Equity Analysis

Financial reports are prepared by all the companies in order to provide information to the investors about the performance and position of the company. The few elements that are discussed in this report are cash flow, equity, other comprehensive income and equity. The financial reports of two of the largest banks are taken into consideration. The name of the banks is Commonwealth Bank and National Australian Bank.

Commonwealth bank is one of the multinational banks which is widespread in Australia, United Kingdome, United States and New Zealand. It is considered to be the largest bank of the entire Southern hemisphere. There are various headquarters of this bank which is located in different areas such as Sydney, Australia and Diamond Harbour. The services that are offered by this bank include fund management of the retail sector, insurance and brokerage services, institutional as well as business banking (Alvarez, 2013). This bank was establishes in the year 1911 by the government and the banks got listed in the same year. However, this bank was later privatised in the year 1996.

In the year 1982, two banks merged together which led to the establishment of National Australia Bank. In regards to market capitalisation, this bank is considered to be the 21^st largest bank in the whole world. There are 8 major divisions of this bank which is divided in two different geographical areas. The customer base is huge which is nearly 12.7 million. Also, there are about 15900 branches and 4412 ATM. The major business activities that are carried out by this bank is wealth management, wholesale banking as well as insurance services (Datar, 2015).

Equity Analysis

The shareholders fund in the balance sheet of a company comprises of the share capital that has been raised by the public to carry out operations along with the profits that has been set aside over the years. These funds are set aside to meet the capital expenses of the company.

Understanding the components of equity

Commonwealth Bank

The shareholder’s equity in the balance sheet of the company comprises of ordinary share capital along with certain reserves and retained profits.

As we know, ordinary share capital is the amount that has been raised from the general public to carry out operations (Easton, 2010). The amount of ordinary share capital amounts to $ 33845 million in the year 2016 whereas it amounted to $34971 in the year 2017. The reasons that resulted in the increase of shareholders equity was issue of shares, dividend reinvestment plan set up by the company and also minimal purchases of treasury.

Debt and Equity Position

We can also observe from the table provided above that the retained earning has increased from $23435 to $26330 in two years. The profit earned in the current year that has contributed to such increase amounts to $9928 (Elaine, 2015).

There was a decline in the total reserves on the company which happened because of the fall in the foreign currency translation reserve and also the cash flow hedge of the company. this declined the total reserves of the company from $2734 million to $18967 million.

National Australian Bank

The components of the equity section of National Australian bank are contributed capital, reserves and the retained profits (Fridson & Alvarez, 2012).

As we can see in the above table, the contributed capital of the company in the year 2016 amounted to $ 3425 million but in the year 2017 it increased to $34627 million. The company reinvested the dividend which increased the share capital by $ 569 million and also the company made a transfer from equity based compensation reserve of $170 million.

There was a decline in the reserves of the bank from $629 million to $ 237 million because of the decline in the foreign currency translation reserve, general reserve and cash flow hedge reserve (Horngren, 2012).

However, the retained earnings of the company showed a considerable increase from $16378 million to $ 16442 million. This reason for this increase was the profits earned by the company in the current year along with the lower changes in the fair value of the investments that the company holds.

Discussion on debt and equity of both the companies

A company has to raise funds from different sources in order to carry out its business operations. There are two major sources of raising funds- raising capital from public by issuing shares or by raising debt from third parties.

On observing the balance sheet of Commonwealth bank we found that the company has equity of $63170 million and debt of $626655 million in 2017 whereas the National Bank has a share capital of $51306 million and debt of $ 500604 million (Ittelson, 2009).

In order to analyse the capital structure of the company, we have calculated the debt equity ratio for both the companies which are as follows:

We can conclude from the table given above that the debt equity ratio of Commonwealth Bank was 9.92 times and for National Australia bank it was 9.76 times. The ratio for both the companies is almost similar.

Cash Flows Statement

A company has to plan for its capital structure so that it can hold the correct ratio of debt and equity ratio. This plan helps the company to analyse the cost of capital and various other factors also (Jensen & Meckling, 1976).

Cash flow analysis

The amount of cash outflow and inflow in the current year is recorded in the cash flow statement of the company. There are three major sources of cash transactions which are divided as-

• Cash from operating activities- The cash that is received or paid in relation to the principal business activity or the activities that are carried out to fulfil the objectives of the company is recorded under this head.
• Cash from investing activities- Cash received or spent on the selling or purchasing of any investments is recorded under this head. Also, if there is dividend received from such investments then it is recorded under this head.
• Cash from financing activities- Cash flows that relate to raising funds or repaying them are usually recorded under this head (Lerner, 2009).

Understanding each item of cash flow statement

Commonwealth Bank

In the year 2016, the cash flow from operating activities amounted to $(4561) million but the loss reduced to $(807) million in 2017 due to decrease in the interest payment in the current year in comparison to the previous year.

Now let us talk about the cash flow from investing activity which amounted to $(2023) million in 2016 and $677 million in 2017. This increase in the cash flow resulted because of the decreased amount of investments that were made in certain tangible and intangible assets (Menifield, 2014).

There was a decrease in the cash flow from financing activities from $1620 million to $10472 million. Such increase in the cash flow from financing activity was because of the fall in the funds that were present for the purpose of redemption of the debt securities, purchase of treasury and also loan capital.

However, the net cash flow of the company increased from $(4973) million to $8988 million in the year 2017.

National Australian Bank

The cash flow from operating activity fell from $14460 million to $13217 million in 2017. Such decline was observed because of the lower interest and premium that was received by the bank when compared to the previous year.

There was an increase in the cash flow from investing activity from $(9970) million to $(313) million because there was less purchase of securities and more inflow from the sale of controlled entities (Penman, 2012).

Now let us talk about cash from financing activity which declined from $9496 million to $(313) million in 2017. This decline was observed because there was a huge amount of repayments made and also cash inflows from instruments were lower.

The net cash of the company declined from $13986 million in 2016 to $12573 million in 2017 (Picker, 2016).

Comparative analysis of cash flow for the past three years

The cash flow from operating activities for both the companies are shown in the table below:

Other Comprehensive Income Statement

Commonwealth bank has larger operations when compare to National Australian Bank still the volume of cash flows are higher for National Australian Bank.

The cash flow from investing activities for both the banks are shown below:

e can observe in the graph provided above that the trend followed by both the banks is the same. There has been a decrease in the cash flows in 2016 and increase in the cash flows in 2017 for both the banks (Piper, 2015).

The cash flow from financing activities for both the banks are shown in the table provided below:

The cash flows under this head are following an opposite direction for both the banks. There has been increase in the cash flows for Commonwealth bank whereas there has been a decline in the cash flows for National Australian Bank (Ramírez, 2018).

Other comprehensive income analysis

It shows the adjustment in the fair value of the assets that are recorded in the books of accounts of the company.

Items that are reported in the other comprehensive income statement

The following items were recorded in the other comprehensive income statement of Commonwealth Bank:

• Any gain / loss on available for sale securities.
• Property revaluation.
• Profit/ loss on cash flow hedging instruments.
• Foreign currency translation reserve.
• Actuarial gains derived from defined benefit superannuation plan.

 The following items were recorded in the other comprehensive income statement of National Australian Bank:

• Revaluation of land and building.
• Profit/loss on cash flow hedging instrument.
• Currency adjustments of other contributed equity on translation.
• Currency adjustments on translation of foreign reserves after deducting hedging.
• Debt instruments at fair value (Robinson, 2014).
• Reasons of not reporting these items in the income statement

There are few items that are held by the companies whose value changes because of the change in circumstances and is determined by the market forces. The initial value of such item is compared with the value as on the end of the financial year. Such change in the value of the items must be recorded in the books in order to provide a true picture of the company’s financial position (Siciliano, 2015). The profit and loss of these items cannot be recorded in the income statement because these items are still held in the books of account.

