Introduction to my company: China Southern Airlines

 Introducing  China Southern Airlines

The parent company of China Southern Airlines Ltd is China Southern Air Holding Co, a state-owned enterprise that was supervised by State-owned Assets Supervision and Administration Commission of the State Council.  They provide passenger, cargo, mail delivery and other transport services throughout the world. With 840 passenger and cargo transport aircrafts and the most developed route networks, they have successfully served 140 million passengers annually. They are ranked 1^st in Asia and 3^rd in the world according to fleet scale and passenger turnover. Currently employing more than 100 831 staff, they are considered the safest Chinese airline, receiving 2 top safety awards.  Their headquarters are located in Guangzhou with 16 branches and 8 holding aviation subsidiaries and 22 domestic business departments, including locations in Hangzhou, Qingdao, Sydney and New York.

KCQ's Chapter 3

ACCT13017 KCQ’s Chapter 3

I have a vague recollection of studying ratio analysis in grade 12, quite some time ago now. It had something to do with the strength of a firm’s assets, profit margin and ability to pay creditors which kind of reflected the strength of the firm. I don’t recall a framework or even testing those ratios to provide evidence of their usefulness. It will be enlightening to learn something worthwhile with a proven formula that can used reliably. Over the years I have seen the progression of accounting go through changes as society demands and legislation commands. The focus on t accounts and journals entries has vastly changed due to technology and even becoming less and less important as they can be generated with a touch of a button or a swipe of the screen. The term profit maximisation was widely used as an aspirational goal for all firms as well as a reason for doing what they do and proving that what they do works. Warren Buffet can prove what he does works, and I’ll be forever grateful for his insights. However, we need to apply all that theory and foresight subjectively in order to gain its benefit.

It seems to me that the ability to at least identify whether a corporation will fail in the future has some usefulness to equity investors. However, the real prize is finding that ‘white whale’, that investment that will give the unprecedented returns in the forthcoming period and way into the future. The ratios I have identified so far are the price/earnings ratio, profit margin (profit/sales), turnover (sales/total assets), interest coverage (number of times earnings before interest and tax exceed a firm’s interest expense) and debt to equity ratio. How can we use these to predict the future? Will those calculations be reliable enough to make future decisions?

“financial statement analysis should involve us using a firm’s financial statements to help us engage with key aspects of a firm’s economic and business realities”

We need to identify the key drivers a firm and develop an understanding of the economic relationships that affect those drivers. The financial statements can show the areas of focus in a company then we can start to think about how future changes might affect these areas and make some predictions. The further I read into this unit the more I realise how understanding business finance would be an advantage. Regardless, I’m sure I can make the necessary connections of accounting and finance to assess my company. It may require some thinking outside the box to discover the key economic and business drivers and make connections to the possibilities of changes in the future.

I am wondering what analysts, Lawrence Brown, Andrew Call, Michael Clement and Nathan Sharp mean by “reflect consistent reporting choices over time”. I understand that economic realties are backed by sustainable operating cash flows (the ability to finance operations consistently) but, what do they mean by reporting choices? It seems to me that in some ways we aren’t just predicting the numbers, we need to predict human behaviour as well. The ability for a firm to adapt to the ever-changing wants people demand. I many connections to my marketing studies and always thought that strategic marketing should involve some sort of financial analysis. It also occurred to me that the value of a firm is difficult to pin point. Therefore, personal judgements are made to ascertain the present value and the potential value in your own opinion, rather than someone else’s.

I always believed that although all businesses are unique, they all have one thing in common, profit maximisation. It seems ridiculous now to compare any two businesses as alike and that all they are interested in is the bottom line. The value lies with the individual and an individual firm. It is far more logical to find connections to your own values and the businesses in order to make sense of the economic reality. Once we derive a sense of the business and economic reality, we can start to make predictions about the future returns or dividends, our investment might yield.

Forecasting Dividends, Cash Flows or Earnings

Accounting is a universal language, apart from the USA, there are standards which are adhered to worldwide, forming a neutral basis for comparison. It’s almost like making money talk!

