewhere or maybe 90 before tax. Or maybe they aren't supposed to add up. How can K + S Group keep track of so many different incomes and expenses with this system. My head hurts. Maybe I'll have an Uh-ha moment for this later...

Cash Flow statements

I keep seeing the Cash Flow statement but we're not using it.

KCQ: So why bother reporting free cash flow at all? I remember Maria saying it's important.

Study Guide says FCF is a transfer of value between a firm’s operating and financial activities but don't we want to separate those? Why?

Study Guide says firms create value for their equity investors by earning a return on net operating assets (RNOA) greater than the opportunity cost of capital; and the more a firm can invest in net operating assets at returns above its cost of capital, the more value a firm can create.

The amount of FCF a firm generates will be affected by a firm’s decisions about how much to invest into its operating assets (I) each year. So a firm may report less FCF but more assets.

KCQ: So as long as the investment in assets earns a return that's higher than the investment, value is created or at least it will be in the future.

So we need to look at FCF to establish a firms cash flow from operations and net cash invested but also economic profit to establish the RNOA.

KCQ: Economic profit is a measure of the extent to which a firm has been able to add value over and above its cost of capital during a period.

The most efficient way to identify the key accounting drivers of economic profit and cash flow is to restate our firm’s financial statements and separate operating and financial activities. We must restate expenses, revenue, equity, liabilities and assets.

Seperating operating and financial activities

I had a look through exemplars and the examples in our Study Guide and didn't have a lot of trouble separating items into operating and financial activities. The items I checked against the examples were:

1. Foreign currency translations
2. Revaluation of defined benefit pension plans. 
 
Net operating assets (NOA) are those assets (net of liabilities) that are used to produce products and services for customers in the product markets, and thus earn operating revenue (OR) for the firm.

Net financial assets (NFA) are those assets (net of liabilities) of a firm that are used to store value and are not used in the operations of a firm.

KCQ: It is through its operating activities that a firm primarily adds value.

KCQ: We separate financial and operational activities so we can focus on operational activities as they have the greatest potential to add value. Financial activities should also be considered, in case high levels of debt are destroying value.

Statement of Changes in Equity

This was relatively easy to re-state. Restating our firm’s statement of changes in equity helps us to identify any other comprehensive income.

The other thing we need to do when restating a statement of changes in equity is to ensure equity only includes genuine equity.

KCQ: Sometimes a firm’s equity can include debt. How can debt be considered equity? I suppose debt could be for assets?

Balance Sheets

Re-stating the Balance Sheets was also fairly simple.

The key benefit of restating a firm’s balance sheet is to clearly identify the firm’s net operating assets (NOA) and net financial obligations (NFO), or alternatively net financial assets (NFA).

Income Statement

This was the hard part. Our purpose in restating the income statement (or statement of financial performance) is to clearly separate operating and financial revenue and expenses, and to clearly identify comprehensive operating income after tax (OI) and also net financial expenses after tax (NFE).

For us to clearly separate a firm’s operating and financial activities in its financial statements we need to allocate tax to a firm’s operating and financial activities. This was the hardest part of the whole assignment. Mostly because of the plus vs minus rules. Some clearer clarification around this in the lecture or Study Guide material would have been really helpful.

KCQ: When calculating the tax benefit for your firm you need to use the corporate tax rate of the country where your firm is based.

This was available online and easy enough to add. The problem was apportioning with the plus vs minus situation. Maria said it's flipped for operations but I'm not sure why.

Conclusion

If my re-stated financial statements are correct, the financial outlook for K + S Group is not as bleak as I originally thought it was. The company seem to be bringing in more income and reducing debts. However, like I said, I'm not confident that my tax calculation is correct. I'm looking forward to receiving feedback though as the rest of the re-stating provided some great insights. 

My top three blogs

My top three blogs

1. http://christynjade.blogspot.com.au/

Christyn is posting every step of her journey, I feel like she already has ASS# 1 completed and I’m not even sure what’s going on. I also get the feeling Christyn has some previous experience with accounting. If not, she’s a natural!

2. http://ladyofledgers.blogspot.com.au/  

Again, so detailed! Love all the memes and the graphs inspired me to set up my own for Gross Profit. Renae is super enthusiastic about the subject which is a little bit contagious. Checking out Lady of Ledgers has inspired me to dig a little deeper in my own analysis.

