BU5574/ BU5575 Financial Analysis and International Accounting

Part A.

Debenhams’ Cash Flows Horizontal Analysis.

Horizontal analysis is used in evaluations of a company to compare its historical financial data over a period of time, (Penman, 2013). Hence, it shows changes in the amount reported by the company in its annual report, (Elhauge, 2015). 

Horizontal analysis is measured by subtracting the base year amount form the current year then dividing the change by the base year and convert it as a percentage, (Dalnial, et al, 2014). The Trend analysis (Horizontal analysis) for the company is as follows,

 

Note

2018

2017

horizontal Analysis

Cash flows from operating activities

 

£m

£m

Change

% change

Cash generated from operations

32

137.5

200.4

62.9

-31.4%

Finance income

 

0.1

0.1

0.0

Finance costs

 

-11.1

-11.2

-0.1

-0.9%

Tax received/(paid)

 

1.3

-16.3

-17.6

-108.0%

Net cash generated from operating activities

 

127.8

173.0

45.2

-26.1%

           

Cash flows from investing activities

         

Purchase of property, plant, and equipment

 

-105.3

-72.6

32.7

45.0%

Purchase of intangible assets

 

-30.7

-52.2

-21.5

-41.2%

Proceeds from the sale of property, plant, and equipment

 

7.1

0.0

-7.1

Investment in associate

 

-7.5

0.0

7.5

Net cash used in investing activities

 

-136.4

-124.8

11.6

9.3%

           

Cash flows from financing activities

         

Drawdown/(repayment) of revolving credit facility

22

66.0

-25.0

-91.0

-364.0%

Dividends paid

12

-35.6

-42.0

-6.4

-15.2%

Purchase of shares by Debenhams Retail Employment Trust 2004

29

0.0

-0.8

-0.8

Finance lease payments

 

-1.6

-1.6

0.0

Debt amendment costs

 

-0.8

0.0

0.8

Net cash generated from/(used in) financing activities

 

28.0

-69.4

-97.4

-140.3%

           

Net increase/(decrease) in cash and cash equivalents

19.4

-21.2

-40.6

-191.5%

Net cash and cash equivalents at beginning of the financial year

 

19.7

40.8

21.1

-51.7%

Foreign exchange (losses)/gains on cash and cash equivalents

 

-0.2

0.1

0.3

-300.0%

Net cash and cash equivalents at the end of the financial year

33

38.9

19.7

-19.2

97.5%

The above horizontal analysis results have been generated by subtracting the amount of cash flow reported in the year 2017 as the base year from the current year which is 2018. The change, (which has been indicated in the 5th column shows the resulting difference in the two years. the last column shows the percentage change used to indicate the horizontal analysis. It has been arrived at by dividing the change by the base year (which is 2017), then converting it as a percentage.

Generally, comparing the current year cash flow with the base year cash flow, the inflows have reduced while the outflows have increased. This has resulted in negative changes as highlighted in the analysis above. Items with more than 50% change from cash inflows include tax received in the operating activities component. The company paid tax amounting to £16 million in 2017 however in the 2018 financial year the company received tax amounting to £1 million which led to the large negative change margin, (Lakada, et al, 2017). Another area with more than 50% change is the difference in drawdown payment received in the current year compared to the last financial year. The company had instead paid £25 million for revolving credit facility but in the current financial year, the company received money from the facility. This also led to a negative change in the tow year cash flow, (Manurung, and Hadian, 2013). These two activities have constituted to the negative changes in the general cash flow where the resulting change have shown an increase in cash and cash equivalent for the company by almost 50%, (Debenhams, 2018)

Part B.

Discussion of Debenhams Cash Flow Statement.

The cash flow statement of Debenhams for the current year shows that there have been more inflows than outflows as compared to the previous financial year 2017. From the statement analyzed above, operating activities generated more cash flow in the year 2017 than the current year, more cash was used in the current financial year than the previous year, financing activities had a positive return in the year 2018 compared to the negative outflow in the year 2017. The resulting results are that the current year had an increase in cash and cash equivalent of £19.4 million compared to the decrease observed in 2019 of £ 21.2 million. The sections results are as explained below;

Cash flows from operating activities

The horizontal analysis shows a negative 26% change from the base year (2017) to the current year 2018. The change has been brought about by the negative change in Cash generated from operations of 31.4%. The amount received reduced by £62.9 million from £200.4 million in 2017 to £137.5 million in 2018. However, it is notable that the finance costs reduced by £0.1 million in 2018. The company did not pay tax too in 2018 but received a £1 million refund of tax which as a positive impact compared to the tax paid in 2017. There was no change in finance income over the two years.

Cash flows from investing activities

In 2018, the company invested more compared to the previous year. The outflow for the year was £136.4 million, an £11.6 million increase from the previous £124.8 million in 2017. This was a 9.3% change from the base year. There are additional outflows that were not present in the previous year where the company invested £7.5 million in associate. There were also some proceeds from the sale of intangible assets. The highest change was the investment in the Purchase of property, plant, and equipment, which was a change of £32.7 million from £72.6 million in 2017, represented as a 45% change. 