Equity Value = Present Value of Expected Future Dividends

The Dividend Discount Model:

Equity value = DIV1 + DIV2 + DIV3 + …

                             ρE        ρE²     ρE³  

DIV_t = expected future dividends (t=year)

pE = the cost of capital (discount rate incorporating opportunity cost incurred anticipating dividend payment)

Of course, theoretically firms can last indefinitely, they are not people defined by mortality. I’m not sure how we would determine the expected lifetime of a firm, and what to include as a terminating dividend? I learned in company law that shareholders legally cannot force the payment of a dividend, it can only be the decision of the board. This is quite confusing when thinking we can predict future dividends as we have no influence on that decision. Share types have always confused me, along with share performance. It is kind of relieving that any transaction between the firm and it’s equity investors will simply be referred to as ‘net dividends’.

Discounted Cash Flows

Dividends (d) = Operating cash flow (C) – Capital outlays (I) + Net cash flow from debt owners (F)

                         = Free cash flow (FCF) + Net cash flow from debt owners (F)

Therefore:

FCF = Operating cash flow (C) – Capital Outlays (I)

d = FCF + F

FCF = d – F

It makes sense to relate free cash flow to dividends as firms would not consider a dividend payment without cash available. Therefore, we need to see how cash flows into and out of the business to gain an idea of how our investment is being employed and the expectation of its future value. I like that this approach discounts forecasting the firm’s dividend policy and focuses on the value of equity instead. It does seem complicated applying all these formulas, so I may have to do yet more review of previous units to cement them to memory.

Equity value = DIV1 + DIV2 + DIV3 + …   

                            ρE         ρE²      ρE³       

                        = (C-I)₁* + (C-I)₂* + (C-I)₃*+… - Value of Debt       

WACC WACC² WACC³ * FCF_t = (C – I) _t = d – F (Weighted average cost of capital)

The cost of operations for a firm is the cost of capital! This is what is costs a firm to function, to be in business. How to we find the value of debt? And, what is the simplified assumption adopted to value the free cash flow beyond the forecast period adopted? This all sounds very complicated and not simple at all. Ok, I understand that dividends are a transfer of value, not value creation. Ah, lightbulb moment, free cash flow is a transfer of value between a firm’s operating and financial activities. The drivers are cash flow from operations and net cash invested in operating assets! It seems ages ago since we restated a company’s financial statements and now its beginning to all make sense! We need to understand why a company would be investing its cash into operating assets and the intention of creating value for its equity investors. It’s kind of like the company investing in itself, to promote growth and future profits but also utilising the available capital and making it work.

Economic Profit

BV₁ = BV₀ + CI₁ – DIV₁

DIV₁ = BV₀ – BV₁ + CI₁

“The book value (BV) of equity in any year can only be increased from the previous year’s level by earning Comprehensive income (CI) or be reduced by the amount of net dividends paid to its equity investors.”

V_E = BV₀ + (CI₁-ρEBV₀) + (CI₂-ρEBV₁) + … + (CI_t-ρEBV_t-1) + BV_t        

                              ρE                  ρE₂                              ρE_t        ρE_t

       = BV₀ + AE₁  + AE₂  + … + AE_t  +  BV_t   

                      ρE     ρE₂             ρE_t       ρE_t

AEt = Abnormal Earnings in year t = CIt - [(ρE -1)BVt-1]. Abnormal earnings (AE) is the difference between Comprehensive income (CI), a measure of the accounting earnings of a firm, and the cost of the capital the firm uses to earn that return ((ρE –1) x BVt-1).

AOIt = Abnormal operating income in year t = OIt-[(WACC-1) x BVt-1]; and WACC is the weighted average cost of capital or the cost of capital for a firm’s operations. Operating income is the earnings on a firm’s total assets (or enterprise) independent of how it is funded by debt or equity (that is, it is before deducting interest) and is after deducting tax.

