Financial Statement Analysis, a coffee with many flavours
Accounting, in the sense of financial reporting, is often thought of as a rigid, automatic task of calculating the value of a firm. After the 2008 financial crisis, creative accounting became popular when companies like Enron, WorldCom, and Starbucks were accused of either overestimating their profits or trying to avoid paying taxes to maintain their position on the market.
However, accounting cannot be reduced to a right or wrong way of calculating revenues and expenses, assets and liabilities. In reality, financial reporting is far more subjective than what investors, shareholders or consumers think.
Source: Wix Media
Firstly, many firms are conglomerates operating in different industries, which makes peer analysis very difficult. For instance, Amazon started as an online bookstore but later diversified into multiple lines of business, becoming the world’s largest online retailer. In June 2016, AmazonFresh – already present in the U.S. – was launched in the UK to compete with major supermarkets through its 24-hour food delivery business. However, comparing AmazonFresh’s financial accounts with Tesco’s could be a job which takes more than 24 hours.​
Since a common way of conducting a benchmark analysis involves identifying potential peers based on Standard Industrial Classification (SIC) codes, the complexities of the global business environment nowadays render industry classification, and thus financial performance comparison, very difficult.
Secondly, companies can choose to end their fiscal year at different times. Most companies in the U.S. file their accounts on the 31st of December each year, but some firms close their financial year on the 30th of April. Financial analysts considers this when they compare the financial performance of different companies based on their most recent accounts.
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In addition, seasonal businesses face fluctuations in revenues even during the same year. For example, the Super Bowl in the U.S. or the UEFA Champions League in Europe generate huge returns but concentrate most of their resources in specific periods of the year.
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Also, international and global firms operate in different locations where different accounting standards apply, which makes it difficult to compare financial statements across national borders. In Europe, since 2005, all publicly listed companies have used International Financial Reporting Standards (IFRS), while in the U.S., public companies use Generally Accepted Accounting Principles (GAAP). In the UK, the financial reporting standards known as the new UK GAAP were revised last time in 2015.
Source: Wix Media
The case of Starbucks, accused in 2012 of avoiding income taxes in the UK, illustrates the difference between international accounting standards. As a U.S.-based public company, Starbucks aligned its accounting to GAAP, which stipulates that taxable income in regional markets, such as the UK, is calculated before accounting for the impact of intercompany licence and interest payment.​
However, in the UK, the tax law requires that companies calculate taxable income after accounting for intercompany licence and interest charges. Therefore, Starbucks reported no profits in the UK and paid no income tax between 2009 and 2013. Nevertheless, since it opened in 1998 and until the income tax scandal burst in 2012, the British subsidiary had over £3 billion in coffee sales. Also, the UK business has become an example of profitability to American shareholders.​
The differences in accounting standards and tax regulation played to Starbucks’s advantage, as it made it possible for the Seattle-based group to transfer money to a Dutch sister company in royalty payments (type of intercompany license) and pay high interest rates to borrow from other parts of the business. The company’s global chief financial officer at the time justified these perfectly legal tactics as ‘an attractive reason’ for basing operations overseas.
Lastly, one-off events such as selling an asset or a merger or acquisition can also impact the statement of financial position. To avoid sending misleading signals to the market, financial analysts need to account for these elements in the balance sheet.
Sources:
BBC.co.uk. (2013). Starbucks pays UK corporation tax for first time since 2009. [online] Available at http://www.bbc.co.uk/news/ [Accessed 10 Jul. 2016].
Hillier, D. (2013). Corporate Finance, 2nd European Edition. New York. McGraw Hill Education.
Starbucks.co.uk, (2012). Starbucks commitment to the UK. [online] Available at: http://www.starbucks.co.uk/our-commitment [Accessed 10 Jul. 2016].