Wednesday, June 5, 2013

Dissecting a P&L

Very often we look at much simpler companies with a few lines of businesses and they are owned almost 100% entirely. I like to analyse these kind of companies as they are easier to understand. Investment need not be complex.

However we still need to learn. There are few conglomerates, and most of the time we relied on Bloomberg, websites for the financial data. I would think few people do their financial calculation as many companies reported the more relevant data in their report. However, sometimes companies may not want to highlight what's important and what's not. Often times, I see press release which are meant for the press. They do not do analysis. Press releases are being taken from the companies which provided the write-up, numbers and I most of the times do not see changes made by reporters.  Let me highlight a complex company (I do not want to name here - perhaps you can check out yourself) and see where are the flaws.

The below is a Malaysian conglomerate with lots of line of business. It has RM13.1 billion revenue. On paper, it looks like it does decent, which based on its bottomline is true. However, in a financial statement, there are more than just topline and bottomline.

Now, as above there are a lot of numbers, but which one do we focus on. I have circled several with different colors.

Certainly not the revenue as revenue can grow 90%, but if you look properly, the company is not that profitable. In fact, for this company, the reporting is minimal reporting. If you look at the revenue vs the cost of sales, the gross profit is RM465 million (RM13.134 billion - RM12.665 billion). Where is the other income from? Most probably profit from sale of assets, businesses etc., it is not revealed. But more often that not, these are one-off item. Without the other income and other expenses, the business itself is much less profitable.

Next is the profit line. Which one to take? There is a Net Profit for the Year. Then there is comprehensive income, then Net profit attributable to the owners of the company.

Net profit for the financial year, represents the profit for the company before taking into account of the minority stake. What is minority stake? It basically means that for some of the business that the company has consolidated, it does not own 100%. A business can be owned say 40% but yet it is consolidated. How? Because the principle says that as long as the company has a controlling stake of the subject, it can be consolidated. For a company that is consolidated, they will take in the topline right down to the profit is are consolidated. Only after the profit for the financial year line, you will see that the non-controlling interest are deducted - hence the net profit attributable to the owners of the company.

If you are the shareholder of the company as reported above, the profit line for the company that you own partially is the one circled with red. And EPS is calculated using that profit line.

What is comprehensive income then? These are not that important as the numbers are inclusive of the changes in items (like securities owned) that are marked to market, foreign exchange gain or losses etc. Again, these lines are not so reflective of the actual business.

By the way, I do not do insurance or unit trusts. And if you have articles that you want to share and you think are of quality, do send to me.


reyes430 said...

nice write-up. i think revenue recognition policy and the growth between revenue and account receivable is another notable point one should not overlooked in analysing income statement.

Multi Bagger said...

Never invest in companies that you can't understand the financial statements, more so when there is insurance business, balance sheet is complicated. This one - you dont understand how the cashflow from operation can be in such big deficit.

P said...

I'm interested to see and really hope they could excel well in the transformation of their automotive sector...

K C said...

I have one question to ask and hope those accounting trained people can help. If the "other incomes" is one-off such as gain from sales of assets, can they be classified before the "profit from operations" as shown in the financial statement here? Or shouldn't that be put at the bottom after that so that investor knows it is an "extra-ordinary item" which would not recur? If not it is highly misleading.

Multi Bagger said...

Extract from MASB, hope it helps.

Extraordinary Items

The nature and amount of each extraordinary item should be separately disclosed.

Virtually all items of income and expense included in the determination of net profit or loss for the period arise in the course of the ordinary activities of the enterprise. Therefore, only on rare occasions does an event or transaction give rise to an extraordinary item. It is possible to view such items as being external to managerial control and exhibiting a high degree of abnormality.

Whether an event or transaction is clearly distinct from the ordinary activities of the enterprise is determined by the nature of the event or transaction in relation to the business ordinarily carried on by the enterprise rather than by the frequency with which such events are expected to occur. Therefore, an event or transaction may be extraordinary for one enterprise but not extraordinary for another enterprise because of the differences between their respective ordinary activities. For example, losses sustained as a result of an earthquake may qualify as an extraordinary item for many enterprises. However, claims from policyholders arising from an earthquake do not qualify as an extraordinary item for an insurance enterprise that insures against such risks.

Examples of events or transactions that generally give rise to extraordinary items for most enterprises are:

the expropriation of assets; or

an earthquake or other natural disaster.

A previous practice has been to view the disposal of long-term investments and land or buildings as extraordinary items. Whilst such items are material and sometimes not expected to recur in the foreseeable future, nonetheless these items are related and incidental to the ordinary and typical activities of the enterprises. Extraordinary items arise from transactions or events that possess a high degree of abnormality that are clearly distinct from the ordinary activities of the enterprise and also are not expected to recur in the foreseeable future.

That an event or transaction is clearly distinct from the ordinary activities is also determined by the nature of the event or transaction in relation to the environment of the enterprise's business operations. For example, losses sustained as a result of a typhoon would normally qualify as an extraordinary item for most enterprises in Malaysia. However, losses from a flood would not normally qualify as an extraordinary item, unless it is of a scale that can be considered as a natural disaster. Reporting enterprises are, however, required to disclose ordinary items separately if their disclosure is relevant in explaining the financial performance.

felicity said...

Reporting for quarterly and annual audited report are different. Annual Audited would have more disclosure, hence the line items being displayed would be different as well.

Which is why, for older reports, do not look at quarterly but rather the audited reports.

mathew tung said...

I am so glad to pay attention to this post. And probably there are loads of info like this that i am not aware about.

mathew tung said...

I am so glad to pay attention to this post. And probably there are loads of info like this that i am not aware about.

Fung C.F. said...

Browsed through the report, notice there are gain on disposal of a business at RM413 mil, gain on disposal of investments at RM42 mil, gain on disposal of PPE at RM55 mil, and a reversal of provision of RM79 mil.

The "real" other incomes are dividend income of RM3.4 mil and interest income of RM95 mil.

There are still around RM191 mil other income hidden behind the scene.

Very unhealthy kind of reporting.

I'm also hoping some professional accountants could clarify on the recognition of gain on disposal of business in the Income Statement.

reyes430 said...

gain on disposal is real gain recorded at IS, but one should exlude it while analyzing IS as its deemed as non-recurring. Correct me if i am wrong. Thanks

felicity said...

Yup non-recurring

panaceaasia said...

It is obvious that there are other considerations apart from fundamentals when many analysts report on equities. There could be the relationship between management and the research analysts and/or the investment bank/stockbroking firm.