Finance

INTRODUCTION

Major constituents of the cost are energy & power – over 60% of the cost of production of cement – and transportation costs. In addition to these elements efficiency of the production process is critical in keeping the overall cost structure competitive. In this regard, the size of the plant, its age, and origin – European or Chinese – are of importance. Until recent years, almost all the plants operating in the country were based on furnace oil, but the increasing furnace oil prices forced the cement industry to switch over to Coal-powered/dual-fuel plants. However, the price of coal has shown significant volatility over the recent periods therefore, some producers, having dual-fuel plants, use a mixture of coal and gas, alternating between the two as per changes in prices and availability.

Cement Sales during FY-10 Compared To FY-09 Source: All Pakistan Cement Manufacturers’ Association As per All Pakistan Cement Manufacturer’s Association (APCMA), the cement sales in FY-10 totaled 34. 20 million tons, registering a decent Year-on-Year (YoY) growth of 9. 30% compared to 31. 29 million tons in FY-09. The local dispatches remained at 23. 54 million tons, up YoY 14. 63% compared to 20. 53 million tons in FY-09 whereas export sales in FY-10 remained almost flat with a minor decline at 10. 66 million tons, down YoY 0. 89% compared to 10. 75 million tons in the previous year. As shown in the table, the local sales were the primary driver behind the growth. It is pertinent to note that the growth on the local front was mainly private-sector driven rather than the Government’s infrastructure spending, showing signs of recovery in the construction sector.

INDUSTRY STRUCTURE

Industry Characteristics

The cement industry is highly cyclical in nature and its performance depends largely upon the economic growth of the country. There is a high degree of correlation between GDP growth and the growth in local cement consumption. Source: State Bank of Pakistan & All Pakistan Cement Manufacturers’ Association Cement exports depend largely upon the demand/supply situation, price levels, and economic situation in the export regions. Cement, being a voluminous product, is a regional commodity.

Critical Factors

The cyclical nature of the sector along with the excess supply situation, whenever it persists, makes cement price a very critical factor. Some level of industry ‘co-opetition’, i. e. cooperative competition, is evident in cement industries globally such as consensual pricing. In the absence of such an arrangement, along with a supply glut, cement industries have witnessed intense price wars. Power & Energy costs constitute over 60% – 65% of the total cost of cement production. Therefore, smart inventory management of coal, along with hedging techniques, etc. lead to significant savings in energy costs. Plants closer to the port have cheaper access to exports and can maintain higher profit margins. Therefore, distance to port is an important consideration. Leverage, both financial and operating, is a major concern owing to the price-sensitivity of the sector. Pakistan’s cement sector is highly leveraged. Cautious capital structure management and utilization of relaxations/incentives provided by the government, whenever possible, such as the Export Refinance facility offered by the State Bank of Pakistan, create a significant difference.

Industry Concentration

Concentration refers to the number of major competitors in a given industry. This has important implications for the inherent profitability of a sector. We have applied the Eight-Firm concentration ratio to determine the concentration in the cement sector. Concentration ratios can generally be categorized into low, medium, and high concentration being 0% – 50%, 50% – 80% and 80% and above, respectively. An eight-firm concentration ratio over 90% is a good indication of oligopoly, i. e. an industry dominated by a small number of sellers. Based on FY10 market shares, the Eight-Firm concentration ratio in the cement sector is 80% which shows clear signs of high industry concentration. Therefore, the cement sector has an oligopolistic structure. However, given the excess capacity situation cement industry has been behaving like a ‘low concentration industry’ from time to time such as the intense price war in the recent past, pning nearly a year, with participants vying for higher volumes.

Market Share

The following pie-charts show the local, export, and total market shares of the top 8 players in the sector for FY-10. The charts show that D. G. Khan Cement is the leading player in the local market (17% market share) closely followed by Bestway (16. 7%) and Lucky Cement (13. 3%). In the export market, Lucky cement leads with its roaring 32. 8% share, followed by D. G. Khan and Bestway cement’s 9. 3% share each. Overall, Lucky Cement appears to hold the highest market share (19. 4%), followed by D. G. Khan (14. 6%) and Bestway (14. 4%). Maple Leaf Cement ranks fourth in all three categories with 9%, 11. 1%, and 9. 7% market share in the local, export, and the overall market. Source: Fortune Securities .

SECTOR OVERVIEW

FY10 Cement Sector in FY-10 witnessed low prices, rising energy costs, the slowdown in construction activities locally and regionally, and a large amount of new supply availability in regional markets resulting in drying out of certain lucrative export avenues especially the Middle East. However, exports to African countries, Iraq, Sri Lanka, etc. mitigated the effect and exports remained flat at 10. 66 million tones (YoY down 0. 89%). As expected by market participants and analysts local sales picked up to close the year at 24. 53 million tons (YoY up 14. 63%). Overall, the sector closed the year at 34. 20 million tones, registering a decent YoY increase of 9. 30%. Cement prices and energy costs remained the key issues in FY-10. Since the dismantling of the alleged cement cartel, after the Competition. Commission of Pakistan imposed a fine in the colossal sum of Rs. 6. 35 billion on 20 cement manufacturers (equivalent to 7. 5pc of each company’s FY08 net revenue), in August 2009, cement prices plunged and went down to Rs. 249/bag in North and Rs. 280/bag in the South zone, compared to Rs. 335/bag and Rs. 370/bag in FY09 in North and South, respectively.

