Operating cash flows
Discuss About The Financial Management Principle Applications.
The cash obtained from customers is captured using the customer receipts. It is noticeable that this has seen a sizable rise in FY2027 when compared to FY2016. Yet another key component is the cash paid by the company during the year to suppliers along with the employees for the raw material and services offered. The growth in these payments is also quite substantial. The finance costs that the company has actually incurred during the year have witnessed an increase during FY2107 in comparison to the year before. Also, the tax paid by the company to the tax authorities for FY2017 has seen a jump over the value paid during the previous year (RFG, 2017).
A key component of the above cash flows is the money spent by company in relation to plant, property and equipment acquisition. This cash outflow has witnessed a significant amount of increase in the year ending on June 30, 2017 in comparison to the year ending on June 30, 2016. Further, the company also tends to liquidate some of the plant, property and equipment holdings which it considers as redundant and cash inflows are realised from the same. Besides, a sizable chunk of cash is used by the company to purchase various businesses along with acquiring intangible assets particularly brands. There is a huge jump in cash outflow on account of investing activities in FY2017 (RFG, 2017).
This reflects on the cash inflow and outflow generated on account of financing activities. Cash inflows can result from issue of shares or incremental debt as these are the two main sources of finance that are tapped by the company. For FY2017, money was raised through both debt and equity amounting to $ 189.5 million and $ 35.6 million respectively. In relation to cash outflow, there are three key elements namely payment of dividends, borrowing repayment and costs for issuance of securities. The dividend paid by the company has witnessed a jump in FY2017 when compared with FY2016. There has been repayment of debt to the extent of $ 149.5 million during FY2017. Besides, money paid in relation to raising money through debt and equity also leads to cash outflow as represented above (RFG, 2017).
The three major cash flow components are cash flow arising from operating, investing and financing activities respectively. The last three years trends are highlighted in the following tabular format.
Investing activities
The above figures clearly reflect a healthy trend as far as cash flow from operating activities is concerned as it has enhanced especially in FY2016 which clearly indicates that the underlying business model of the company is sound. Further, it is evident that the company seems to be investing aggressively in acquisition of various business assets which is why for all the years under consideration, the investing activities related cash inflow indicates an outflow. Also, this investment in the business would lead to sizable benefit for shareholders in the future as higher earnings may be delivered. Also, another positive observation is that the company has ensured that over-leveraging of the balance sheet does not happen which is why the company is raising money through equity dilution and also aiming to keep the debt levels within limits (Damodaran, 2015).
- The Other Comprehensive Income (OCI) extract for FY2017 is as illustrated below.
- The OCI statement highlighted above has two main items since the third item related to the tax effect of these. These items are briefly discussed below (RFG, 2017).
“Exchange difference on translation of foreign operations” – The exchange difference tend to arise due to a particular receivable for the foreign operations or may arise on account of any payable in cases where settlement does not seem possible in the near future.
“Changes in the fair value of cash flow hedge” – This is applicable for the derivative instruments that the company has categorised as cash flow hedge since the losses or profits (notional or actual) on the value needs to be captured in the financial statements.
- It needs to be analysed as to why the above items cannot be recognised in the income statement and why a separate OCI statement is required. The key contributor to this need is that the accounting standards which currently apply do not permit the representation of the above items in the regular profit and loss account. Also, there are people who argue that some of the profits/(losses) highlighted in the OCI statement are notional in nature and not realised. This is partially true as is apparent from the use of cash flow hedge in the given case whereby difference in fair value from the beginning of the financial year and closing of the financial year would be recognised as either profit or loss depending on which value is greater. However, OCI statement can also reflect on actual losses and gains that have been realised by the company on the assets/liabilities and therefore is vital for users (Deegan, 2014).
- The income statement highlights the underlying tax expense which for RFG for FY2107 stands at $ 25,686,000 (RFG, 2017).
- In order to verify whether the tax expense can indeed be obtained by simply multiplying the applicable corporate tax rate to the pre-tax income, the following computations ought to be performed (RFG, 2017).
Tax expense (Pre-tax income*Corporate Tax Rate) = 0.3*87,613,000 = $26,283,900
Tax expense as reported in the financial statements = $25,686,000
Clearly, the two deviate and are not the same. To account for the underlying differences between the two figures computed, it makes sense to consider the analyse the actual computation of income tax expense by the company as indicated in the notes to account (RFG, 2017).