Cash flows from financing activities

The current year 2018 shows positive results from the net cash flow from financing activities. The year had a net inflow of £28 million cash generated from using financing activities as opposed to the £69.4 million spent on financing activities in 2017. This was a positive change of £97.4 million, a 140% change margin. This was a result of the 364% change in the drawdown of the revolving credit facility observed between 2017 and 2018. Notes 22 on the company's financial statement indicate that the company increased its net unamortized revolving credit for the year compared to the previous year resulting in this change. Other contributors include a reduction in the dividend paid 2018 compared to those paid in 2017, which resulted in a 15.2% change. According to note 11 on the financial report (pp115), it resulted from the reduced interim dividends paid in 2018.

The above change in cash flow from financing activities is attributed to the net increase in cash and cash equivalent change for the two years mainly due to increased liabilities in 2018. There was an increase in 2018 of £19.4 million while 2017 had a decrease of £21.2 million, a positive £40.6 million (191.5%) change. After adding and deducting beginning balances and foreign exchange losses and gains, the net cash and cash equivalent for the current year were more than that of 2017. This was £19.2 million (97.5) change. According to note 33 in the report, the change was mainly attributed to the change in debt composition where the current liabilities, especially bank overdraft were fewer in the current year.

Part C.

  • Has Debenhams been engaged in earnings management or income smoothing?

From both the horizontal and vertical analysis of Debenhams, it shows that the company has been involved in income smoothing. This is because the company's five-year income statement has shown a consistent and steady income earned from 2014 to 2018, (Ji, and Lee, 2015). For the period, the gross transaction value reported by the company only varies between £2,823.9 million as the lowest and £2,954.1 million as the highest value. This is a maximum change of £130.2 million which has been evenly distributed within five years. This has been smoothened on the following basis;

  1. The overall revenue collected by the company has been steady over the years without higher margins of change. The sales revenue has only ranged between £2,200 million to £2,350 million between 2014 and 2018. Vertically comparing this with the cost of sales, the percentage change has been consistent between 89% and 87%.

Source: (Debenhams – Vertical Analysis)

The only year 2018 had a shift to 89% while the rest four years were stable at a maximum variance of 0.8%.

  1. Analyzing the financing structure from the notes to the financial statement, the company has heavily depended on current liabilities for its financing. This implicates the unavailability of cash which also is shown by low payments of dividends. Consistently for the period, the total liability has been more than 50% of the total equity for the five years, an average of 59.5% to 75.1% in the current year.

Source: (Debenhams – Vertical Analysis)

Current liabilities have been consistent between 31.4% and 41% of the company’s equity.

With the results of the high outflows analyzed in the cash flow statement, it shows that there has been income smoothing in the company to report the steady revenues on the income statement.

  • Should Debenhams be considered a “going concern”?

To assess the going concern, the company’s current debt ratio is 0.8 (1,478.5/1,967.9). This shows that liabilities/ debt is financing most of the company activities. This is a risky move as the solvency of the company is in doubt, (Demerjian, et al, 2017). The balance sheet indicates that the company is mainly being funded by debts and its reserves. The report has not indicated any declaration of dividends payment in future to its shareholders, showing a red flag on the availability of cash in the company.

Therefore Debenhams is not a going concern and needs immediate action taken to prevent insolvency. 

(Word Count Part B&C: 1000)

References.

Bao, B.H. and Bao, D.H., 2004. Income smoothing, earnings quality, and firm valuation. Journal of Business Finance & Accounting, 31(9‐10), pp.1525-1557.

Dalnial, H., Kamaluddin, A., Sanusi, Z.M. and Khairuddin, K.S., 2014. Detecting fraudulent financial reporting through financial statement analysis. Journal of Advanced Management Science, 2(1).

Debenhams, 2018. Company Annual Reports [Online] Available at https://ir.debenhams.com/financial-information/annual-report [Accessed 6th February 2020].

Debenhams, 2020. Preliminary Reports and strategic update [Online] Available at https://ir.debenhams.com/static-files/8f1ff5d2-d1cf-4f04-9afe-3549c844716f [Accessed 6th February 2020].

Demerjian, P., Lewis-Western, M. and McVay, S., 2017. How does intentional earnings smoothing vary with managerial ability? Journal of Accounting, Auditing & Finance, p.014.

Dionyssopoulou, P. and Avesta, S., 2012. The role of financial statement analysis in the decision-making procedures of hotel units. International Journal on Integrated Information Management, 1.

Elhauge, E., 2015. Horizontal shareholding. Harv. L. Rev., 129, p.1267.

Ji, G. and Lee, J.E., 2015. Managerial overconfidence and going-concern modified audit opinion decisions. Journal of Applied Business Research (JABR), 31(6), pp.2123-2138.

Takada, M.N., Lapian, S.J. and Tumiwa, J.r., 2017. Analyzing the financial statement using the horizontal-vertical analysis to evaluating the company financial performance period 2012-2016 (case study at pt. Unilever Indonesia Tbk), 5(3).

Manurung, D.T., and Hadian, N., 2013, November. Detection fraud of financial statement with fraud triangle. 23rd International Business Research Conference, World Business Institute.

Penman, S.H., 2013. Financial statement analysis and security valuation. McGraw-Hill.


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