The Value of Equity:

V_E = BV₀ + PV of AE (or Abnormal Operating Income)

“This draws on the same theoretical base as the discounted dividend model: the value of equity is the present value of expected future dividends.” 

Without the bother of dividend policy or cash re-invested in operations. Oh wow, what a powerful concept! Being able to focus on just those aspects that are potentially creating value is very exciting! I am wondering what those aspects will be revealed from my company.

KCQ's Chapter 2

ACCT13017 KCQ’s Chapter 2

Life has many different journeys. The beginning of my degree started off as a Diploma and when I achieved success, I decided to go even further. I reset the goal posts and now I’m almost finished. When I’m done, it will be time to reset the goal posts once more. I guess it’s the same with companies.  With proper analysis and perhaps a little luck, they will achieve their goals and continue with success. It’s all a bit unpredictable, but as with achieving a degree, a bit of study goes a long way to achieving success. It all depends on what you do that adds to the value of the destination.

It’s all very subjective, what adds value to me? To me, the investment into gaining this degree means increasing the value of my family’s quality of life, so highly valued. Businesses would be focusing their efforts on the areas they value too. Could this reflect bias in their accounting methods and distort an outsider’s view? Where do we look for subtlety’s indicating predisposition?

Carpe diem – Seize the day!  One of my favourite lines from “Dead Poet’s Society”.  We have only today to react and tomorrow to respond but to succeed, we need strategy. As an investor I would be interested in the current affairs of the company’s industry, the down low on sustainability of the resources the firm needs, who are their rivals and how are they handling things, what are other future possibilities. I want to know the ethics and values of the company organisational culture, their abilities and weaknesses. These are things I would need to consider before investing and make comparisons to my personal alignments. The main goal in mind being to make more than invested and the firm’s capacity to do so.  I can see that a firm’s strategy shows its’ intentions and previous intentions form patterns and patterns form indications of the big picture. From Rymans example, I need to find how the firm is employing leverage from it’s operating liabilities and utilizing net operating assets. I need to study the firm’s ability to sustain its’ intentions. Of course, if they matched Ryman’s ability, it would be very attractive to the investor, well one can dream!

I’m finding the concept of the cost of capital confusing. How on earth do the capital markets use the clearing price when there are unlimited potential uses?  Does this mean equity interests ‘go off’ after just one day if not consumed? I get that investors are buying the future of a firm and guessing that some returns are more likely than others but what is the real guarantee on the expectation of a return? It all seems a very risky business in predicting whether a firm will create value and earning a return greater than the cost of capital we are willing to invest.

What does strategy look like? How would we recognise it in a dark alley? I’m guessing ‘the persistent stuff’ are the things a firm consistently does well, the repetitive daily grind that keeps them going. These are the heart and soul of the business and our focus for research. Then look at the competing environment and how they stack up when faced with the same challenges. How does the firm add value for its customers? Who is their target market?

Plan, Ploy, Pattern, Position or Perspective

I’m familiar with the 4 P’s of marketing, product, price, place and promotion, to some extent I can relate. Every business needs a plan, a direction and a map to get there. So, it makes sense that a plan would include the business intention of addressing the market, its competitors and challenges it faces. In contrast, a ploy would be countermeasures to try and outsmart the competition. This would involve creating barriers to new competitors from entering the market and in general make it difficult for the competition take market share. Kind of like how Apple protects their technology and limits accessibility to prevent copycats. Patterns may be more difficult to ascertain, without in-depth research. Keeping with the Apple example, I think their pattern strategy would be to constantly keep updating, keep the customer up to date with the latest and greatest. In this respect, I would expect a lot of Apple capital would be employed in developing new technologies and thus creating the value add for their customers.

The key to positioning is too home in on the aspects of the firm’s environment and match them with strategies to give them a competitive edge. This is the firm’s ability to provide defence mechanisms against the competition and future challenges. After discussing this point with Dr Martin, I realised that position is much more than market share. It’s about stance on issues that affect the company’s values, it’s about their position in the community, industry and the world! It’s a lot more challenging than I expected and will be difficult to apply to my company.

