Analysis of Owner’s Equity

The following report contains a detailed analysis on equity, other comprehensive income, cash flow statement and the tax expense of the two top players of the food and retail industry in Australia, Woolworths and Wesfarmers group.

Woolworths group is a top retail group which has its business spread across Australia and major parts of New Zealand. It is the second largest revenue generating company in Australia and New Zealand. The company is also engages in the business of takeaway liquor store, hotel business and gaming poker machines. The company was ranked as the nineteenth largest retailer in world in the year 2008. The company when established in 1924 was popular for using the cash registers which printed electronic receipts. Later with the growth in business the company got listed in the early nineteen nineties.

Wesfarmers limited is an Australian conglomerate which has its headquarters situated in Perth, Western Australia, which also has its business spread across New Zealand. It is the largest revenue generating company of Australia. Also, it is the top private employer of about 220000 employees in Australia. The company is engaged in business of chemicals, industrial and safety products along with retail. The group was first formed as a cooperative society in 1914 and later got converted and listed on the Australian stock exchange in 1984.

Therefore, we see that both the companies are the top players of the food and staples industry in Australia.

Owner’s equity refers to net worth of the company which comprise of the share capital and reserves. These are the owned capital of the shareholders of the company. The net worth is also calculated by netting off the assets of the company with its liabilities (Alvarez, 2013).

We have discussed about the equity of both the companies in our discussion below:

The equity of both the companies’ consists of the following items:

The issues share capital of the companies represents the shares issues and subscribed by the public and other shareholders. The share capital may consist of preference or equity share. Both the type of shareholders has their respective characteristics. The shareholders also have the right to vote in certain decision making matters of the company.

The issued share capital of Woolworth’s group has increased from $5252 million to $5615 million, and that of Wesfarmers have increased from $21909 million to $22242 million. Increase in the share capital represents issue of new shares or capitalisation of profits by the company. The reserves of Woolworths have increased from 93.9 million to 113.8 million and that of Wesfarmers have increased from 166 million to 190 million. The reserves of the company represent the excess profits of the company which have been set aside in order to fulfil certain obligations. The retained earnings of the company represent the profits earned by the company which have accumulated over the years. The retained earnings of Wesfarmers have increased from 3124.5 million to 3797.2 million, and the retained earnings of Wesfarmers have increased from 874 million to 1509 million.

Debt and Equity of Both Companies

Therefore we see that the owner’s equity of both the companies has increased from last year. The total increase in owners’ equity of Woolworths was for 1055.40 million and than for the Wesfarmers group was 992 million.

The capital of the company can be divided into two major heads- debt and equity. We have discussed about the equity share capital of the company in above discussion (Bragg, 2015). Debt is the amount of capital taken on loan from the third parties with an attached obligation to pay interest. The debt providers do not hold a say in the affairs of the company.  Both the type of funds has their own pros and cons (Donohue, 2015). The proportion of debt and equity to be used is determined based on various factors. The cost of capital plays a very vital role in determining the debt equity ratio of the company. The management prefers to keep the cost minimum in order to gain maximum advantages (Easton, 2010).

Therefore we see that Woolworths have a debt of $ 3030.5 million and Wesfarmers have a debt of 5413 million in there capital. We have also calculated the debt ratio of both the companies. The debt ratio of Woolworths is 13.22% and that of Wesfarmers is 13.49%. This indicates that the companies have almost 13% of their assets financed using the debt funds.  The equity ratio of Woolworths is 41.57% and that of Wesfarmers is 59.68%. This indicates the proportion of assets financed by the owned funds of the shareholders.

Therefore, these were the details of the debt and equity of both the companies.

The books of accounts of the companies are required to be made on accrual basis in order to determine the profitability of the business for a given period (Elaine, 2015). The actual cash inflows and outflows are not taken into consideration while evaluating the profitability. But it is important that cash flows of the companies are also reported in order to keep the liquidity of the company in check (Fisher, 2012). In our discussion below we have discussed about the cash flow statement of both the companies. The cash flow statement of the companies consists of three broad heads- cash from operating, investing and financing activities (Fridson & Alvarez, 2012).

The cash from operating activities of Woolworths group mainly comprise of cash flows from activities like receipts from customers, payment to suppliers. The net cash flow from operating activities of Woolworths increased from 2357.5 million to 3122 million. The major increase was result of increase in inflows from customers and decline in payments made to the suppliers.

