Accounting and Finance for Managers - Case Study Example

Accounting and finance for managers

Table of Contents

Introduction3

Organisational setting3

Understanding the financial objectives of a company6

Discussion and analysis of the basis of content of statements9

Methods of raising and deploying financial resources12

Critical assessment of information which is valuable to shareholders15

Identification of financial objectives17

Ratios analysis of company’s capital structure and share price19

Conclusion21

Recommendation22

Reference List23

• Introduction

RasGas Company Limited is one of the major integrated natural LNG (or Liquefied Natural Gas) producing organisations in the world and it is headquartered in Qatar. The organisation is mainly known for being a responsible, reliable and safe supplier of LNG. The total capacity of the company is approximately 36 million tonnes of LNG per year, which is contributed by seven LNG trains (RasGas, 2014). The company oversees operations associated with production of LNG and natural gas production facilities. This business report will analyse the published financial reports of RasGas Company Limited for the past three years and evaluate the financial and non-financial information which are relevant for the shareholders to make investment decision. On the basis of analysis, this report will recommend the shareholders whether or not they should sell or hold existing shares or they should buy more shares.

• Organisational setting

RasGas Company Limited is a joint stock firm by ExxonMobil RasGas Inc and Qatar Petroleum in 2001 and in just over two decades, it has become a global energy producing business. It has also world-class onshore and offshore production facilities that are capable of extraction, liquefaction, processing and storage of liquefied gas in the North Field of Qatar (RasGas, 2014). The basic organisational structure of the company is depicted as follows:

Table 1: Operating companies

Operating companies

Established

Production capacity

Ras Laffan Liquefied Natural Gas Company Limited - 'RL'

1993

3.3 mn-tonnes

Ras Laffan Liquefied Natural Gas Company Limited (II) - 'RL (II)'

2001

4.7 mn-tonnes

Ras Laffan Liquefied Natural Gas Company Limited (3) - 'RL3'

2005

7.8 mn-tonnes

Exxon Mobil Middle East Gas Marketing Limited (Al Khaleej Gas)

2000

750 million standard cubic feet per day

Ras Laffan Helium

2003

17.3 tonnes per day

(Source: Author’s creation)

(Source: Author’s creation)

The organisational chart of the company shown above indicates that all the strategic decisions are taken by the CEO of the company, Hamad Mubarak Al Muhannadi. All the major functions including finance, HR, production, planning, sales and marketing are under the respective departmental heads; who in turn, reports it to the CEO. The swift growth and development of the organisation can be attributed to its strategic global positioning and Qatar’s strong economic independence. RasGas Company Limited supplies LNG to America, Europe and across Asia. In order to ensure timely delivery of LNG to the customers, RasGas Company Limited maintains a dedicated fleet of 26 LNG carriers to transports LNG to domestic and international clients. The company’s strong foundation of management, robust processes, professionalism and experienced workforce, works hard to ensure that the company operates efficiently with ethics, social accountability and integrity. The company has a clear vision and an effective framework of policies, control, training, values and procedures, which underpins the success of the organisation. The organisation has demonstrated accountability and responsibility in all major operations and projects by safely implementing necessary methodologies, improving environmental sustainability as well as supporting the local community. Responsibility of the company is not limited to safety operations; but also actively planning for the future, which is effectively managed by providing an adequate training to the employees and recognising their talents. However, the most important priorities of the company are safeguarding the environment, interest of the stakeholders and developing the society (RasGas, 2014).

• Understanding the financial objectives of a company

RasGas Company Limited is a privately held organisation and the financial objectives of the company can be analysed from information disclosed by the company in its official website. The company was able to become a major contributor of energy supply in a very short span of time. Not to mention, the company is globally recognised for its safe and reliable supply of LNG to domestic and international clients (The Financial Express, 2015).

The most important financial objective of any firm operating in the capital intensive sector is to protect the interest of the stakeholders. The main stakeholders of the company are:

(Source: Author’s creation)

Financial objectives of RasGas Company Limited are explained below:

• High performance – The organisation defines high performance by a stating some key performance indicators that include profitability, sustainability, corporate responsibility, etc. The objective of the company is to become more profitable in the next five years and improve the competitive advantage by increasing economic and social benefits of its core activities and also reduce the adverse environmental impacts. The demand for LNG sector started increasing since 2006 when the renewable energy sector was given priority in most of the developed countries over the world. The demand for LNG drastically grew in Asia and other developing economies which were growing faster than the developed markets (Schaefer, 2009). In order to improve the financial performance, the company will have to diversify operations in the international markets. The financial objective of high performance can be achieved by increasing productivity. RasGas Company Limited might have to acquire new client base particularly in the countries where there is strong demand for LNG.
• High return on investment for the investors and shareholders – RasGas Company Limited is grateful to the investors and shareholders who have believed in the mission and vision of the organisation and helped it to expand its operations across the globe. In order to reward the shareholders for their contribution, the company’s financial objectives are directed to increase their wealth. The shareholders can hold their respective stakes in the organisation or they can exit and book profits by selling shares in the market when the company gets listed in near future. Public listing will also allow the private investors to realise profits.
• Minimise operational and financial risk – The operational risk of the company arise from core operations and it can be minimised by controlling the direct expenses. The financial risk of the company will arise when its capital structure will be highly leveraged with debt capital. When a company lacks strong risk management frameworks, then it could lead to production failure and internal crisis.
• Reducing global volatility in global markets – As the organisation is a global supplier of LNG in major markets of Europe, USA and Asia. It is exposed to currency risk and economic risk. The exports and imports activities will have direct impact on financial performance and adverse effects of the currency market could erode profits earned by the company from operations. One way to protect from international volatility is by hedging currencies with forward contract or options. These financial instruments will not be able to eliminate market volatility completely but to certain extent it will be possible for the firm to bring certainty in transactions and minimise losses.
• Decrease cost of operations – The international oil markets are experiencing headwinds and high volatility at present and the prices of crude oil have plunged below $50 per barrel. There is an opportunity for the company to improve financial health by minimising the cost of operations. This can be achieved by decreasing the inventory holdings at minimum level and streamlining the business by sourcing products to the right suppliers having high inventory turnover. Further, the organisation will also have to minimise the overhead costs by saving energy wherever possible and even resorting to outsourcing part of business process if required.
• Discussion and analysis of the basis of content of statements

The main statements of RasGas Company Limited are its consolidated statement of balance sheet, statement of comprehensive income (or the profit and loss statement), statement of cash flows, and statement of changes in equity. The contents of these statements are generally published along with periodical filings or annual report of the company. Hence, the information contained in the annual reports of the company thoroughly highlights the financial and non-financial aspects of the organisation during the previous financial year. It is the most important source of information for the shareholders and other stakeholders who are interested in the activities of the organisation. The information disclosed in the published statements of the company helps the investors and other stakeholders to take major investment decisions regarding whether or not they should put their money in the company.

The directors of the business play a very important role in creating the contents for annual report and other statements of the organisation. It is their responsibility to make sure that the various statements published by the company have been prepared in accordance to laws applicable in Qatar or place of listing. In other words, if the information disclosed in the contents of the statements is not true and misleading, then the shareholders can file class action suit against the directors of the organisation for misrepresenting facts (RasGas, 2013a).

The consolidated statements of the company are prepared on historical cost basis apart from for some items which are estimated at fair value concept. The financial facts shown in the statements are represented in Qatari Riyal (QR) and all values are generally rounded off to nearest digit if not stated otherwise. The consolidated statements should be prepared as per the Emiri Decree Number 10 (1974) which has been amended by Law Number 5 in the year 2012. The consolidated statements should also contain all relevant disclosures and information required as per QP accounting policies (Reportstack, 2012).

