The Last Hurrah

Apologies for the lateness of my draft, I did not plan my time so well for this assignment.

Please find my spreadsheet and word doc uploaded for you to review.  Most appreciative of all comments and feedback.

I have not completed step two.  At this stage, I only have the investment decision written up and am yet to do the calculations but please let me know if you think the investment decision sounds feasible and looks ok.  I am still yet to compare my ratios with others or benchmarks so I am aware I have not covered this in step one.

Clarius Group ASS#3

Clarius Group Spreadsheet 2016

Cost of Capital

Economic profit introduces us to the concept of cost of capital.  I am pleased to say that my accounting “paint by numbers” has been filled in a bit more, while investigating cost of capital and the four drivers of economic profit.

Economic profit is made up of RNOA, cost of capital and net operating assets (NOA).  Simple right? Not quite.  It’s a bit like the movie Inception where we now have to step down into another level and then another (something, inside of something, inside of something).  RNOA is then made up of profit margin (PM) and asset turnover (ATO).  PM is then made up of operating income (OI) and sales while ATO is sales and NOA.  Because PM and ATO have an inverse relationship, the sales amounts are going to cancel each other out leaving us with OI and NOA.  Inception moment!

	2015	2014	2013	2012
Economic Profit	-$14,343.99	-$6,289.17	-$46,844.38	-$18,265.47
RNOA	-43.5%	-4%	-112.6%	-11.4%
Cost of capital	14.09%	14.09%	14.09%	11.06%
PM	-6.05%	-0.77%	-18.48%	-3.39%
ATO	7.19	5.16	6.09	3.36
NOA	$24,902	$34,782	$36,980	$81,459

With 2012 as our benchmark we can see that 2013 was a mess and I am not sure it is even a good thing that ATO increased because it is due to the denominator in the ratio (NOA) dropping just over 50%.  This shows that while ATO is a driver of economic profit, it is not a very strong one as ATO almost doubled but still lead to a rather large decrease of economic profit.

PM dropped 15% which seems to be fully reflected in the increased economic loss.  This makes sense as both PM and economic profit are profitability measures.  A drop in PM marks a worse economic loss and an increase in PM shows an improvement so I would say PM is a primary driver in economic profit ratio.  However, the scale of the drops and increases in PM do not fully explain the magnitude of the drop and improvements of economic loss.  This is where RNOA comes into it.

RNOA follows the same trend as the economic loss and we can see when RNOA drops 101% in 2013 that this is fully reflected in the 150% drop in the economic loss figure.  The cost of capital is subtracted from RNOA so the higher the magnitude of the RNOA loss, the worse the result of the economic loss.

NOA is a final factor in the economic profit equation.  NOA decreases each and every of the four years but we do not see a corresponding continual increase in economic loss each year.  I believe this is because NOA is more of a multiplier that is used to reflect the total return for the number of assets your firm holds.  So it helps contribute to the economic loss trend but is not a primary force.

It looks like Clarius Group were trying to improve RNOA in 2014 by drastically reducing expenses and may have ended up with a positive result if revenue had not also dropped.  A new CEO has then come in 2015 and has decided to let Clarius take a hit while trying to change strategies.  I found a news announcement recently on the ASX stating that local New Zealand business operations will be closed and moved back to be run from Australia.  Maybe this is the start of diverting capital to try and improve their return.  They certainly need to try something because if they continue to make an economic loss, risk will increase, investors will go elsewhere and there would not seem much point in staying in business and flogging a dead horse!

1. 2016, InvestingAnswers, http://www.investinganswers.com/financial-dictionary/financial-statement-analysis/economic-profit-2927
2. 2016, Cashfocus, http://cashfocus.com/economic-profit-analysis/

 

Love, actually #2

We waded through most of the restated financial statement ratios in the first Love, actually blog post but there are still two relationships that need to tell their story.

Profit margin is almost the twin to net profit margin and I did not expect to see much of a difference between these two ratios.  Profit margin still shows how much profit can be extracted for every dollar earned by a firm but it just uses operating income instead of net profit after tax.  This allows us to focus on operating activities and ensure they are actually generating returns rather than them coming from financial activity.