Analysis of Cash Flow Statement

The cash from operating activities of Wesfarmers mainly comprise of receipts and payment for sales and purchases, and other adjustments made in order to arrive at cash from operating activities. The cash flow from operating activities increased from 3365 million to 4226 million. The major contributor to the increase in cash was a result of increased cash flow from customers and lower payments made to the suppliers.

The cash outflows from investing activities of Woolworths increased from 1266.7 million to 1431.4 million. The increase in the outflows was a result of increased investments made in plant and other assets by the company in the current year.

The cash outflows from investing activities of the Wesfarmers declined from 2132 million to 53 million. The decline in cash outflows was a result of increased cash inflows from sale of subsidiaries which offset the outflows of cash made in connection with other investments.

The cash outflows from financing activities of Woolworths increased from 1474.9 million to 1729.3 million. The increase in outflows was due to increased payments made in connections with the borrowings.

The cash outflows from financing activities of Wesfarmers increased from 1333 million to 3771 million. The increase in cash outflows was a result of lowered inflows and increased repayments of the loans by the company in the current year.

The following chart shows the cash flow from operating activities of Woolworths and Wesfarmers for the last three years:

The cash flows of both the companies have increased in the last three years. Only a decline in 2016 for both the companies were witnessed (Woolsworth Limited)

The following chart shows the cash flow from investing activities of Woolworths and Wesfarmers for the last three years:

The cash flows from investing activities have been moving in the opposite directions for both the companies. The cash flow for Woolworths declined in 2016 and then increased, whereas for Wesfarmers the cash flow increased in 2016 and then declined in 2017. (Woolsworth Limited)

The following chart shows the cash flow from financing activities of Woolworths and Wesfarmers for the last three years:

Cash flow from financing activities for Woolworths declined in 2016 and then rose in 2017; the cash flows from investing activities of Wesfarmers declined in 2016 and then rose by more than 100% in 2017 (Wesfarmers Group).

The cash flow of the companies has been moving in different directions. Even if the movement is in same direction, the variances of change in cash flows are way higher for Wesfarmers than the Woolworths. A gradual increase or decrease in the cash flows of the Woolworths can be seen, whereas the cash flows of Wesfarmers seem to be volatile with high variances than the last year.

Tax Expense

The other comprehensive income of the Woolworths consists of the following items:

• Changes in fair value of the cash flow hedges
• Changes in the exchange rates related to foreign operations
• Changes the fair value of the equity instruments held as investments
• Changes in the value of superannuation fund
• Tax effect on all the above

The other comprehensive income of Wesfarmers consists of the following items:

• Changes in the exchange rate of foreign currency
• Changes in fair value of the cash flow hedges
• Re-measurement of the defined benefit plan
• Tax effect on all the above (Wesfarmers Group)

Therefore we see that the other comprehensive income statement of both the companies have reported similar items for the year ending 2017.

The items which are recorded in the other comprehensive income represent the amount of profit and losses that affect the financial statements of the company, but which have not been realised yet (Girard, 2014). Since, the books are made on accrual basis, these items cannot be reported in the profit and loss, but in order to meet up with the GAAP requirements, it is important that they are shown in the books (Ittelson, 2009). Hence the other comprehensive income shows these items. When they are realised, the relevant amounts are recognised in the profit and loss statement (Lerner, 2009).

The other comprehensive income of Woolworths reported about $4.8 million for cash flow hedge, and that of Wesfarmers reported $23 million. Woolworths reported about 6.9$million in connection with the foreign exchange fluctuations and Wesfarmers reported $2 million. The amount reported for changes in the provisions made for payments to employees by Woolworths was for $2.2 million and for Wesfarmers it was for $3 million. Therefore, we see that the OCI of both the companies have reported about similar items.

The items disclosed in the OCI comprise of unrecognised profits and losses (McLaney & Adril, 2016). Due to changes in the fir value and carrying amount of certain items, the financial statements can be affected. For example, changes in value of investments helps if fall down too much, and then they will affect the financials when they are sold. In order to account for the loss every year the changes in the fair value are recognised (Parrino, 2013).

These items which are reported are due to changes in values which are beyond the control of the company and its management (Penman, 2012). These prices are judged by the market forces, and have no relation with the operating performance of the company individually.  The evaluation of the performance of the managers should be based on the factors which affect the operational efficiency of the company (Picker, 2016). Since, the items reported in the OCI are beyond the control of the management, these should not be considered while evaluating the performance of the manager.

