Equity Analysis

In our report below we have used the data of two largest listed companies in Australia which belong to food and staples industry- Wesfarmers limited and Woolworths limited.

Wesfarmers limited is a conglomerate based in Australia. The company mostly engages in retails chemical, coal mining, fertilizers and safety products. The company became the Australia’s highest revenue generating company in Australia in 2016 beating the top two companies, BHP Billiton and Woolworths limited. The company has been known to employ about 223000 people. The company was established as a cooperative society in 1914, later in 1984 the co-operative society was converted into a company and subsequently listed on the Australian stock exchange.

Woolworths group is another largest revenue generating companies in Australia which rank second after Wesfarmers. Woolworths is primarily engaged in the business of retail, hotels and poker machines. The first store of the company was opened in 1924, when only 619 subscribers subscribed to the shares of the company. The store gained recognition for using the first cash register printing electronic receipts for the customers. The business slowly rose and now the company has over 205000 people working for t all around.

Both the companies are the top players of the retail food staple industry. We have used the data of both the companies using the annual report.

In accounting terms equity is the amount net off assets and liabilities. It represents the worth of share that the owners hold in the company. The main components of the owner’s equity are share capital and reserves (Alvarez, 2013).

1. The owner’s equity of Wesfarmers limited and Woolworths limited consist of the following:

Wesfarmers	2017	2016
Issued Capital	22,242.00	21,909.00
Retained earnings	1,509.00	874.00
Reserves	190.00	166.00
Woolworths	2017	2016
Issued Capital	5,615.00	5,252.20
Retained earnings	3,797.20	3,124.50
Reserves	113.80	93.90

The issued share capital of the company represents the equity and preference shares issued to the public and other holders. The shareholders are entitles to vote on certain matters of the company based on their shareholding (Bragg, 2015).

We see that the shareholding of Wesfarmers have increased from $21909 million to $ 22242, the increase in shareholding was due to issue of shares under Wesfarmers Dividend Investment Plan and Wesfarmers Employee Share acquisition plan. The shareholding in the equity of Woolworths limited increased from $5252 million in 2016 to $5615 million in 2017. The major variance in shareholding was due to issue of shares under dividend reinvestment plan.

The retained earnings represent the portion of profit and loss accumulated over the years. The retained earnings can be disposed off in the manner as the management deems fits. We see that the retained earnings of the Wesfarmers group have increased from $874 million in 2016 to $1509 million in 2017. The increase in retained earnings was due to transfer of the current year profits. The management also distributed dividends of $2235miilion in 2017. The retained earnings of the Woolworths group have increased from $3124 million in 2016 to $3797 million in 2017. The increase in retained earnings was due to transfer of current year profits earned.

Debt and Equity Position

The reserves represent the amount of profits set aside which are to be used to some set purposes (Donohue, 2015). The reserves of Wesfarmers group increased from $ 166 million to $190 million. The reserves of Woolworth’s group increased from 93.9 million to $113.8 million. The increase in reserves for both the companies is due to appropriation of profits to reserves for the financial year (Easton, 2010).

The major sources of capital for a company are its share capital and loan from the third parties. Both the sources of capital have their respective pros and cons (Elaine, 2015). The capital structure of the company is planned in such a way so that the cost of capital is least. We the following dent and equity for both the companies:

Debt and equity
	Wesfarmers	Woolworths
Debt	5,413.00	3,030.50
Equity	23,941.00	9,526.00
Total Assets	40,115.00	22,915.80
Debt %	13.49	13.22
Equity %	59.68	41.57

From the table above we see that the proportion of debt in total capital for both the companies is almost 13%. This indicates that the industry to which these companies belong operate on a low debt ratio. The equity of Wesfarmers group is 60% approximately; this indicates that the company has a strong hold on its assets, as most of its assets are funded by owner’s equity. The equity of Woolworths group is 42%; this indicates involvement of more third party funds in the operations of the company.