3. http://jasonsaccountingjourney.blogspot.com.au/

Jason is really analytical and even a little critical of the Study Guide at times but I can totally relate to his experience. I feel like I’m learning accounting in the wrong order and my lack of knowledge when it comes to accounting terms is really undermining my progress. Jason’s KCQs definitely mirror my own experience and I’ll be checking back to see if these get answered.  

Annual Reports and My Company Spreadsheet

Analyzing the Annual Reports was a nightmare for me as they were 242, 192 and 176 pages respectively. In the first instance I transferred the Annual Financial Statements, which also included Income Statements and Balance Sheets, rather than the Annual Report data. So two hours were wasted. Re-transferring the new data took four hours. I'm not sure if I'm transferring more detail than I'm supposed to be but the resulting spreadsheet is pretty large. Lol. Accounting has my head spinning!

Here are my annual reports:

1. Annual Report 2012 > http://www.k-plus-s.com/en/pdf/2012/fb2012.pdf    
2. Annual Report 2013 > http://www.k-plus-s.com/en/pdf/2013/fb2013.pdf 
3. Annual Report 2014 > http://www.k-plus-s.com/en/pdf/2014/fb2014.pdf        

My Company Spreadsheet can be found here.

My  decision making questions included:

    ·       Trends in profit.
    ·       Share price.
    ·       Long-term prospects (challenges and strategy).
    ·       Ethical considerations.

Key concepts and questions included:

Gross Profit comparison

Current share price
Share price in 2014 closed at 22.92, up slightly from 22.38 in 2013. As stated in the 2014 Annual Report, the 30th of July 2013 is known as the Black Tuesday of the potash industry. In 2012 K + S Group reported share prizes of 35.00 but these have been on a downwards trend since 2010 when shares are reported at 56.36.

Refer to the following articles regarding 'Black Tuesday' -

http://www.globalpost.com/dispatch/news/afp/130730/potash-market-suffers-black-tuesday-after-uralkali-shock-move

http://www.bangkokpost.com/lite/news/363461/favicon.icohttp://www.bangkokpost.com/lite/news/363461/favicon.ico

http://rbth.com/business/2013/08/06/uralkali_director_predicts_great_demand_for_potash_28711.htmlhttp://rbth.com/business/2013/08/06/uralkali_director_predicts_great_demand_for_potash_28711.html

http://www.bloomberg.com/news/articles/2014-03-13/k-s-says-2014-profit-to-drop-sharply-on-low-potash-prices

Why is capital expenditure so high?
Capital expenditure is so high because potash reserves in Germany are limited. The 'Legacy Project' is a new site in Canada with the aim of supporting the company legacy when Germany is no longer viable. According to media reports, the Canadian plant isn't due to come online until 2016. 

Why are expense cuts occurring? 
Expense cuts are occurring in order to be competitive against Russian suppliers who in 2013 moved their pricing strategy from 'price above volume' to 'volume above price'.

Long-term prospects
K + S Group seem to be in a better place than other potash suppliers thanks to their salt business unit but the market seems volatile.

Other suppliers have moved to a 'volume above price' strategy, meaning the K+ S Group will need to increase production to remain competitive. With German potash in limited supply, the 'Legacy Project' assures that the Group will have access to the mineral for long-term production.

Strategies around streamlining and maximizing production, finishing the 'Legacy Project' and expanding the salt business unit will assist K + S Group to meet these challenge.


Ethical considerations - Environmental impacts
 "Despite awareness and best efforts, the fact remains that our production impacts nature. Our
considerable efforts include the investment of millions in environmentally-friendly facilities and
8 conservation measures. Staff in our research center as well as at our headquarters and sites does
its utmost to keep the consequences of production at a minimum. However, demands such as
“production without residues” and “a North Sea pipeline crossing four German states” are high.

The former is an illusion, as production without residues is simply not feasible anywhere in
the world. Even taking the ecological benefits into consideration, the latter is not economically
viable. Against this background we have jointly developed a Four-Phase Plan with the Hessian
Ministry of the Environment to reconcile economic and ecological feasibilities. This represents our
roadmap for future production in the Hesse-Thuringia potash district, even after depletion of
resources there." - 2014 Annual Report

Decision
This is a highly successful and resilient company but I wouldn't buy shares for three reasons -
1. Shares and gross profit have been on a downward trend since 2010 and the 2014 recovery in share price, although a positive for the Group, was not substantial.
2. The market is volatile due to a small number of suppliers producing high volumes of potash.
3. I'm not satisfied by K + S Groups environmental strategy.

