Concept of Financial Statement
Financial statements are the periodical documents prepared for the purposes of showing the financial and operational performance and position of the business entity. These are prepared quarterly, half yearly and annually (Williams &Dobelman, 2017). The main three financial statements are the “Income Statement”, “Balance Sheet”, and “Cash Flow Statement”.
- Income statement: It is prepared to calculate the profit or loss earned by the organization during the financial period. Accrual basis of accounting is followed for the preparation.
- Balance sheet: The main purpose is to know about the current value of liabilities, capital and assets.
- Cash flow statement: This statement is drafted to know about the real cash movement from and inside the business. It is very much accepted by the analysts since it is more realistic in nature. (Monahan ,2018).
Financial statement analysis
Every stakeholder wants to know about the financial and operational performance of the business entity they are associated with. Mere reviewing the published financial statements may not give in-depth picture of the organizational performance. Financial analysis helps the stakeholders to know about the performance of the organization from various operational points of views. Ratio analysis is an important tool of financial analysis. According to Ahmed&Safdar (2018), in such analysis, one financial item is represented with respect to some other financial item. Year to year comparisons can be done by accumulating the financial ratios of the past years and predictions can be done by using appropriate methodologies.
About the Company
Telstra Corporation Ltd. is a telecommunication service provider company based in Australia. The company operates in both international and domestic level. The services provided by the company include business and domestic telephone connectivity; international, local and long distance mobile and land phone calls. The company also provides directory services and other online services.
Telstra Corporation Ltd.
Income statement (In $M)
| Particulars | 2019 | 2018 | 2017 | 2016 |
| Total Revenue | 25,259 | 25,848 | 26,013 | 25,911 |
| Revenue | 25,259 | 25,848 | 26,013 | 25,911 |
| Cost of Revenue, Total | 9,138 | 8,338 | 7,671 | 7,247 |
| Gross Profit | 16,121 | 17,510 | 18,342 | 18,664 |
| Total Operating Expenses | 24,104 | 22,791 | 21,969 | 20,737 |
| Selling/General/Admin. Expenses, Total | 8,876 | 9,193 | 9,212 | 8,557 |
| Research & Development | – | – | – | – |
| Depreciation / Amortization | 4,282 | 4,470 | 4,441 | 4,155 |
| Interest Expense (Income) – Net Operating | -12 | 22 | -32 | -15 |
| Unusual Expense (Income) | 1,518 | 481 | 546 | 445 |
| Other Operating Expenses, Total | 302 | 287 | 131 | 348 |
| Operating Income | 1,155 | 3,057 | 4,044 | 5,174 |
| Interest Income (Expense), Net Non-Operating | -618 | -458 | -601 | -710 |
| Gain (Loss) on Sale of Assets | 686 | 601 | 686 | 335 |
| Other, Net | 1,849 | 1,939 | 1,518 | 801 |
| Net Income Before Taxes | 3,072 | 5,139 | 5,647 | 5,600 |
| Provision for Income Taxes | 923 | 1,582 | 1,773 | 1,768 |
| Net Income After Taxes | 2,149 | 3,557 | 3,874 | 3,832 |
| Minority Interest | 5 | 34 | 17 | -69 |
| Equity In Affiliates | – | – | – | – |
| U.S GAAP Adjustment | – | – | – | – |
| Net Income Before Extraordinary Items | 2,154 | 3,591 | 3,891 | 3,763 |
| Total Extraordinary Items | 2,017 | – | – | – |
| Net Income | 2,154 | 3,591 | 3,891 | 5,780 |
Balance Sheet
| Particulars | 2,019 | 2,018 | 2017 | 2016 |
| Current assets | $M | $M | $M | $M |
| Cash and cash equivalents | 604 | 629 | 938 | 3550 |
| Trade and other receivables and contract assets | 5,392 | 5,500 | 5468 | 4737 |
| Deferred contract costs | 95 | 69 | ||
| Inventories | 448 | 492 | 893 | 557 |
| Derivative financial assets | 179 | 75 | 21 | 62 |
| Current tax receivables | 7 | 6 | 11 | 8 |
| Prepayments | 457 | 431 | 531 | 426 |
| Assets classified as held for sale | 121 | – | ||
| Total current assets | 7,303 | 7,202 | 7862 | 9340 |
| Non-current assets | ||||
| Trade and other receivables and contract assets | 780 | 729 | 1039 | 1293 |
| Deferred contract costs | 1,232 | 1,180 | ||
| Inventories | 35 | 19 | 29 | 29 |
| Investments – accounted for using the equity method | 1,298 | 1,237 | 194 | 171 |
| Investments – other | 25 | 36 | 292 | 394 |
| Property, plant and equipment | 22,332 | 22,108 | 21350 | 20581 |
| Intangible assets | 7,210 | 7,922 | 9558 | 9229 |
