Operational cash flows
- The requisite cash flow extract from the latest annual report in public domain is indicated as follows (Orica, 2017).
The critical aspects in relation to operational cash flows are highlighted below.
- “Receipts from Customers” – This is the key operational source of finance for the company and comprises of the money that the customers have paid for consumption of products and services that the company provides. It is essential to make note that revenues only highlight the sales in accrual manner while the given item highlights the actual cash that customers have paid. In comparison with FY2016, the receipts from customers in FY2017 have seen a significant decline which might be the result of lower demand of explosives from the mining sector.
- “Payments to Suppliers and Employees”- Using the money received from customers, the company pays not only the suppliers but also the employees. Both are key aspects of the company’s value chain which eventually is able to provide the desired product and services. In comparison with FY2016, the payments made to suppliers and employees in FY2017 have seen a nominal increase.
Besides the above, the company also receives other operating income and also interest income. Consequently, the cost involved in terms of borrowing has also been considered. Additionally, another pivotal element is the amount of tax paid by the company on the operational profits generated which has seen major jump in FY2017 to the extent of 40% over FY2016.
With regards to cash flow arising from investing activities, there are three elements that need to be discussed. The most pivotal is the payment that the company has done for acquiring PP&E in a given year which has seen about 20% increase in FY2017 as compared to FY2016. Another pivotal element is the amount that the company pays for acquisition of intangible assets which has seen a 10% increase in FY2017 over the previous year. A key cash inflow would comprise of the proceeds derived on sale of PP&E which has dipped in FY2017 compared to FY2016 (Orica, 2017).
The critical aspects in relation to financing cash flows are highlighted below.
- “Proceeds from long term borrowings” – This points towards the cash inflow that the company realises on account of higher assumption of long term borrowings. For FY2017, there has been a reduction of about 45% in this regards as compared to FY2016.
- “Repayment of long term borrowings” – This refers towards the cash outflow that the company realises on repayment on the long term borrowings. For FY2017, this has seen a decline in excess of 60% as compared to corresponding figure in FY2016.
- “Dividends paid” – This refers towards the cash outflow that the company realises on the payment of dividends. For FY2017, there has been a dip in the dividend payment compared to FY2016.
- The trends in relation to the cash flow components are captured in a tabular form indicated as follows.
The key observations which emerge from the table above are indicated as follows (Lasher, 2017)
- While the cash flow from operating activities for FY2015 and FY2016 highlight a healthy trend but the same is interrupted by the significant fall in these cash flows in FY2017. One of the contributory reasons could be the lower demand of explosives from mining customers.
- Over the last three years, there has been an increase in the investing activities related cash outflows. This probably hints that the company in the future expects the demand would pick up and thereby is making requisite investment.
- The company has made dedicated effort in FY2015, FY2016 to reduce the debts on the books so as to strengthen the balance sheet. This would also allow the company to raise incremental debt in the future as and when required.
- The relevant extract containing the various OCI statement related items is shown below (Orica, 2017).
- The OCI statement extract highlighted above, the various gain or loss tends to arise on the basis of company having foreign operations. This is because in these operations the revenue realisation would take in a foreign currency which would require to be converted into AUD and owing to time delays between receipt and conversion, possible gains or losses can arise. Additionally, the company with the intention of limiting this risk of adverse currency movements may initiate positions in financial instruments such as cash flow hedge. The fair price of these financial instruments would change on a real time basis and could lead to both notional and realised profit or losses which are realised in the OCI statement (Northington, 2015).
- There are various reasons why the items discussed above merit a separate section. One of the key reasons is the existing regulatory norms particularly in relation to preparation of financial statements which need to be adhered to by all reporting entities. As part of these regulations, there are certain transactions or items which ought to be reported under OCI. Another reason is that the nature and characteristics of these items is fundamentally different from that of the other items reflected in the P &L statement. One difference is that for certain select items captured in P&L statement, the resultant profit or loss may be notional and not real unlike items in the P & L account. Another difference is that the items shown in P&L statement are linked to the operational activities of the company and aimed to generate profit for the company. This is not the case with OCI activities as these are meant for business purposes but the management does not intend to earn any income from these items (Damodaran, 2015).
- The latest financial statements for the company are available for the year ending on June 30, 2017. In accordance with the income statement for this period, the company has reported a tax expense of $ 164 million (Orica, 2017).