	2015	2014	2013	2012
Net Profit Margin	-6.3%	-0.9%	-18.7%	-3.5%
Profit Margin	-6.05%	-0.77%	-18.48%	-3.39%

The reason I did not expect to see much difference between the two profit ratios was because Clarius Group did not have many financial activities and only one item from other comprehensive income that was deemed operational.  However, this other comprehensive income (from foreign currency translation differences) being added in was enough to make the operating loss smaller.  As the operating loss is the numerator in the ratio, this infers the result will be smaller (which is good as we are dealing with losses) while the denominator is sales which stays constant across both ratios.  The tax expense and exclusion of net financial expenses also made a slight difference in the operating loss figure.

You can find a more in depth discussion about what financial statement items affected these ratios in The Holy Grail blog post.

Another set of twins are the total asset turnover ratio and the asset turnover ratio (ATO) from the restated financial statements.  The only difference being that ATO shows how efficient a firm is at using net operating assets to produce sales rather than total assets.

	2015	2014	2013	2012
Total Asset Turnover	3.80	3.03	3.88	2.53
Asset Turnover	7.19	5.16	6.09	3.36

The results for the ATO are higher because net operating assets is a much smaller figure than total assets. As previously discussed, a smaller denominator leads to a larger ratio result.  the ATO shows that assets are being used even more efficiently because the turnover rate has increased.  As a manager you would have to be happy to see these ATO figures, although, I start to wonder if the 2013 and 2015 ATO are starting to stray into the “abnormal” zone.

The ATO also has an inverse relationship to the profit margin, just like the total asset turnover has with the net profit margin.  You can see a further discussion on asset turnover in my blog post Turning Over.

 

Love, actually

When I think of ratios, I think of relationships.  If a ratio had a Facebook profile I imagine it would put, “It’s complicated” in their status profile.  When I think of relationships, I think of the movie ‘Love, actually’.  It is a tale that revolves around eight different couples and shows their complicated and sometimes interrelated relationships.  I thought it was fitting to use this movie as my blog title for looking at the family of ratios based on restated financial statements.  Indeed, three of these ratios are interrelated with ratios previously discussed.

The first couple’s relationship that we examine is comprehensive income and shareholder’s equity.  They make up the return on equity (ROE) which is an important profitability indicator.  ROE shows how well a firm generates a return on the funds invested into the company from an owner and also show how well a firm uses its equity.  Clarius Group is doing neither of those things well as is clearly shown by a negative ROE for all four years.

2015	2014	2013	2012
-44.7%	-4.2%	-113.1%	-12.0%

2013 and 2015 were years where there were large impairment losses and one-off costs but even in the years where it was “business as usual” it still did not generate a return for shareholders.  The figure for 2015 shows that Clarius Group lost almost half of its total shareholder equity in that year.  I fear a divorce is on the horizon for this rocky relationship!

If I was an investor or a manager I would be fairly appalled at the trend of negative returns.  I cannot fathom how the new CEO could have sat down and looked at the possible projections, based on his decisions for the year, and still gone ahead with all the restructuring.  I am also confused as to what triggered the 2015 software impairment when it is never previously mentioned, in other annual reports, that their technology was aging.

Management look like they were starting to get back on track in 2014 and then the CEO seems to have pushed out or fired a lot of them (he was fairly derogatory in his assessment of the past CEO and executive).  He tries very hard in the 2015 annual report to sell this decision and talk about what a wonderful experienced team he now has, but I am not sure I am buying it.

Return on net operating assets (RNOA) is a relative of the return on assets (ROA) ratio, which I previously discussed in The Holy Grail #2.  The difference between them is that RNOA shows how well a firm is managing its operating assets to produce an operating income during a certain period of time.  I thought the ROA was trouble but his relation RNOA is even worse!

	2015	2014	2013	2012
ROA	-24.0%	-2.8%	-72.7%	-8.7%
RNOA	-43.5%	-4%	-112.6%	-11.4%

So what causes the negative amount to increase?  This is due to the denominator used, which is the net operating assets (NOA).  The operating assets (OA) and liabilities (OL) are isolated from financial ones and then OL is taken away from OA.  This leaves a much smaller denominator which makes the result bigger as I also discussed in The Holy Grail #2.  The result would have been even worse except for the fact that the operating income is used, rather than the larger net profit after tax (NPAT) amount.  The RNOA really focuses on operating activities and magnifies Clarius Group’s losses even further because the financial activities have been taken out of the equation.