| Derivative financial assets | 2,083 | 1,897 | 1623 | 2180 |
| Deferred tax assets | 59 | 54 | 44 | 54 |
| Defined benefit asset | 232 | 250 | 142 | 15 |
| Total non-current assets | 35,286 | 35,432 | 34271 | 33946 |
| Total assets | 42,589 | 42,634 | 42133 | 43286 |
| Current liabilities | ||||
| Trade and other payables | 4,528 | 4,528 | 4189 | 3948 |
| Employee benefits | 804 | 868 | 865 | 913 |
| Other provisions | 103 | 89 | 190 | 92 |
| Borrowings | 2,222 | 1,635 | 2476 | 2655 |
| Derivative financial liabilities | 57 | 1 | 42 | 286 |
| Current tax payables | 103 | 132 | 161 | 176 |
| Contract liabilities and other revenue received in advance | 1,657 | 1,532 | 1236 | 1118 |
| Liabilities classified as held for sale | 79 | – | ||
| Total current liabilities | 9,553 | 8,785 | 9159 | 9188 |
| Non-current liabilities | ||||
| Other payables | 68 | 65 | 70 | 66 |
| Employee benefits | 158 | 157 | 160 | 169 |
| Other provisions | 158 | 168 | 134 | 127 |
| Borrowings | 15,031 | 15,316 | 14808 | 14647 |
| Derivative financial liabilities | 283 | 388 | 536 | 663 |
| Deferred tax liabilities | 1,529 | 1,511 | 1539 | 1493 |
| Defined benefit liabilities | 8 | 7 | 6 | 4 |
| Contract liabilities and other revenue received in advance | 1,271 | 1,681 | 1161 | 1022 |
| Total non-current liabilities | 18,506 | 19,293 | 18414 | 18191 |
| Total liabilities | 28,059 | 28,078 | 27573 | 27379 |
| Net assets ( Shareholders Fund) | 14,530 | 14,556 | 14560 | 15907 |
Cash Flow Statement
| 2019 | 2018 | 2017 | 2016 | |
| Cash flows from operating activities | $M | $M | $M | $M |
| Receipts from customers (inclusive of goods and services tax (GST)) | 30,231 | 31,901 | 31,288 | 31163 |
| Payments to suppliers and employees (inclusive of GST) | -22,748 | -21,948 | -21,997 | -21179 |
| Government grants received | 156 | 174 | 235 | 182 |
| Net placement of deposits that are not part of cash equivalents | -173 | |||
| Net cash generated by operations | 7,639 | 10,127 | 9,526 | 9993 |
| Income taxes paid | -956 | -1,521 | -1,751 | -1860 |
| Net cash provided by operating activities | 6,683 | 8,606 | 7,775 | 8133 |
| Cash flows from investing activities | ||||
| Payments for property, plant and equipment | -3,235 | -3,571 | -3,725 | -3051 |
| Payments for intangible assets | -1,135 | -1,361 | -1,596 | -1143 |
| Capital expenditure (before investments) | -4,370 | -4,932 | -5,321 | -4194 |
| Payments for business and shares in controlled entities (net of cash acquired) | -115 | -56 | -63 | -92 |
| Payments for equity accounted investments | -21 | -15 | -6 | -38 |
| Payments for other investments | -26 | -67 | -76 | -67 |
| Total capital expenditure (including investments) | -4,532 | -5,070 | -5,466 | -4391 |
| Government grants received | 53 | 91 | – | 470 |
| Proceeds from sale of property, plant and equipment | 646 | 796 | 679 | 1340 |
| Proceeds from sale of business and shares in controlled entities (net of cash disposed) | 42 | 49 | – | 56 |
| Proceeds from sale of other investments | 6 | 24 | 285 | 82 |
| Distributions received from equity accounted investments | 33 | 9 | 10 | 131 |
| Interest received | 33 | 65 | 109 | 105 |
| Proceeds from finance lease principal amounts | 104 | 125 | 104 | -2207 |
| Net cash used in investing activities | -3,615 | -3,911 | -4,279 | 5926 |
| Operating cash flows less investing cash flows | 3,068 | 4,695 | 3,496 | |
| Cash flows from financing activities | 4987 | |||
| Proceeds from borrowings | 4,669 | 4,195 | 4,710 | -3954 |
| Share Buyback | -1,502 | -101 | ||
| Repayment of borrowings | -4,637 | -5,148 | -4,571 | 0 |
| Repayment of finance lease principal amounts | -79 | -120 | -131 | -68 |
| Purchase of shares for employee share plans | – | -18 | -22 | 0 |
| Finance costs paid | -781 | -776 | -854 | -860 |
| Dividend paid to equity holders of Telstra Entity | -2,259 | -3,150 | -3,736 | -3787 |
| Other | -1 | 2 | 2 | 6 |
| Net cash used in financing activities | -3,088 | -5,015 | -6,104 | -3777 |
| Net decrease in cash and cash equivalents | -20 | -320 | -2,608 | 2149 |
| Cash and cash equivalents at the beginning of the period | 620 | 936 | 3,550 | 1396 |
| Effects of exchange rate changes on cash and cash equivalents | 4 | 4 | -6 | 5 |
| Cash and cash equivalents at the end of the year | 604 | 620 | 936 | 3550 |
Profitability analysis
In this section, the profit earning capacity of the company has been outlined. Both the net profit margin and EBITDA margin has been used for the purpose of analysis.