The basis of contents of the profit and loss statement, which depicts financial results of operations of the firm during a specific period of time, should clearly specify the level of profit or loss during the period resulting from selling of LNG products. In addition, the following contents are essential in the profit and loss statements:

• Total sales – This item represents the primary source of income received by the core operations of RasGas Company Limited from its clients in both domestic and international markets.
• Cost of sales and other operating expenses – This item shows the cost of production including factory cost to convert raw materials into finished goods.
• Operating profit – It is calculated by deducting the operation cost of the organisation from its net sales.
• Net profit – This is calculated by deducting interest expenses, tax liability and other expenses.

The main contents of the balance sheet of RasGas Company Limited are:

Owner’s equity – It represents residual interest of the business promoters and owners.

Non-current assets – It includes all economic resources utilised by the company including land, building, production units, etc. that cannot be liquidated in less than one year.

Current assets – It includes cash and cash equivalents, bills receivables, inventories, etc. that can be liquidated easily in less than one year.

Non-current liabilities – It highlights the long-term obligations of the firm including term loans which the company do not have to repay in one year.

Current liabilities – These are short-term obligations which the organisation will have to honour in less than a year and includes items like bills payable, corporate debts, commercial papers, etc.

The company will also have to represent the above mentioned contents as per the prescribed accounting standards by AICPA (American Institute of Certified Public Accountants) or IFRS (International Financial Reporting Standards) which are also of global standards. The main rationale for using global reporting standards is that it will encourage foreign investors and shareholders to trust the company’s management policies. Further, as the company has already become a global firm having presence in multiple nations, it is more advisable to follow a common set of accounting policies which are globally accepted.

• Methods of raising and deploying financial resources

The global commodity markets have become very uncertain especially in regards to the oil and natural gas industry. The prices of crude oil have already plunged by over 50% in the past four months and natural gas prices are also following similar trends. The US market on the other hand is recovering fast from recession. As the US dollar strengthens with respect to other currencies, the impact of declining commodity prices will become more severe for oil and natural gas producing companies like RasGas Company Limited. There is uncertainty looming about how the international gas markets will emerge out of the uncertainty. However, the extent of potential losses makes it imperative for LNG buyers and suppliers to take precautionary measures by raising and deploying financial resources (RasGas, 2013b).

The main source of volatility and uncertainty in this sector initiated during the shale-gas boom in USA about eight years ago. The events were amplified by increasing demand for LNG in Asia and further economic crisis in the Euro zone that created price discrepancies in regional and global markets. The global natural gas industry is expected to cross $700 billion by 2030. The LNG market only accounts for about 10% of the global gas market. It will be the key determinant of market prices and shareholder value creation. At the moment, LNG is short in supply given the global demand but this does not improve the bargaining power of the suppliers because of uncertainty in future prices. This uncertainty has made the buyers cautious as they are reluctant to sign new contracts under conventional terms. The challenges that uncertainty and market volatility poses for the LNG companies requires robust strategies, risk mitigation frameworks and proper financial planning (McKinsey, 2014).

Therefore, it is likely that the natural gas sector could face financial challenges in near future due to prevailing uncertainties in the market. RasGas Company Limited can use the following methods to raise and deploy financial resources in times of uncertainty:

Liquidity management –LNG exporting companies such as RasGas Company Limited is exposed to currency fluctuations which creates uncertainties in expected cash flows. In order to protect the cash flows from volatile currency markets, it is necessary for the company to hedge currency risk for international transactions. The uncertainties in the global markets can create unexpected changes in expected income. By introducing hedging strategies it will be possible for the company to minimise the downside risk of currency volatility. Proper liquidity management will help the company to deploy funds in managing current assets like paying interest on loans, purchasing raw materials from suppliers, paying wages to labourers and so on (Campello et al, 2010).

