Common Wealth Bank and Westpac Bank - Income statement and Financial Position Analysis - Case Study Example

Student Name: Tutor: Title: Common Wealth Bank and Westpac Bank Course: Common Wealth Bank and Westpac Bank Question 1 i) Goals and ethical issues: The company main goal is to make profit through maximizing of shareholders equity and effective use of debt capital. In his report, the chairman has acknowledged 2012 as a very challenging year and has pointed out some of the aspects that made 2012 a tough year. He points out that the macroeconomic environment had been dominated by volatility and uncertainty in the global financial markets. The Chinese economy slowly down raising concerns while the pace of recovery of the United States and the challenges ongoing in the European Union weighed heavily on the economy of Australia. Absence of consumer and corporate confidence had affected demand for credit and forced customers to strengthen their balance sheet while being cautious of the immediate outlook. The company faces ethical issues in its disclosures of determination of interest paid and how variations are made. Adverse conditions require revising which may affect the customer negatively. ii) Income statement analysis The main sources of revenue for the company include net interest income and other banking income. This is interest that the bank receives after lending out money to customers. Other banking income could include overdrafts and running of competitions. There is funds management income and also insurance income; this is the come obtained from the operations of the company in remittance services and insurance. Investment experience is income from the investment made by the bank like in investing in government securities. The main expenses of the company included operating expenses, loan impairment expenses, corporate tax expense, and non-controlling interests. Operating expenses form the bulk of expenses because they facilitate the day to day running of business in the bank. Net interest income has increased progressively over the three years. Net interest income increased by 4% from $12,645 million in 2011 to $13,157 million in 2012. Other banking income decreased by 2% from $3,996million the previous year to 3,927million in 2012. Insurance income increased by 12% as compared to the previous year. Increase in net interest income impacted positively on the profitability of the company. Operating expenses reduced by 3% and this was a boost to the company’s profitability. The format of presentation of comprehensive income statement is correct for this business because horizontal format makes it easy for someone to understand the changes experiences since there is room comparison and even extra notes. iii) Financial position analysis The company has balance sheet that is not very healthy because the assets are enough to deal with the normal operations of the business but not strong enough to deal with emergencies or contingencies. The current ratio is 1.06 which is below the ideal current ratio which should be 2:1. The liabilities are almost equal to assets hence the 1.06 ratio. The company has to improve its current ratio for the sake of its liquidity in meeting short term debts (Duignan, 2012). Most significant Assets include loans, bills discounted and other receivable which make up a big percentage of the assets. Available for sale investment and derivative assets are other important assets that support the company. A large percentage of liabilities include deposits and other public borrowings. Debt issue and derivative liabilities also come in as significant liabilities. Problems that assets or liabilities may present include fluctuation of liquid assets due to the fluctuations in the financial markets which require huge base of deposits base to deal with shocks. Some of the liabilities and assets require calculation and revaluation of interest to determine their real value from time to time which may be tedious to the company (Kieso, Weygandt & Warfield, 2007). Most of the assets and liabilities are not within the control of the bank and therefore the bank may find it difficult to control their amount. Consequently, measurement of assets and liabilities is not an easy routine for the company. iv) Cost and measurement analysis The historic or cost principle states that the measure of an asset on the balance sheet has to represent its original or nominal cost when it was acquired by the company. Assets have to be recorded at their historical cost even if they have substantially changed in value from the time they were acquired. Assets from trading and insurance have to be recorded at their original cost even though they have changed in value of time. The alternative to measurement of assets will be determined whether there is an indication of the fair value or book value. v) Funding analysis Customer deposits represented 62% of the total funding of the group as at 30th June 2012, up from 61% which was reported the previous year. Customer deposits increased by $30 billion margin to $379 billion as at 30th June 2012. Another source of funding was covered bonds which became a significant contributor of the Group’s funding as a result of amendment to regulations of banking that permitted Australian banks to issue covered bonds. The risks from customer deposits is the challenge of meeting the cash reserve that has been set by the central bank and volatility of the interest due to changing conditions in the work. The company has not paid any dividends (Brigham & Daves, 2008). The company is a position to reduce debt and utilize its retained profits because the retained profits are more than the loan capital. Loan capital stand at $10,022million while retained profits stands at $13,356million. Therefore, retained earnings can be used to offset or reduce loan capital. vi) Share price and market capitalization analysis The current share price as at 22nd April 2013 was $69.07. The share price in 2012 was below $64 and even low the preceding year. Market capitalization captures the real events happening in the market while book value of the company gives a historical cost of the assets of the company. Volatility in the market may result in a huge difference between market capitalization and book value (Cragg, 2009). vii) Expense and depreciation analysis Some of the large expense amounts for the company are the interest expense and operating expenses. The expenses may get out of control if the company is not keen to monitor its daily operations or promises interests to customer deposits that it cannot meet considering its assets. Question 2: Notes to account Financial statements and notes t accounts are relevant, comparable, relevant and understandable because they give further explanation on how the figures in the financial accounts have been arrived at and what financial principles, rules and regulations have been applied. Note 1 to accounts explains the accounting policy that has been followed in the preparation of the financial accounts. Note 2 explain how the profit in the comprehensive income statement has been arrived at. This explanation is important for someone who did not take part in the preparation of the final accounts but has an interest in the performance and financial report of the company (Lumby & Jones, 2003). Question 3: comparison with Westpac Bank Net profit margin =gross profit/revenue (sales) Common Wealth bank (2012) = 7,838/38,258= 0.2049 = 20.49% Common Wealth bank (2011) = 5,884/37,477= 0.1570 = 15.7% Westpac Bank (2012) = 6,036/36,873 = 0.1637 = 16.37% Westpac Bank (2011) = 7,059/38,098 = 0.1853 = 18.53% 2012 2011 Westpac Bank 16.37% 18.53% Common Wealth Bank 20.49% 15.7% The net profit margin for Westpac Group decreased from 18.53% in 2011 to 16.37% in 2012. Both the sales and the net profit reduced. This means that the company profitability was poor as compared to the previous year. Losses could have increased to reduce the profits and besides, the revenue collected was below what was collected the previous year. Common Wealth showed an improvement in the net profit ratio from 15.7% in 2011 to 20.49% in 2013. Revenue realized improved as well as the reported net income. The expenses might have reduced whereas the revenue collected improved. Common Wealth Group performed better in 2012 as compared to the previous year. Return on investment = Income after taxes/total assets Common Wealth bank (2012) = 7,106/718,229 = 0.00989 = 0.99% Common Wealth bank (2011) = 6,410/667,899 = 0.009597 = 0.96% Westpac Bank (2012) = 6,036/694,965 = 0.008685 = 0.87% Westpac Bank (2011) = 7,059/670,228 = 0.0105 = 1.05% 2012 2011 Westpac Bank 0.87% 1.05% Common Wealth Bank 0.99% 0.96% Common Wealth Group return on investment ratio improved slightly from 0.96% in 2011 to 0.99% in 2012. This means that the asset of the business were used well and hence the improvement in the ratio. The income after tax improved and the same case happed to the assets but overall the ratio improved. Asset deployed efficiency and effectiveness improved. On the other hand, Westpac assets and income after taxes dropped hence the decrease in the return on invest ratio from 1.05% in 2011 to 0.87% in 2012. The assets of the company were not deployed effectively hence the drop in the ratio (Bragg, 2012). Assets did not yield the satisfactory return as reflected in the return on investment. 2012 was not a good year for Westpac Group. Return on equity = net income/owner’s equity Common Wealth bank (2012) = 7,838/42,572 = 0.1841 = 18.41% Common Wealth bank (2011) = 5,884/37,287 = 0.1578 = 15.78% Westpac Bank (2012) = 6,369/46,219 = 0.1378 = 13.78% Westpac Bank (2011) = 7,316/43,808 = 0.1670 = 16.7% 2012 2011 Westpac Bank 13.78% 16.7% Common Wealth Bank 18.41% 15.78% Westpac Bank Group showed a drop in return on equity ratio from 16.7% in 2011 to 13.78% in 2012. This was a drop margin of 2.92 percent. This means that the owner’s equity was not used well to give good returns hence the reduction in the ratio. The income also dropped and hence prompting the decrease in the return on equity ratio. Moreover, the owner’s equity reduced indicating to more problems on the profitability of the company. The performance was not good as compared to the previous year. Whereas Common Wealth Group saw its return on equity ratio improve from 15.78% the previous year to 18.41% in 2012. This means that owner’s equity was used well in Common Wealth Bank to warrant this improvement. Both the net income and owner’s equity improved. There were more people who were willing to invest in the bank to purchase of its stock due to improved performance and an indicator to better performance in future. Any company that shows future signs of improved performance attracts more investors (Shim & Siegel, 2007). Debt-to-equity ratio = Total liabilities/total equity Common Wealth bank (2012) = 676,657/41,572 = 16.28 Common Wealth bank (2011) = 630,612/37,287= 16.91 Westpac Bank (2012) = 628,746/46,219 = 13.6 Westpac Bank (2011) = 626,420/43,808 = 14.3 2012 2011 Westpac Bank 13.6 14.3 Common Wealth Bank 16.28 16.91 Both banks had their debt to equity ratio reduce ion 2012. Westpac debt to equity ratio reduced from 14.3 in 2011 to 13.6 in 2012. The total equity for both companies reduced. Westpac had its total liabilities increase as it intensifies ways of improving its performance. Common Wealth also had its total liabilities increase as it improved its operations and got committed in short term debt. Debt ratio = total debt/total equity Common Wealth bank (2012) = 10,022/41,572 = 0.2411 = 24.11% Common Wealth bank (2011) = 11,561/37,287 = 0.3101 = 31.01% Westpac Bank (2012) = 9,537/46,219 = 0.2063 = 20.63% Westpac Bank (2011) = 8,173/43,808 = 0.1866 = 18.66% 2012 2011 Westpac Bank 20.63% 18.66% Common Wealth Bank 24.11% 31.01% Common Wealth bank had its total debt to equity ratio reduce from 31.01% in 2011 to 24.11% in 2012. This means that the company reduced its borrowing of debt capital by 6.9% margin. The source of capital from other avenues might have improved and the retained earnings improved to warrant the company to reduce its debt capital hence the drop in the ratio. Westpac shows a completely different picture. The debt ratio increased from 18.66% in 2011 to 20.63 in 2012. This shows that Westpac Borrowed more funds in an effort to revise its operations that dwindled in 2012. The margin increase in borrowing was 1.97%. Provided that the profitability of the company did not improve then the increase in borrowing did very little to correct the worsening situation in terms of Westpac performance. The retained earnings also dropped compounding the problem. Increased bowing plunged Westpac into more debts without improving the performance of the business as far as profitability is concerned. Question 4 i) Cash from Operating activities in 2011 and 2012 of Common Wealth Bank are similar. Despite the in the amounts, the cash inflows and out flows came from the same operating activities in both years. The subtractions are additions have been done similarly on every item from these years. The bank took part in almost similar activities in 2011 and 2012. i) Investing activities cash flow in 2012 Cash used in investing activities in 2012 was $1,281m. Cash used in investing activities in 2011 was $1,041m. There was more cash used in investments in 2011 as compared to 2012. Expenses used in investing activities increased hence the increase in the cash used in investing activities. ii) Financing activities in 2012 Some of the financing activities included issue of shares, purchase of treasury shares, and redemption of loan capital. Issuance of securities in the previous year culminated into losses while in the present year there were gains. There was more redemption of loan capital as the bank sought to reduce its debt capital and seek more share funding. There was dividend of $3748m paid in 2012 as compared to $4188m paid the previous year. The company reduced the dividend paid in order to increase retained earnings and reduce debt capital (Pratt, 2010). The company wanted to use other forms of capital rather than loan capital. References Bragg, S.M., 2012, Financial Analysis: A Controller's Guide, John Wiley & Sons, London. Brigham, B.F. & Daves, P.R., 2008, Intermediate Financial Management, Cengage Learning, New York. Cragg, J.G., 2009, Expectations and the Structure of Share Prices, University of Chicago Press, Chicago. Duignan, B., 2012, Banking and Finance, The Rosen Publishing Group, London Kieso, D. E., Weygandt, J. J., & Warfield, T. D. (2007). Intermediate Accounting (12th ed.). Hoboken, NJ: John Wiley & Sons. Lumby, S. & Jones, C.M., 2003, Corporate Finance: Theory and Practice, Cengage Learning EMEA, Melbourne. Pratt, S.P., 2010, Cost of Capital: Applications and Examples, John Wiley & Sons, London. Shim, J.K. & Siegel, J.G., 2007, Handbook of Financial Analysis, Forecasting, and Modeling, CCH, New Delhi. Read More