Comment: Net profit margin percent is continuously declining since 2016. It was 21.36% in 2016 and downgraded to 7.74% in 2019. Also the EBITDA margin declined from 23.32% in 2016 to 13.97% in 2019. This is mainly due to suffering from outrages in network since 2016. Continuous operational disruption is the another cause of fall in the profitability position.
Efficiency analysis
The organizational performance is measured in terms of the efficiency in the process of providing goods and services. Cash generation capacity is another important indicator. The operating cash flow ratio, asset turnover ratio and cash return on asset ratio are the important measures used in the analysis. (Campisi et al. 2019)
Comment: During the period 2016 to 2018, the operational efficiency was quite satisfactory. All the efficiency ratios depicts almost same pattern of activity. Since 2018, a negative growth rate is identified in all the ratios and it is expected to be continued in the upcoming years. The ‘ Telstra 2022 Plan” is the main reason behind this outcome.
Short term solvency
The liquidity position is a measure for the day to day asset management efficiency. Current and quick rations are applied for the analysis.
Comment: A negative growth pattern can be identified from both the quick and current ratio analysis. The short term liquidity position is deteriorating gradually since 2016. In 2019, the current ratio is 0.76:1. On the other hand, the quick ratio is 0.71 in the same year. The change of CEO and failure of the joint venture plan in the “Philippines” are the driving forces behind such result.
Long term solvency
Long term liquidity stability is the basic requirement for the survival of the business in the long run. It indicates the long run debt paying capacity of the firm (Otekunrin et al. 2018). Capital structure position and the debt equity ratio have been used for analysis.
Comment: The positive growth in the value of the ‘non-current liabilities” indicate that the company is borrowing funds and reducing the proportion of equity in the “capital structure”. Though the debt proportion declined in 2019, yet the overall increase in the debt proportion increases the risk of default. Since the company is facing several operational disruptions since 2015, the long term solvency position is not satisfactory.
Market based ratios
Market based ratios are applied to analyze the company’s performance from the shareholders point of view. Book value per share and operating cash flow per share are used for the purposes of analysis.
Comment: Both the book value per share and operating cash flow per share are showing highest positive value in 2018. This is perhaps due to the removal of the CEO Andy Penn. The job loss of 9500 employees as a consequence of the “Telstra 2022 plan” had very negative impact on the share price in 2019. Dividend cut is another cause for such result.
Recommendations for improving the business
Since Telstra Corporation Ltd. is facing a number of problems since 2015, it is recommended that the company needs to comply with proper strategy for the future. The Australian market can be captured by adopting a new strategy by simplifying set of product and operations, enhancing consumer experience and minimizing the total cost (Rakićević et al. 2016). A five year plan can be formulated on the basis of the 2016 strategic investment plan. This strategy main basically change the feature of telecom products and services in the Australian Market by enhancing the customer value. This new strategy can enhance the capabilities already acquired by the company since 2016 in the domain of digitization and networking. The largest and smartest new generation networking system shall be implemented for both domestic and business uses. This digitization program shall deliver the steps of new technology for enterprise and consumers which shall be the base for launching new products and services (Ibrahim et al. 2019). The main areas in which the management of the company should focus for the purposes of expansion of market and goodwill enhancement are discussed below:
- Simplification of product and service offerings and enhancing consumer experience
This shall be a totally different approach to the existing and the potential market by addressing the requirement to enhance the transparency, simplicity and satisfaction that the potential consumers will experience. This is an initiative to make some fundamental changes to the process of designing products, customer supports and after sale services. The new investment strategy in networking and digitization will eliminate many existing plans and some plans may be introduced which are required to be backed by an efficient and effort less online customer services. For business and enterprise customers, some best solutions can be offered. The business organizations, the company may remain the best “one stop shop” for every business to business technology requirements, by offering the customers curated, modular and simplified portfolio of products and services.
