Analysis of Cash Flow Statement for Sorouh 2011 - Coursework Example

Analysis of Cash Flow Statement Student’s Name College Instructor’s Name Subject 7th April, 2013 Executive Summary This paper examines the financial health and competitive viability of Sorouh which is the unquestioned leader of the pack, having displaced other companies in the country. Explanations have been given on each position. Some of the calculations performed to give a clearer picture about the company’s liquidity performance. Its profits grew from the in the two years as well their net cash and equivalent. This report uses the most recent reports provided by Sorouh. Even in tough economic times, the Company is still remarkably strong. The cash flow statement analysis of the company shows that it utilizes its brand and financial strength to achieve long-term sustainable growth. Outline Title page 1 Executive summary 2 Table of contents 3 Introduction 4 Definition of items 5 Operating activities 5 Cash flows from investing activities 8 Cash flow from financing activities 9 The percentage increase / decrease 10 Cash flows from operating activities 13 Cash flows from investing activities 13 Cash flow from financing activities 14 Reasons for comments as good or bad 14 Conclusion 19 References 20 Introduction Sorouh is a company that deals with asset development and management in Arab Emirates. The company has its strategy for the last three years. This has enabled them to have increased profitability to AED383 million. in the year 2011 the company delivered more than 1700 units as well as completed major projects like Abu Dhabi Aviation Complex and Al Murjan Tower. This means the company is committed to deliver its goals and ensure quality housing for its customers. This paper is going to analyse items of the cash flow statement of this company and determine the influence of the cash flow statement on the operations of the company. Evaluation of the company’s cash flow position involves deriving value of free cash flow which indicates how much cash is available to the business for meeting its expansion plans. The cash flow statement is an important financial statement as it provides information on how the company generated cash has been used and the net balance. It contains cash flow from operations, cash flow from investing activities, and cash flow from financing activities. Cash flow from financing activities is the inflows and the outflows related to additional borrowings, equity financing, dividend payments, interest on debt and equity repurchases. Cash flow from investing activities relate to inflows and outflows on long-term assets of the company such purchase and disposal of assets. Capital expenditures may be calculated net or gross of proceeds on the sales of these assets. The cash flows from such sales are considered investment cash flows, regardless whether they are netted in capital expenditures. Trends in gross capital expenditures contain useful insights into management plans. Segment disclosures should be monitored for differential investment patterns. Other components of cash flows from investing activities include cash flow from investments in joint ventures and affiliates and long-term investments in securities. The cash flow consequences of acquisitions and divestitures must also be reported in this category. Footnote disclosures should be used to segregate operating assets and liabilities obtained in acquisitions. Cash flow from operating activities is the cash flow that is generated from day to day operations of the company. Definition of items Operating activities These are earning-related activities of a company. Beyond revenue and expense activities represented in an income statement, they include the net inflows and outflows of cash resulting from related operating activities like extending credit to customers, investing in inventories, and obtaining credit from suppliers. Operating activities relate to income statement items and to balance sheet items relating to operations- usually working capital accounts like receivables, inventories, prepayments, payables and accrued expenses. Practice also requires operating activities to include transactions and events that do not fit into investing or financing activities. Depreciation and amortisation- Depreciation allocates the cost of fixed assets to the current period, the period in which they are used. Loss/ (gain) on disposal of property, plant and equipment- this is a loss or again made for sale of non operating assets. These assets do not form day to day merchandise of the company, they are meant for long term use but because of one reason or another they are sold. The gain or loss if recognized in the profit and loss account should be adjusted in the cash flow statement. Profit for the year- these are net earnings as reported in the profit and loss account. Provision for infrastructure costs – this is the provision provided for infrastructural investment are to be made like roads in the areas where they have estate construction. Project costs written off, net- this is the cost for a project that has been incurred and the project owners are not going to pay for them thus the company incurs the cost. Reversal of impairment of property, plant and equipment- this is a charge on property, plant and equipment which had been recognized in the previous financial statement that is being reversed. Impairment of goodwill- this is a charge on worthless goodwill that is the recognition in the books of accounts, goodwill that is written off because it is loss of value. Bad debts written off- this are debts that cannot be recovered due to defaulting debtors that are written off. Allowance for doubtful debts- this is a provision of debts that are likely to be defaulted based on policies laid down. Reversal of allowance for doubtful debts- This is a change in provision of bad debts in the books due to policy changes. Fair value loss on investment properties- this is a loss incurred by valuing the assets on their value rate. Gain on disposal of an associate- this is a gain that is made during the sale of investment in an associate firm. Gain on disposal of investment properties- this is a gain made during the sale of properties that was meant for investment that is for generating investment income. Gain on disposal of available-for-sale financial assets- this is the gain made on swale of financial assets like treasury bills and bonds that are available for sale or held for short-term basis. Loss on disposal of other financial assets- this is a loss that is made upon the sale of financial assets like convertible bonds of other companies. Impairment loss on available-for-sale financial assets- this is a loss that is recognized during the revaluation of available-for-sale financial assets Gain on financial assets at fair value through profit and loss- this a gain that is recognized when financial assets are recognized at fair value rate. Share of losses/(profits) from associates and joint ventures- this is a gain or loss that is shared by investors of an associate and the company’s share is recognized in the books. Finance income- this is interest earned from borrowings made from the company or investment made by the company in financial assets. Finance cost- this is the interest is paid or to be paid by the company for borrowings like loans and bonds Provision for employees’ end of service benefit- this is a percentage estimation of gratuity to be paid by the company in case an employee retires. Operating cash flows before movements in working capital – this the cash flow that is generated before changes in the current and liabilities. The items that are excluded in this case relate to debt, payables, inventory and other current assets and liabilities. Decrease in land held for resale – this is the negative change on the value of land being held for the purpose of sale. It is like inventory that has been devalued. Increase in inventories- this is the increase in the inventory held in the warehouse. Movement on development work in progress- this is the change in the work-in-progress that is the change in value of the projects that have been stated but not completed. Decrease in trade and other receivables- is the reduction in the amount owed to the business at the end of the financial period compared to the previous period. (Decrease)/increase in trade and other payables- this is a reduction or increase in the amount owing to the suppliers of goods and services. Decrease/(increase) in due from related parties- is the increase or decrease to the amount owed by related companies to the company. Decrease in due to related parties- is a decrease in the amount the company is owing to related businesses or companies Net cash from/(used in) operating activities- is the net cash flow after deducting all the above mentioned items. Investing activities These are means of acquiring and disposing of noncash (and noncash equivalent) assets. These activities involve assets expected to generate income for a company. They also include lending funds and collecting the principal on these loans. The items under this title are defined below Payments for property, plant and equipment- this is the cash outflow for purchase of property, plant and equipment. Proceeds from disposal of property, plant and equipment- this is a cash inflow upon sale of property plant and equipment. Payments for investment properties- this is actual cash paid for purchase of investment properties. Payments to acquire available-for-sale financial assets-this is actual cash paid for purchase available -for -sale financial asset. Proceeds from disposal of financial assets at fair value through profit and loss- this is actual cash received for sale of financial assets Proceeds from disposal of