Comparative analysis of the items of other comprehensive income statement

The items that are recorded in the other comprehensive income statement can be divided into two parts. One part gets classified in the income statement of the company in the later periods and the other parts do not get classified even in the later periods. There are some items which is related to the change in the fair value of reserves, investments, employee superannuation fund etc. The tax effect on the profits of the company is reflected in this statement.

Evaluation of manager’s performance on the basis of other comprehensive income statement

Tax Expenses

The changes in the value of items occur due to changes in the economy or due to the changes in the market forces. So, we cannot judge the operating efficiency of the company on the basis of other comprehensive income statement. We should ignore the profits and losses that the company has on account of change in the fair value of the assets because the management does not play any role in it. Hence, we can conclude that the managers performance cannot be evaluated using the other comprehensive income statement.

Analysis of Corporate income tax

Corporate tax can be defined as the tax paid by the companies on the profits earned by them.

Tax expenses of the current year

The tax expense of Commonwealth bank and National Australian Bank for 2017 is $3990 million and $2480 million respectively.

Effective tax rate calculation

The formula for calculating tax rate is as follows:

Effective tax rate= Income tax for the current year/ Earnings before tax

The above formula has been used to calculate the effective tax rate of both the companies which are as follows:

The profits of the companies differ under the provisions of accounting and taxation (Simpson, 2012).  These differences arises the concept of deferred tax asset and liabilities. The tax that is charged on these items is known as deferred tax.

The items that are recorded as deferred tax assets in the balance sheet of Commonwealth bank are as follows:

• Unearned income
• Financial instruments
• Defined benefit superannuation plan
• Provision for employee benefit
• Provisions for impairment on loans, bills discounted and other receivables

The items that are recorded as deferred tax liabilities in the balance sheet of Commonwealth bank are as follows:

• Financial instruments
• Intangible assets
• Insurances
• Lease financing
• Investment in associates

The items that are recorded as deferred tax asset in National Australian Bank are as follows:

• Tax losses
• Employee entitlements
• Collective provisions for doubtful debts
• Specific provisions for doubtful debts
• Unrealised revaluations on funding vehicles

The items that are recorded as deferred tax liabilities in National Australian Bank are as follows:

• Intangible assets
• Depreciation
• Defined benefit superannuation plan assets
• Change in deferred tax assets and liabilities

It has been observed from the financial statements that the deferred tax asset of the Commonwealth bank has increased from $2361 million in 2016 to $2499 million in 2017 whereas the deferred tax liability of the company reduced from $1465 million in 2016 to $1275 million in 2017.

In case of National Australian Bank, the deferred tax assets amounted to $2254 million in 2016 and increased to $2292 million in 2017. Also, the deferred tax liabilities reduced from $329 million to $304 million in 2017.

Calculation of cash tax amount for both the companies

The tax that is calculated on the book profits of the company using the provisions of GAAP is known as book tax whereas the tax that has been paid by the company in actual is known as the cash tax (Skonieczny, 2012).

Effective Tax Rate

If we tax the tax rate to be 30% then the book tax of Commonwealth bank will amount to $4183 million.

The cash tax for the year after using the adjustments for deferred tax items is shown below:

We can see in the above table that the cash tax for Commonwealth bank amounts to $3992 million in 2017.

The cash tax of National Australian bank taking into consideration the adjustment of deferred tax items are shown below:

The cash tax of National Australian bank for 2017 is $2480 million.

Calculation of cash tax rate

The cash tax rate of both the companies is calculated in the table provided below:

The cash tax rate of Commonwealth bank and National Australian bank is 28.6%. It is just a co incidence that the cash tax rate for both the companies is the same (White, 2015).

Difference in cash tax rate and book tax rate

The book tax for both the companies is taken at 30% and the cash tax rate of both the companies is taken at 28.6%. These differences in both the rates are because of he provisions of accounting and taxation as discussed earlier.

Conclusion

In this report, we have discussed about few elements of the financial statements and the ways to analyse them. A proper analysis of these financial elements helps us to get a clear picture about the performance and position of the company. Such analysis also helps the investors in the process of decision making. It is important for the company to provide true information about its workings in order to survive in the long run.

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