- Establishment of an unit of infrastructure business
A wholly owned infrastructure unit for business can be established for the purpose of availing the facility of fixed networking system of high quality. This business unit may report to the company CEO for the purpose of fulfillment of legal compliances. This infrastructure company may provide networking infrastructure services including copper, domestic fiber, HCF, data centers, poles, subsea cables, pipes and ducts. The NBN Company, wholesale customers and Telstra may purchase services from this standalone company. Since the innovations in technology largely rely on the networking system, the function of telecommunications setup and infrastructure is becoming very crucial. By establishing a separate infrastructure unit, the business can better manage and optimize its business operations.
- Simplicity of organizational structure
The company may implement a new organizational structure and operating model to simplify the organizational functions. The ways in which the organizational functions are conducted can be realigned and simplified to focus on the product leadership and better customer services. A separate company can be established for providing the large scale backhouse processes and other related functions for the purpose of cost reduction for heavy repeatable operations. This separate unit shall report directly to the Telstra. The main focus of this company should be on product development and the overall management across the business by enhancing leverage and also sharing the technical efforts among various customer segments.
- Portfolio management and cost reduction
During the period 2017-18, company narrowed the strategy for ensuring all new investments which mainly focused on services and products very close to the core business. Since that time decision have been taken to restructure the strategy of investment in Ooyala, Foxtel and for streamlining the health related business. The company may try to monetize its assets up to $2.5 billion during the next two or three years for the purpose of strengthening the balance sheet position. The company may also increase the target for or productivity plan by an additional amount of $1.5 billion for reducing the underlying fixed costs by the amount of $2.5 billion by the year 2022. It is expected that the total costs and remain same on a reduced in spite of the absorption of around $1.5 billion or more as compared to the total cost incurred by NBN.
Therefore, it can be said that the main driving forces behind the enhanced productivity targets include the simplification of products and service offerings, phasing out old systems and delivering customers products and services with more value. On the other hand service channels; sales digitization and continuous process of improvement in the procurement process are the other factors behind the success of the company.
Investment analysis and project appraisal is very important before investing money into any project.
Assumed dataset for investment
| Cost of equity | 11.50% |
| After tax cost of debt | 3.30% |
| Total Investment (Assumed) ($) | 100 |
| Tax rate | 26% |
It is assumed that there are three alternative investment plans. In the alternative 1, the debt equity mix is 60: 40. In alternative 2, the ratio is 70:30 and in alternative 3, the ratio is 80:20.
Cost of capital evaluation
| Particulars | Alternative 1 | Alternative 2 | Alternative 3 |
| Equity | 4.6 | 3.45 | 2.3 |
| Debt | 1.98 | 2.31 | 2.64 |
| Total Cost per $100 | 6.58 | 5.76 | 4.94 |
Comment: Alternative 3 is more acceptable than the other investment plans, since the total cost per $100 is minimum for alternative 3, which consists of 80% debt and 20% equity. Debt financing yields greater return for the firm since the total cost of capital is minimum.
Net present value
This is a scientific technique applied for the purpose of project evaluation before investing money. According to Ben-Horin& Kroll (2017), it considers time value of money and also associated risk factors.
Weighted Average Cost of Capital
This is a percentage of the total return expected by the external and internal fund providers. Weights are assigned to the individual capital structure components on the basis of their proportion in the total capital structure.
a. Alternative plan evaluation
A comprehensive analysis has been made to evaluate three alternative investment plans on the basis of the total cost of capital for each alternative. The investment plan with highest net present value is to be selected for investment.