CCP’s decision has been challenged by the cement manufacturers on a number of grounds in the Lahore High Court, the Sindh High Court, and the Supreme Court of Pakistan. In all these cases stay orders have been granted by the Courts and the matter awaits the court’s verdict. Given the increased overall supply in the regional markets, the cement export price hovered around $47-$52 per tone, compared to the average export price of $60-$62 in FY09. On the other hand, energy costs remained on the rising trend and coal prices averaged around $88 (FoB) per ton compared to the 2nd half FY-09 average of $70. Australian (Newcastle) coal price made its 18-month high of $108 (FOB) per ton on April 27, 2010, after making a low of around $61 (FoB) per ton in Mar-09 last year. Thus, as a result of subdued prices and increasing energy costs, a sub-breakeven scenario prevailed in the industry for the most part of FY-10. In 9 months FY10, cement companies posted cumulative losses of Rs. 3. 3 billion compared to profits of Rs. 3. 7 billion in the corresponding period last year, YoY down 189%. Cement prices hiked by Rs. 40 per bag in North in June 2010. With no price moves in South – a region that was already enjoying higher prices due to lower intensity of price war largely for its geographical advantages – prices in the two regions finally came at par. FY-10 also saw the announcement of a 35% inland freight subsidy, during March 2010, on cement exports. It is likely to make Pakistan’s cement exports more competitive in the regional market, as cement manufacturers will be able to reduce their export prices by almost 10% going forward, if needed, without hurting their margins. However, the government needs to make timely payments to the manufacturers for the subsidy to be of much use.

SECTOR OUTLOOK

Local market. Short Term Cement prices have risen by Rs. 24 per bag since the beginning of the ongoing financial year to Rs. 312 and Rs. 325 per bag in North and South, respectively. This bodes substantially well for the sector after bleeding profusely in a price war and indicates a price consensus among the manufacturers. Also, we believe there is a limited appetite for price wars going forward especially as seasonal 1Q demand slowdown kicks in (Monsoons, floods, Ramadan, etc. ). The recent floods have severely affected the roads and the distribution network which will inevitably hurt the local cement sales as well as export sales to some extent. We expect cement demand from the local market to remain subdued during the first half of FY11, due to monsoons, flood-related issues, the slowdown in construction during winters, etc. , and start picking up from 3Q FY-11, in the wake of reconstruction activities. Overall, we expect local dispatches to remain flat during FY-11 and believe that the real impact of the increased demand from reconstruction activities will materialize during FY-12. We believe the cement prices have hit the ceiling for now and do not expect further increase in them and expect the recent price hikes to sustain for a relatively longer time than the one-step ahead, two steps back situation that prevailed throughout FY-10. Going forward, Fauji Cement’s capacity expansion, due in FY-11, of 2. 27 million tons, would create downward pressure on utilization levels. However, we expect capacity utilization levels to remain between 70% to 75% range.

Medium to Long Term

We have a positive outlook for the local market on a medium to long-term basis. The rehabilitation work along with the construction of dams will boost demand and possibly push prices upwards as cement manufacturers operate on higher and higher capacity utilization levels. Construction of dams seems inevitable given the power crisis and the recent flood. The Council of Common Interests (CCI) unanimously approved the construction of Diamer Bhasha dam on July 18, 2010, leading the way for the release of funds from the Asian Development Bank (ADB). The projected timeline for completion is stated by the end of 2019. Manufacturers estimate a total requirement of 9. 0 to 11. million tons of cement for the project with annual demand in between 1. 0 to 1. 5 mn tons. While all northern manufacturers would directly or indirectly benefit from the project, we believe the big players such as Askari and Bestway would be the key beneficiaries with proximity to the project. 5. 9 Export Market We are pessimistic about the export dispatches during FY-11 owing to i) increased availability of cement in the regional markets, especially after lifting of the export ban in Saudi Arabia, ii) slowdown in construction in the Middle East and iii) local transportation problems ensuing from the flood. Therefore, we expect a decline of 10-15% in exports during FY-11. Our export price outlook remains flat around $45, keeping in view the competitive environment in the export market. During FY-10 exports to Qatar, Oman, UAE, and Kuwait declined whereas exports to Afghanistan, Djibouti, Sudan, Sri Lanka, and other African Countries increased, as shown in the chart. We expect the trend to continue going forward as cement producers penetrate further into the African markets. Source: TDAP 5

FINANCIAL ANALYSIS – CEMENT MAJORS

On the 9M-FY10 basis, the top-7 cement players face a tight liquidity situation with the Current ratio at 0. 71x, Quick ratio at 0. 63x, Cash Ratio at 0. 05x and an Operating Cash Flow ratio at 0. 16x. Among the Top-7, Attock Cement is the most liquid with a Current ratio at 2. 67x, Quick ratio at 2. 33x, Cash ratio at 0. 66x, and Operating Cash Flow ratio at 1. 02x. Overall, the Top-7 Average liquidity ratios show a low ability to settle short-term financial obligations as well as finance additional sales without incurring further debt. 6. 11. 2 Financial Leverage (average) among the top-7 cement players is at 0. 1x, which seems moderate. Bestway, Maple Leaf, and Pioneer Cement have financial leverage at 2. 32x, 3. 56x, and 1. 64x, respectively, which is high. Lucky and Attock Cement have financial leverage in control, at 0. 35x and 0. 25x, whereas D. G. Khan Cement’s financial leverage stands at 0. 67x. The average Interest Coverage ratio is at 1. 04x, which means, on average, the cement players barely have enough earnings to meet their finance charges. Given the high financial leverage and low-Interest Cover, we believe cement companies’ ability to take on further financing is highly subdued, with the exception of Lucky and Attock Cement.

Asset Utilization

We have adjusted the Asset Utilization ratios to reflect the full year (extrapolated) sales by a 4/3 adjustment factor. The resulting ratios, fixed asset turnover at 0. 65x, and total assets turnover ratio at 0. 45x, suggesting overall low asset utilization, point towards the capital intensive nature of the industry marred with low capacity utilization levels. Among the top-7 players, Lucky Cement seems to have the most efficient asset utilization with fixed assets turnover at 0. 90x and total assets turnover at 0. 75x levels. Lafarge Pakistan cement’s asset utilization ratios rank lowest among the Top-7, being 0. 3x and 0. 11x on a fixed and total assets turnover basis, respectively. Lafarge’s extremely low asset utilization levels call for further investigation into the causes. 6. 11. 4 Profitability We have adjusted the Return on Assets (ROA) and Return on Equity (ROE) ratios to reflect the full year (extrapolated) sales by a 4/3 adjustment factor. The resulting ratios suggest moderate gross profitability and basic earnings power, at 21. 26% and 9. 68%, respectively. However, the final profitability is extremely low at 0. 03% reflecting the sky-rocketing financial charges. Bestway, Maple Leaf, Lafarge, and Pioneer have negative net margins at -6. 7%, -18. 33%, -24. 86% and -14. 38%. Attock Cement appears most profitable during the period under review, with Net margins at 13. 32% followed by Lucky Cement at 12. 02%. Both these players have managed to post decent net profitability partially due to higher retention prices in the South, compared to North, and higher export contribution margins. During 9M-FY10, Maple Leaf, Lafarge, and Pioneer Cement posted negative Basic earnings power at -3. 14%, -13. 94% and -10. 95%, respectively, which points towards the intense price war, especially in the North, throughout the period under review. D. G. Khan Cement has managed to post a decent EBIT margin, at 16. 91%, however, the financial charges, which amount to Rs. 1. 5 billion for 9M-FY10, have left only 3. 79% in net margin.

DuPont Analysis is an expression that breaks Return on Equity (ROE) into three parts, profit margin, asset turnover, and equity multiplier representing, the operating efficiency, asset utilization efficiency, and financial leverage, respectively. Our DuPont analysis of the top-7 players suggests that the main reason behind the low industry ROE during the period under review has been low profitability. The price wars during the period under review, along with high financial charges have severely affected the ROE. Asset utilization is not too healthy either but is moderate. 6. 11. 6 Conclusion Based on our financial analysis, we have a liking for Lucky and Attock Cement and feel that these are safe companies to lend to. D. G. Khan Cement seems to be under stress at the moment due to its current maturity of long-term debts, worth Rs. 4 billion (approx. ), and an O/S Forex loan of US$ 40 million (FY-09 carrying value Rs. 3. 5 bn), payments commencing June 2011, therefore it is expected to go for re-financing arrangements with banks. However, strong sponsors’ support, good reputation, largest local, and 2nd largest total market share, a large portfolio of liquid investments worth Rs. 17 billion (approx. ), and Income from investments serve as strong mitigating factors. Bestway, Maple Leaf, and Pioneer Cement have financial leverage ratios at 2. 32x, 3. 56x, and 1. 64x levels which are certainly not sustainable. The DuPont suggests both profitability and leverage are a cause of concern for these companies. Lafarge Pakistan’s low profitability and poor asset utilization have greatly affected its financial results. Overall, we recommend caution for the above three players.

Rise and fall of ABC Learning

History of ABC Learning and its business strategy

ABC Learning led its foundation in the year 1988 in Ashgrove, Brisbane, Queensland in Australia. The rapid expansion of ABC resulted in 43 childcare centers around the year 2001 to a whooping 697 centers in 2005 all over Australia and New Zealand. ABC Learning is subjected to child care and quality education hence; its performance can be gazed from its rapid expansion in the country.  The child care company acquired similar groups in the United States and United Kingdom for its further global expansion and is aiming to provide child care services on a global scale. The business strategy of ABC is to achieve its objectives through global expansion but for that they had enormous dependency on debt which eventually led to its fall out due to the recent subprime mortgage crisis.

ABC Learning acquired United States Learning Care Group Inc, Peppercorn Management Group, La Petite Academy of Chicago, UK based Busy Bees Group Ltd, etc, which resulted in its striking the chord with the major global child care operators and creating a global brand image for itself. The first and foremost reason for mergers and acquisitions is the firms’ desire to increase market power. In order to expand the size of the firm, firms go in for horizontal, vertical and conglomerate mergers. If two firms operating and competing in the same business activity merge, it is known as horizontal merger. When firms in the same industry but in different stages at value chain merge, it is known as vertical merger. When two firms from unrelated types of business activities merge, it is known as conglomerate merger. The ABC Learning had enforced vertical mergers for their business expansion in the global scenario.

The company ABC Learning is following a very aggressive strategy of acquisition and expansion in its business, which is very risky owing to the scenario of the maturing child care industry. ABC is quite open with the fact that they are going to continue their expansion procedure in the same way. This strategy is too risky as it will increase their debt ratio and they might not be able to integrate their business in an effective way. The share price is at the 24 times of the historical earnings per share and is considered as one of the biggest problems of ABC in the near future.   (Kruger, 2009).

Intangible asset problem of ABC Learning

Intangible assets are those assets which have no physical being but nevertheless are of economic value, sometimes more than all tangible assets taken together, to the business entity. Intangible assets include items such as patents, copyrights, trademarks, franchises and goodwill. Despite their lack of physical substance, these assets are extremely valuable resources for a company. An intangible asset should be measured initially at cost. Therefore, an intangible asset should be recognized if, and only if the cost of the asset can be measured reliably. An intangible asset can be generated from separate acquisition, acquisition as part of amalgamation, acquisition by way of a governmental grant or exchange of assets. Hence, the measurement and valuation of an intangible asset is dependent to its process of acquisition.

ABC according to its recent financial statement holds intangible assets worth $ 3.05 billion, which is a huge percentage of its net holding of assets. According to the accounting standards, if any intangible has the probability to generate future economic benefits to the business entity then only is can be recognized but this is not the case for ABC. ABC’s claim of childcare licenses worth $ 3 bilion is questionable as the company had never made any profit from childcare. This sort of business strategy and valuation of assets is creating major problems for ABC and putting its image in lots of trouble. The share price hike of the company is also due to its net worth of assets but the major worth of the intangible assets does not seem to be very supportive to that hike. The main problem that the company and its shareholders might face is that if there is any fall in share price then that would not get the necessary back up support from the company’s assets.  The rapid expansion strategy of ABC Learning had created enormous business risk but that is not clearly visualized in the financial statements of ABC. Hence, the shareholders did not have a transparent view of the business performance and procedures of ABC, which subjected them to large risk of losses in the near future.     (Schwab, 2008).