available-for-sale financial assets- this is cash received for investments of available for sale financial assets sold. Payments for investment in associates- are the actual cash payments made for purchase of investments in associates. Proceeds from finance lease- this is cash received from finance leases entered into. Interest received- this is income receipt in cash from investments such as treasury bills and bonds, and other financial assets in the organisation. Net cash (used in)/from investing activities- this is aggregate cash flow under the investing activities. Financing activities These are means of contributing, withdrawing, and servicing funds to support business activities. They include resources from creditors and repaying of principal amounts borrowed. They also include contributions and withdrawals by their owners and their return on investment. Major investing and financing activities not involving cash are reported separately in either narrative or summary form. Bank borrowings raised-this is the cash received from the loans given by banks to the company. Repayment of bank borrowings –this is the cash payment for part of the loan. Repayment of non-convertible Sukuk- this is the payment in cash for non convertible Sukuk Dividends paid- is payments of profit shared among shareholders. Finance costs paid- is interest payments Directors’ remuneration paid- is the actual cash payments to the directors as remunerations The Calculation of percentage increase / decrease Looking at the cash flow of the company, one will note that net cash flow is large because the company deals in products that require huge cash outflows and inflows to cater for business transactions. The net cash flow is large in the year 2011 because the company did not repay non-convertible Sukuk than the year 2010. In the year 2010 the net decrease in cash and cash equivalents was AED472, 974,000 while in the year 2011 it was an increase of AED449, 505,000. It can be noted that the net cash flow at least improved immediately from 2010 to 2011 with positive figures. All of this however is still isn’t enough to stem the massive damage from the changes in liabilities in 2010 especially movement on development work in progress. The cash flow statement shows the cash position of the firm. Dividing all the cash flow relevant segments in to investing, operating and financing activities, it provides a clear picture of where cash was spent and where it came in. The statement of retained earnings shows the amount of dividend paid the amount of earnings that was retained by the company and reflects any changes made to the equity of the company. Consolidated statement of cash flows Increase/(decrease) Good/bad for the year ended 31 December 2011 2011 AED’000 AED’000 Change Operating activities Profit for the year 383,323 16,179 2269% Good Adjustments for: Depreciation and amortisation 42,630 44,156 -3% Good Loss/(gain) on disposal of property, plant and equipment 34 (195) 117% Good Provision for infrastructure costs 76,065 55,142 38% Bad Project costs written off, net 2,005 13,066 -85% Good Reversal of impairment of property, plant and equipment (23,800) - - Good Impairment of goodwill 116,888 162,860 -28% Good Allowance for doubtful debts 16,016 141,931 -89% Good Reversal of allowance for doubtful debts (2,232) - - Good Bad debts written off 3,259 - - Bad Fair value loss on investment properties, net 77,527 49,327 57% Bad Gain on disposal of an associate - (2,026) - Good Gain on disposal of investment properties (15,795) - - Good Gain on disposal of available-for-sale financial assets (4,873) (492) 890% Good Loss on disposal of other financial assets - 21,191 -100% Good Impairment loss on available-for-sale financial assets - 17,513 - Good Gain on financial assets at fair value through profit and loss (77) (2,767) -97% Good Share of losses/(profits) from associates and joint ventures 20,431 (48,655) -142% Bad Finance income (52,388) (59,600) -12% Good Finance cost 22,281 103,242 -78% Good Provision for employees’ end of service benefit, net 5,143 5,870 -12% Good Operating cash flows before movements in working capital 666,437 516,742 29% Good Decrease in land held for resale 87,079 23,818 266% Bad Increase in inventories (7,821) (22,435) -65% Bad Movement on development work in progress, net 43,123 (1,485,233) -103% Good Decrease in trade and other receivables 387,603 456,958 -15% Good (Decrease)/increase in trade and other payables (925,453) 316,606 -392% Bad Decrease/(increase) in due from related parties 13,414 (241,937) -106% Bad Decrease in due to related parties (31,587) (13,702) 131% Bad Net cash from/(used in) operating activities 232,795 (449,183) 152% Good Investing activities Payments for property, plant and equipment (11,131) (23,142) -52% Good Proceeds from disposal of property, plant and equipment 1,894 4,403 -57% Good Payments for investment properties (615,529) (473,915) 30% Bad Payments to acquire available-for-sale financial assets - (28) - Good Proceeds from disposal of financial assets at fair value through profit and loss - 20,806 - Good Proceeds from disposal of available-for-sale financial assets 17,000 1,737 879% Good Payments for investment in associates - (2,700) - Good Proceeds from finance lease 5,512 - - Good Interest received 48,104 71,390 -33% Bad Movement in term deposits with original maturities greater than three months and restricted short-term deposits (81,015) 983,613 -108% Bad Net cash (used in)/from investing activities (635,165) 582,164 -209% Bad Financing activities Bank borrowings raised 1,000,000 1,700,000 -41% Good Repayment of bank borrowings (12,543) (107,932) -88% Good Repayment of non-convertible Sukuk - (1,974,334) - Good Dividends paid (1,087) (5,710) -81% Good Finance costs paid (141,866) (208,323) -32% Good Directors’ remuneration paid - (9,656) - Good Minority contribution in the capital of a subsidiary 14,000 - - Good Adjustment on the minority contribution in the capital of a subsidiary (6,630) - - Good Net cash from/(used in) financing activities 851,874 (605,955) -241% Good Net increase/(decrease) in cash and cash equivalents 449,505 (472,974) 195% Good Cash and cash equivalents at the beginning of the year 1,132,695 1,605,669 -29% - Cash and cash equivalents at the end of the year (note 18) 1,582,200 1,132,695 40% Good The results presented in the above table suggest that although the company is generating healthy positive net cash inflows from its operating activities, its free cash flow position is not positive for the year 2010. But it is positive for the year 2011. This is why we have a profit increase of 2269%. Upon examination of the values that constitute this figure it clearly indicate that the company is investing heavily in property, plant and equipment as we have a negative value for the year 2011. Also, its current assets exceed its current liabilities by significant amount which means that the company’s cash is stuck in its current assets particularly in the form of trade and other payables and land held for resale. Cash flows from operating activities Sorouh had positive cash flows from operating activities before movements in working capital in both 2011 and 2010. In 2011, it was AED666, 437,000 million and AED516, 742,000 in 2010. The cash flow increased in 2011 when compared to 2010 and this is not a good sign. This is because the net income for 2011 increased from the net income in 2010. The net income was AED 383,323,000 in 2011 as opposed to AED 16,179,000 in 2010. The increase in net income is attributable to increased sales, reduction in expenses and decreased cost of goods sold, and not because of any decline in revenue. There is also a decrease in the amount of land held, movement on development work in progress, a decrease in trade and other receivables. However a decrease in trade and other payables used a lot of cash flows as the decrease was AED925, 453,000. Cash flows from investing activities The cash flows from investing activities for the year 2011 is negative (AED635165, 000) for both 2011 and the year 2010 the figure is positive AED582164. This shows that Sorouh had invested a lot, but the investments were comparatively higher in 2011 than in 2010. Cash flow from financing activities Through its financing activities Sorouh had a cash inflow of AED851, 874,000 of its finances in 2011, and in 2010 it had an outflow of AED605, 955,000 which was an increase 242%. This means that there has been a decrease in funds available for operations due to outflow of cash in the financing activities of Sorouh in year 2010, and an increase year 2011 which means that there is higher level of cash available for operations in 2011. This is evident in the higher cash and cash equivalents available in 2011. Reasons for comments as good or bad The increase in profits lead to an increase in the net cash and cash equivalents, however, these profits was reduced by adjustments in the operating activities has shown in the table below Consolidated statement of cash flows Increase/(decrease) Good/bad Reasons for the year ended 31 December 2011 Change Operating activities Profit for the year 2269% Good It means the ability to pay dividends improved and also the amount of cash flows increased. Adjustments for: Depreciation and amortisation -3% Good This is because decrease in depreciation means a decrease in expenses although it does not involve actual cash flows. Loss/(gain) on disposal of property, plant and equipment 117% Good Increased the cash flows and the profits. Provision for infrastructure costs 38% Bad The amount of costs increased Project costs written off, net -85% Good The company incurred less cost. Reversal of impairment of property, plant and equipment - Good The company gained Impairment of goodwill -28% Good It reduced the profit