Overall the capital structure of both the companies seems to be in a healthy position.

The books of accounts of the companies are made on accrual basis and not on cash basis in order to determine the profitability of the business (Fisher, 2012). But it is necessary that cash flow of the companies also be taken care of in order to have a check on the liquidity position of the company (Fridson & Alvarez, 2012).

The cash from operating activities for Wesfarmers include the cash receipt and payments from its customers, suppliers. Movement in inventory, reversal of interest dividend and borrowing costs and income tax paid. Major movements in operating cash for the year were witnessed in increases receipt and payments from its customers and to its suppliers. The tax paid for the current year was lower than what was paid last year. Overall increase in cash from operating activities foe Wesfarmers was noticed in the current year.

The cash from investing activities of Wesfarmers mostly comprise of payments and recipes in connection with purchase and sale of properly and assets and associates. The company nearly made investments of $2132 million in the last year, but in the current year only $53 million was spent on investing activities.

Cash Flows Analysis

The cash from financing activities show a major decline in receipts from borrowings. The company has made regular repayments of loan and dividends. The overall cash outflow from financing activities of the company increased from $1333 million in 2016 to $3771 million in 2017.

The cash from operating activities for Woolworths for the year mainly comprised for cash receipts and payments from its customers and suppliers along with the income tax authorities. There was a little increase in cash receipts from customers and lower payment to suppliers were made in the current year. This resulted in higher operating cash of $3122 million in current year as compared to $2357.5 million in the last year.

The cash from investing activities many involve cash from disposal and purchases of property and other businesses. The cash outflows from investing activities are $ 1431.4 million in 2017 as compared to $1266.7 million in 2016.

The increase in cash flow from financing activities of Woolworth’s group increased to $1729.3 million from $1474.9 million. The major increase was a result in increased outflow for payments of debts.

Following tables show the comparison between the cash flow from operating activities for both the companies:

Cash flow – operating activities
	2017	2016	2015
Wesfarmers	4,226	3,365	3,791
Woolworths	3,122	2,358	3,345

The trends in movement of operation cash for both the companies have been same. But the rate of change in movement in cash from Wesfarmers is higher. This is why the company has been ranked number one in revenue in Australia (Girard, 2014).

Following tables show the comparison between the cash flow from investing activities for both the companies:

Cash flow – Investing activities
	2017	2016	2015
Wesfarmers	-53	-2,132	-1,898
Woolworths	-1,432	-1,267	-1,334

The investments made by Wesfarmers have declined in the current year, whereas Woolworths seems to follow huge investments policy. Decline in investments by Wesfarmers for the current year was about 97%, whereas increase in investments by Woolworths in the current year was 13%. (Wesfarmers Group)

Following tables show the comparison between the cash flow from financing activities for both the companies:

Cash flow – financing activities
	2017	2016	2015
Wesfarmers	-3,771	-1,333	-3,249
Woolworths	-1,729	-1,475	-1,611

Wesfarmers has almost doubled its cash outflows from financing activities from last year. Whereas only 177% increase in cash outflows from financing activities for Woolworths was witnessed. Wesfarmers has been trying to reduce the debt financing which has resulted in higher cash outflows in the current year. (Woolsworth Limited)

The overall analysis of the cash flows for both the companies is quite different. The cash flows of Woolworths have been in the same trend, whereas there has been total structuring of overall cash flows from Wesfarmers. There have been high variances in change in financing and investing cash flows for Wesfarmers, whereas those of Woolworths have been following the general trend (Ittelson, 2009).

Operating Activities

The other comprehensive income of Wesfarmers constitute of exchange differences arising in foreign operations, changes in values due to cash flow hedge reserve, and changes in values of defined benefit plan. All these items represent holding of an asset or a liability by the company. Since these items are still held by the company, the changes in the values are to be recorded. These changes cannot be classified as an item of profit or loss, so they are adjusted with profits but named as other comprehensive income.