Accounting Standards of ABC Learning

In this age of globalization, companies are operating in different countries. They are not restricted to the country of their origin. With their different area of operations, it has become imperative to the companies to follow similar practices in terms of accounting. This would mean higher transparency and it would be more useful to the users. In the last century, different frauds unearthed which underlined the value of accounting standards. There are several factors for the creation of accounting standards like political, legal, tax factors, cultural, economic, educational, and capital market but the main four drivers are state of economic development, business complexity, political persuasion, and some reliance on a particular system of law.

ABC Learning follows some specific standards in their accounting practices, which are quite rigid in their prediction and interpretations. They use bright line rules, which are very narrow in terms of interpretation and composed of some specific objective factors. The purpose of this type of standard rules in terms of their application is to produce consistent results which are also predictable beforehand.  This type of accounting standard made the financial statements of the company quite narrow in terms of its interpretation and thus they fail to cover every contingency of the business entity. They use bright line rule of accounting standards and not the other one because weighing various factors might result in inconsistent application of rules and would reduce objectivity of the business entity. However, principles based accounting standards would lead to the reduction of objectivity of ABC but would also ensure more practical view point of the future prospects and would make the business procedure more transparent to the stake holders.

As it has been said earlier that the use of bright line rules type accounting standard helps ABC to produce predictable consistent results but there are also some dangers of changing it. The foremost danger of changing such type of accounting standard is to get diverge from the ongoing business strategy. The business strategies are planned according to the objectivity factors of the business entity and if the principles based accounting standards are followed then they would reduce the objectivity factors which would led to the failure of the ongoing business strategies. The change of bright line rules would also lead to the inconsistency in the results of application of rules, which would hamper the business procedure and the interpretations. (McRobert, 2009; A.B.C. Learning Centres Limited, 2008).

Mechanism of agency cost minimization

The agency costs are those costs which are borne by the stakeholders for the encouragement of the managers to uplift the wealth of the shareholders rather than working on their self-interest. The most important types of agency costs are: (1) the expenditure on monitoring the activities of the manager like, the audit cost; (2) expenditures of hiring outside members for the structuring of the business organization and putting limitations on the undesired managerial behavior; and (3) opportunity costs that are incurred in case of shareholder-imposed restrictions. The agency costs can be minimized by shareholders by controlling the above discussed points.

ABC Learning had already indulged itself into a huge debt and the financial position of the business entity is not very sounding in the present scenario but still some of the shareholders are hoping the company to recover from the increased debt. For this they are opting to minimize the agency cost of the company to help it in its recovery. The audit cost of ABC is quite high as they had appointed the top auditors of the country and the audits were done on half yearly basis. The auditors of ABC were Pitcher Partners and Ernst and Young, who are the topmost auditors of Australia. Hence, the cost of the audits of ABC is very high and can be controlled by the lenders or the shareholders of the business entity.  They had also used KPMG as a neutral party for a fair judgment on the audits of the other two audit firms, which also incurred a fair amount of expenditure from the lenders. (Kruger, 2009).The lenders of ABC should also look into putting limitations on the managerial behavior so that the business strategies and the financial statements reflect the transparent and fair picture of the company’s present scenario. The business strategy of the company involving aggressive acquisitions resulted in the huge possession of intangible assets, which boasted the share price of the company but does not provide a great future prospect for its lenders. Hence, the managerial abilities came under scrutiny and the lenders have the opportunity to limit the managerial behavior and also the agency cost for the same.  (McRobert, 2009; A.B.C. Learning Centres Limited, 2008).

Auditor’s opinion on ABC Learning

The audit of ABC was previously done by Pitcher Partners on and before 2006 and thereafter by Ernst and Young. These auditors are the top ranked auditors of Australia but their reports were quite different to each other. The previous auditors of the company that is, the Pitcher Partners’ audit reports lacked transparency and provided the financial scenario according to the will of the company. The audit report of Ernst and Young provided a fairer picture of the financial position of the company. This divergence of opinions of the two auditors of the company is due to the conflict of interest among the lenders and the business entity. The previous auditors acted according to the will of the company whereas, the current auditor acted according to the will of the lenders of the company.  The previous audit reports were misleading the potential investors of ABC by artificially creating apparent shareholder value. Hence, the need of changing the auditors had aroused and the current auditors, Ernst and Young was appointed to depict a fairer picture of the present financial position of ABC.  However, a third neutral party KPMG was also appointed to judge the audit reports of the two auditors and they concluded that the report of Ernst and Young are fairer among the two. (Kruger, 2009).

There were significant reforms introduced in the framework of auditor independence by CLERP 9. The reforms stated in the Division 3 Part 2M. 4 of the Act were enforced from 1 July, 2004 and are subjected to the fundamental importance of independence of auditors and the credibility of their reports. These reforms were made to promote and protect the auditor importance and make their reports more reliable to the mass. The Act provides independence requirements for auditors in various forms of organizations. The organizational forms include, individual auditors along with audit firms comprising of many auditors and the Act provides a framework for auditor independence. If any auditor breaches any independence requirement under the Act, then he is subjected to criminal liability. Generally, the independence requirements revolve around a central concept of conflict of interests between an auditor and his client. Although the auditor might be aware of this conflict but still he does not take any initiative to resolve it. Hence, a conflict of interest arises in such situation and CLERP 9 advocates the issue of auditor independence and opts to follow the framework of the Act in such circumstances.   (Mirzabegian, 2005).

