Aabar Investment: Cash Flow Statement Analysis - Case Study Example

University

Introduction

Aabar Investment PJS is a subsidiary company of the International Petroleum Investment Company (Annual Report, 2014). International Petroleum Investment Company is a public joint stock firm which was established in 1984; and it is an Abu Dhabi government owned entity (Annual Report, 2014). The main business objective is to invest in energy-related assets and energy projects abroad (Annual Report, 2014). Thereby, it is appropriate to mention that the company is an investment firm mainly designed to collect funds from different sources and invest them on behalf of their clients; and for this investment purpose, the parent company used Aabar Investment PJS as the main subsidiary for the purpose of investment (Annual Report, 2014).

In the following parts of this paper, first cash flow statement components have been defined. After that part, the cash flow statement of the International Petroleum Investment Company, which is the parent company of Aabar Investment PJS, has been evaluated. In this evaluation part, figures have been taken from 2013 and 2014 for carrying out the assessment process. However, it is still worth important to mention that each part has been separately analyzed along with elaborating components of each segment in the subsequent part of this paper. Subsequently, conclusion and recommendations part has been included.

Cash flow statement components

Operating activities, investing activities and financing activities collectively represent statement of cash flows. Operating activities refers to the main revenue-producing activities whereas investing activities represent activities in long term assets and their acquisition and disposal; financing activities exhibit those activities which change the equity capital and borrowing composition of the firm (IAS Plus, 2016). Additionally, statement of cash flows highlights changes in cash and cash equivalents especially any specific financial period (IAS Plus, 2016). Based on this perspective, it can be easily deduced that the basic framework behind statement of cash flow is to point out cash-related transactions.

Table 01: % changes in operating activities

Operating Activities

% Increase (Decrease)

Profit before tax:

-41

Depreciation and amortization of fixed assets

25.1

Net impairment of fixed assets

0.13

Gains on acquisitions and disposals

-55.6

Other losses (gains) on financial instruments

54 (gains)

Finance income

-44.5

Finance costs

-9.3

Unrealized foreign exchange difference

-962.9

Share of post tax profits of associates and joint ventures

-39

Movements in pensions, provisions and other liabilities

38.4

Inventories written down to net realizable value

3191.7

other non-cash adjustments

79.1

Working capital Changes

Inventories

-70.3

Trade and other receivables

109.4

Trade and other payables

-26.3

Other assets and liabilities

-8.6

Income tax paid

39.1

Net cash from operating activities

-12

Source: (International Petroleum Investment Company’s Financial Statements, 2014).

The operating activities begin with profit before tax. Various figures are taken to commence the operating activities of the business. For example, net profit, or profit before tax or profit before interest and tax are some of those figures which are normally taken to begin accounting for the cash flows.

The company has incurred a loss of 41 percent in profit before tax during the accounting from 2013 to 2014. This figure clearly indicates the operational performance mentioned in the statement of profit or loss has not been impressive during the period of last two years and that is being reflected by a decrease of 41 percent profit before tax figure. Thereby, it is appropriate to mention that this decrease is not good for the company as loss in revenue is not a good sign for the financial and operational performance of the company.

Depreciation and amortization are two methods to account for decreasing value of fixed assets. Depreciation is mostly used for recording a decrease in the tangible or physical fixed assets, such as machinery, building and equipment (Dorf, 2005). On the other hand, amortization is used for intangible assets, such as goodwill, patents, copyrights and other similar fixed assets. However, it is worth insisting that both items are non-cash. Thereby, it is highly essential to add them back to profit before tax. The provided depreciation and amortization increase is considerably higher than the global depreciation standard, which is around 10 percent for fixed assets. This increase is considerably higher and it is not a good sign as this increase substantially affects profitability of the firm.

Impairment is mostly related with property, plant, equipment and other fixed assets. An increase in impairment of fixed assets reflects that the fixed assets’ impairment, which is a natural process, has slightly increased. In this regard, it is important to mention that this increase is common in such firms. Thereby, it would be appropriate that the mentioned net impairment is a good indicator that the firm has not substantially decreased the costs attached with the fixed assets during this period.

