Appunti del corso Accounting finance & control

GROUPS AND CONSOLIDATED FINANCIAL STATEMENTS

Group: collection of companies (legal entities) constituted by a parent and one or more controlled

companies.

Depending on the percentage of shares owned by company X and other information company Y can be

classified as:

 Subsidiary (controlled company): an investor controls an investee when it is exposed, or has rights,

to variable returns from its involvement with the investee and has the ability to affect those returns

through its dominant power over the investee. How to exert dominant power:

 Parent owns more than 50% of shares with voting rights -> de jure/legal control

 Achieve more than 50% of voting rights with agreement with other investors OR It can

appoint or remove the majority of the members in the BoD OR It is able to cast the majority

of the votes at a BoD voting OR has some special powers (golden shares etc.) -> de

facto/actual control

 Associate company: parent exert a significant but not dominant influence, the rule is that needs to

have more than 20% (10% if listed) and less than 50% of shares but is not the only relevant

information.

 Joint venture: when 2 or more legal entities undertake an economic activity under a joint control ->

unanimous consent for decisions

 Minor investment Consolidation process

Consolidated financial statement: combine the financial statements of separate companies that belong to

the same group into one set of financial statements for the entire group.

Group financial accounting is needed to provide comprehensive and clear information about the amount of

assets and liabilities controlled by the parent’s shareholders. IFRS defines principles of control, requires a

parent to prepare consolidated financial statements, sets out the accounting requirements and the

procedures that must be followed in order to prepare a consolidated financial statement, sets out

exceptions to consolidation requirements. Does not replace the financial statement of single entities.

The preliminary analysis of the consolidation process: verify that accounting principles are homogeneous

among companies in the group:

 Same reference accounting standards adopted (reference is the one in which the legal

headquarters of the holding are based)

 All financial documents used in the consolidation process have to be from the same reporting date.

If it is impossible adjustments must be made and in no case can exceed 3 months’ difference.

 Same currency

 Same operational criteria (for inventory, depreciation, provisions for risks, future obligations etc.)

The line by line method: all the financial statements of the subsidiaries are fully integrated (summed to

those of the parent company) to create the financial statements of the group as a whole (whatever the % of

shares owned by parent company); steps:

1. Sum all like items of the balance sheet and income statement.

2. Eliminate all intra-group transactions.

3. Eliminate the carrying amount of the parent’s investment in each subsidiary (value recorded in BS

of the parent company) and the parent’s portion of equity of each subsidiary. A goodwill may

emerge in the assets section of the consolidated balance sheet (when difference between equity

investment and corresponding book (historical) value of the controlled company is positive) if the

difference is negative, this should be recorder as a loss in the P&L.

The equity method:

 no line by line consolidation of financial statements is made -> the investor keeps equities as an

asset (displayed in the consolidated balance sheet).

 The value of the equity investment in the BS of the investor equals the percentage of the equity of

the associate owned.

 The associate company’s net income (generated in the year) increases the value of investment by

the investor pro quota (proportionally to the stock owned by the investor) vs. the corresponding

value in previous year, while a net loss decreases it.

 The payment of dividends decreases the investor’s value pro quota. In the investor’s income

statement, the proportional share of the investee’s net income or net loss is reported as a single-

line item. CORPORATE FINANCIAL PERFORMANCE INDICATORS

Financial indicators are the most common corporate performance measures, they are based on financial

statements and they are usually computed on a yearly basis. They can be classified according to 2

dimensions:

 Type of indicator (ratios vs absolute measure)

 Nature of the performance measured (profit vs cash flow)

ROE= net profit / equity -> measures the return of shareholder’s capital -> the most important performance

indicator for shareholders. (the value can be computed in different ways that leads to different values)

ROI=ROA=ROTA= operating profit /invested capital -> measures the return generated by the core business

activities relative to all the capital invested in the company

 The same value of ROA can be achieved with very

different combinations of EBIT margin and assets

turnover

 The average values of EBIT margin and assets turnover

ratio tend to be correlated to the sector in which the

company operates

The denominator management phenomenon -> to increase ROA is easier to work on the denominator

(increasing profit is difficult especially in the short term) -> this can lead to both good (eliminate useless

things) or bad (investment plants reduces and jeopardizing the future) decisions -> bad decisions reduce

future profitability.