Next relationship to consider is the net borrowing cost (NBC) which shows Clarius Group’s cost of debt.  You can think of the NBC as the “interest rate” Clarius Group is paying on financing.  Maria mentions that this is a more true cost of debt then what they might show in the annual report.  This is because we are isolating just the financing activities and using them for the calculation.

2015	2014	2013	2012
32.4%	14.7%	–	6.7%

There is no result for 2013 as Clarius had no net financial obligations that year and you cannot divide by zero.  However, the other years tell an interesting story, in that the cost of debt is trending upwards.  In personal finance, creditors generally raise the interest rate the more they see you as a credit risk.  Think of pawn shops and ‘payday loan’ businesses that charge outrageous rates compared to personal loans from a bank.  The same thing happens in a business setting and this supports my assumption that Clarius Group is becoming increasingly risky.

Forgive my relationship stories, they are a bit more depressing than those in Love, actually!

To Market, To Market

To market, to market, to buy a fat pig,
Home again, home again, dancing a jig;
To market, to market, to buy a fat hog;
Home again, home again, jiggety-jog;
To market, to market, to buy a plum bun,
Home again, home again, market is done.

– Mother Goose Rhymes

Market ratios are used in valuing a firm’s stock¹.  They help to show current market perception, regarding future profit potential, to both internal and external interested parties².  With this being the case I would have to say my perception of Clarius Group, from looking at the market ratios, would be something like a train wreck!

2015	2014	2013	2012
-$ 12.65	-$ 1.87	-$ 47.12	-$ 10.56

Firstly, the earnings per share (EPS) was negative all four years.  EPS shows the amount of money that is potentially available to distribute for each outstanding share (it is not the actual amount paid out).  However, in Clarius Group’s case it shows the amount of money lost per share.

EPS gives an indication of profitability, or lack thereof and can also be a measure of how management is performing³.  A negative EPS decreases the value of Clarius Group and can be a factor in reducing the share price.

In some situations a negative EPS is not a huge drama – these include biotechs, startups and established companies incurring major one off expenses⁴.  Sadly, Clarius Group does not fall into those categories and there is a definite downward trend showing (despite the better 2014 result) indicating signs of trouble at Clarius Group.  Not surprisingly, as EPS uses the net profit after tax (NPAT) figure, it follows the same trend as net profit margin (NPM).

The EPS figures for 2015 and 2014 are exactly spot on to what is shown in Clarius Group’s annual reports.  This is because the amount of shares issued did not change in those years.  The slight discrepancy in 2012 and 2013, I attribute to the fact that I used the share balance as at end of financial year while Clarius Group would have used a weighted average of shares in their calculation.

Dividends per share (DPS) is quite similar to EPS with the only difference being that the DPS shows the actual profit amount paid out to each outstanding share.

2015	2014	2013	2012
$0	$0	$0	$0.03

In 2012, Clarius Group paid out 3 cents to each outstanding share.  Considering that Clarius made a loss in 2012, this meant they would have had to use debt to distribute this payment to shareholders.  With Clarius Group’s lack of cash and profits and no retained earnings, they seem to have wised up and stopped issuing dividends.  With no plans to reinstate dividends, this shows a lack of confidence in being able to produce future profits.

The price to earnings ratio (PE) compares share price to EPS.  From an investor’s point of view it shows how long it will take to get paid back if they invest in a firm’s shares.  It also provides an indication on whether buying at the current share price is a good opportunity⁵.  A manager tries to ensure the PE ratio looks as good as possible because it provides confidence in the company.

While I have calculated the PE ratio, I don’t think it particularly means anything because my EPS was negative which means my PE ratio is negative.  While a negative PE is mathematically possible, I imagine it is hard to compare and make sense of negative PE ratios and the financial community normally does not show them and instead marks them as not applicable⁵.  What runs through my head when I see a negative PE ratio is the Lost in Space robot flashing his red light and saying, “Danger, Will Robinson, danger!”.