Gains on acquisitions and disposals are not a good sign for the International Petroleum Investment Company. Aabar Investments PJS, which is the subsidiary and is mainly used for the purpose of investing, mostly deals with investment properties and other related instruments. In other words, the main purpose of Aabar is to trade in investment in which buying and selling of different assets are carried out. A decrease of 55 percent in a single year clearly reflects that the company is not using Aabar investment effectively and efficiently as well. And this perspective has been clearly authenticated by the substantial decrease in the gains and acquisitions of different investment assets during the reported period.

Gains on financial instruments are a good indicator for the effective use of different financial instruments. A total increase of 54 percent on financial instruments indicates the parent company is productively using Aabar investment during this period. And this becomes more essential when improved gains on financial instruments, which represent both derivative and non-derivative instruments, have shown a very impressive growth in a single year. In this regard, it pertinent to highlight that the company recorded losses on the financial instruments and the subsequent year performance clearly highlights that the effective use of financial derivatives has been carried out with a single objective of generating more gains instead of incurring more losses in the second year (2014).

Income from dividend and interest is mostly accounted for as finance income. Generally, an investment firm purchases different shares in firms and this entitles them to receive dividend income from the invested company. Similarly, investment firms also extend credit facility to needy firms and in return they receive interest income from the extended credit.

Decrease in finance income is not a positive sign for the firm. For investment firms, finance income is the most important source of income as it is generated through extending loan to different firms. And the most effective benchmark is that increase in finance income is also attractive and preferred by the investment firms as it gives them finance income which improves their overall profitability and cash flow performance as well. Subsequently, when this perspective is applied to the statement of cash flows of International Petroleum Investment Company, it can be easily seen that the firm has not been able to increase income from this very important source instead a considerable decrease has been observed in a single year.

Cost of borrowings can be defined as finance cost. This type of cost takes place when a firm avails loan facility from financial institution either for the short term or for the long term period. In both cases, interest is paid on the borrowed amount. When more than different sources or more than different types of loans are availed and different amount of interest is paid on each source or type, in that case, aggregate amount of interest on the total borrowings is placed under the finance costs. In other words, the nature of this component is cost which is paid annually or someone monthly as well.

A decrease in cost (finance cost) is a good sign for the company as this shows that a liability around 9 percent has been decreased during this period. However, it is still worth insisting that the mentioned decrease is small. Consequently, it would not be inappropriate to indicate this decrease has no considerable effect on the cash flow statement of the company.

Unrealized foreign exchange difference can only be accounted for when all foreign exchange liabilities and assets are needed to be revaluated on the specified exchange rate (KPMG, 2013). This definition clearly indicates that the unrealized foreign exchange difference has no substantial effect on cash flows because it is only a revaluation exercise. More specifically, the indicated -962.9 percent decrease from the 2013 figures clearly exhibits that only value on paper has been adjusted so as to reflect the market value of the assets and liabilities. As a result, it is appropriate to mention that this difference is not good for the company as it adds value in the cash flows without generating actual cash flows during this period. At the same time, it is relevant to highlight that the previous year’s unrealized foreign exchange difference was positive revaluation of the related assets but this positive revaluation did not appear in the subsequent year instead negative or decrease in the revaluation of foreign exchange assets and liabilities was reported.

Decrease in Share of post tax profits of associates and joint ventures is not a good indicator for the company. Share of post tax profits of associates and joint ventures is a cash inflow generating income from additional sources. If the associates and joint ventures are performing well, then there are chances that they would also generate more profit. However, when this perspective is applied to the table 01, it can be easily seen that the company has experienced a decrease in this share and that means the company’s investment in associates and joint ventures has not generated more return when it is compared with the previous year’s similar share of profit of associates and joint ventures. More specifically, the highlighted decrease (-39) is considerably higher, reflecting that some associates and joint ventures have underperformed when their performance is compared with previous year’s profit share.

Nature of pensions, provisions and other liabilities is outflow rather than inflow. During this period, it can be easily seen that the company has paid 38.4 percent more for the liabilities when this figure is compared with the previous year’s figure, clearly authenticating that the pensions and other similar liabilities have increased in 2014. In this regard, it is relevant to mention that this type of expenditure is of routine nature as they cannot be avoided. Thereby, it would be appropriate to mention that this increase is of routine nature and has no positive effect for the company because it outflows cash from the company.

Inventories are revalued so that they reflect their market value or net realizable value so as to provide true and fair view of the financial statements. In this regard, it is important to mention that this exercise has also no specific impact on the statement of cash flow because it is a revaluation process which is only done to reflect the true and fair value of inventories and other related assets. Additionally, it is important to mention that this increase is substantial but it does not actually generate any cash inflows for the company. Similarly, it is relevant to mention that the non-cash transactions and other similar transactions are mostly added back so as to provide true and fair view of the statement of cash flow.

Decrease in inventories is a positive sign for the company. Inventories are mostly employed for providing products or services to customers. If inventories are decreasing, this shows that more products and services are being provided to the customers. In other words, the sale or consumption of inventories indicates that business has more customers and their frequency has increased during this period. Within this context, it is important to mention that around $1,140,497,000 were remained unused in 2013, indicating that the inventories were not used for generating more sale but they remained idle during this period. On the contrary, more inventories were used in 2014, authenticating that the firm has employed more inventory for providing services to their customers.

Increase in trade and other receivable is not a sign for the company. Trade and other receivables are those short term assets payable by the customers. Increase in trade and other receivables that the customers have not this outstanding amount. As a result, an expected inflow has not been made by the customers. Additionally, trade and other receivable is an outflow which is a liability for the company and its decrease is a positive sign for the company. And the same is also applicable to other assets and liabilities. Similarly, income tax is an expense and its increase indicates that the company has paid more tax in comparison to tax paid in 2013. Overall, a decrease in net cash from operating activities is not a good sign because it shows that a reduction from operating cash inflow has been recorded comparatively.

Table 02: % changes in investing activities

Investing Activities

% Increase (Decrease)

Purchasing of subsidiaries, net of cash required

274.3

Purchase of financial instruments

167.7

Acquisition of associates and joint ventures

-25

Acquisition of interest in existing subsidiaries

8086.8

Purchase of fixed assets

30.2

Proceeds from sale of fixed assets

80.8

Movement in derivative financial instruments

-57.1

Advance received against asset held for sale

0

movement in advances on investment properties

27322.6

Movement in financial instruments

11.9

Short-term deposits

0

Interest received

-37.9

Dividend received

-16.9

Payments on other assets

85.7

Net cash (used in ) from investing activities

36.5

Source: (International Petroleum Investment Company’s Financial Statements, 2014).

Rise in purchase of subsidiaries is a good indicator for the firm. This shows that the company has invested in subsidiaries through purchasing more subsidiaries. In this regard, it is relevant to mention that the mentioned 275 percent increase is a substantial figure, reflecting that the company is giving more attention to investing activities for generating more income and income sources as well. Additionally, it is important to mention that increase in purchase of financial instruments is also considerable. However, it is worth indicating that both figures represent that the firm has substantially invested in associates, joint ventures and subsidiaries during this period, which is a sign of positive optimism within the top management of the company. However, this point also indicates that more cash outflow has been recorded during this period.

Decrease in acquisition of associates and joint ventures are not a good sign. Acquisition is a process through which a firm buys another entity and obtains management control of that entity. In this regard, it is relevant to mention that an associate entity has been defined as an entity in which a purchasing firm has 30 percent shareholding (Ernst & Young, 2008). On the contrary, joint venture is formed when two or more than two parties enter into a business relationship (Kan et al., 2008). More specifically, it is formed between a local and an international firm (Kan et al., 2008). Based on this situation, it can be easily deduced that associate entity only gives partial ownership whereas joint ventures gives more ownership in a joint venture firm. As a result, when this perspective is applied to the International Petroleum Investment Company, the subsequent results reveal that the company has decreased investing in associates and joint ventures and that is not a good sign because it will decrease their income from invested associates and joint ventures. On the contrary, it is relevant to mention that the interest from the existing subsidiaries has been substantially increased during this period, highlighting that the associated firms have made a considerable interest payment to the company. In other words, it would not be incorrect to say that this substantial income source is clearly indicating that the firm’s investment philosophy and policy are generating expected returns which are clearly reflected by the tremendous increase in the interest amount collected from the associated firms.

Increase in the purchase of fixed assets is also a positive sign for the firm. Fixed assets are those assets which are immovable and mostly fixed by their very nature. The main objective behind this purchase is to increase business capacity for generating more attractive services and products for the customers. In this regard, it is relevant to mention that the International Petroleum Investment Company is an investment firm which mostly earns profit through investing in various financial instruments and assets as well. Thereby, this increase is the purchase of fixed assets also signifies that the firm has increased its investment in fixed assets so as to earn more profit or return on their subsequent use. At the same time, increase in the proceeds from the sale of fixed assets has similar benefit for the company as this indicates that fixed assets have been used for the trading purpose. And this trading purpose is also generating result through the receipt from the sale of fixed assets.

Movement in derivative financial instrument has not been a good sign for the company. The mentioned figure in the cash flow statement is substantially negative in 2014. In the year of 2013, movement in derivative financial instruments generated positive inflow but this trend did not take place in 2014, indicating that more cash outflow was reported during this period. However, increase in movement in advances on investment properties has positive effect on the firm. First, this is investment in various properties. The firm has paid advances to different properties. However, it is worth mentioning that this specific transaction reflects cash outflow but it is beneficial as it would generate more return in future for the company.

Interest received is a positive inflow as it is an income which is generated through investment. However, a decrease in interest received shows that the firm has not been able to maintain the previous year level of interest received during that year. In this regard, it is pertinent to indicate that this decrease indicates that the firm has collected 37 percent interest income during 2014. And the same perspective is also applicable to the dividend received, indicating that the ownership of different shares has provided less dividend during this period. At the same time, payments on other assets are a sort of investment. Thereby, increase in payments on other assets will mean that the company will have more income from this payment. Overall, net cash from investing activities recorded 36.5 percent increase during this period. This increase is positive as this would put more positive effect on the investment portfolio and performance of the firm in the long term.

Table 03: % changes in financing activities

Financing Activities

% Increase (Decrease)

Proceeds from borrowings

35

Repayment of borrowings

-14.2

Interest paid

-11.2

Dividends paid to non-controlling shareholders

20.4

Net cash used in financing activities

76.5

(Decrease) Increase in cash and cash equivalents

-38.9

Net foreign exchange difference

306.8

Cash and cash equivalent at 1 January

38.8

Cash and cash equivalent at 31 December

-22.2

Source: (International Petroleum Investment Company’s Financial Statements, 2014).

Proceeds from borrowings show positive sign for the firm. It is clearly mentioned that the firm has extended borrowings to various institutions and the subsequent payments from the borrowed amount shows that a considerable increase has been recorded during this period. In this regard, it is relevant to mention that this increase is substantial as increase shows that a considerable inflow has been made to the company. On the contrary, repayment of borrowings, which is a form of cash flow, has been considerably smaller and it is also good sign for the company. Based on this situation, it can be easily deduced that the firm has made 14 percent repayments on borrowings, indicating that the cost of borrowings has been diminished in this period.

Dividend is simply a payment to shareholder which is normally given to the invested amount. This increase is good sign as this indicates that around 20 percent more dividends has been paid to non-controlling shareholders during this period. A 20 percent increase is considerable considering the investment scale of this firm. Similarly, decrease in interest paid amount also shows that the firm has paid less interest on borrowed amount. This indicates that the firm has reduced its reliance on the external source for which interest has been paid. Subsequently, decrease on financing activities shows that firm has considerably decreased its dependence on such sources. Thereby, this can be taken positively.

Conclusion and recommendations

Majority of the cash flow components show positive situation of the firm during this reported period. The important thing is that operating activities show decrease in net cash from operating activities. In this regard, it is important to mention that the firm management should take more strong actions for improving its operational performance because the net operating cash flows has been decreased during this reported period. For this objective, it is highly recommended that the firm should look for new activities purely for the sake of improving the operational cash flows and this only are done through increasing the current investment portfolio which requires additional productive and less risky investment. On the other hand, it is relevant to mention that this decrease in net investing activities has also been reported. In 2013, the annual report mentions that positive cash flows have been generated whereas negative net cash flows have been accounted for in the subsequent year. On the basis of this situation, it is highly recommended that the firm should also revisit its investment strategy and this must consider those factors which bring unattractive returns. More specifically, the firm should more focus on new markets and new firms particularly in the European and other developed part of the world at the same time, the important factor that the portfolio should be constructed in a way that should decrease risk and increase long term return. Similarly, the above mentioned conclusions are recommendations are also supported by the negative net cash and cash equivalent during this period. Thereby, it is the time for the firm to reconsider its whole investment philosophy and approach and also evaluate all financial instruments which have become a source of loss during this reported period of time.