The financial leverage

 If a company is able to get a return from its business operations (ROI) higher than the cost of debt

(r), the higher the debt/equity ratio the best it is for shareholders -> higher ROE

 r tends to remain constant in the years while ROI is very volatile -> ROI can be lower than r at the

end of the year -> in this case the higher D/E the lower ROE -> risk of bankrupt if ROE remains

deeply below 0 for years.

 D/E ratio (gearing ratio) amplifies variances of ROE values -> the higher D/E the higher the risk

perceived

 In the HP of no financial assets, no taxes on profit and no discontinued operations S=1

 If ROI-r>0 and S=1 ROE>ROI

 In real cases usually 0< s < 1

 The financial leverage is a proxy of risk

RI = residual income =operating profit – K*invested capital.

 Measure of the extra profitability compared to the minimum profit expected from shareholders.

 K= cost of capital (weighted average of equity and debt WACC [ (E/(D*E)) *Ke + (D/(D*E)) *Kd) ]

depends also on how you computed ROI

 Invested capital = debt + equity

 If ROI is greater than WACC you have RI >0

Economic value added EVA

 In order to compute it you have to do some corrections/adjustments to the financial statements

FINANCIAL STATEMENTS ANALYSIS

The aim of the analysis of an annual report is to provide a quick and useful overview of the company’s main

performances. Ratio analysis

Ratio analysis is a very common approach, it summarises information concerning the profitability achieved

and its main components (profitability analysis) and the ability of the company to fulfil its current

obligations (liquidity analysis). The ratio analysis is more meaningful than the absolute measure one

because:

 Profitability must always be compared with amount of capital employed

 Cash generated must always be compared with the cash needed to fulfil current obligations (or

budgeted plants in the future)

Ratio analysis allows:

 To compare with past company’s performances (longitudinal analysis) to find out possible trends

for each ratio, eliminating the effects of contingencies or extraordinary events.

 To compare the performance of the company with that of other firms (main competitors) ->

benchmark analysis

In calculating ratios of the balance sheet items you need to define when the calculation is done:

 End of the year value

 Starting value

 Average value

NB. In the benchmark analysis, strict competitors should be preferred even if financial statements are not

easy to find. The accounting principle adopted and the operational criteria for the main items (cost model

vs fair value for some assets etc.) must be comparable

Profitability analysis

The aim of profitability analysis is to evaluate the ability of the company in making profit and to identify its

main components. Can be done under 2 prospective:

 Shareholder’s prospective -> ROE, the higher the risk, the higher the return expected. A

complementary profitability indicator can be the net profit margin= net profit/revenues.

 Company prospective -> ROI, ability of the managers to generate profit with company assets, the

higher the better. You can also do second level (EBIT or EBITDA) and third level analysis

Risk-operational efficiency matrix (done with the competitors) -> financial leverage expression

Third level analysis Liquidity analysis

The aim of liquidity analysis is to evaluate the status of the liquidity and its coherence with existing

obligations -> the ability of the company to meet its financial obligations when claimed by owners of

related rights. Ratios are used in 2 different prospective:

 Assets-liabilities prospective -> liquidity analysis of the items in the balance sheet -> short term

(next 12 months)

 Cash flow prospective -> liquidity analysis of the items of the cash flow statement -> long term (2 3

4 years) THE PLANNING AND CONTROL PROCESS: THE BUDGETING PROCESS

The reference framework can be applied to:

 Strategic planning process (long term oriented 5-7 years)

 Budgeting (1 year typically)-> more detailed and analytical in nature

Two main phases:

 Planning (important to have a link between objectives plans and resources to have a good plan.

Performances (objectives) must always be compared with risks) (one of the most important things

is to set the target performances challenging but feasible and put in relationship with risks)

 Control-> actual results are different because of external (environmental) and internal variables. 3

phases:

 Measurement of actual performances

 Variance analysis (vs target performance values)

 Feed-back (possible corrective actions identification that can affect both future plans and

final objectives)

The master budget -> it estimates the potential profit of a BU, generally on 1 year and implies management

commitment. Can be used for deployment of the strategic plan into operational plans, coordination,

assignment of responsibilities, basis for individual performance evaluation. At the end you compute some

indicators and if not reached you iterate. It is made of:

 Operating budgets -> opex budget of the current activities, their number and relative importance

depends heavily on industry-specificity.

 Capital budgets -> capex budget, also include divestments, the focus is on cash outflows -> cash

flow prospective.

 Cash budgets -> ai