substantially. Allowance for doubtful debts -89% Good The amount of debt that were expected to be written off was reduced Reversal of allowance for doubtful debts - Good The company gained from unexpected source Bad debts written off - Bad The company lost revenue and cash flow. Fair value loss on investment properties, net 57% Bad The company lost the value of assets Gain on disposal of an associate - Good The company had increased cash flow Gain on disposal of investment properties - Good The cash inflows increased Gain on disposal of available-for-sale financial assets 890% Good The cash inflows increased Loss on disposal of other financial assets -100% Good There was no loss this year Impairment loss on available-for-sale financial assets - Good In 2011 there was no impairment. Gain on financial assets at fair value through profit and loss -97% Good There was gain but in small amounts compared to 2010 Share of losses/(profits) from associates and joint ventures -142% Bad The company lost revenue and cash flow. Finance income -12% Good There was income although in reduced amount. Finance cost -78% Good The expense reduced Provision for employees’ end of service benefit, net -12% Good The provision reduced. Operating cash flows before movements in working capital 29% Good This means operating activities generated positive activities Decrease in land held for resale 266% Bad The company lost the value of the asset although it does not affect the cash flow until when it is sold. Increase in inventories -65% Bad The company committed more funds in stock Movement on development work in progress, net -103% Good Cash being held in work-in-progress reduced Decrease in trade and other receivables -15% Good Cash inflows increased (Decrease)/increase in trade and other payables -392% Bad Cash inflows decreased. Decrease/(increase) in due from related parties -106% Bad Cash received from related parties decreased Decrease in due to related parties 131% Bad Amount expected to be paid increased. Net cash from/(used in) operating activities 152% Good Net cash inflows from operations increased Investing activities Payments for property, plant and equipment -52% Good Less funds was spend for purchase of fixed assets. Proceeds from disposal of property, plant and equipment -57% Good Obsolete assets were sold Payments for investment properties 30% Bad The value of investments purchased increased, committing more funds Payments to acquire available-for-sale financial assets - Good There were no purchases for this financial asset. Proceeds from disposal of financial assets at fair value through profit and loss - Good There was no transaction Proceeds from disposal of available-for-sale financial assets 879% Good Cash inflows increased Payments for investment in associates - Good There was no transaction in 2011 Proceeds from finance lease - Good There was no transaction in 2011 Interest received -33% Bad Interest received reduced Movement in term deposits with original maturities greater than three months and restricted short-term deposits -108% Bad A loss was incurred Net cash (used in)/from investing activities -209% Bad This is poor performance but it is subject to returns from investments Financing activities Bank borrowings raised -41% Good Although it borrowed less, it shows they have an ability to borrow. Repayment of bank borrowings -88% Good Principal payments of loan reduced if arrears are not kept. Repayment of non-convertible Sukuk - Good There was no transaction Dividends paid -81% Good Cash outflows was reduced Finance costs paid -32% Good Cash outflows was reduced Directors’ remuneration paid - Good Cash outflows was reduced Minority contribution in the capital of a subsidiary - Good Cash inflows was increased Adjustment on the minority contribution in the capital of a subsidiary - bad Cash inflows was reduced Net cash from/(used in) financing activities -241% Good The company generated more cash Net increase/(decrease) in cash and cash equivalents 195% Good Overall cash was health. Cash and cash equivalents at the beginning of the year -29% - Cash and cash equivalents at the end of the year (note 18) 40% Good Cash at hand improved. Working capital amount is quite adequate which increase consistently during the past two years. It shows that company is in good position to finance its short term financial needs This means that so far, so good – the company has enough liquidity although fluctuating. On the other hand, the Gain on disposal of an associate, Gain on disposal of investment properties, Gain on disposal of available-for-sale financial assets, Loss on disposal of other financial assets of the company changed positively as shown above, which is understandable on the basis that they are not regular transactions of the company. This shows a mixed trend, as for instance, there is a significant fall in the Gain on disposal of available-for-sale