MBA504 Accounting and Financial Management

Provides a brief overview of the nature of the firm. This introduction should discuss the firm's products/brands, history, size and the locations of the firm's operations.Discusses how the firm balance sheet, income statement and cash flow statement could be used to support the decisions of a range of specific stakeholders of the firm.

Identifies the key assets, liabilities, equity classes, incomes and expenses which impact the reported position and performance.Outlines how the measurement of the firm's key assets is influenced by underlying accounting conventions and by managerial judgement.

Conducts an analysis of the financial performance and position of your firm. This analysis should be supported by an in-depth analysis of relevant ratios which help to understand the firm profitability, liquidity, solvency and efficiency (at least 2 ratios for each should be discussed).

BHP Billiton was formed in the year 2001 when there was a merger between two mining groups i.e. BHP from Australia and also Anglo Dutch Billiton Plc from UK. Owing to the roots in both UK and Australia, the company is listed on both the exchanges i.e. LSX and ASX. The existing market capitalization of the company stands at $ 111 billion with a revenue of $ 31 billion (which has declined in the recent years) and $ 3 billion PAT (FY2015). The company is a mining behemoth as is apparent from the wide segments which clearly reflects a diversified portfolio led by iron ore & coal. The mines of the company are geographically distributed with Australia hosting most of the mines but the mines are also found in North America (US, Canada, Mexico), South America (Brazil, Chile, Peru, Colombia) along with Africa (Algeria).

Financial reporting is aimed at fulfilling the information needs of the various stakeholders. Shareholders and lenders are two critical stakeholders. The shareholders have to take decision if the underlying stock is investment worthy at current price levels or not. In this context, Earnings per Share or EPS is critical as Price/EPS multiple typically depends the fair price of the share. Additionally, the leverage is also significant particularly in the context of future growth as business is capex driven. Dividends are also crucial as reflected from cash flow statement. With regards to lenders, enough operating profits need to be generated so as to honour interest obligations. Further, the ratios in context of liquidity and solvency should be healthy based on which the extent of exposure is fixed and also the security is demanded.

Another vital stakeholder is the government along with regulators. The financial statements reflect the level of adherence to various disclosure and accounting standards. This is critical as it is a public listed company. Further, in adverse times such as the ongoing time, there is increased risk of window dressing in accounts and misreporting which regulators need to be vigilant about. For mining business, a pivotal role is played by contractors which render a host of service. The revenue of the company is imperative as it hints at the prevailing commodity prices. Further, the short term liquidity ratios would be imperative as it affects the short term ability of the company to meet payment obligations for contractors.

For a mining business, one of most critical statements is the income statement. This is because the revenue essentially tends to drive the financial health of the company. For instance, if the price of commodities is high, the revenue realised would be higher and hence profit generation would improve which would ensure a healthy financial position reflected in the balance sheet. A drop in commodity prices which is being currently witnessed has reduced the profits and can adversely impact the financial strength. On the expense side, the only noticeable expense relates to cost of revenue.

The balance sheet reflects the financial position of the company. Since the business requires high capex, hence about (3/4)th of the assets of the company would be found in the form of PP&E.  Also, debt financing is critical due to the capital requirements of the business. Considering the long gestation period of various capital projects, long term debt funding is required which is why these borrowings reflect 40% of the overall liabilities. However, 10% of the liabilities is in the form of current borrowings required for working capital. In relation to equity, imperative aspect would be the number of share issued coupled with internal accruals captured through retained earnings.

 In relation to measurement of assets , the use of accounting conventions coupled with management judgement is imperative especially for mining where inherent subjectivity is involved. The role of these aspects can be witnessed when the material or ore which can be recovered from a mine needs to be determined which besides technical report also requires management insight and fair judgement. With regards to expenditure on exploration, the likelihood of future benefit arising is driven by management judgement which essentially drives the accounting treatment extended. Similarly, impairment and depreciation computation besides determination of fair value also are influenced by the ongoing accounting conventions and management judgement.

A ratio analysis has been carried out for BHP Billiton and the competitor firm has been selected as Rio Tinto. This analysis has been carried out taking the financial statements from FY2012 to FY2016 into consideration. The various ratios considered in this endeavour are profitability, efficiency, liquidity and solvency. The profit generating ability of the business is captured by the profitability ratios. Further, the operational efficiency particularly with regards to turning inventory into sales and sales into cash is captured through efficiency ratios. Liquidity and solvency ratios tend to focus on short term and long term liquidity of the company respectively which is critical so that debt funding can be availed in the future.

The gross profit margin of the company shows high variation owing to the changes in the commodity prices. From 2012-2014, there was a firming of prices which is reflected in the form of higher gross margins but in 2015-2016, there is a trend reversal.  For the competitor even though, the performance at gross level is worse than BHP, but the pre-tax margins are significantly superior in comparison with BHP. One positive aspect for BHP is in the form of improving liquidity which continues even in FY2015 and FY2016. However, despite the improvement in liquidity ratios, these continue to be worse than the corresponding values for Rio Tinto which highlights the need to improve these further.

The solvency ratios for BHP are essentially driven by the business performance which in turn depends on the prevailing commodity prices. During 2012-2014, there was a rise in the commodity prices leading to improvement in solvency ratios. However, in 2015-2016, as the commodity prices plummeted, the solvency ratios have following suit. However, the competitor Rio Tinto has superior ratios in terms of solvency in comparison with BHP which provides a better future growth platform for Rio in terms of debt financing. The falling trend in efficiency ratios for BHP is clearly appalling especially considering Rio’s performance. It has led to an increase in the working capital requirement for BHP owing to higher cash cycle.

This slides summarises the implications of the information collected from ratio analysis for the various stakeholders. For the shareholders, falling profitability ratios is an indication that the share price would underperform as the price is a function of EPS. Further, the dividend payout can potentially be adversely impacted.  For the lenders, deteriorating solvency and efficiency ratios are concern for long term and short term lending respectively. Further, the interest cover would also be adversely impacted. For the government, lowering commodity prices imply greater risks of misreporting and higher vigilance on the part of the regulators. For the contractors, lower commodity prices mean delay in projects which implies lesser work.