1. 2016, Reference for Business, http://www.referenceforbusiness.com/management/Ex-Gov/Financial-Ratios.html
2. 2016, Baskerville, P, Quora, https://www.quora.com/What-are-the-key-financial-ratios-to-know-when-going-through-financial-statements-of-any-company
3. 2016, Ready Ratios, http://www.readyratios.com/reference/accounting/earnings_per_share_eps.html
4. 2016, Merrit, C, the nest, http://budgeting.thenest.com/negative-eps-mean-31095.html
5. 2016, Investopedia, http://www.investopedia.com/ask/answers/05/negativeeps.asp

Other People’s Money

Money contributed by shareholders and creditors falls under the definition of other people’s money.  The acronym (OPM) actually sounds the same as opium, which is fitting, considering the drug like power that other people’s money can exert on people managing that money.

One way to measure how much of a company’s assets are funded through other people’s money is by calculating the equity ratio.  The equity ratio shows how much of a firm’s total assets are owned outright/financed by equity investors, that is, after all liabilities are paid off how many remaining assets will they end up with.  The inverse of this calculation shows how much creditors finance the firm’s assets (1-Equity ratio).

	2015	2014	2013	2012
Equity	52.0%	59.9%	63.7%	72.8%

	2015	2014	2013	2012
Debt	48%	40.1%	36.3%	27.2%

There is a definite downwards trend to the equity ratio and a larger and larger portion of assets is being funded externally rather than through shareholders.  This is not surprising considering total assets and total equity also show a clear downwards trend as well.

Clarius Group have less and less assets, mainly due to accounts receivable reducing over four years (not being able to make consistent sales) and intangible assets suffering impairment losses and needing their carrying values adjusted (due to economic environment and potential reputation damage?).  They also have less and less equity because their accumulated losses have steadily increased over the last four years as well.

A higher equity ratio is generally better as it shows a more sustainable and less risky firm.  It also intimates that a firm has more free cash on hand as it does not have to pay so much in interest costs.  For an established firm, like Clarius Group, it is expected that equity should be higher than debt.  While this is currently the case, if we continue following the trend, their equity ratio will fall under 50% next year.  This is a cause for concern and backs up my initial thoughts on Clarius Group being a risky business.

In Debt We Trust

Unlike personal debt, debt in a business environment is not always a bad thing.  As I look at the debt to equity ratio, through management eyes, I need to constantly repeat this mantra to myself.  This is because my experience in life has always been focused on paying down  and eliminating debt, like my credit card and car loan, as this kind of debt is not helpful in any way.

Debt financing is an inexpensive source of capital compared to equity, improves the return on equity and can produce tax savings.¹  So having a very low debt to equity ratio is not always a good thing and neither is having it too high.  You want it just like Goldilocks wanted her porridge – not too hot, not too cold, “just right”.

Debt to equity ratio shows how much debt a firm is using for finance relative to the total value of shareholder’s equity.  So for every dollar a shareholder put in, Clarius Group received 92 cents from creditors in 2015 or another way to phrase it, would be, Clarius Group used debt financing equal to 92.2% of shareholder’s equity.

2015	2014	2013	2012
92.2%	66.9%	56.9%	37.4%

100% or 1 would indicate that equity investors and creditors have equal stakes in Clarius Group’s assets.  Debt to equity ratio is an indicator of risk and a higher ratio normally shows a firm is more aggressive with debt (or potentially is a start up trying to grow rapidly).  This is confusing to me as I know that Clarius Group are focused on having a low amount of financial leverage.  The figure for 2015 seems to indicate they are taking on more risk and being aggressive, so I did some more research about this ratio, as I am not convinced Clarius Group are displaying these qualities.

It seems the debt to equity ratio can be calculated a number of ways and one of those ways is to exclude liabilities from the calculation that are non interest bearing².  If we ignored trade payables (which the notes clearly say are non interest bearing), tax obligations and provisions then we get an extremely different result which more aligns with what I know about the Clarius Group.

2015	2014	2013	2012
3.5%	0.0%	2.0%	3.4%

Either way, shareholders of the Clarius Group own more than it owes for all four years which is a good sign.  The trend of this ratio fluctuates a bit which shows that their debt management is not consistent (sometimes they need the overdraft or to sell invoices and sometimes they don’t.  Also started using finance leases in 2015 which previously was not seen).

Maria also looked at the trend in profit margin to relate it to the debt to equity ratio.  This is because, if you have to pay interest to external debt providers you would assume you will have less profit.  This assumption does not hold for 2014.  If we look at the debt to equity ratio of 66.9% (calculated in excel spreadsheet) this is an increase from 2013 but net profit margin also increased.  The explanation behind this is that while liabilities rose in 2014, none of them  were interest bearing liabilities.

