Economic Profit Drivers

Leave a comment

After completing my ratios and building up to the big scary economic profit ratio, I thought by this stage I would have had some level of comprehension on what this road was leading to…but no. Economic profit, what is it? Renault had both ne positive and negative numbers. Guessing that’s a bad thing? Surely a negative profit cannot be good. That’s when I hit the books and spoke to my peers to understand exactly what was happening.

Economic profit is derived from RNOA, the cost of capital and NOA. A formula which measures not only the financial status of a company but also reflects the effectiveness of the company’s management strategies. It relates to the opportunity cost of the capital investments meaning it compares alternative returns foregone by utilising the selected inputs. Knowing this now, makes me feel slightly more relaxed about Renault’s economic profit because not only do they have a positive revenue, they also produced a positive economic profit for most years.

I was able to identify Renault’s annual weighted average cost of capital (WACC) from their annual reports and they varied from 8.3% to 8.80%. As I was able to find these records, I decided to use them to present a more accurate representation of economic profit rather than using 10% as suggested from Maria if we were unable to identify them.

Utilising the previously calculated ratios, this ratio was easy to calculate however understanding the reasons behind the changes over the years was tricky. Renault when from an economic profit of negative 1480 in 2013 (see figure 5.5) to a positive economic profit of 1160 in 2016. Why was this? I started by compiling a list of each of the numbers that were used in this equation in my notebook for the four years and begun comparing.

I wanted to understand how the WACC effected my numbers. From swapping WACC rates in different years I gained an understanding that the lower the WACC, the greater my economic profit would be if all other figures remained constant.  My WACC (see figure 5.6) didn’t change very much over the years however it did reflect my economic profit figures whereby when Renault had a RNOA higher than the WACC, the economic profit was a positive figure explaining why 2016 and 2015 were economic profits and why 2014 and 2013 were economic losses. The 2015 financial year had the lowest WACC (8.3%), and when applied to 2016’s economic profit calculation increased the profit however this alone did not explain the large differences between the different years, so further investigating was required.

I then looked at NOA, these figures had large differences and had been increasing over the last three years. I started by adjusting my 2016 equation by multiplying it by 2015’s NOA. This displayed that the higher the NOA, the higher my economic profit was. I changed 2015’s NOA to 2016’s higher figure and the profit grew substantially. It increased so much that it was now higher than 2016’s economic profit. Noting we are multiplying our RNOA – Cost of capital by our NOA, the large differences in these numbers I believe to be contributing towards the variation of economic profit. From 2015 to 2016, the NOA did deviate substantially due to the fact that Renault had a lot more operation assets than it did liabilities.

The two key accounting drivers for RNOA are Profit Margin (PM) and Asset Turnover (ATO). I broke these down and noticed that the ATO for 2016 was considerably less at just 7.21% compared to 2015’s 10.49%. Noting Renaults continuous growth in OI, I knew this could not be a contributing factor.  PM’s in 2013 and 2014 were dramatically less than were recorded in 2015 and 2016 for Renault. When playing around with formulas, it appears that PM has a significant input into economic profit.

From comparing different figures with different years, I was able to determine the main drivers affecting the economic profit. WACC was the main contributor in determining a positive or negative economic profit and NOA and PM appeared to play a crucial role in determining how large the profit or loss was. Through making a previous mistake in restated financial statements in assignment 2 step 3, upon rectification, I was able to see the difference it made to my ratios. I went from a negative to a positive economic profit by simply increasing the NOA by 20 million. For this reason, and through analysing other potential contributors I am confident in my drivers of economic profit.

Through discussing economic profit with other students NOA, WACC, ATO and RNOA appeared to be common themes for reasons behind changes. I have gained a lot of insight into my firm’s financial statements and financial status by doing this step of the assignment but it has definitely been a lengthy stage. I in no way consider myself an expert at any of this however I know for a fact my level of knowledge has dramatically improved through the hours put into calculating my ratios and analysing my firms annual report. I am glad to put the pen down so to speak on this step of assignment two!

Regards,

Taylor

Ratios

Leave a comment

Another step down.. only a few to go!

I found ratios to be reasonably easy to calculate especially by following previous instructions of putting in acronyms next to each of the important totals such as NOA etc. I was able to complete all the formulas whilst watching the lecture and I believe this aided in ensuring I was on the right path and through listening to how Maria explained each ratio, this allowed me to understand what I was doing as I figured out each column.