 Reference:

1. Kruger. C, (2009, January 2). Lessons to be learnt from ABC Learning Collapse. Sydney Morning Herald. Retrieved from: http://www.smh.com.au/business/lessons-to-be-learnt-from-abc-learnings-collapse-20090101-78f8.html (Accessed on May 6, 2010)

2.  Schwab. A, (2008, August 28). ABC Learning, the great money losing machine. Crikey. Retrieved from: http://www.crikey.com.au/2008/08/28/abc-learning-the-great-money-losing-machine/ (Accessed on May 6, 2010)

3. McRobert. A, (2009). ABC Learning Centres Limited – did the annual reports give enough warning? Jassa, the finsia journal of applied finance. Retrieved from:

http://www.amcrobertandassocs.com.au/otherwriting/JASSA_ABCLearningCentres.pdf (Accessed on May 6, 2010)

4.  A.B.C. Learning Centres Limited, (2008, February 25). Condensed Financial report for the half-year ended 31 December 2007. Retrieved from: http://www.childcare.com.au/files/financial-results/30-12-07/Appendix%204D.pdf (Accessed on May 6, 2010)

5. Mirzabegian. L, (2005, March 1). Auditor independence and the role of the client. All business. Retrieved from: http://www.allbusiness.com/accounting-reporting/auditing/389801-1.html (Accessed on May 6, 2010)

Berkshire Hathaway

Overview Before Warren Edward Buffett, Berkshire Hathaway was a textile company. Buffet acquired stocks and before long he was the largest shareholder (1963). He became part of the board and appointed the chairman so he would have someone he trusted running the company. With the funds from Berkshire Hathaway coming in, Buffett used it to invest in National Indemnity. The company was bought but he left it the way it was: left previous Ringwalt in charge, kept current employees, shareholder benefits, and so on. Insurance companies are a perfect way to get a lot of capital upfront because you can then use this money to purchase other companies or stocks, like what Buffet did. The buffet was involved with several companies and bought GEICO(Jayanti), General Re, and other manufacturing and service companies. Today Berkshire Hathaway is one of the largest holding companies in America. It owns different companies from retail to jewelry to electric companies. These companies run separately from Berkshire Hathaway.

It does not produce the goods or provide the services but serves as an umbrella that owns shares or the whole of the companies that are underneath it. Many of these companies were purchased by the company’s many insurance options. Big names include GEICO, Borsheim, PacifiCorp, and Vanity Fair. (Jayanti). Porter Five-Force Model Porter’s Five-Forces Model of Industry Competition pertains to the threat of new entrants, the bargaining power of buyers, the bargaining power of suppliers, the threat of substitute products and services, and the intensity of rivalry among competitors in an industry. These five forces can determine the stature of a market. In the case of Berkshire Hathaway, there is a low threat of new entrants for the multi-businesses in one industry. It is significantly hard to own various different companies, have them operate to full potential, and still remain a leader on the industry board. Although competitors cannot directly compete with Berkshire Hathaway, they still take a nice chunk from its potential market. As a matter of fact, there are only two direct competitors in the industry that are above Berkshire Hathaway, it is Motors Liquidation Co and Ford Motor Co. As more self-made businesses(which is what Warren Buffett likes to acquire) open competition is created through price, increase in the advertisement, and suppliers. This competition benefits buyers by giving them more options or bargaining power in where they choose to shop. For Instance like what happened to Berkshire’s textile business, after a while competition increased prices dropped and textiles had simply become another commodity.

So as you can see from the example, this affects Berkshire directly because of their higher quality products but premium prices make it hard to compete with low-cost leaders. This takes valuable time and effort away from internal operations because in cases like these the opposition has to be constantly analyzed. Consequently, if neither competitor decreases their prices to a consumer’s expectation this may result in the consumers going to the suppliers directly; once again giving the bargaining power to the buyer. As far as bargaining power to the suppliers, they wouldn’t really have an edge in increasing their prices or power unless it is a scarce resource and demand is high. Substitutes, on the other hand, limit the potential returns of an industry by putting a ceiling on the prices industries can profitably charge. Finally, the only reason why the rivalry is intense is that when you have large companies like Motors Liquidation, Ford and Berkshire rivalry heats up and everyone fights for the number one spot, and usually does whatever it takes to get it. The rivalry forces constant close monitoring of competitors, which entails unnecessary excessive expenditure. For example, they would have to ask and analyze questions such as, where are they opening their stores? Are they using the same criteria in choosing locations? How much are they charging for similar products? And can we compete with their price? In Summary, Berkshire needs to be aware that intensive rivalry will increase costs, such as constantly competing with prices, having to offer bargains which will lead to high exit barriers.

The exit from CEQ was primarily conducted by reducing rapidly the most flexible asset on the Boss’s balance sheet which Is the amount of Its bills purchases from private banks, to match the rapid decline in the amount of excess serves. The advantage of this strategy was that the exit of CEQ was predominantly limited to Just one item on the Boss’s balance sheet and that the balance sheet adjustments were conducted through operations directly with the banking sector, which facilitated the management of the exit process.

Intentionally, the BOX chose to reduce its holdings of Japanese government securities very slowly and moderately in order not to distort supply and demand conditions in Japanese bond markets. In fact, the BOX kept In place Its regular purchases of long-term Japanese government bonds. It realized the gradual reduction of Japanese government securities on Its balance sheet mainly by reducing the amount of short-term Japanese government securities. The BOX implemented certain new liquidity providing operations in order to promote the proper functioning and stability of interbrain money markets.

The Japanese experience shows that when exiting from CEQ, a central bank needs to consider very carefully how to restore the functioning of these crucial markets, as one result of CEQ may be that activity in interbrain markets becomes very subdued. All in all, the exit room CEQ in Japan has been considered a success and its experience may serve as a useful example for other central banks. Fernando Gutsurge del Arroyo Gong;leg provided excellent statistical support. The views expressed in this note are solely the responsibility of the author and should not be Interpreted as reflecting the views of the Bank of Spain.

After having followed a zero interest rate policy strategy and facing a further deteriorating economy in an environment of falling prices (deflation), the Bank of Japan (BOX) announced the introduction of CEQ on 19 March 2001 and kept it in place until 9 March 2006. The Japanese version of CEQ consisted of the following elements, such as published by the Boo]: 1) Monetary policy target: The current account balances (CABs = required + excess bank reserves) became the operating instrument of Japanese monetary policy, replacing the overnight institutionalized call rate.

