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’s 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 firm’s 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’s profitability, liquidity, solvency and efficiency (at least 2 ratios for each should be discussed). This analysis should include comparisons through time to identify trends and comparisons to at least one other firm. You are encouraged to make use of relevant charts, tables and/or figures prepared in Excel to summarise your findings. Relevant ratio data can be accessed through the OneSource database – you are not required to calculate the ratios on your own.
BHP Billiton is one of the largest mining companies in the world which is headquartered in Victoria. Australia. The company is listed on the ASX and has a current market capitalisation of about $ 111 billion making it the fourth largest company in Australia. The company came into existence in 2001 through the merger of the Australian company (BHP) and UK based Billiton Plc. BHP has five major business verticals namely iron ore, coal, copper, potash and petroleum. Also, the mines have a wide geographical coverage including Australia, North America and South America as highlighted.
Two key stakeholders which depend of financial statements are shareholders and lenders. The shareholders tend to focus on EPS which in turn is driven by profit margins. This is essential in determination of share price. The going concern assumption needs to be validated through the liquidity while the credit risk is represented by capital structure. The dividends are captured in cash flows which act as a pivotal income source. For the lenders, liquidity and solvency ratios are critical which are determined from the balance sheet as they indicate the creditworthiness. Also, operating profit and cash flow from operations indicates the ability to meet the interest obligations.
Two other stakeholders of importance are contractors and employees. In the mining business, role of contractors is pivotal. Contractors tend to analyse the income statement to capture the likely growth of business along with profitability which in turn determine their future business. Further, the balance sheet and cash flow through liquidity position indicates the ability of the firm to clear their outstanding payments in a timely manner. Employees analyse income statement to determine their present and future bonuses which is driven from company’s profits. Further, the ability to meet employee expenses is reflected from short term liquidity measures.
One of the key parameters of the income statement is the revenue as it drives the profitability of the business. This in turn reflects the trend in commodity pricing which owing to cyclical trends is pivotal. With regards to expenses, the largest expense is cost of revenue which essentially indicates the efficiency but is less vital than the income. Considering the capital intensive nature of mining business, majority of the assets are in the form of fixed assets i.e. PP&A. An increase in this aspect auger well for the future. Further, from short term liquidity perspective, cash is imperative.
The capital intensive nature of the business implies that a large component of funding is secured through long term debt besides short term debt for working capital requirements. Hence, a trend analysis of both long term and short term debt becomes pivotal as increased financial leverage may increase business risk and consequently cost of debt. Only in the recent years i.e. 2014 onwards have there been accounts payables which coincide with the plummeting commodity prices. In relation to equity, common stock outstanding coupled with retained earnings or internal accruals are pivotal to determine financing of capital projects.
The asset measurement is highly influenced by presence of accounting convention and judgement of management considering the nature of business. With regards to exploration costs, the management determines based on its sound judgement where future benefits are expected to result or not which in turns decides the representation of these costs. In this regard, the management would take judgement about the recoverable ores, the percentage of mineral present, expected future prices coupled with stripping cost. Ofcourse all these are guided by technical reports from professionals which help the management to make estimates. Besides, the presence of inventory coupled with valuation also involves role of convention and management judgement.
Also, since the company has acquired various intangible assets, thus in order to test for impairment especially when there is a drop in commodity prices, the fair value needs to be determined which would be driven by the likely quality and quantity of ore to be recovered coupled with the estimated costs which is essentially driven by management judgement. Also, depreciation of the asset requires prudent use of accounting convention and management judgement regarding useful life and the method of depreciation to be deployed.
The ratio analysis of BHP Billiton based on the last 5 years financial statement is shown. The values in bracket indicate the corresponding values for the competitor Rio Tinto for the corresponding period. The profitability ratios typically tend to represent the profit margins of the business. The liquidity ratios represent the short term liquidity of the business which becomes critical for BHP considering the plummeting commodity prices since 2014 due to slowing demand for China. The long term liquidity is highlighted by the solvency ratios which represent the financial leverage as well. The efficiency of the business operations becomes critical especially when commodity prices are low so that margins can be maintained.
The profitability ratios of the company are mirroring the trends in commodity prices which peaked out in 2013 and have been declining from 2014 onwards thus adversely impacting profitability of operations. However, the more worrisome aspect is that the major competitor has generated profits in 2016 compared to losses for BHP Billiton. With regards to liquidity, it is positive for BHP Billiton that there is an improvement in these ratios ensuring greater comfort to short term lenders, contractors and employees. However, for the period the ratios are better for Rio Tinto which is negative for BHP Billiton.
The deterioration in solvency ratios from 2014 to 2016 may be attributed to the declining profitability of the firm as a result of which the company had to secure incremental debt to fulfil ongoing obligations. Further, due to lower equity prices from 2014 onwards, raising incremental equity was not a prudent option. However, Rio Tinto has performed significantly better in this regards indicating lesser financial leverage. The downward trend in efficiency for BHP Billiton during the period is worrisome particularly considering that these values have seen improvement for Rio Tinto that too at a time when the industry conditions are unfavourable.
The low profitability translates into lower EPS and declining share price along with lower dividend payout, hence adversely impacting the interest of the investors. For long term lenders, the increasing financial leverage especially in the recent years is a matter of concern coupled with lower operating profit leading to higher risks and lower comfort. The lower commodity prices imply lesser work for the contractors in the near future while liquidity constraints may cause some delay in repayment of dues. On account of falling profits, the employees bonuses would be adversely impacted and also salary hikes and introduction of hikes may be deferred to future when commodity prices improve.
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