Just like the other comprehensive income of Wesfarmers, the other comprehensive income of Woolworths show the changes in the fait value of defined benefit obligations, changes in the value of cash flow hedge and exchange differences.

Other comprehensive income represents the amount of profits and losses that have not been realised yet(Lerner, 2009). For example, changes in fair value of investments, these investments still stand in the books, but the changes in the fair value of such investment as per GAAP requirements would be classified as other comprehensive income. These amounts will be realised in the profit and loss when the investments are actually disposed off.

• These items are not recognised in the profit and loss as they are recorded in the books just for better presentation of data, these amounts have not been recognised, and hence they are classified as comprehensive income and shown separately below the profit and loss items (McLaney & Adril, 2016).
• Wesfarmers reported other comprehensive of $23million for cash flow hedge, $2 million foe exchange rate fluctuations from foreign operations and $3 million for revaluations in connection with defined benefit plan. Whereas, the financials of Woolworths group reported $4.8 million foe cash flow hedges, $6.9 million of changes in exchange rate for foreign operations and $2.2 million for changes in superannuation defined benefit plan. Therefore, we see that the comprehensive income of both the companies have reported about same items.

The items which are recorded in the other comprehensive of the company represent the changes in the values which are likely to affect on the financial of the company in future (Penman, 2012). The change in the values of holdings of the company is dependent on the functioning of market. For example, the changes in the foreign exchange currency rate are not in the control of the management, but any changes in the rate will affect the position of the company (Picker, 2016). While evaluating the performance of the managers the items of other comprehensive income should not be considered. The revenues earned and expenses incurred which are charged in the profit and loss account should be considered for evaluating the performance of the managers (Piper, 2015).

1. The taxes paid by the corporate on their income are corporate income taxes. The expense for taxes recorded in the books of Wesfarmers for 2017 was $1265 million and that for Woolworths was reported to be $837.7 million.
2. We have calculated the effective tax rate for both the companies. The following table show the effective tax rate calculation:

Effective Income Tax rate
	Wesfarmers	Woolworths
Income tax expense	1,265	837.70
Earnings before tax	4,138	2,431
Income tax rate	30.57	34.46

Note: we have also included the profit and tax expense for discontinued operations in Woolworths Limited.

Therefore, we see that the effective tax rate for Wesfarmers is 30.57% and that for Woolworths is 34.46%. The effective tax rate of Wesfarmers is higher than that of Woolworths by 3.89%.

• While calculating the tax expense of the year for corporate, we calculate the profits of the company twice(Parrino, 2013). These are accounting profit and the taxable profit. Accounting profit is the profit that is calculated as per the accounting norms. The profit and loss account which is presented in the financial statements is made as per the rules laid down by the accounting authorities (Robinson, 2014). There are certain items under the tax laws which are not allowed to be claimed as deduction while arriving at profits. Also, there are certain items for which deduction is allowed in the later financial years (Simpson, 2012).

Due to these differences in the accounting and taxable laws, there arise a difference between the accounting and taxable profit (Taillard, 2013). Now the question arises, on which profit is the company required to pay taxes? In order to answer this question deferred tax was introduced. Irrespective of differences between the accounting and taxable profits, the tax amount shall be the same (Skonieczny, 2012). In order to present the data as per said laws and regulations, the deferred tax assets and liabilities are set off and shown in the balance sheet.

Investing Activities

The deferred tax assets of Wesfarmers include items such as provision, employee benefit, accrued and other payables, borrowings, derivatives, trading stock, fixed assets, and other insignificant balances. The deferred tax liabilities of Wesfarmers include items such as depreciation expenses derivatives, accrued income, intangible assets, and other insignificant balances.

The deferred tax assets of Woolworths group include temporary differences created due to assets, provisions and accruals, cash flow hedges, foreign exchange rate differences and others. The deferred tax liabilities of the group include items such as intangible assets, prepayments and other items.