Calculation of the net Present Value for alternative plans
| Year | Cash flow after tax ($) | Alternative 1 | Alternative 2 | Alternative 3 | |||
| Discounting factor | Present value ($) | Discounting factor | Present Value ($) | Discounting factor | Present Value ($) | ||
| 1 | 2000.00 | 0.94 | 1876.52 | 0.95 | 1891.07 | 0.95 | 1905.85 |
| 2 | 2500.00 | 0.88 | 2200.84 | 0.89 | 2235.10 | 0.91 | 2270.17 |
| 3 | 2600.00 | 0.83 | 2147.56 | 0.85 | 2197.91 | 0.87 | 2249.83 |
| 4 | 3000.00 | 0.77 | 2324.98 | 0.80 | 2397.92 | 0.82 | 2473.76 |
| 5 | 3000.00 | 0.73 | 2181.44 | 0.76 | 2267.33 | 0.79 | 2357.31 |
| TOTAL PRESENT VALUE | 10731.34 | 10989.33 | 11256.91 | ||||
| Less, Initial Investment | 10000.00 | 10000.00 | 10000.00 | ||||
| NET PRESENT VALUE | 731.34 | 989.33 | 1256.91 | ||||
Comment: According to the net present value evaluation, the alternative 3 is the best investment plan since the net present value is highest. On the other hand, the 1st alternative investment plan with higher proportion of equity yields lower amount of net present value. Therefore, in the long term investment proposal, the company should focus on external sources of funds rather than the equity financing.
b. Use of retained earnings or own cash for investment
If the company has future growth potential and has investment options which would yield higher return than the equity cost of capital, then the company utilizes the part or full of the retained earnings for the purpose of further investment. The company is planning to expand its business, which would automatically enhance the value of the shareholders. Another important point is that the opportunity cost of idle cash at bank and retained earnings should be evaluated. If which case, the opportunity cost is lower, that source should be utilized for the purpose of investment. Since the company is planning to expand its business, the “retained earnings” should be utilized. On the other hand, the cash balance can be optimally utilized for the “working capital management”.
Question 4
Decision on income distribution
The distribution of income among the shareholders is an important decision area in corporate finance. Since the main objective of any corporation is to enhance the market price of the share, the division policy should be formulated in such a way, so that the enterprise value maximizes. For those companies which have many investment opportunities and the internal rate return is greater than the cost of equity, reinvestment of profit is the best choice(Nambukara-Gamage&Peries, 2020). On the other hand, those corporate which does not have investment opportunities with higher return, should distribute the surplus among the shareholders as dividend. Telstra Corporations Ltd. has been facing various problems since 2015 and as a result of that the payment of dividend has been disrupted. In the year 2018, 10% fall in the dividend payout ratio was observed as a consequence of the fall in the net profit after tax by around 40%. During the tenure of CEO Andy Penn, the company lost its market value to a great extent. The dividend cut was announced by the company which led to the fall in the price of the share by approximately 10 percent. The “Telstra 2022″ plan is expected to be a turning point of the company, since various reforms were proposed. Since the company is going to implement the new strategy, it requires money for investment. In such a situation, pay out of dividend is not a good option for the company. The company largely depends on the external financing, which is a major source of credit risk. To neutralize that risk factor, the investment of retained earning can play a crucial role. Payout of dividend may enhance the share price in short run. But the investment of retained earning can increase the overall value of the business in the long run by providing long term return in terms of capital gain to the shareholders. Therefore, the reinvestment of accumulated profit is the best option for the company. Due to the outbreak of coronavirus pandemic, the financial market across the globe is suffering to a great extent. Many listed companies on ASX are preserving their capital and trying to strengthen the balance sheet position. As a consequence, the company is adopting the policy of capital protection by deferring the dividend payouts. The uncertain economic conditions may put the company’s dividend in future at risk. Telstra have recently paid 8% interim dividend per share by distributing $951 million to the equity shareholders. Under the unfavorable economic condition, investors and analysts are analyzing the future dividend policy of the company during the post pandemic period. Telecommunication companies play an important role in the economic and social aspects in Australia. The telecommunication services provided by the Telstra are very important and it has exposure at low level “discretionary spending”. On the other hand, Telstra experienced huge demand for internet data for communication with larger proportion of the total Australian workforce since maximum employees are working from home. Though the “Telstra 2022″ plan is an important scope of investment and may reduce the dividend payment, it is expected that in the long run the company would pay adequate amount of dividend to its shareholders and maximize their market value with largest market share.
References
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Online sources:
https://www.macrotrends.net/
https://www.gurufocus.com/term/wacc/OTCPK:TLSYY/WACC-/Telstra#:~:text=Telstra%20WACC%20%25&text=As%20of%20today%20(2020%2D11,using%20TTM%20income%20statement%20data).