It is evident that the computations of income tax expense begin with the 30% corporate tax rate on the accounting income before profit. However, thereafter several adjustments are made which tend to produce an income tax expense which deviates from the theoretical understanding. In the above backdrop, it is crucial to consider that the adjustment is required due to the different provisions for computation of income for accounting purposes as against computing the same for tax purposes. The net result is that there are differences created which tend to extend in the future years through the deferred tax assets and liabilities (Petty et. al., 2012).
For the year ending on June 20, 2017, RFG has both deferred tax assets and deferred tax liabilities. Their respective amounts are $13.657 million and $119.433 million.
Financing activities
When these numbers are compared with the figures obtained for the previous year (i.e. FY2016), it is clear that there has been a rise in these figures for the year ending on June 30, 2017. These assets and liabilities of deferred nature tend to arise on account of temporary difference which is created in the carrying value of key assets when depreciation is charged as per accounting norms on one hand and as per tax norms on the other. For analysing these assets and liabilities the tabular information highlighted below is useful (RFG, 2017).
Deferred tax assets are defined as the future effect of the transactions carried out in the year which would result in tax savings for the company. On the contrary, deferred tax liabiltiies are defined as the future effect of the transactions carried out in the year which would result incremental tax outflow for the company (Gilders et. al., 2016).
The company did not have any current tax assets on the balance sheet as on the last day of FY2017. However, there was presence of tax assets to the extent of $ 4.455 million as indicated in FY2016 related balance sheet. The effect of this is highlighted from the name whereby a tax benefit in the FY2018 would arise on account of current tax assets in FY2017 (RFG, 2017).
Tax expense tends to deviate from the tax payable which may be attributed to primarily one reason which is the difference in the rules related to accounting income computation and taxable income computation. The prime concern of income tax expense is the accounting income reported on pre-tax basis which then requires appropriate adjustments based on deferred tax assets and liabilities. On the other hand, the taxable income is computed through reconciliation to the accounting pre-tax income taking into consideration suitable difference in the assessability and deductions (Damodaran, 2015).
Income tax expense (FY2017 income statement) = $25.686 million
Income tax paid (FY2017 cash flow statement) = $ 21.46 million
The above difference may be related to the following two issues which are briefly enumerated as follows.
Tax expense is obtained from income statement. This is prepared considering an accrual basis which essentially leads to a creation of tax payable liability for the expense. In contrast, tax paid is obtained from the cash flow statement. This is prepared considering a cash basis and hence the tax paid in FY2017 would constitute some tax paid for the previous year (i.e. FY2016) along with some tax outflow for FY2017. Therefore, the difference arises (Petty et. al., 2012).
Besides, the difference in the two amounts also arises due to tax norms being at odds with accounting norms. The net result is that that tax paid is linked to the tax payable and not essentially the income tax expense. This leads to some deviation between the two figures (Deegan, 2014).
A particular aspect which attracted my maximum attentions was the topic of tax liabilities/ assets of deferred nature and the manner of their creation and functioning. A key takeaway from the given task is that the computation of tax liability in theory is quite simple but practically it is a complex affair which is why there are dedicated professionals whose services are sought after by companies. The underlying complexity is increased to a higher level because of the differences in tax regime and accounting regime with regards to certain deductions, income assessability and treatment of depreciation. Thus, the given year income tax expense would also be impacted on account of transactions in the past which would either lower or increase this tax expense amount. Also, considering the complexity of the computation of tax as exhibited in the current company’s financial statements, it is apparent that this requires high concept clarity and practice in dealing with various transactions so as to ensure that financial statements are reflective of the financial performance. Further, the given task by posing various questions and provided actual financial statements provided valuable insight into the application of the concepts learnt in the class in reality and thus has contributed to incremental learning having positive implications for future professional life.
References
Damodaran, A. (2015). Applied corporate finance: A user’s manual 3rd ed. New York: Wiley, John & Sons.
Deegan, C. (2014). Financial Accounting Theory, 4th ed. Sydney: McGraw-Hill
Gilders, F., Taylor, J., Walpole, M., Burton, M. and Ciro, T. (2016) Understanding taxation law 2016, 9th ed. Sydney: LexisNexis/Butterworths.
Petty, J.W., Titman, S., Keown, A., Martin, J.D., Martin, P., Burrow, M., and Nguyen, H. (2012) Financial Management, Principles and Applications. 6th ed. NSW: Pearson Education, French Forest Australia.
RFG (2017), Annual Report FY2017, Retrieved from https://www.rfg.com.au/index.php/110-general-pages/investor-news/816-2017-annual-report (
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