If you look at my secondary debt to equity calculation, you can see the discrepancy falls in the year 2013 instead.  Debt to equity improves to 2% but net profit margin gets worse anyway.  I think this is explained by the fact that equity drops almost 50% in size in 2013 and is the denominator in the ratio calculation.

For a firm like Clarius Group that has a volatile revenue stream (dependent on economic activity and cyclical business environment) or has a large portion of business tied up in just a few customers (40% of revenue from just two customers) it should have a low debt to equity ratio⁴.  Otherwise it may find a sudden loss in revenue means it cannot support all its financial obligations.

If I look at the ratio calculated with just interest bearing liabilities, I would be happy to see low risk (although this probably also means less efficiency).  If I look at the ratio calculated in my excel spreadsheet I think I would be fairly concerned as the trend shows increasing risk in the business (from an investor perspective, Clarius are definitely risky to put your money into).  However, at this stage, each yearly debt to equity ratio sits under 1:1 which is considered acceptable for most industries³.

1. 2016, Way, J, http://smallbusiness.chron.com/advantages-using-debt-capital-structure-22011.html
2. 2015, Gallo, A, https://hbr.org/2015/07/a-refresher-on-debt-to-equity-ratio
3. 2015, Accounting for management, http://www.accountingformanagement.org/debt-to-equity-ratio/
4. 2013, Accounting-simplified.com, http://accounting-simplified.com/financial/ratio-analysis/debt-to-equity.html

3 Dollars

Poor Eddie, he had a stable and happy life working as a public servant and living in his own home with his family.  He was able to pay his mortgage and other financial obligations each month and remained financially sound.  When the forces of economic and social change threaten this, Eddie realises just how fragile his reality and security is.  He loses his job and finds he has three dollars left in the bank.  How will he pay his debts?

Sounds a bit like the Clarius Group, although their situation is not so drastic yet.  Forces of economic change have shown their business reality and security may be a bit more fragile than they realised.  How do we know if they can pay off debts and remain financially sound?

The current ratio is used to keep track of liquidity and measures if the Clarius Group is able to pay off any short term debts or other financial obligations lasting less than a year (current liabilities) with the current assets it has on hand.

2015	2014	2013	2012
2.07	2.27	2.47	2.12

These numbers tell us that Clarius Group’s current assets are two and bit times larger than current liabilities.  If they needed to pay off all their debts within a year, they could manage this and still have current assets to spare.  Here, finally, is a ratio that the Clarius Group may be excelling at!  A firm is generally deemed to have good short term financial strength if your current ratio is 1.5 – 3¹.

The current ratio trend is different again to what I have seen while analysing the previous ratios.  Now 2012 and 2015 are the worst years!  While the ratio stays higher than the benchmark (2012) for 2013 and 2014, it is starting to trend down and I would like to know why.

In 2013, trade receivables decreased and we know this is due to a drop in revenue as the economy worsened.  However, current tax receivables significantly increased because Clarius Group did not have to pay any tax and were due for a tax refund.  This meant that while current assets dropped, they did so at a lower rate than might otherwise have been expected.

Current liabilities dropped in 2013 due to a large change in trade payables (a result of on hired labour costs reducing and not having the same number of contractors in paid work?).  There were no current tax liabilities (as mentioned above there is a tax refund due) and no interest bearing liabilities.  The bank overdraft, however, sneakily went up and shows it was more heavily used in 2013 (a sign of not enough cash coming in?).

The interesting thing to note about the interest bearing liabilities is that they came from a Receivables Purchases Facility that Clarius set up.  This means they sold their trade receivable invoices to their finance providers at a discounted rate.  In 2013, they utilised only a non recourse agreement which means the finance provider bears the full loss if the customer does not pay.  If the facility was provided under recourse then Clarius Group would have had to pay some of their financing back.  Being able to get non-recourse funding is probably due to their good management of accounts receivable.

In 2014, current assets stayed relatively stable because while current tax receivables dropped, Clarius Group’s cash increased due to a large tax refund.  The bank overdraft was not utilised in 2014 (due to the big influx in cash?) but trade payables increased enough to slightly affect the current ratio.  I cannot see the reason why trade payables increased, however, I am not too concerned in the downward movement for 2014.

Trade receivables dropped again in 2015 which is starting to become a bit concerning because I would think the economic downturn has steadied but they are still struggling to make sales.  Cash also dropped due to timing differences in superannuation payments but also because of major restructuring costs (feels like management in 2014 were on the right track so it starts to look like they prematurely fired and hired and maybe this was not a good use for their cash?).  This left current assets at their lowest level seen in four years.

Trade payables went back down in 2015 which meant current liabilities decreased overall.  However, the decrease was at a slower rate than current assets meaning the current ratio decreased again.  Clarius Group did not use their Receivables Purchase Facility in 2015 but they did dip into their bank overdraft as their overall cash flow became negative.  They also have a new current liability, in the form of finance leases, to help them finance software licenses over the next three years.

It is great that Clarius Group have what is seen as a healthy current ratio but I think this is out of necessity rather than good management.  With such low cash balances, Clarius Group would be hard pressed to pay back any significant ongoing interest payments.  I think Clarius Group’s management realise that if they don’t keep themselves lowly geared they could edge towards troubled waters.  With the way the recruitment industry is at the moment, management cannot afford to take on any more risk.

If Clarius Group continue to struggle with revenue and cash and cannot obtain any significant debt financing while also making losses to the point where no one wants to buy any more shares issued (equity financing), how are they going to grow and develop?

1. n.d, Boundless.com, https://www.boundless.com/accounting/textbooks/boundless-accounting-textbook/reporting-of-current-and-contingent-liabilities-9/reporting-and-analyzing-current-liabilities-64/current-ratio-302-3754/

 

Turning Over

22 May 2016

Weight: 136 lb
Cigarettes: 42
Alcohol units: 30 50

You only get one life. I’ve just made a decision to change things a bit and spend what’s left of mine looking after me for a change.

Am enjoying a relationship with two men simultaneously.  The first is called Ben, the other, Jerry (as in the ice-cream).

Bridget Jones’s Diary

The first thing that comes to mind when thinking about turnover is turning over a new leaf or making a fresh start.  Bridget Jones’s Diary is a quintessential movie about starting anew and has an entertaining love triangle as part of the plot.  I love complicated relationships, after all, isn’t that what ratios really are? Relationships of varying complexities?

Unlike when Bridget Jones records her weight, cigarette and alcohol units – the total asset turnover ratio is generally better when the number is bigger.  Maria stated she would at least like to see a 1:1 occurring.  A bigger number is generally better because it measures how efficient a firm is at using its assets to produce sales.

2015	2014	2013	2012
3.80	3.03	3.88	2.53

We would read the 2015 result as saying each dollar of assets generates $3.80 of sales.

The first thing that springs to mind when looking at this trend is that 2013 and 2015 are now the best performing years instead of the worst!  Therefore, asset turnover must have an inverse relationship with net profit margin and return on assets.

I would like to think that the Clarius Group has finally performed outstandingly well in one ratio calculation but total asset turnover is quite dependent on the type of industry your company is in.¹  A company like Clarius, that runs more on “brain power” (therefore having a small asset base) is expected to have higher ratios¹.  This is because it makes the denominator smaller which means the answer is divided by less parts so its size gets larger (also addressed in The Holy Grail #2).

The total asset turnover trend is a bit haphazard but the ratio has definitely improved all three years from 2012.  However, the ratio did not improve because of increased sales, in fact, sales dropped repeatedly each year and total assets declined two of the three years.  This does not inspire confidence at all!

There are many ways to improve total asset turnover², including:

• Increasing sales
• Liquidating obsolete or unused assets
• Leasing assets instead of buying
• Improving asset usage and productivity (efficiency improvements)
• Better collection of accounts receivable
• Improve inventory management

Clarius Group have talked about improving their software and technology to gain efficiency.  They are also extremely focused on collecting their accounts receivable (only 2% was overdue by 90 days) and lease a lot of their premises.  I have no doubt the trend shows an improvement in operational efficiency but I still feel the company is in a bit of trouble if they cannot increase sales.

I did find it interesting that the total asset turnover ratio can sometimes be too high, which is just as bad as being too low.  Maria mentions she would be concerned that this would not be sustainable and a sign of assets overworking or stretched to capacity.

One final point I wanted to note about total asset turnover ratio is how similar I found it to be to the return on operating assets (ROA) ratio.  When I started calculating asset turnover I thought, ‘hang on a minute, haven’t I just done this?’.  However, the ROA measures how well a firm uses assets to generate profit whereas asset turnover measures how well a firm uses assets to generate sales.  Just like with return on net operating assets (RNOA) that Martin mentioned in chapter four, ‘it is the interaction of profit margins with efficiency that is critical,’ so asset turnover is a key part of the ROA.

 

1. 2016, Merrit, C, http://smallbusiness.chron.com/companys-asset-turnover-ratio-mean-60811.html
2. n.d, eFinance Management, https://www.efinancemanagement.com/financial-analysis/how-to-analyze-and-improve-asset-turnover-ratio

The Holy Grail #2

We continue our holy grail hunt with another profitability ratio, this time, the return on assets (ROA).

ROA shows how efficiently a firm manages its assets to produce a profit during a certain period of time.  We have previously seen that cash flow from operations can be used to invest in operating assets.  An investment in operating assets are generally the biggest investments a firm makes so ROA helps managers to see if the money the are pouring into the firm is making a difference by providing a return on investment of assets.

Clarius Group have a negative ROA for each of the four years so it is not doing very well in converting its investment in assets into profits.  For 2015, Clarius Group lost 24 cents for every dollar of assets they held!

2015	2014	2013	2012
-24.0%	-2.8%	-72.7%	-8.7%

As we saw with net profit margin (NPM), 2013 and 2015 are the worse performing by a large order of magnitude.  We saw with NPM that while revenue has trended steadily downwards, expenses fluctuated greatly in 2013 and 2015 due to one-off costs related to impairment losses and restructuring.  These same issues are having an effect on ROA because it also uses the net profit after tax (NPAT) in its calculation.

The reason ROA is larger than NPM is because total assets are used as the denominator and these amounts are much smaller than the sales figures used in NPM.  As a denominator decreases the answer is divided by less parts so its size gets larger.

Let’s have a look at the trend of total assets:

2014 was again a little ray of hope in a fairly bleak outlook for Clarius Group because they managed to stop the decline in assets.  If you remember from my last blog post, 2014 was the year expenses reduced at a faster rate than revenue decreased which meant a positive NPAT figure and a very small negative NPM (less than one cent was lost per dollar of sales).

Let us see if we can find what has been going on with Clarius Group’s assets…

2013 annual report states that a goodwill impairment reflected the uncertainty and market turbulence that hit in that year.  This was due to two reasons:

• Clarius Group acquired two businesses during the peak of the market and it looks like the economic issues of 2013 triggered the need to revalue them
• Clarius Group stated that they needed to take into account the impact of brand consolidation that had taken place since they had acquired certain recruitment brands.  This sounds like a loss in reputation to me!

The goodwill impairment shows in the balance sheet as a staggering 94% drop in intangible assets.  An almost 20% drop in trade and other receivables was due to less sales and a 20% drop in deferred tax assets (DTAs) was because Clarius had to derecognise tax losses (check out my comments on Sue’s blog about DTAs and why derecognition is necessary).

Cash made the difference in 2014 along with an increase in DTAs and intangible assets.  Don’t get too excited though! Cash from operating activities reduced further and it was more the fact that investing activities were reduced in the form of purchasing less plant and equipment and spending less on software development.  Financing activities were eliminated all together which also helped the cash balance.  Clarius Group also received a $1.2M tax refund and kept a tight control on receivables meaning they pulled in as much cash as they could from accounts.

Intangible assets went up 21% due to capitalised software costs.  This is because Clarius completed a full implementation of new back end systems to help automate their processes and improve technology.

Things went a bit pear shaped in 2015 and every single asset decreased in value.  The main culprit was once again intangible assets.  This time, due to a software impairment, which meant the revaluation almost completely wiped out what was left of intangible assets.  Restructuring costs also effected cash and the annual report stated that changing superannuation payments from quarterly to monthly also had an impact.

It looks like Clarius Group is struggling and that the new CEO and management team have actually made things worse since they started.

While looking at NPM and ROA, I have started to wonder if I should be removing the figures for impairment losses, restructuring losses and derecognition of tax losses.  These items look like they are skewing the trends and maybe should not be included as they are not everyday operational items that occur every single year in the business.