4.3 Profitability analysis
4.3.2 Analytical financial statements
cash.
During the years 2004 and 2005 we can see uptrend peaking in 2006, followed by downtrend until 2008. But in 2009 the downtrend reversed and the figure reached higher level than in 2007.
From the liquidity perspective, Company has sufficient funds of cash ready to pay for the expenses. On the other hand, it seems like that idle cash is held for too long, especially in the year 2006.
4.3.1.4 Long-term solvency risk
Long-term solvency risk is measured in order to examine a firm's ability to to make interest and principal payments on long-term debt and similar obligations as they come due.
Perhaps the best indicator for assessing long-term solvency risk is to generate earnings over a period of years. Moreover, if a company wants to survive in a long run, they have to be able to survive in short-term. Short-term liquidity was analysed in the preceding subchapter.
I decided not to go deeply in analysing of long-term solvency risk, as the company in fact does not have any long-term liabilities on its balance sheet.
4.3.1.5 Conclusion
After analysing various risks that the Company is facing, we can conclude that they are managed carefully and they do not present any potential threat for the Company due to their small relative size as compared to net profits etc.
The Company is stable over the long-term and is expected not to have problems post by various kinds of risk in the future.
4.3.2.1 Analytical Income Statement
The analytical income statement requires that every accounting item is classified as either operations or finance.45
The income statement is reformulated to better reflect economic value by dividing into two parts on operations and financing.
Cost of goods sold, distribution expenses, administrative expenses and other operating expenses are combined together in the operating expenses. Operating income consists of other income and other operating income. Using these figures I calculated earning before interest and taxes (EBIT). EBIT is what the firm would have earned if not for obligations to its creditors and the tax authorities. EBIT is a measure of the profitability of the firm's operations abstracting from any interest burden attributable to debt financing.46
Then, there is calculated net operating profit after tax (NOPAT). NOPAT is a company's after-tax operating profit for all investors, including shareholders and debt holders.47
45 Petersen, p. 14 46 Bodie et al., p. 561
47 http://moneyterms.co.uk/nopat/
Source: own computation based on Philip Morris Annual Reports
Tax is computed by using effective tax rate, which is counted on the basis of the information obtained from the Annual Reports.
For control purposes NOPAT and net financial expenses after tax were totted up in order to obtain net earnings, which has to be exactly the same like the bottom line in income statement in the Company's Annual Report.
4.3.2.2 Analytical Balance Sheet
In order to match the items in the income statement with the related items in balance, items marked as operations and finance, respectively must be marked the same way in the balance sheet.48
The analytical balance sheet is prepared according to Copeland et. al.
The balance sheet is reformulated to reflect the capital invested in Philip Morris ČR
48 Petersen, p. 14
Table 5: Analytical Consolidated Income Statement
2009 2008 2007 2006 2005
Revenues 11,690 9,902 10,369 10,031 11,790
COGS (6,398) (5,771) (5,648) (4,917) n/a
Distribution expenses (1,236) (1,202) (1,415) (1,697) n/a
Administrative expenses (923) (721) (792) (884) n/a
Other operating expenses (251) (288) (136) (94) n/a
Sum of all expenses (8,808) (7,982) (7,991) (7,592) (8,177)
Other income 60 86 102 59 n/a
Other operating income 264 324 146 83 n/a
Sum of all incomes 324 410 248 142 183
EBIT 3,206 2,330 2,626 2,581 3,796
Tax on operating earnings 681 520 648 668 1,048
NOPAT (A) 2,525 1,810 1,978 1,913 2,748
Financial expenses (24) (152) (13) (9) (16)
Financial income - - - - -
Net financial expenses before tax (24) (152) (13) (9) (16)
Tax saving on interest expenses 5 34 3 2 4
Net financial expenses after tax (B) (19) (118) (10) (7) (12)
Net earnings (A+B) 2,506 1,692 1,968 1,906 2,736
Effective tax rate 21.24% 22.31% 24.68% 25.89% 27.62%
Consolidated Income Statement – analytical
(in CZK million)operations. Invested capital is the sum of operating current assets less operating current liabilities, net off interest-bearing debt, plus property, plant and equipment (PP&E), PP&E classified as held-for-sale and deferred tax assets.
Operating current assets include all current assets used in or necessary for the operations of the business. For the Philip Morris ČR case, the current assets include inventories, trade and other receivables, current income tax prepaid and cash and cash equivalents.
Inventories involve material, work-in-progress, finished goods and merchandise. The cost of inventories, excluding excise tax and allocated overheads, is recognised as expense and is included in cost of goods sold in the income statement. Inventories include excise taxes.49 Excess cash is normally excluded, because it represents temporary imbalances in the company's cash flow. Excess cash is short-term cash and investment that company holds over and above its target cash balances to support operations. By excluding interest and excess cash, we can get a better sense of how operating working capital has changed over time.
Moreover, this is consistent with the practise of excluding interest income from the calculation of NOPAT.50 Therefore, I include only cash at banks, which is completely assumed to be operational. I do not divide the cash on the operational and excess cash. But mainly, I do not include on-demand deposits with related parties, which are part of cash and cash equivalents at the consolidated balance sheet.
Non interest-bearing current liabilities are subtracted to calculate operating working capital.
In the Philip Morris ČR case, current liabilities include trade and other liabilities, non - financial liabilities, current income tax liabilities, other tax liabilities and provisions for current liabilities.
Non-financial liabilities includes amounts due to employees and related expenses. Other tax liabilities consist of VAT and mostly of excise tax, which is the most important tax in the tobacco industry.
In 2008, management of the Company approved a plan related to the restructuring of sales and distribution and to the transfer of certain procurement and information services activities
49 PM Annual Report 2008, p. 41 50 Copeland et. al, p. 161
to the regional shared centres in Madrid and Krakow. The estimated restructuring expense representing termination payments, to those made redundant, were CZK 22 million as at December 31, 2008.51 This amount appears in the provisions for current liabilities.
The next step is to add net PP&E, intangible assets, deferred tax assets and PP&E classified as held-for-sale to operating working capital.
Net PP&E value is the book value of the company's fixed assets less depreciation. The amounts in the balance sheet are already depreciation adjusted.
Deferred income tax assets and liabilities are offset when there is a legally enforceable right to offset current tax assets against current tax liabilities and when the deferred income tax relate to the same fiscal authority. However, there is deferred tax asset which is not offset.52 Therefore I added it to the invested capital.
The last thing which is added in order to calculate total invested capital are non operating assets. In the Philip Morris case it is only PP&E classified as held-for-sale. It has to be added because it is not netted against equity or debt.53
For control purposes the invested capital can be calculated in one more way, this time by using the liability side of balance sheet. The invested capital includes equity, deferred income taxes and interest bearing debt.
Equity is comprised of registered capital, share premium and other shareholders' contributions, reserves and retained earnings and minority interest. Net interest-bearing debt involves interest-bearing assets deducted from interest-bearing liabilities. In this case it means borrowings less on-demand deposits with related parties.
51 PM Annual Report 2008, p. 47 52 PM Annual Report 2008, p. 43 53 Copeland et. al, p. 162
Source: own computation based on Philip Morris Annual Reports