Perspective is more difficult to define. It seems to be attitude, personality and integrity, almost like the Myers Briggs test for companies. How does this affect their ability to make decisions? What determines the organisations behaviour? Perspective is people!!! It’s about the personality of the people in charge, the decision makers. Every leader puts their personal touch on the organisation they lead. This means we need to know the people, their values, personality and ethics and how that reflects in the business. Richard Branson comes to mind with his well-known ethos of “Train people well enough so they can leave, treat them well enough so they don’t want to.” This tells me his business is willing to train employees to a high standard, then remunerate them as a reward for their hard work. There is something to be admired in that.

I recall Net Present value but alas my memory has diminished how to calculate. My understanding is that positive net present value relates to the firm’s ability to generate future returns on equity greater than the cost of capital. I definitely need a refresher on how to calculate this. I cannot even fathom how to calculate the infinite possibilities relating to opportunity cost, but I can see the importance. The comparison of one decision made against another not taken can cost a firm dearly and show us how well decisions are being made. This determines the decisions made in the future and the strength of the firms’ capability to add value to an investor.

I have learned previously that judgements and assumptions can be made using depreciation and revaluation to manipulate true value. Regardless of rules and regulations, firms will always use the best filters to present the best picture. Much like a photo on Instagram, the reality may be somewhat different, but the intent is similar, the poster presents the picture they want you to see. We need to be vigilant and scrupulous to find the underlying truths.

KCQ’s Preface and Chapter 1

ACCT13017 KCQ’s Preface and Chapter 1

Preface:

“Relying too heavily on other people’s opinions can damage our sense of reality.”

- Derek Rowntree

Absolutely, we need facts to create our own opinions and make decisions to suit ourselves. You only get one life, it’s important to make it your own, not someone else’s. Giving people the information returns the power dynamic to be able to control their own lives, in my opinion, the way it should be. We are all masters of our own destiny and should be entitled to accurate relevant information to make decisions to make the most of it.  What does it mean to conduct a fundamental analysis ourselves? What adds value to a genuinely interested stakeholder and why? I want to know, what adds value in a business and how does accounting help?

Chapter 1: Focus on Reality

It makes sense that investors will want to invest in a business that is doing well and would reflect so in the value of stock. Therefore, there is little need to rely on share price as an accurate measure of how well a business is doing, it is simply a reward for doing well in the past. But what of the future?

Fundamental Analysis:

From the investor’s perspective, fundamental analysis of the financial statements is a centrally forming assessment of the personal connection to a firm. A basis or a start with which judgements can be made according to what is valuable to an individual.

I’m seeing a lot of encouragement to make our own judgements and to connect our personal experiences. I can’t help but feel this is the why and how a person begins a business, invests in a venture and creates their own business agenda and what adds value not only in money terms but life fulfilment.

Efficient market hypothesis, finance theory? I’m curious about learning more and avoiding errors!

A Framework:

It seems that learning the discounted cash flow and discounted economic frameworks are the first important concepts to master and incorporate into a conceptual map. Focus needs to be on understanding the operating activities of a firm. Somehow, I must build a mental picture to create a mind map to manage an effective and efficient way to analyse financial statements, with a personal connection to draw on those skills time and time again and make excellent business decisions, personally beneficial.

 Personal and imprecise:

So, how do I currently think businesses add value, what does value adding even mean to me? I have gleaned form the study guide that a good financial statement analysis is insightful and convincing, it has to inspire confidence and be intelligent. Although using the frameworks give a precise measure of value for a firm, it is not foolproof, but it does provide a “safety margin”, if we make good judgements and assessments. Value is subjective, ‘one man’s trash is another man’s treasure’.

Economic Profit:

“Return on net operating assets (RNOA) is Operating income after tax (OI) divided by the Net operating assets invested in the business (including both working capital and non-current assets such as Property, plant and equipment).”