- As per the given question, tax expense expected would be the corporate tax rate (0.3) multiplied by the pre-tax income ($563.4 million). This yields a theoretical value of $ 169 million which does not match with the actual reported value of $ 164 million as there is a deviation of $ 5 million.
The above deviation is on the basis of the reconciliation that has been performed so that using the accounting pre-tax income as the base the computation for the tax payable in accordance with the income tax provisions can be performed. The following note to account highlights the same (Orica, 2017).
It is apparent from the above notes to account that requisite adjustments have been made to highlight the differences in provisions related to tax and also accounting income. Also, certain adjustments are also prompted owing to tax being paid abroad owing to foreign operations where the tax rate is different from that prevalent in Australia. Also, some portion of the tax may have been held as part of the withholding tax.
- Deferred Tax Assets (FY2017) = $ 323.1 million
Compared to the previous year i.e. FY2016, the deferred tax assets have witnessed a decline as the corresponding level that existed as on June 30, 2016 was $408.3 million. Further, the different components of deferred tax assets coupled with changes in this regards are summarised below (Orica, 2017).
Based on the above, it is apparent that these assets tend to attribute their existence to the temporary differences that tend to arise for the above items. Further, the implication of a deferred tax asset is that in the future owing to the present transaction, the company would save taxes or experience a tax refund (Petty et. al., 2015).
Deferred Tax Liabilities (FY2017) = $ 274.6 million
Compared to the previous year i.e. FY2016, the deferred tax liabilities have witnessed a increase as the corresponding level that existed as on June 30, 2016 was $267.2 million. Further, the different components of deferred tax liabilities coupled with changes in this regards are summarised below (Orica, 2017).
Based on the above, it is apparent that these liabilities tend to attribute their existence to the temporary differences that tend to arise for the above items. Further, the implication of a deferred tax liability is that in the future owing to the present transaction, the company would pay more taxes or experience a tax outflow (Petty et. al., 2015).
- In the balance sheet, there is no mention of any current tax assets or liabilities for the year ending on June 30, 2017. However, there is a possibility that either of these may have been concealed as other current assets or other current liabilities. As these are current in their underlying nature, hence the impact is materialised during the following 12 month period (Orica, 2017).
The payable income tax highlights the amount of income tax for a given period which has not been still paid based on essentially two parameters i.e. the tax paid and the tax expense. Considering that tax expense highlights the total amount that the company ought to pay the tax authorities for the given year, the tax payable would be derived by subtracting the tax paid from the tax expense. Further, it is unlikely that the tax payable and tax expense would be the same since some portion of current year tax expense would already have been paid (Parrino and Kidwell, 2014).
- For the given company, it is apparent that for the year ending on June 30, 2017, the two values i.e. tax paid and tax expense do not match. The tax expense for the full financial year can be reliably estimated only after the year has ended and hence it would be unreasonable to expect that the company would pay a tax amount which matches the actual tax expense. This is because by the time the year ends, the tax expense for the year is not known with certainty and thereby the company cannot pay the precise amount even if wants to (Brealet, Myers and Allen, 2014).
- A key aspect which was quite tough for me to interpret was the concept of deferred tax assets and related liabilities. This had various aspects such as the underlying origin on account of temporary differences which I felt was quite onerous to compute even though the underlying concept is relatively clear. A useful insight that emerged from the task was related to tax expense which unlike theoretical understanding is based on reconciliation owing to the difference in provisions related to tax from accounting principles.
References
Brealey, R. A., Myers, S. C., & Allen, F. (2014) Principles of corporate finance, 2nd ed. New York: McGraw-Hill Inc.
Damodaran, A. (2015). Applied corporate finance: A user’s manual 3rd ed. New York: Wiley, John & Sons.
Lasher, W. R., (2017) Practical Financial Management 5th ed. London: South- Western College Publisher.
Northington, S. (2015) Finance, 4th ed. New York: Ferguson
Parrino, R. and Kidwell, D. (2014) Fundamentals of Corporate Finance, 3rd ed. London: Wiley Publications
Orica (2017) Orica Annual Report FY2017, [online] available at https://www.orica.com/Investors/Annual-Report/downloads#.Wwiiqe6FPIU (Accessed May 25, 2018)
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