Working capital management – During crisis, it is important for capital intensive companies to raise short-term funds for effective working capital management. RasGas Company Limited will have to consider that profitability and liquidity is inversely proportional implying that increase in liquidity will decrease profitability and vice versa. The banks offer short term loans at lower interest rates because of more certainty. This means acquiring short term funds will increase profitability of the company. From the standpoint of risk, RasGas Company Limited is exposed to risk of interest fluctuation and refinancing risk. The interest fluctuations will be more prominent if the bank avails floating rate debt to finance its working capital. Interest rate volatility can increase the cost of finance leading to lower profitability. The refinancing risk arises from uncertainty in case the creditor denies loan for reasons like low credit ratings, inadequate assets or operating income (Wachs, 2006).

Equity financing – RasGas Company Limited can issue shares to public or private investors and raise long-term funds which can be deployed for expansion of business. The company can use equity funds for financing critical long-term projects like installing new production unit, natural gas exploration projects or even expanding existing resources. There are many advantages of equity financing like the company will not have to pay regular interest on the amount invested by the shareholders. It can reward the investors by paying dividends only when it earns profit. This is because the shareholders also take the risk of investment. However, there is one drawback because the owners will have to dilute their stake in the company which will minimise their strategic decision-making authority in the company (Sundaresan and Wang, 2007).

Debt financing – Another means to raise long-term funds is through raising term loans or issuing corporate debt. In either case, RasGas Company Limited will have to pay interest on outstanding debt regularly. The main disadvantage is that it will have to pay the interest on loan even it is unable to earn profits. However, the company will have to note that debt capital is cheaper than equity capital and lower cost of financing will increase profitability (Sundaresan and Wang, 2007).

• Critical assessment of information which is valuable to shareholders

The information disclosed in the statements of the company are very valuable to the shareholders they highlight company’s performance, social responsibilities, position of assets and liabilities, potential business risk, opinion of the management and other intricate details which are not available elsewhere (Business Standard, 2014).

The key information of RasGas Company Limited that is valuable to the shareholders are summarised below:

• Sustainability – RasGas Company Limited is committed to create a sustainable environment by working together with the stakeholders (both internal and external) to deliver optimal business performance alongside protecting the environment. The company actively involves in programs that encourage social and economic benefits by developing capabilities that will create more jobs in the economy in-line with the objectives of Qatar National Vision 2030. The organisation follows 4 developmental pillars namely, economic development, social development, human development and environmental development (RasGas, 2014).
• Integrity, transparency and accountability – RasGas Company Limited maintains highest level of ethical standards by prudently following every legal compliances and achieving operational integrity. The key performance indicator of the entity is number of sustainable indicators which have been publicly reported (RasGas, 2014).
• Operational excellence – The operational excellence in the LNG sector is assessed by the ability of the company to generate natural gas expressed in million tonnes per annum (see table 1). RasGas Company Limited was able to increase production capacity from 28.5 million tonnes per annum in 2009 to 37.2 million tonnes per annum at the end of 2013.
• Safety – The energy sector is prone to accidents and therefore, it is important for RasGas Company Limited to ensure the safety of the workers as well as the environment. The information given in the sustainability report of the organisation shows that the total injury rate recorded at the end of 2013 is 0.08 while the overall injury rate is less than 0.20. The lost time injury rate of the organisation is very low that is 0.01 (RasGas, 2013a).
• Mission and vision – RasGas Company Limited is aiming to achieve excellence in operations by using state-of-the-art technology. The organisation strives to become the global energy supplier by producing and selling hydrocarbons from gas fields in safe manner (RasGas, 2014).
• Financial performance – The financial statements of the organisation reflects the ability of RasGas Company Limited to generate revenues from operations. The main financial information will reveal the position of assets and liabilities of the organisation on a given date. Other critical aspects including profitability, liquidity, solvency and operational efficiency can also be analysed using the financial ratios (RasGas, 2016).
• Strategic decisions – RasGas Company Limited recognises that it is accountable to stakeholders for performance by acknowledging the fact that successful business strategy depends on understanding stakeholder needs and interest. Sustainability of the company is part of strategy that is derived from vision and mission. The company’s goals are incorporated and defined within specific objectives. The strategic choices are centred on achieving cost optimisation, reliable operations and environment friendly business processes (RasGas, 2014).
• Identification of financial objectives

RasGas Company Limited supplies liquefied natural gas to Qatari market to meet the mounting demand for energy by downstream industries and power stations. The financial objectives of the company should be directed to achieve long-term sustainability and profitability. The management of the company should segregate financial objectives on the basis of key performance indicators which are described below:

Shareholders’ wealth – The shareholders wealth can be estimated by EVA (Economic Value Added) that represents the real income generated by the company, total distributed profits and overall cost of capital. The main rationale for suggesting EVA for financial objective is because it helps to identify what part of profit will be actually adding to value to shareholders’ wealth. The formula for calculating shareholders’ value or EVA = (net operating profit) – (cost of financing); the interpretation of this formula is that if the EVA is positive then shareholders wealth increases and if it is negative then shareholders lose money (Damodaran, 2010).

Revenue growth – One of the most important indicators of financial performance is revenue growth. The revenues of RasGas Company Limited come from sale of LNG products to domestic and international clients through principal activities including extraction, processing, exporting and storing LNG products. The company will have to increase the production capacity in order to improve revenue growth. The present production capacity is around 37 million tonnes per annum. Hence, the first financial objective of the company should be to increase production capacity and future streams of revenues (Brown, Fazzari and Petersen, 2009).

Profit margins – If the company is able to generate profits from operations only then it will be able to reward the investors and shareholders. The objective of using profit margins as financial indicator is that many companies generate revenues but might not generate profits due to high administrative expenses, depreciation and amortisation, tax liabilities, provisions and other extraordinary items. The profit margin helps to analyse the cost management strategies of the company and economies of scale (Claessens, 2006).

Sustainability – The brand image and reputation of energy sector companies depend on sustainable business because it is concerned with the economic survival of the business entity. Based on the financial objectives, the company will have to be financially sustainable during the period of economic uncertainties (RasGas, 2014).

ROI – The Return on Investment (ROI) analyses the ability of the company to generate earnings for the owners who have invested in the company. The ROI can be used to assess the financial consequences of company’s financial and investments decisions. If the ROI is high then returns on investment exceeds the cost of investment (Perrini and Tencati, 2006).

• Ratios analysis of company’s capital structure and share price

The capital structure of a company reveals how the company plans to raise long-term capital funds. RasGas Company Limited can choose either equity sources or debt sources or a combination of both. The main essence of capital structure analysis is that if it is found that most of the long-term funds are financed with debt capital then financial risk can increase. If the company is unable to generate sufficient earnings to service interest rates then it might have to liquidate some assets to honour liabilities (Faulkender and Petersen, 2006). Hence, the capital structure analysis is very important from shareholder’s perspective. Similarly, the shareholders wealth is dependent on the share price of the company because it directly influences market capitalisation. The following ratios analyses RasGas Company Limited’s capital structure and share price:

Table 2: Ratio analysis for shareholders

all amount in RQ'000

2014

2013

2012

Long-term debt

69,99,484

50,70,498

3141512

Equity

33,68,89,409

34,13,74,830

345860251

Total debt

3,93,93,928

3,54,97,340

31600752

Total assets

40,05,11,640

39,65,02,668

392493696

Net income

11,26,12,946

11,86,43,243

124673540

Dividends

9,78,22,127

11,36,39,748

129457369

Outstanding shares

4,14,70,00,000

4,14,70,00,000

4147000000

Ratios

2014

2013

2012

Debt-to-equity

0.02

0.01

0.01

Debt-to-asset

0.10

0.09

0.08

EPS

0.27

0.29

0.30

DPS

0.02

0.03

0.03

(Source: Author’s creation)

Debt-to-equity ratio – This ratio will help the shareholders to measure the financial leverage of RasGas Company Limited. It is calculated by considering the long-term interest bearing loans and bonds used by the company to finance projects and then dividing it by stockholder’s equity (Margaritis and Psillaki, 2010). The debt-to-equity ratio of RasGas Company Limited in 2013 was 0.01 which further increased to 0.02 in 2014 (see table 2).

A critical analysis of this ratio suggests that at the end of 2014, debt capital represents only 2 percent of total shareholder’s equity. This value is very small implying that there is limited financial risk in the company.

Debt-to-asset ratio – The debt-to-asset ratio is very important indicator for the shareholders to assess the capital structure of the company. Higher value of this ratio indicates high leverage and high financial risk because the company will not have sufficient assets to cover liabilities. The value of this ratio was 0.09 in 2013 and it increased to 0.10 in 2014 (see table 2). The value of this ratio is less than 0.50 and hence it is very low. In other words, the shareholders can be assured that there is not financial risk in the company and they can put their money in the company (Welch, 2011).

EPS (Earnings per share) – The EPS represents the part of profit that will be allocated to outstanding common shares of the firm. The EPS of RasGas Company Limited was QR 0.29 in 2013 and it decreased to 0.27 in 2014. This indicates that for each QR 1 by the shareholder, he or she is entitled to receive QR 0.27 at the end of 2014 (Qatar Petroleum, 2014). However, a careful analysis shows that the company needs to improve profitability because low EPS reduces the cash available to the company to finance operations (Perrini and Tencati, 2006).

DPS (Dividend per share) – The dividends in the DPS formula refers to total dividends paid by the company during the year. This ratio is very important from shareholder’s perspective because it shows how the company rewards its shareholders for contributing to the development and growth of the company. The DPS of the company was QR 0.03 in 2013 and it decreased to QR 0.02 in 2014 (Qatar Petroleum, 2014). Since the company is in its growth stage and there is opportunity to expand its portfolio, the shareholders may postpone dividends for the time being and encourage the management to reinvest in company’s operations. This will help RasGas Company Limited to acquire more clients, expand resource base and improve profitability in the long-term (Damodaran, 2010).

• Conclusion

This report analysed the published financial reports of RasGas Company Limited for the past three years and found that the organisation is one of the major integrated LNG enterprises in the world. Over the years, the company has made an enviable reputation for operating as safe and reliable supplier of liquefied gas that transformed regional source into global energy mix. The company believes in sustainable business practices and it has positioned itself as transformative organisation in Qatar. The financial analysis revealed that the company is becoming more profitable by reducing adverse environmental impacts and enhancing economic and social benefits. From shareholder’s point of view it can be said that there is negligible financial risk in RasGas Company Limited because of very low level of debt. Company’s robust management and strategic framework are its strength. In addition, strong corporate governance and clear vision makes the company an attractive investment destination for the shareholders.

• Recommendation

The most important requirement for the shareholders is commitment of the organisation for transparent business activities and integrity in information disclosures. In case of RasGas Company Limited, both the criteria have been satisfied and the financial health of the company is also prudent. In short, the existing shareholders hold the shares of the company and new shareholders are advised to buy the shares of the company.

• Reference List

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Sundaresan, S. and Wang, N., 2007. Investment under uncertainty with strategic debt service. The American economic review, 97(2), pp.256-261.

The Financial Express, 2015. Gas stocks surge on report RasGas may modify SPA with Petronet. [online] Available at: <http://www.financialexpress.com/article/markets/indian-markets/gas-stocks-on-bse-sensex-nse-nifty-today-on-nov-20-2015-gail-petronet-lng/168227/> [Accessed 3 June 2016].

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Welch, I., 2011. Two Common Problems in Capital Structure Research: The Financial‐Debt‐To‐Asset Ratio and Issuing Activity Versus Leverage Changes. International Review of Finance, 11(1), pp.1-17.