Corporate MOTing: Hints and Tips on Interpreting Business Reportage: Part two: Show me the money by Doreen Soutar
Let me tell you about financial ratios. Financial ratios were developed in the dim and distant as a way of finding out whether a company was worth investing in. Theoretically, financial ratios can tell you how much profit the executive team are making out of every buck that is invested with the company, and whether they are likely to be able to keep on doing it.
They really are quite clever in some ways, because you can take any two companies of any size in any business, working to any fashionable business guru you like, and financial ratios will put them on an even playing field and tell you which one is doing the best at making profits. Now, there is indirect and implied information you can get out of financial ratios, but at the absolute core, financial ratios are all about how much bang for their buck the shareholders are going to get.
It is that simple.
And you need to remember that: business is about profits for company owners.
Now this is not a Marxist rant about how the workers are oppressed and how the owners of the means of production live off the fat of the land. Yes, I admit it does come off as sounding a bit socialist, but that is only because the profit maximisation mantra is a concept that is shared by capitalists and socialists. Companies do indeed go all out to make as much money as they possibly can. In fact, if you look at public companies – with shareholders who own the company and an executive team who run it – this profit maximisation mantra is enshrined in law.
Let me repeat that: the Chief Executive Officer is responsible to the shareholders for making them as much money as possible by whatever means possible.
Are we clear on that? So with that in mind, let’s look at some common ratios investors look at when they decide whether the CEO is doing a good job. Let’s check one out so you can get a flavour for them.
The oldest ratio – the first one to be developed – is the current ratio. Basically, you take the current liabilities (purchases to you and me) and the current assets (retail sales, give or take) and you divide one by the other to get a figure on roughly how much profit you are making.
If we look at Royal Dutch Shell’s accounts, the Consolidated Statement of Income on p.103, followed by the Consolidated Balance Sheet on p.104.
Now there are a lot of numbers and calculations on the previous hundred pages, and I will leave you to imagine why it takes them so long to get down to the nitty gritty. In their defence, they don’t just go out and buy an oil rig at B&Q and suck petrol out the ground. It’s a complicated business. We can appreciate that, can’t we? Course we can.
But pages 103 and 104 is where all the diverse stuff has been put into a single set of figures that we can use.
So, if we are looking to calculate a current ratio on Royal Dutch Shell, their current assets stand at $103,343 million. Their current liabilities are $93,258 million. The ratio achieved by dividing the assets by the liabilities is roughly 1.108. Obviously, the assets are bigger than the liabilities and that basically means that they have brought in more money in sales than they have had to put out in creating the product. Super.
Of course, you might note that the current assets and current liabilities do not equal the total assets and total liabilities. So they are doing other stuff to make money, and they have other expenses to pay out. And this is where shit gets tricksy. Manners cost nothing?
For example, let me draw your attention particularly to an item labelled “Intangible Assets”. Intangible assets are literally assets that you can’t touch. In fact you can’t touch them, see them, or feel them. They are a combination of knowledge, experience, and reputation. Now you could see how a company could be more profitable if it had a load of original ideas, fantastically smart research and development scientists, and everybody thought their products were the dog’s bollocks.
But look at the ratio of intangible assets in relation to other assets. In the Royal Dutch Shell accounts, intangible assets were valued at $191,897 million. That is almost double their retail sales of £103,343 million. In fact, intangible assets are by far the biggest item in the Royal Dutch Shell asset list. The next closest item is ‘trade and other receivables’ (the actual oil-type stuff they sold to customers) at $63,638.
Cool! Shell must have loads of knowledge and experience if it is worth three times as much as the actual oil they sell. Could I just ask one itsy bitsy question here: how did they put a value on something intangible? Oh, yes, I am sure there are formulas and explanations, but it is not like they can count ideas like barrels of oil. And an idea can only be as good as the number of people who are using it.
I mean, copying new developments is a nightmare in the information computer technology industries. Apple and Samsung are never out of court trying to keep their research and development results to themselves. A company that has to reduce its intangible assets figure might not seem quite so profitable to new investors.
But let’s look at it from the other direction: what if you have loads of good stuff, but you are also paying a lot of tax? Could anyone seriously suggest with a straight face that no tax lawyer in any publically listed company has ever thought of devaluing a good idea or the value of the company brand if it got them out of paying tax?