Some may have access to private equity funds, some may not, but you can always find a friend, a family member or an angel investor, who will readily fund your venture. Moreover, young entrepreneurs can also look for a mentor, who will help them raise funds and establish their business. An entrepreneur, who is just setting up his business, must know how to use the available framework and data. If they are interested in involving investors, they must know at what time they should move back.

Mentorship helps companies in raising funds

Various kinds of funds, like venture development, portfolio services, are available today. A lot of fund is spent on building a support ecosystem in different functional areas like HR, product and technology. So if you chose the right partner, they already have the mechanism to mentor you, beyond what you expect from friends.

Sectors that may impact in coming days

Artificial intelligence(AI) will hugely impact or may disrupt certain areas, especially customer support system and how things are delivered; before new set of products come into play. It will be incorporated into a lot of technology, which will give us smarter products.

Healthcare is another sector, which will see much growth in coming days. Bringing in an investor and taking them out is a very crucial decision. Cash-rich companies now prefer to acquire smaller companies or startups, which are coming out with better plans and solutions, instead of spending two-three years time in R&D. From there, they are using their resources to improvise the product further. But, the original product is always valued by the investors.

Use of data and framework to start a business

When an entrepreneur comes to us to talk about his space, we try to find out, whether he understands what he is talking about, how passionate he is about the project? Does he relate to the product, he is pushing for? Where does he see himself a few years later in term of growth, scalability and revenue churning? Moreover, what kind of framework and data resources he has to back his project. The data should be free of all pre- conceptions and misconception, and what kind of insight can be derived from it. If you are not clear in terms of how you derive value from the data, then it is not going to be very meaningful.

Horizon an entrepreneur looks for seed round

Surviving the initial struggle is the key to success. The seed money should last for twelve to eighteen months at least. So, when you start looking for series A funding, you can at least tell the financers that you have figured out a team, some aspect of the product, there is some initial validation and may be some amount of revenue, even if you are not earning a lot of money.

If it’s an enterprise product, the financers will immediately look for revenue. Meanwhile, if you are pushing for a consumer product, the investors will try to find out whether it has some validation from customers, even if it’s not churning any monetary benefits. It really depends on the sector, but 12 to 18 months time is good enough to convince the investors that you have made your mark in the market.

In the long run, it is all about how much disruption you have been able to cause to the market. If you do succeed, it needs to be really large. Building a business takes a lot of effort, and not many of them succeed. But the few who succeed, can easily find VCs, which can push them further.

It’s always important to ensure that the product is earning a good revenue. If it’s an enterprise business, you want to monetize early, you want to see your customers are committed to to the product and they are actually willing to pay for it. In a consumer business, however, you will probably first need to build enough of validation, customer base and proof points, before you actually start monetizing. VCs will also look at your ability to generate a lot of cash.

(This article first appeared in the Indian edition of Entrepreneur magazine (October 2016 Issue).

Ones of the first economists to predict the euro’s ascendancy as a strong international currency were Richard Portes ; Hine Rey (1998). Their analysis, based on econometric modelling, accurately established the integration of the European financial markets as the key, as it was, independent variable in determining whether the euro would topple the dollar. Inching towards the International Political Economy terrain, they acknowledged that this variable would only be optimised by an active policy of financial market integration and international currency promotion by the European authorities.

They assumed and justified this political activism on the grounds of the benefits that derive from issuing an international currency. While they briefly covered how an international currency translates into political power and prestige, their attention was more directed to the economic gains, which they consider more significant and less ‘nebulous’. First of all, they highlighted the trade advantage of buying and selling products in one’s own currency, thereby avoiding exchange rate risks for local companies and institutions.

Secondly, they pointed to the ‘exorbitant privilege’ of financing one’s balance of payment deficits with liabilities denominated in one’s own currency, which makes one less reliant on foreign reserves, offers better protection from external shocks (price volatility) and, most importantly, reduces financing costs due to the centrality and demand-pull that the currency has in the system. Overall, then, an international currency provides the issuing country with enormous international sovereignty, defined in simple words by Portes & Rey ‘as the ability to obtain real resources (net imports) in exchange for almost costless notes’ (1998, p. 309).

In the dollar’s case, foreign residents hold approximately 60% of total outstanding US dollar stocks. In Portes ; Rey’s calculations this means that annual revenues of international sovereignty for the US account for around 0. 1% of US GDP which, updated to 2010 GDP figures, would reach an actual sum of US$14. 6 billion. With the benefit of hindsight, it can confidently be said today that most of the assumptions presented by Portes & Rey in their 1998 calculations have not yet materialised.

While it is true that Europe’s financial markets have been integrating further thanks to policy decisions like the Financial Services Action Plan (FSAP) set in motion by the European Commission in 1999 (Galati ; Wooldridge, 2006), transaction costs are still higher in Europe than in the US (Grant 2010) and, most importantly, the European Central Bank has not shown any signs of actively promoting the internationalisation of the euro.

This development has been left to market forces. 2. 2 The “Euro-Pessimist” Hypothesis Despite these optimistic views about the euro’s rapid internationalisation, not all economists agree with these predictions. Around the same period, several authors highlighted the obstacles facing the single currency in its attempt to rival the dollar. Rudi Dornbush (1996), for instance, identified from an early stage some internal limitations that would hamper the EMU’s global aspirations.

His analysis is of relevance today because it predicts with great accuracy some of the difficulties experienced by peripheral EZ countries as a result of the effects of the Great Recession. Drawing on the fact that the EZ is not an Optimum Currency Area (Mundell, 1961) and considering that the Maastricht Treaty limits any transfer of funds from one country to another, Dornbush foresaw that potential asymmetric external shocks or growth disequilibria within the European Monetary Union would be extremely difficult to manage under a single monetary policy.

Historically, in Europe these asymmetries would be offset by moves in the exchange rate, but lacking this mechanism and a common fiscal policy to allow transfers between EZ member states (something Dornbush does not conceive to be feasible in the European context), the adjustment costs will have to come through the labour markets. It is certainly astonishing how this description written 15 years ago closely resembles the current situation in countries such as Portugal, Greece, Ireland, Italy and Spain (the PIIGS), which are all suffering high unemployment, massive public spending cuts and major labour reforms.

In the end, it must be mentioned that a vehicle currency is likely to function also as a reserve currency, but it is also true that a reserve currency might gradually become a vehicle currency. This can be explained by an example. If the European debt markets were to integrate into a single one, they would acquire greater liquidity; this, in turn, would mean that China would be able to invest more of its reserves in euro and so achieve a greater diversification in its portfolio in pursuit of higher returns.

Seeing the advantages of this, the Chinese authorities and institutions would be encouraged to sell more of its products in euro to the EZ and this would mean that the euro would function more as a unit of account. The euro collected through this trade pattern would then presumably return to the European financial markets for further investment and thus lower foreign exchange transaction costs for the euro, which would mean that the euro would also be increasingly attractive as a vehicle currency.

Path-dependency, and especially hysteresis, might hamper this process, but theoretically it is certainly possible. THE EURO VERSUS DOLLAR DEBATE IN ECONOMICS TODAY The Euro Challenge Hypothesis Reinvigorated More than 10 years after these opposing hypotheses on the euro challenge to the dollar were first laid out, the debate in the Economics field is still dominated by these two contending analyses. This was the case up to the current sovereign debt crisis in the eurozone and presumably, if the euro does not break up, it will continue into the future.

After being predicted in 2005 that the euro would possibly surpass the dollar in 2022 as the leading reserve currency, their latest econometric calculations in 2008 pushed the tipping-point even closer to 2015. Their predictions are based on the main factors that economists generally consider are determinant to gain international currency status: (1) economic size measured in output and trade; (2) deep, liquid and well-developed financial markets; (3) confidence in the value of the currency; and (4) network externalities.

The Euro Challenge to the Dollar Measured in Quantitative Terms Figure 1. Dollar-Euro(USD/EUR) exchange rate; 11. 11. 2006-11. 11. 2011 Source: www. oanda. com/currency/historical-rates/ The presentation of the econometric calculations in 2008 was timely as the dollar was depreciating rapidly vis-i?? -vis the euro (see Figure 1) and triggered a rapid reaction by economists that were more sceptical about this outcome.

It is worthwhile presenting the response of De la Dehesa (2009), who provides a good summary of the international use of the euro to underscore his claim that the euro is still far from posing a challenge to the dollar. The Chairman of the European Central Bank Observatory, (OBCE), Guillermo De La Dehesa, assesses the euro challenge to the dollar through its relative weight in three different international markets: the international liability management market; the international asset management market; and the foreign exchange market.

International Liability Management: the issuing of euro-denominated securities around the world has increased substantially since the creation of the single currency. ‘According to the ECB, in a narrow sense -excluding domestic issuance of debt securities at constant exchange rates, ie, adjusted by valuation effects-, the share of euro-denominated debt securities of the total stock grew from 20% at the start of EMU in 1998 to a peak of 33. 8% in mid 2005’ (De la Dehesa, 2009, p. 7). This amount has dropped slightly in recent years, hovering just above the 30% mark.

In 2009 the actual figure was 31. 4% of total issuance (ECB, 2010). Dollar-denominated debt securities, by contrast, experienced a decline from 49% of total stock at the start of EMU in 1998 to a low of 41% in 2005, when the euro peaked. Since then, however, dollar-denominated issuance has increased and in 2009 (the latest figure to date) it stands at 46%. The data show a rapid growth for the euro in the first years, with a plateau at around 30%. The dollar remains robust at around 45% (ECB, 2010, p. 17-18).

Customer’s business name, address and contact details Type of information (economic / other) Other – details ensure business exists and invoices can be posted to the correct address . Years customer has been in this business Other – establishes track record and history 3. Total assets and estimates of values of assets in the business Economic – establishes size of asset base of business 4. Total liabilities (total commitments) Economic – establishes how much the business currently owes others to assess the extent of claims against assets 5.

Profits of the business for the most recent and previous periods Economic – used to assess whether the business generates sufficient profits to cover the payments that will have to be made of their account 6. Credit references Other – enables Ashley to follow up with other businesses the customer already has accounts with, to assess whether the customer has paid their accounts in time and in full 7.

Details Of any collateral or security that can be provided should the customer default on their payments Economic and other – Ashley will want to ensure that the business will be able to recover any unpaid amounts by claiming from a third party or having a claim over the assets of the business Page 2 of 19 Exercise 1. 7 Factors in making a government decision Consult the relevant business journal or newspaper article and identify the acts of your case involving an important government decision. Identify the key government decision involved.

Discuss the impact of the decision and its relevance to the press and community. Factors to be taken into account in arriving at a government decision include: 2. 3. 4. 5. 6. 8. 9. 10. 11. 12. 13. 14. The nature of the government decision. The government policy dictating the decision. The political impact of the decision. Identifying all parties affected by the government decision. Identifying all the stakeholders (I. E. Parties to which the decision will have a positive or negative impact). Identifying any particular lobby or special interest groups involved with the Issue.

Identifying the available funding or resources available for the government decision. How is the government initiative to be funded? Identifying the cost of the initiative. Was the decision made in a consultative manner? Was there much political debate or commentary? Possible gains or losses anticipated to be experienced by the community. Possible alternatives which could have been employed by the government. Was the resultant decision considered to be the most efficient use of community resources? Page 3 of 19 Exercise 1. Economic decisions made by management Required: Provide examples of economic decisions that the following people would need to make with the use of accounting information: ; A manager in a sales department Of a shoe store ; A factory manager ; The manager of a state cricket team ; The manager of an animal shelter which relies on donations for funding Manager of a sales department: Decisions about number of staff required, and when the busy times are (for additional staffing); type and quantity of stock to purchase (based on historic sales figures), cost of inventory researched (for deciding on selling prices and specials / discounts / sales during the coming season); average length of time for which stock is held; stock on hand at any point in time (for purposes of re-ordering); latest fashion trends; information about the demographics of the customer base to enable appropriate stock to be held and appropriate prices to be set. Factory manager: Decisions about appropriate factory staff levels; appropriate plant and machinery capacity to run the factory; costs of raw materials, labor and overhead, such as electricity, in order to make decisions bout goods to be manufactured, production mix; costs of occupational health and safety to make decisions about the most cost effective way to achieve compliance.