The items have been recorded as deferred tax assets and liabilities by the company in there financial statement as these items are not deductible for tax purposes (White, 2015). Also, if the deductions of previous years, which have been allowed as deduction in the current financial year.

The net deferred tax assets declined from $1042 million from last year to $971 million in the current year for the Wesfarmers group. This indicates that the company will be able to claim deduction in future for about $971 million when it satisfies certain criteria for deduction.

The net deferred tax assets declined from $497.7 million in the last year to $372.3 million in the current year for the Woolworth’s group. This indicates that the company will be able to claim deduction in future for about $372.3 million when it satisfies certain criteria for deduction.

The amount of deferred tax which has been calculated is adjusted with the basic tax rate charged on the accounting profit. The company is required to pay the tax amount which is higher of the both, the taxable or accounting profit. The company is later allowed to take credit for the tax which has been paid in excess in the earlier years. This results in cash profit and book profit. Book tax is net off credit taken, whereas cash tax is the tax actually paid by the company.

1. The book tax is the tax charged on book profit, which is calculated keeping in mind the guidelines of generally accepted accounting principles. Cash tax on the hands is the simple tax is charged as a percentage of the accounting income. There are differences between the cash tax and the books tax due to temporary differences. Temporary differences are differences arise in the amounts which are expected to be reversed in future. The tax charged on temporary differences is deferred tax. So we have

Accounting profit * corporate tax rate= book tax

Taxable profit * corporate tax rate= cash tax

We have calculated the cash tax and book tax for both the companies and explained the reasons for their differences.

The accounting profit by Wesfarmers was $4138million, on which book tax charged is $1241 million using the corporate rate tax of 30%. In this tax amount non deductible items of $12 million, deferred tax of $37 million and taxes of associates and other of $25 million were adjusted, which resulted in the cash tax of $1265 million. (Wesfarmers Group)

Financing Activities

Profit before tax	4,138
Income tax at the statutory tax rate of 30%	1241.4
Adjustments relating to prior years	0
Non-deductible items	12
Share of results of associates and joint venture	-18
Effect of differences and changes in tax rate in UK	20
Other	10
Income tax on profit before tax	1,265

The accounting profit by Woolworths was $2431 million, on which book tax charged is $729.33 million. In this tax amount adjustments of tax towards non-deductable expenses, unrecognised tax losses and other deferred tax adjustments were made, which resulted in the cash tax rate of $837.7 million. (Woolsworth Limited)

Profit/Loss before income tax expense	2,431
Income tax expense/benefit using the Australian corporate tax rate of	729.33
Non-deductible expenses	96.2
Non-deductible impairment expense	5.1
Tax losses no longer able to be carried forward as a deferred tax asset –	0
Unrecognised tax losses from the current year	24.4
Impact of differences in offshore tax rates	-5
Other	-0.7
Adjustments relating to prior years	-11.63
Income tax expense	837.7

The cash tax for Wesfarmers is 30.57% and that for Woolworths is 34.46%. the differences in the cash tax rate for both the companies are due to various non-deductible items. The temporary differences arising are the reason for the difference between the cash tax rates of both the companies

From the above table we see that the book tax rate for both the companies are 30%, whereas the cash tax rate for Wesfarmers is 30.57% and that for Woolworths is 34.46%. There is difference in the book tax rates and cash tax rates, as there are items which are required to be adjusted in the books to meet with the requirements of various authorities. There are certain items which are not allowed as deduction or some expenses which are allowed as deduction in later years. The adjustments for these lead to differences in the cash and book tax rates.

Conclusion

From the above analysis of the financial statements of Wesfarmers group and Woolworths group has helped us have an insight into the workings of the company. Both the companies seem to have strong hold on profitability. Performances of both the companies have been excellent for the given financial year. With the given resources and management, both the companies seem to have generated optimum results.

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