At the very least, there is an argument to be had about just how many dollars, say, the Starbucks logo is actually worth. I mean, how many are there out there? How many people see them? Are they accounted for by square inch sizeage or by repetitions per square kilometre?
So to recap: the numbers you see in an annual report do look like exact amounts. They are numbers, for fuck’s sake. They give off this air of being precise, rational, and definite. But that is smoke and mirrors.
The exact number you see is the result of a multitude of manipulative decisions about what gets counted and how, based on a balancing act between looking like a great bet for new investors buying shares, and a poor, struggling enterprise barely making ends meet to the tax department.
And talking of poor, struggling enterprises, let’s take a look at the Statement of Income and Balance Sheet of Capital City Partnership Limited. Let’s see if we can apply the current ratio we applied with Royal Dutch Shell: current assets divided by current liabilities. And indeed, we find that net current assets are £1,168,461.
- But in the case of Capital City Partnership Limited, there are no current liabilities.
- Hmm, now that is a bit of a bugger.
- How do we tell if the company is profitable?
- Good question.
- If you take the time to look, Capital City Partnership Limited is not a limited company after all – it is a charity.
- So why is it called ‘limited’?
- Another good question.
- It is a little puzzle. Why are they named this way? Answers on a postcard.
- Of course, it would have nothing whatsoever to do with how the company/charity reports how it has disposed of all the money it has received, would it?
- No: that isn’t possible: we know from the accounts that Capital City Partnership Limited don’t have any good ideas, or knowledge, or experience, or brand value.
- How do we know this? In contrast to Royal Dutch Shell, where the company reports a magnificent set of intangible assets, Capital City Partnership reports no intangible resources whatsoever.
The importance of being Frank and Earnest
If you are getting the feeling of being sucked into a quicksand of half-truths and statistics produced by obsolete number crunching machinery vomiting endless rows of figures ticker-taping down on you a la Alice in Wonderland, you are not alone. It can be quite vertiginous to realise that this short piece is but a mere snippet of the machinations of business accounting.
But let’s look at what we have learned: by one simple action of division, we have learned that Shell does make a bit of profit from actually selling oil, but not exactly a huge amount. They gain much more profitability from intangibles, which might mean that they hire out experts or sell blueprints for unique tools and equipment to other companies. Everybody knows their brand and their logo, and that alone is worth a chunk of change.
If you fancy checking out some stuff yourself, try looking into Apple’s intangibles and brand value in comparison.
So if you can do this with a few random pieces of information, imagine how much information you could extract with a complete set of financial ratios and the determination to get to the bottom of the way a company works. Yes, I can see how it might appear to be an odd kind of fun, but hey, the world would be no fun if we were all the same, and if no-one was willing to dive into the financial quicksand, companies would be getting away with a whole load of stuff.
- Oh, that’s right, they are getting away with a whole load of stuff.
- Somebody should do something about that.
- Shouldn’t they?
- While you are thinking about who might be a good person to be checking up on companies we give our hard-earned cash to, why not meet me back here for the third and final part of company MOTing: SWOTS, PESTS, and Corporate Social Responsibility.
Oh, go on – you know you want to.
After all, look at how much intangible assets can be worth, right?
Some helpful online resources:
Internet Research Clinic: The Research Clinic features internet research links, training and apps. It accompanies the training courses delivered by renowned Internet research specialist Paul Myers. As the internet grew in significance, Paul was able to blend his technical knowledge of the medium with the realities of his work in the BBC. As a result, he was able to devise many groundbreaking techniques and strategies that continue to shape the way journalists conduct online research and investigation. Paul heads up BBC Academy’s Investigative Hub project. This sees him work within program teams, solving issues related to investigation whilst sharing vital new skills with those he works with. Paul will source experts in diverse fields as required. He also manages and delivers training related to various related areas such as online research, business research, due diligence, people research, data journalism and analysis, reporting of statistics, social media investigation, digital security, saving and verifying evidence, digital photography, web design and image production.
Full Fact: Full Fact is the UK’s independent, non-partisan, factchecking charity. We check claims made by politicians, the media, pressure groups, and other voices in public debate, and push for corrections where necessary. We also work with government departments and academic research institutions to improve the quality and communication of technical information at source, and campaign for greater transparency in the public arena:
Corporate Watch: Corporate Watch is a not-for-profit co-operative providing critical information on the social and environmental impacts of corporations and capitalism. Since 1996 our research, journalism, analysis and training have supported people affected by corporations and those taking action for radical social change: