Cash Flow from Operations
The company that has been selected for this task is RFG also known as Retail Food Group. The most recent annual report available for the company is for FY2017 which ended on June 30, 2017.
The various components of the cash flow from operations are captured below.
Receipts from customers highlights the cash proceeds that company obtains from the franchising business and this has witnessed a significant jump in FY2017 in comparison to the previous year. The other major component is the payment that company has done to various suppliers as well as employees which has also shown a significant growth in line with the receipts. There has been an increase in the costs related to the finance that have been paid in FY2017 over the last year. Besides, there has been about 12% increase in the income tax paid in FY2017 which may be linked to the higher profits made by the company in the same year.
The various components of cash flow on account of investing activities are represented below.
One of the major components is the payment done by the company for acquisition of PPE which has seen a major uptick in FY2017 when compared to the previous year. There has been some proceeds realised from sale of PPE but that is quite insignificant when compared with the monies paid for acquiring PPE. Considering the nature of the business, the company while acquiring other businesses would potentially also acquire related intangible assets and the payment made for these is also recorded. However, an almost 10 fold jump is seen in the cash spent on making payments for businesses in FY2017 over the previous year.
The various components of cash flow on account of financing activities are represented below.
The most noticeable aspect is that in FY2017, the company has raised equity proceeds to the extent of $ 35.6 million which was nil in the previous year. However, the proceeds from incremental borrowings continue to increase in FY2017 as the repayment is lesser than the fresh proceeds in this regards. Also, the company has paid dividends to the shareholders in FY2017 to the extent of $42.888 million and represent a significant rise to the previous year. Also, for raising the incremental equity and debt, there are associated costs such as in obtaining approvals, legal fees, merchant bankers which are also recognised.
- ii) The changes in the three major components of cash flow are illustrated below.
Based on the apparent, it is apparent that the operational cash flow has been showcasing a healthy trend as it has improved in the recent years, which is a reliable indicator of the business model robustness. Additionally, it is apparent that company is investing actively in the business as in the last three years, there is a significantly cash outflow on account of investing activities. These investments are likely to be EPS accretive in the future when the impact of these would be reflected in earnings. Further, with regards to financing activities also, the company in the recent years has ensured that the balance sheet does not get over leveraged and hence kept the debt within manageable portion while exploring equity based financing.
Cash Flow from Investing Activities
Other Comprehensive Income Statement
- The relevant extract in this regards is reflected below.
- The two main items highlighted in the OCI statement are as highlighted below.
“Exchange difference on translation of foreign operations” – These refer to the foreign exchange differences that arise on account of any receivable or payable in relation to foreign operations, the settlement for which is unlikely to happen in the foreseeable future.
“Changes in the fair value of cash flow hedge” – For the various derivative instruments that are termed as cash flow hedge, this item is used to highlight the profits or losses made on the same.
Also, the net tax impact of the above transactions is also stated.
- The obvious question that arises is to highlight the need of recognising the above mentioned entries in OCI statement instead of the income statement. The primary reason for the above treatment is because the prevalent accounting norms and standards prescribe the same and thus it needs to be adhered. Also, another argument in this relation is based that the profit or loss of certain entries is essentially notional which is true for financial instruments such as hedges which tend to represent the actual position based on market prices at the beginning and closing of the year rather than the actual profit or losses made by the company. However, this is not always true and certain profit/losses realised are not notional but actual. But, an imperative role in played by OCI statement since it indicates the relative change in value of the various assets and liabilities present on the books of the company.
Accounting For Corporate Income Tax
- The tax expense for the company is captured through the income statement and stands at $25.686 million for the year ending June 30, 2017 (RFG, 2017).
- Based on the calculations highlighted as follows, it is evident that the income tax expense for the year ending on December 31, 2017 does not equal to the simple computation where the corporate tax rate is multiplied with the pre –tax profit. (RFG, 2017).
Tax expense (theoretically) = Tax rate * Pre-tax profit = 0.3*87,613,000 = $26,283,900
Tax expense (actual amount in income statement of company) = $25,686,000
In order to account for the difference between the above two numbers, it is essential to refer to the actual schedule pertaining to income tax expense calculation which is illustrated as follows (RFG, 2017).
With regards to the above schedule, it becomes evident that there are several adjustment which are attributed to the company operating in different geographies (hence difference in tax obligations) coupled with differing norms for accounting and tax computation (leading to temporary difference creation). But a key highlight is that the computations start from the theoretical base only after which various adjustments are done and the net figure that emerges post these adjustments is referred to as income tax expense (Petty et. al., 2012).
In relation to FY2017, the company’s balance sheet indicates the presence of both deferred tax liabilities and tax assets to the tune of $ 119.433 million and $ 13.657 million respectively.
On comparison with corresponding number for FY2016, it becomes evident that both deferred tax liabilities and tax assets have seen an increase in FY2017 over the corresponding numbers for FY2016. One of the main contributors in the creation of these assets and liabilities is the difference in norms applicable for accounting and for tax owing to which there is temporary difference created across various assets and liabilities which serve as source of future tax assets or liabilities. In this context, the following information is relevant (RFG, 2017).
The deferred tax assets arise on the back of current transactions which can lead to potential tax savings in the future and hence there are realised as assets owing to the cash inflow that they can bring. Similarly, the deferred tax liabilities arise on the back of current transactions which can lead to incremental tax outflow in the future and therefore is captured as a liability since additional tax expense might result. A potential example of deferred tax asset is in the form of a doubtful receivable which may be rendered uncollectible and therefore would reduce the tax obligations (Deegan, 2014).
Cash Flow from Financing Activities
For the financial year terminating on June 30, 2017, no current tax assets were recorded by the company. But tax assets were present for the company at the end of FY2016 amounting of $ 4.455 million. In accordance with their name, these refer to the assets related to tax whose benefit is expected to be derived by the company within one year (RFG, 2017).
The deviation between tax expense and tax payable is caused on account of differential rules that are prescribed for accounting income computation and for taxable income computation. Income tax expense is linked to the pre-tax income post which adjustments are made. On the other hand, the tax payable is linked to the computation of taxable income which is not based on existing accounting norms but rather the tax provisions. A case to consider is the depreciation provision which according to tax provisions may differ from the norms of accounting leading to temporary difference formation which impact the computations (Deegan, 2014).
Based on the income statement, it can be derived that the income tax expense for the year ending on December 31, 2017 amounts to $25.686 million. This is in sharp contrast to the amount actually paid during the year which stands at only $ 21.46 million as highlighted in cash flow statement. There are two reasons that may contribute to the deviation observed. These are highlighted below.
Tax expense is listed in the income statement which is prepared on accrual basis and thereby represents an expense thereby creating a liability. On the other hand, tax paid is listed in the cash flow statement which is prepared on cash basis and thereby represents discharging of liability. Also, with regards to cash flow statement where tax paid is represented, this would capture a part of previous year tax payment and part of current year tax payment (Deegan, 2014).
Also, there is another reason for the difference highlighted between the two. This amounts to tax expense being based on accounting income and tax paid being derived from tax payable which is based on tax provisions. As a result, a difference tends to arise between the two (Petty et. al., 2012).
One of the most interesting aspects which I found was in relation to deferred tax liabilities and assets along with the underlying mechanism by which they actually originate. Besides, the given task clearly made me understand that tax computation while studying may appear simple and straight forward but in reality happens to be quite complex. This complexity is further enhanced owing to the regulation difference highlighted through tax and accounting norms. As a result, the income tax expense in a given year is also impacted by transactions which have happened in the past which came as a big surprise to me. Besides, the whole exercise whereby matching of balances is to be done considering the recording of deferred tax assets and liabilities for future seemed very challenging to me and therefore would require proper expertise and in-depth knowledge of the various provisions. Additionally, it was a revelation to understand that income tax expense does not simply arise by multiplying the corporate tax rate by the profit before tax. As a result, this task and the related concepts have helped me understand the key differences between theoretical concepts and their practical application along with the skills sets required to manage this transition.
References
RFG (2017), Annual Report FY2017, [Online] Available at https://www.rfg.com.au/index.php/110-general-pages/investor-news/816-2017-annual-report (Accessed May 18, 2018)
Deegan, C. (2014). Financial Accounting Theory, 4th edn. Sydney: McGraw-Hill
Petty, J.W., Titman, S., Keown, A., Martin, J.D., Martin, P., Burrow, M., and Nguyen, H. (2012) Financial Management, Principles and Applications. 6th edn. NSW: Pearson Education, French Forest Australia.
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