The amount of tax reported by Woolworths for the year ending 2017 was $897.7 million and that reported by the Wesfarmers was $1265 million.

The following table shows the effective tax rate calculation for both the companies:

The effective rate is calculated by dividing the tax amount with the earnings before tax for the companies (Piper, 2015). The above figures of the tax and earnings include the amounts from the discontinued operations also.

The effective tax rate of Woolworths for 2017 was 34.46% and that for Wesfarmers was 30.57%.

The items that have been reported by Woolworths for deferred tax calculation include the following:

• Depreciation differences on property, plant and equipment
• Provisions and accruals
• Cash flow hedges
• Unrealised foreign exchange differences
• Intangible assets
• Prepayments
• Other adjustments

The items reported by Wesfarmers for deferred tax calculations include the following:

• Adjustments for provisions
• Adjustments for employee benefit expenses
• Adjustment for depreciation on fixed assets
• Adjustment for accrued incomes and pre payments
• Adjustments for borrowings
• Adjustments for derivatives and other stock
• Other relevant adjustments.

The items recorded by the companies as the deferred tax assets and liabilities are the items which have not been allowed as income or as deduction as per the taxation laws. There are certain items which are not allowed under taxation rules to be considered while calculating the tax expense (Robinson, 2014). These items are allowed only when certain condition is fulfilled. When these conditions are fulfilled they are allowed for calculating tax. Until that moment they are recorded as deferred tax assets or liabilities (Simpson, 2012).

The profits calculated for the company are based on two set of rules, accounting and taxation (Skonieczny, 2012). Due to the differences in the profits under both the set it is important that reconciliations are made. In order to record these differences in the books we record the deferred tax assets and liabilities (Taillard, 2013). These are the temporary differences which are likely to recover in future which will either generate tax expense or benefits for the company in the future.

The deferred tax assets for Woolworths was 497.7 million in2016, at the end of 2017 the deferred tax declined to 372.3 million. The deferred tax assets for Wesfarmers were 1042 million at the end of 2016, and it declined to $ 971 million at the end of 2017.

Deferred tax is the result of temporary differences arising due to difference in accounting and taxable profits. Every year some differences are created and reversed. Due to changes in these assets and liabilities there are changes in deferred tax calculation every year. This is the reason why deferred taxes for the companies for both the years are different.

Due to the differences arising in the income of the company, there are two taxes which can be calculated- Book tax and cash tax. Cash tax is the simple tax that is charged on the book profit derived from the profit and loss statement. Book tax is the tax which is calculated after making the adjustment to the book profits. The differences in the cash tax and the book tax are due to the temporary and permanent differences. We have the book profit of both the companies, using which we have calculated the cash tax.

Woolworths reported earnings before tax of $2431 on which tax was charged for $837.7 million. This was book profit. The book profit of the company amounted to 34.46%. The adjustments of the non deductible expenses along with unrecognised tax losses and other deferred tax adjustments were made which resulted in cash tax amount of $729.33 million.  This resulted in the cash tax rate of 30% which is the general corporate tax rate for the companies in Australia.

Wesfarmers reported earnings before tax of $4138 million on which tax was charged for $1265 million. This is the book profit for the year. The book profit of the company resulted in 30.57%.  The adjustments of $12million in connection with non deductible items, $37 million for taxes for the associates and $25 million for other adjustments were made to this book profit. This resulted in cash tax for $1241.4 million. Therefore the cash tax for the company resulted in 30% which is the general corporate tax rate for the companies in Australia.

The cash tax rate of both the companies resulted to be 30%. This is so because, this is the general tax rate that is charged on the companies before any adjustments to the book profits are made. All the companies in Australia are liable to pay tax at 30%.

As already discussed, there are two types of calculations of tax. One which is straight away charged on the book profit, and the other which is calculated after making adjustments (White, 2015). Due these differences there is a difference between the cash tax and book tax rates. The cash tax rate of both the companies mentioned above is 30%, whereas the book tax for Woolworths is 34.46% and that for Wesfarmers is 30.57%. Due to the deferred tax assets and liabilities and also certain items of permanent differences, there is a difference among both the tax rates.

Conclusion

The above analysis in the financial statement of the companies has helped us to learn a lot about these companies and also about various financial concepts. The financial health of both the companies seems to be fine. Both the companies have been performing and providing positive results to their shareholders.

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