The opportunity cost is virtually impossible to measure. There are so many alternatives and missed opportunities available how on earth can one consider them all and waste the opportunity of time doing something else? I decided 6 years ago to embark on my accounting journey to gain qualifications firstly in a diploma and later a Bachelor of Business. I could have studied something else, Radiology for example, or simple TAFE courses, found employment or continued doing what I was doing. The list of possibilities was endless, but I analysed my options, placed my ultimate desires at centre and created a mental map of how to achieve that goal. I run my family as a business of sorts, every investment is completely personal so it’s important to make good choices. It also involves taking a risk but not without calculation and safety net.

“Also, the more a firm can invest in its Net operating assets at returns above its costs of capital, the more value a firm can create. In other words, growth creates value as long as RNOA is greater than the cost of capital on new investments of Net operating assets that a firm can make.”

Free Cash Flow:

“If you know the enemy and know yourself, you need not fear the result of a hundred battles. If you know yourself but not the enemy, for every victory gained you will also suffer a defeat. If you know neither the enemy nor yourself, you will succumb in every battle.”

  - Sun Tzu, The Art of War

A firms operating income less our net investment in the business for a period – change in net operating assets.

FCF = OI - ∆NOA

Omg light bulb!!! Of course, different firms need different amounts to generate profit. Using less capital to create the same income means better utilization of resources!!!! This makes the amount invested in the future more valuable!!! Of course, these are projections whereas Economic profit is a direct measurement, in real time, using the firm’s accounting profit compared to the cost of capital. It’s important to note that profitability and growth are two vastly different concepts. I’m starting to recall this from previous studies.

Operating and Financial Activities:

Breaking a firm’s financial statements in bit to analyse key aspects using the DCF and Economic frameworks….what key aspects???  I guess you can ignore how a firm is financed, that is equity (invested capital) and debt (borrowed capital) because in the end the result is how much you have to work with.  Separating the operating activities from the financial activities can show where the value is created…or not. I am unfamiliar with Modigliani and Miller theorems but embrace the challenge of new financial theorem aspects. 

Many Points of View:

I read Warren Buffets letter to his grandchildren many years ago and I don’t really remember much, but he does seem to defy the logic of the efficient market hypothesis.  If it directly relates to me as a relevant stakeholder I would take more notice. I look forward to taking the perspective of an equity investor and exploring just what’s of value to me in that role.  I do recall from previous units that successful businesses must take into account all relevant stakeholders, not just shareholders points of view, and remembering that we are also part of a community that will be affected by business decisions.  The financial statements need to be useful to these stakeholders and accessible. So, how do you access this information and how can you be sure it contains useful reliable information needed?

What it Takes:

Using the past, in the present to predict the future! What a concept! Structuring all the available information to relate to our current realities is quite the skill. It helps to have a guide, a map, a framework. It does seem overwhelming to precisely forecast a firms financial and operating activities using the financial statements. It’s my understanding that the Economic Profit and DCF helps direct our efforts using their current financial information. It will be interesting to analyse how and what this information reflects the decisions our firms make.

The Light at the End of the Tunnel

When I first began this journey or rather leap of faith, my at home children were ages 3, 5, 14,14 and 16. Since then 3 more of my gorgeous, resilient chidren have not only graduated highschool, attained higher education certification and acquired viable employment but have left the nest to be fully functioning independant adults!!! I am so proud of them and the leaps and bounds of the younger ones now in grades 3 and 5.  Child rearing itself is a challenge as has been studying but I can see the light at the end of tunnel.  

The time for finding viable employment myself and putting all this hard work to proper purpose is rapidly  approaching. All the HD's, D's, C's and P's won't mean bubkiss but a deep seated ingrained knowledge experience is soul filling and life enriching . This entire journey has required grit and determination and now is no time for slacking. It's kind of poetic to begin this adventure with Dr Turner and have him guide me towards the grand finale. As this subject is the embodiment of all we have learned so far, it's only fitting that the preliminary beginnings start with review.....and Peerwise too😃😃

"A determined soul will do more with a rusty monkey wrench than a loafer will accomplish with all the tools in a machine shop" - Robert Hughes - art critic and author