Analytical Balance Sheet and Income Statement

The reformulation of the B/S and I/S is necessary in order to determine how ISS creates value. The operational items must be valued separately from the financial items, since the operational items are the primary source of value creation. In other words, the operating items are essential in order to depict a company’s profit excluding any possible financial gains (Petersen & Plenborg, 2012).

By dividing the analytical B/S into operating and financial assets and liabilities, the analyst can deter-mine how much invested capital the company needs in order to generate profit. The assets that are related to core activities are classified as operating, whereas the items that are not associated with the core operations are classified as financial. Additionally, interest bearing liabilities are classified as finan-cial, whereas non-interest bearing liabilities are characterized by being operational (Petersen &

Plenborg, 2012). The separation makes it possible to subtract the non-interest bearing debt from the operational assets in order to get the net operating assets, i.e. the operating invested capital. The ana-lytical I/S also distinguish between operating items and financial items, where the operating items are items that are connected to the core business and therefore reveal how the company generates value.

In order to determine the true value generated from the business, the unusual items must be determined and critically categorized as being either recurring or non-recurring. If an item is non-recurring, it should be removed from the EBITDA, EBIT and NOPAT, since the item is not part of the value drivers in the future (Petersen & Plenborg, 2012).

When conducting an analytical I/S and B/S many reflections and assumptions are needed in order to make the distinctions mentioned above. In the following section, the most important reflections will be discussed. The entire analytical I/S and B/S can be found in Appendix 3.

Calculating Gross Profit

The norm when producing an analytical I/S is to calculate the gross profit as the revenue less costs of goods sold. However, since ISS is a service company, they do not have cost of goods sold. Instead, the gross profit can be calculated by subtracting the cost of revenue (Hoeksema, 2012). The cost of revenue

is the cost directly related to the services of the company, i.e. the variable costs. For ISS the cost of rev-enue consists of consumables and the fraction of the staff costs that is variable. From the annual report it is not possible to determine how big a portion of the staff costs that is fixed, and therefore all staff costs are assumed to be variable and part of the cost of revenue. However, this assumption will not have any impact on the calculation of EBITDA and therefore is not considered to have an effect on the valua-tion.

Pensions

ISS' pension plans are primarily “defined contribution plans where contributions are paid to publicly or privately administered pension plans on a statutory, contractual or voluntary basis” (ISS Annual Report, 2016, p. 100). These are regular costs allocated under staff costs and are considered as an operating item. However, they have a few unfunded pension obligations, where an actuarial figure is calculated as the present value of the future expenses of such benefit plans. In this calculation, a number of assump-tions is made about salary, mortality, inflation and interest rates. These pensions are considered as financial items, since they are discounted to present value, i.e. they are interest-bearing (Petersen &

Plenborg, 2012, p. 78). Therefore, the unfunded pension liabilities are excluded from the rest of the pen-sion obligations and are recognized in the B/S as interest bearing debt.

Other Income and Expenses

From the notes in the annual report it is determined which part of other income and expenses that is related to core, and moreover is expected to recur (Note 1). None of the items are assessed as financing activities. However, some of the items are unusual and non-recurring in nature, e.g. the gain on sales of land and buildings in 2012, as well as the costs related to the IPO in 2014. Other items such as restruc-turing expenses are up for further discussion, since they are determined to be special items, yet they occur every year and account for approximately the same percentage of the revenue each year. How-ever, it is reasonable to expect adjustments in ISS' organization in order to cope with changing market conditions. For this reason, they are assumed to be recurring operational expenses. Likewise, a big part of ISS' strategy is based on divestments: “In support of our continued strategic alignment, we will continue to review our business platform to identify potential divestments as well as capability enhancing acquisi-tions” (ISS Annual Report, 2016, 78). Therefore, income and expenses from divestments occur every year and are therefore considered to be recurring.

Investments in Associates

Investments in associates is a part of ISS' core business, since it is investments in companies operating within the same business-area as ISS, and therefore should be treated as an operating item. The share of results from investments in associates are part of financial income in the consolidated I/S, and it is removed to separate the operating from the financing activities. This division is only accessible from the notes of the annual reports in 2012-2013. It is assumed that the proportion of financial income, stem-ming from share of results from associates, is constant in the following years, and therefore an average percentage (2.6%) is calculated and used to find the result from associates in 2014-2016 (Note 7). In the B/S investments in associates is a part of other financial assets, whereby it is reallocated to operating activities (Note 8). The separation of the assets is not possible in all years, and an average percentage of the total other financial assets is calculated (2.1%) in the remaining years.

Deposits

Deposits appears under other financial assets in the consolidated I/S. However, deposits is an operating activity and therefore should be separated from the financial activities. In the same manner as with in-vestments in associates, the distinction is only possible in 2012-2014, and an average percentage (42.9%) is therefore calculated in the remaining years (Note 8).

Cash and Cash Equivalents

In general, most cash and cash equivalents is deemed to be access cash, which can be paid out as divi-dends, used to buy back shares or used to repay debt. This is not affecting the operations and is therefore part of the financing activities. However, the cash and cash equivalents reported might consists of some cash needed in the day-to-day operations (Note 5). However, the annual report of ISS does not reveal how big a portion of cash and cash equivalents that is related to operations, resulting in an assumed proportion of 1% of cash being allocated to operations (Petersen & Plenborg, 2012, p.77).

Tax on Activities and the Effective Tax Rate

The income taxes in the consolidated I/S relate to both operating and financing activities, whereby there is a need to separate the tax on operational and financial items. When making this distinction, a tax rate must be chosen as a proxy for the corporate tax rate. The effective tax rate assumes that the tax rate is identical for operating and financial items, while the marginal tax rate is built on the assumption that the current corporation tax rate is equal to the tax value from the net financials (Petersen & Plenborg, 2012). Therefore, both the effective and marginal tax rates have pros and cons when utilized. However, the effective tax rate will be applied in this thesis (Note 2).

Operating Lease

ISS leases properties, vehicles and other equipment under operating lease agreements. Typically, these lease agreements run for a period of 2-5 years with an option to extend the lease (ISS Annual Report, 2016, p. 99). The operating lease of ISS is not capitalized on the B/S, since the exact duration and pay-ment of the lease contract would be needed. This information is not possible to retrieve and therefore the operating lease is not capitalized to present value.

It should be noted, that a new accounting standard on operating lease is to be implemented in 2019.

With this new standard, operating lease agreements are required to be capitalized to present value as tangible assets (PwC, 2014). This will improve EBITDA and NOPAT, due to lease payments being divided into depreciation of the asset and the interest payments. In addition, the invested capital will increase, resulting in the change in Return on Invested Capital (ROIC) being very difficult to predict. The new standards are relevant for ISS, since operating lease agreements constitute a somewhat large part of their business model. However, it is an accounting technicality that should not affect the estimated value of ISS, and it is therefore not taken into consideration in this thesis.