financial assets of the company, whereas the Gain on disposal of an associate of the company was not there in 2010. Apart from the accumulated depreciation, which increased by 100%, there is no change in the fixed assets of the company. Considering the performance of the company in the year 2011 in comparison with year2010, it is observed that the performance of the company declined significantly due to a sharp decline in the Provision for infrastructure costs by 15%. This decrease could have been more significant if there was no work in process brought down in year 2011 from the previous year. The cash flows from investing activities were negative indicating that the returns from the company’s previous investments have yet to yield, in the mean while the organization has invested in more capital projects allowing the organization to secure future cash flows while sacrificing the present cash flows. Nevertheless, during the year 2011 the cash flow from investing activates improved significantly, this can be observed as the organization spent AED635,165,000 less during 2008 than 2007’s gain of AED582,164,000. This was improved by the absence of Movement in term deposits with original maturities greater than three months and restricted short-term deposits during the year 2011 as in the year 2010. This horizontal analysis of the company’s financial statements reveals that the company is weak in managing its working capital. As can be observed, the year 2010 and 2011 comparison shows that the company’s Repayment of bank borrowings, Repayment of non-convertible Sukuk and Dividends paid all declined at higher levels, and there was borrowing by AED1,000million. An overall increase in cash flow activities was experienced by the organization which was made possible by the positive cash flows of operating activities. Despite this fact, the cash flows cash flows cannot be described as being smooth as 2010 showed a significant decrease in cash flows when compared with 2010. It is observed that the Depreciation and amortisation experienced a significant decrease although there was an increase in the property, plant and equipment in the investing activities at same time there was a sale of the same. The sales were high as compared to purchases of assets. Moreover, the Loss/(gain) on disposal of property, plant and equipment also decreased, this is not good for the company. This observation is suggestive of the fact that the company made a loss in the sales of property and equipment considerably in year 2011 and this may also be regarded as one of the main reasons of decrease in the profits for the two years. At the end, the considerable point to note is that the operating income of the company increased by more than 2269% in year 2011. Interest income received from investments in other firms as a result, the return on capital is separated from the return of capital. In this case it is classified as operating activity and it increased which is good to the company, it changed by 12% Interest repayments are classified as operating cash outflows in this cash, however, such payments are the result of capital structure and leverage decisions and they reflect financing rather than operating risk. It changed by -78% in this case this means that there was a slight increase from year 2010 to year 20111. This increase is evident from the lowering down of interest expenses due to a increase of -78% in the total long term obligations of the company. Interest rates, if high can considerably reduce the operating income of the company. The stakeholders and other investors keenly observe this factor as their dividend income and return on investments is based upon it. Conclusion The overall position of the company has improved as compared to the last two years. Cash flow from operating have improved and together with from investing activities. The company is able to convert its resources more quickly in to cash than in previous two years. The company has made payments on account of long term and short term debts so there is a sound liquidity position. So it can be concluded that the company has produced reasonable results in 2011 and further, this situation can be improved with little efforts to control the operating cost. References Alexander, D., & Britton, A. (2004). Financial reporting. Florence, KY: Cengage Learning. Berman, K., Knight, J., & Case, J. (2006). Financial Intelligence: A Manager's Guide to Knowing What the Numbers Really Mean. Business Literacy Institute, Inc. Bragg, S. (2007). Business Ratios and Formulas: A Comprehensive Guide. Hoboken: John Wiley and Sons Ernst & Young. (2002). Preparing for internal control reporting: A Guide for Management's Assessment under Section 404 of the Sarbanes-Oxley Act. Ernst & Young. Eugene, F., & Brigham, M., (2010). Financial Management: Theory & Practice. 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