K + S Group 2015 - 2020

In a media release issued in November 2015, the K + S Group have outlined the management agenda for 2015 - 2020. The release reaffirms continued weakening of the potash market and the proposed strategy to tackle this. Investment in the 'Salt 2020' strategy is a clear indication that the K + S Group are confident the Salt Business Unit will continue to grow and support the Group until potash markets recover.

Potash are mined and manufactured salts that contain potassium in water-soluble form. Potash is used predominately as a fertilizer. Within industrialized economies, the mineral is also processed for uses like aluminum recycling, mining and medicine.

Having recently declined a take over proposal from Canada-based PotashCorp, the K + S Board of Executive Directors are obviously confident that the market will recover. This insight is further supported by the development of a new potash plant in Canada, titled the 'Legacy Project'.

Dr. Ulrich Lamp, President and CEO of K+S Potash Canada, announced the ongoing positive development of the 'Legacy Project': "Construction of the new potash plant in Canada is progressing very well. The project is within budget, on time and the plant is all set to be commissioned in summer 2016 as planned."

Dr. Burkhard Lohr, Chief Financial Officer, explained in the November press release that the capital expenditure in the 'Legacy Project', as well as the strict cost discipline within the Group, will have a positive effect on the financial situation of the K+S Group in the very near future: "We will see a substantial reduction in our debt levels and we expect to start generating positive free cash flows again from 2017 onwards. Our investors will benefit from this in the form of attractive dividends and an unchanged investment grade credit rating."

Source: http://www.k-plus-s.com/en/

The story of a business

This week I set out to read and contemplate Chapter Three of the Study Guide. The Chapter revolved around financial statements, the different kinds of statement required from a business and the story these statements can tell about the reality of the business they represent.

I found it interesting that there are no specific rules about how financial statements are set out. It's no wonder that analyzing financial statements seems to be more of an art than a science.

KCQ: The fact that a firm's annual report is a marketing document was a new concept for me. This explains why I am currently wading through hundreds of pages of pictures, executive profiles and just a whole lot of fluff. The K + S Group definitely have their Marketing department working overtime. I can't help wondering if this is an attempt to hinder analysis and queries from shareholders.

The Study Guide has also reaffirmed what I've observed so far during the recorded lectures and analyzing K + S Group reports. There are four main types of financial statement:

1. Comprehensive Income Statement.
2. Balance Sheet.
3. Cash Flow Statement.
4. Statement of Changes in Equity.

A Comprehensive Income Statement reflects how things like revenue and expenses are changing over a period of time, usually one year. The bottom line of the statement reflects the income for that period.

A Balance Sheet is a snap shot of the financial position on a particular day. The same date is compared each year. In fact, all financial statements include data from the previous year to assist with analysis.

The Balance Sheet and Income Statement set out all five elements of accounting: assets, liabilities, equity, revenue and expenses. 

A Statement of Changes in Equity shows the various changes in shareholders’ equity over a 12 month period. 

A Cash Flow Statement shows the opening cash balance at the beginning of the 12 months, cash inflows and outflows during the period and the closing cash balance.

These four statements should be used to engage with and consider the economic and business realities. Only a complete analysis of all four statements within the context of the driving economic and business realities will tell the story of a business.

KCQ: Seems a little bit time consuming to me. I still don't quite understand why I need four separate statements to tell me all this. What is the benefit of using one statement over another or a specific purpose for each? Thankfully Chapter Four of the Study Guide had some answers for me:

1. We restate the Income Statement to clearly separate operating and financial revenue and expenses, and to clearly identify comprehensive operating income after tax (OI) and also net financial expenses after tax (NFE).
2. Restating the Balance Sheet helps us separate the operating and financial assets and liabilities of a firm. It facilitates an assessment of the long-term and short-term liquidity of a firm.
3. Analysts look at the Cash Flow Statement to observe the net investments needed to generate future operating income. The Free Cash Flow refers to operating income - net investments (or capital outlays). The Cash Flow Statement provides insight into a firm's operating activities.
4.  The Statement of Changes in Equity shows how a firm’s income statement and balance sheet inter-connect. Restating a firm’s statement of changes in equity helps us to clearly identify all of a firm’s earnings and to make sure its equity only includes genuine equity.

Ok so Chapter Four in general was really helpful. Anyone struggling should read it ASAP!