I did come across some difficulties whereby I had completed this stage before receiving my grades for restated financial statements. Unfortunately, I had made a mistake whereby I had put one of my objects in operating and not financial. Fixing up this mistake meant that a lot of my ratios changed significantly and I had to look into just what that meant! My economic profit went from a negative to a positive which eventually helped me complete the remainder of the step in finding out the drivers of economic profit for my company. I consider NOA and WACC to be the main drivers for Renault whereby WACC determined if the profit was a negative or positive and NOA determined how large the figures were.

I am interested to see how everyone else is going with this state and to compare the key drivers among different companys!

Regards,

Taylor

Restating Financial Statements – Commentary and Spreadsheet

1 Comment

1 + 2 = 3

2 + 1 = 3

The equation equals the same either way, so what’s the point in restating financials?

Company Spreadsheet 2017 ASS 2  – Renault Spreadsheet

Re-stating financials for Renault felt like I was on a roller-coaster of emotions whereby at times, I was ready to scream in frustration and at others, I though ‘this isn’t so bad after all’. Originally, I had the mind-set of ‘not again’, surely this is just another way of writing what we already know, and quite frankly who cares about that? After reading what the actual process involved, I was soon pleasantly surprised by the reasons behind re-stating financials and was eager to get in and give it a crack!

Changes in Equity:

My company did not have any operating comprehensive income which created confusion in itself. Is this correct? Shouldn’t a major company have both financial and operating comprehensive income to put into the spreadsheet? Am I going to get marked down for not having any? I added the heading in my spreadsheet regardless to ensure that the reader knows I didn’t simply forget to add it in, rather there was only zeros for this section.

Balance Sheet:

Completing the balance sheet required quite some time spent reading up on certain notes in the annual statement. I found it strange that all the operating liabilities were positives, in my mind, an expense is a negative still and I am sure this will take some time getting used to. It was nice to see that Renault had more operating assets than liabilities (the opposite to Marias), it gave me the warm and fuzees knowing my company was doing well!

After watching Maria’s lecture, the first time I was slightly petrified on the though on splitting the cash and cash equivalents. Needless to say, I watched the lecture again and this time followed her through the process and generated the numbers I was required to. From this, I believe I need to keep far more cool and collected and give everything a go before I start to scare myself out of doing it.

Income Statement:

I believed that the Annual Reports and Financial Statements we are covering for our companies would be audited and hence the possibility of typos or errors would be eliminated. Unfortunately, I was proven wrong! I was unable to get Renaults restated income statement to add up and after days of going through every figure and every formula in my spreadsheet, I identified a typo. The typo was in the 2013 Income Statement attained from the 2014 Registration Document whereby it had Renaults other sources of income as 22 million. When looking at the 2013 Income statement attained from the 2013 Registration Document it had Renaults other sources of income listed as 222 million. Just 200 million more! I am unsure if anyone else has experienced this in their reports or if this is a common or rare thing to see. I understand typos are easy to make, but surely 200 million cannot just be ‘missed’ and not noticed in a document that is audited by professionals. This process of going through every formula, and every statement cross-checking all my numbers was a lengthy and frustrating process and I hope no-one else has to encounter this anger!

Having a Net Financial Income as opposed to Net Financial Expense in Marias example slightly put me off in deciding when to put negative numbers in my formulas. Marias lectures were great and I only wished she did numerous companies with different financial situations to gain further insight into how different numbers reflect and change others.

I thought that 33.33% company tax rate was a strange amount to have when viewing some of the other company’s rates. Surely it would be easier just to have 30% or 33%, not 33.33 reoccurring.

I initially used the revenue figure for the income statement that was stated in the financial statements for Renault. After completing the re-stated numbers however, I soon found I was exactly the entire Financial Income amount above all my totals. I then subtracted this from my revenue realising I could only include it once in my statement and although this seemed like a weird thing to do, there was no other way around it and I was able to get numbers to match! This was a great learning point to take away for future calculations I need to cover.

The income statement definitely took me the longest to complete compared to the changes in equity and balance sheet however once I got the few problems nutted out, I was extremely happy to see figures matching and knowing that I must have (hopefully) completed it correctly.

Conclusion

I look forward to comparing some of these figures and exploring them through means of Ratios in a few weeks. Overall, this step took me quite some time to complete but now it is completed, I look forward to feedback and fixing up mistakes that I am sure I have made!

Drive the Future – Renault

8 Comments

Renault is the number-one French automotive group worldwide, with 3,182,625 vehicles registered in 2016. Sounds impressive, doesn’t it? Below is a little about Renault including some key concepts and questions, firm challenges and my initial thoughts when given this company.

Existing in 127 countries, Renault is an international vehicle manufacturer who designs and manufacturers vehicles adapted to specific needs of different regions.  Founded in 1898, the company now has 36 production sites and 12,700 dealerships worldwide, this company is growing steadily with shares available to purchase on the stock exchange.

With 10 cars being released in 2016 alone, Renault is ahead of schedule with its “Drive the Change” strategic plan to increase revenue (currently €51.2 billion), and achieving a higher profit through a greater diversity of vehicles targeted at geographical locations. Growth is now more global and with the injection of new resources such as plants in Morocco, Algeria and China, a goal is to promote and sustain strong performance in the future.

Carlos Ghosn is the current Chairman and Chief Executive Officer of Renault and employs a workforce of almost 125,000 people worldwide. The company continue to reduce costs in production and with the significant impact that of a lot of the new models of vehicles made, the raise in the price tag meant the company’s finances show them heading in a positive direction.

Key Concepts and Questions:

Through reading Renaults 2016 annual report, I am still left with some confusion about the exchange rate and how this can impact the cost of raw materials utilised in the manufacturing of vehicles. In addition to this, I am curious as to what would happen to Renault’s value should a major recall be required of specific parts or should the price of fuel increase so substantially that less people are purchasing and driving vehicles and opting for public transport. Another question I have with the automotive industry is at what stage will the automotive industry reach a climax in reported annual sales and we begin to see a fall is purchases due to populated locations. If vehicles are become safer, more reliable and lasting longer, will the requirement to purchase vehicles so frequently drop?

Key Challenges the firm is facing:

With technology changing so quickly, Renault must remain up to date and address the technological challenges of the future and maintain a strategy of profitable growth.  Renault plans on continuing to grow its international presence with its five complementary brands (Renault, Dacia, Renault Samsung Motors, Alpine and LADA). Keeping ahead of the times, Renault plans on paving the way for the future using electric, connected and autonomous resources. The ability to produce a range of vehicles that stand out is a difficult task. Standing apart in concept and design is a factor Renault aim to maintain. An example they provided in their 2016 annual report was, “It would be risky for us to merely follow trends. For example, the Chinese market today is dominated by SUVs. Does that mean we should replace this vehicle generation with the same thing? I’m not so sure. SUVs are the latest thing but what will the next thing be? One of the keys to success is becoming more international, learning how to read the needs of our markets, observing so as to improve our concepts”.

Another challenge international automotive companies may experience is the potential for currency devaluation. To offset this, Renault were required to increase the price of newer models in emerging countries to ensure they were not at a loss or decreasing in value from the previous years. This proved effective.

Initial Thoughts on Company:

After reading that I had been assigned Renault as my company, all I wanted was to be given the opportunity to swap with someone. I am not a massive ‘car’ person and this was a huge international company whose financial statements I dreaded to look at. After reading their annual report, I was shocked to see how much money goes both in and out of the company and I must admit finding the correct resources was a struggle. The financial statements were not in the annual report rather in a document of their own titled Consolidated Financial Statements. There were pages and pages of reports and I was required to ask for assistance from another student who I had made contact with via Facebook. With previous work history in finance, she was able to provide advice and pointed me in the right direction as to which statements I was looking at in order to conduct assignment one.  So many numbers on one page can be extremely daunting! After going through everything multiple times, I believe I now have a better understanding of what it is Renault do and I look forward to completing the rest of the assignments.

First blog post

4 Comments

Hello and welcome to my first ever Blog!

Over the Summer I am enrolled in ACCT11059 as an elective in my Undergrad Psychology degree. I am excited to learn about accounting and hope to take away some of the dos and don’ts of accounting to potentially benefit some of my own personal finances! I am currently studying External part-time as to maintain a full time job, and being located in Cairns, I would be happy to meet some/any other students enrolled in Accounting. Good luck to everyone and I look forward to hearing from you throughout the semester 🙂