Creativity time in the reporting round

By Peter V O'Brien

Friday 13th August 2004

The June balance date reporting round is another opportunity for company officers to exercise creative abilities when announcing preliminary results.

Stock exchange reporting forms are standard for all companies and artistic deviations prompt a "please explain" if the company monkeys with the figures.

Companies have considerable discretion when preparing comments to accompany the basic financial information.

The exchange's forms for preliminary results has a section for "comments of directors." It has a note, "if no report in any section, state nil," which bestows the ultimate discretion.

Relevant "sections" are:

* material factors affecting the revenues and expenses of the group for the current full year;

* significant trends or events since end of current full year;

* changes in accounting policies since last annual report and/or last half-yearly to be disclosed;

* critical accounting policies;

* management's discussion and analysis of financial condition, result and/or operations (optional) this section should contain forward looking statements that should outline where these involve risk and uncertainty; and

* other comments.

It would be naive to expect companies to comment on their results in anything but the best possible light, particularly if there was a profit downturn or a loss but even naive people could suggest an appropriate presentation.

An announcement of the net after-tax earnings for the relevant period should come first, then the adjusted net earnings, after allowance for extraordinary and unusual items and one-offs that were outside the definitions of extraordinaries and unusuals.

Operating cashflow should be next. A business and its apparent returns are nothing without continuing strong cashflow.

Comments accompanying Telecom's preliminary report for the year ended June 30 got that presentation partly right last week.

"Telecom today announced reported net earnings after tax for the 12 months to June 30, 2004 of $754 million, an increase of 6.3% on the $709 million reported for the 2003 year.

"Adjusted net earnings for the 12 months to 30 June 2004 were $775 million, an increase of 10.1% on the previous corresponding 12 months."

The company detailed five abnormal and special items included in reported net earnings.

It gave figures for adjusted earnings before interest, tax, depreciation and amortisation" (ebitda) ahead of operating cashflow. Ratios based on ebitda are controversial issues.

Telecom said operating cashflow rose 7.3% to $1.68 billion, reflecting stronger income growth and lower interest payments.

A "right" figure for operating cash flow is impossible to quantify across all companies. Different industries and commercial activities have different cashflow needs.

Solid growth in cashflow from the appropriate base is an indication of the enterprise's financial health.

Information about returns on shareholders' equity and the relationship between shareholders' equity and total assets (the proprietorship ratio) should be included after figures from the revenue account.

Many companies are silent about returns, often in favour of extolling the apparently excellent stewardship of directors and management.

Shareholders with a modicum of financial nous could calculate the numbers but they should be in the report's comments.

Proprietorship ratios are guides to whether a business is undercapitalised, overcapitalised, or has its debt:equity mix in reasonable balance. They are important investment indicators.

Undercapitalisation could signal potential trouble without an equity injection.

Overcapitalisation allows the introduction of additional debt and/or repayment of capital. Reasonable balance should indicate to shareholders there would be no immediate change to the mix.

Shareholders can crunch those numbers but companies should provide them in preliminary report comments, given the current insistence on importance of immediate disclosure.

Numbers are more important then textual waffle.

Establishing a pecking order of companies and their prospects, based on how they listed financial items and ratios in preliminary report comments, could be a worthwhile exercise.

The ebitda concept was interesting in that context. Companies that began their comments with ebitda results usually disclosed profit downturns or losses further down the page.

Analysts and their corporate allies produced esoteric arguments about the validity of ebitda, most of which had nothing to do with the actual profit result for the reporting period.

Interest was a cost against revenue in the period, as was tax, both being cash outgoings.

Depreciation provisions and amortisation writeoffs were non-cash costs, both of which reduced profit and the return on a company's apparent "value."

The late Dr Gert Lau, a noted business consultant, economist and financial expert, had a simple, and possibly the best, disposal of management accountants' and investments analysts' views of financial performance, as reflected in ebitda.

You took last year's shareholders' equity from this year's. The difference was the profit or loss. It was actually the change in value but "profit" was a value measure, so Lau's argument made sense.

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