Manager of a state cricket team: Decisions about the selection and costs of players and coaching staff; appropriate playing and training Venues and their location to the centre of the city; sponsorship enticements and entitlements; purchase of appropriate sporting equipment for training and match days. Manager of an animal shelter: Decisions about the cost of collection systems to receive donations and the most appropriate method of obtaining nations; the cost of maintaining animals in the shelter such as food and veterinary costs; overheads such as electricity, insurance and premises; the costs of full-time employment in the shelter, and the management of volunteers. Page 4 of 19 Exercise 1. 10 The small business owner What types of economic decisions would a person wishing to start their own small business be required to make?

How could an accountant assist in making these decisions? The following are examples of the types of economic (financial) and non-financial decisions a small business owner would have to make: A clear definition of the product or service that is to be provided (non- financial), and what the business will charge for these products or services (financial) – this will determine the projected or likely income ; How the business will be funded – will the owners put all the money in or will there be other owners or lenders (non-financial and financial)? ; How the business will market its product or service (non-financial), and how much it will cost to do this? Financial) ; Where the business will be located (non-financial), and what the rental cost will be (financial) How much staff will be required, what skills do they need to perform their jobs properly (non-financial), and how much will they be paid (this will have to be benchmark against other businesses in the same industry or using staff with similar skills and experience) ; What equipment or other assets are required to start the business (non- financial), and how will these be acquired and at what cost (financial)? ; Will the business be registered for SST? ; What accounting and information systems are required for the business (non-financial and financial)?

This should be adequate to provide information o the owners, and accurately capture transactions that take place, (including any SST components thereof) The above are just some examples of decisions that will need to be made by a person wishing to start a business. There are many others, and it should be noted that many decisions have both a financial and non-financial component – it is therefore often difficult to make non-financial decisions without considering the financial implications and impacts of those decisions. Accountants can help small business owners With the selection of an appropriate accounting system, with regulatory’ acquirement such as registering for SST, registering a business name, and applying for tax numbers and other tax obligations (such as PAYS) as required – this will depend on the size of the business and what staff will hired.

They can also assist by providing the financial information and assisting in the drafting of a sound business plan that covers all the likely financial impacts of the decisions to be made. They can provide book-keeping and page 5 of 19 accounting services to maintain accurate financial records for the business and assist in preparing income tax returns, SST returns and other regulatory porting requirements. Accountants can also help a small business owner prepare a budget for the business, forecast cash flow requirements, and make decisions about which assets to purchase and how best to finance them. CHAPTER 2 FINANCIAL STATEMENTS FOR DECISION MAKING DISCUSSION QUESTIONS SOLUTIONS 2. Define the terms, assets, liabilities, and equity. Are these terms related in anyway? If so, how?

Assets are defined in the Framework as resources controlled by the entity as a result of past events and from which future economic benefits are expected to flow to the entity. Liabilities are defined in the Framework as present obligations of an entity arising from past events, the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits. Liabilities require future payments from assets, generally in the form of cash, or the performance of services to cancel them. Equity is the owner’s claim to (or the residual interest in) the assets of the entity after deducting all its liabilities. The basic accounting equation (Assets = Liabilities + Equity) indicates the relationship between assets, liabilities and equity.

From the equation, the total assets of the entity equal the total claims against those sets by creditors and owners. Creditors’ claims take precedence over owners’ claims, and owners are seen as the ultimate risk-takers in the entity. Thus, equity is a residual claim on the assets of the entity after liabilities are fully paid, and the basic accounting model which expresses this idea clearly is: Assets – Liabilities = Equity 3. A local restaurant is noted for its fine food, as evidenced by the large number of customers. A customer was heard to remark that the secret of the restaurant’s success Was its fine chef. Would you regard the chef as an asset of the business? If so, would you include the chef on the balance sheet of the business and at what value?

Suggested topics of discussion: Asset definition – “Assets are resources controlled by the entity as a result of past events and from which future economic benefits are expected to flow to the entity. ” Does the chef provide future economic benefits to the entity? Yes. Is the chef controlled by the entity? In Page 6 of 19 many cases, it is evident that he/she could not be controlled by the entity (e. G. He/she can resign when he/she likes, can take sick days). He/she cannot be “acquired” or “sold” by the business, I. . They do not have rights to possess him/her. How would you value the chef as an asset? Usually you have some idea of the “life” of the asset, however, the restaurant would not know how long the chef would be working for them (this argument relates back to controlling the asset). 6.

Discuss the significance of the following assumptions in the preparation of an entity financial statements: (a) entity assumption (b) accrual basis assumption (c) going concern assumption (d) period assumption (a) Entity Assumption If the transactions Of an entity are to be recorded, classified and summarized onto financial statements, the accountant must be able to identify clearly the boundaries of the entity being accounted for. Under the accounting entity assumption, the entity is considered a separate entity distinguishable from its owner and from all other entities. It is assumed that each entity controls its assets and incurs its liabilities. The records of assets, liabilities and business activities of the entity are kept completely separate from those of the owner of the entity as well as from those of other entities. The accounting entity assumption is important since it leads to the derivation of the accounting equation. ) The Accrual Basis Assumption Under the accrual basis of accounting, the effects of transactions and events are recognized in accounting records when they occur, and not when the cash is received or paid. Hence, financial statements report not only on cash transactions but also on obligations to pay cash in the future and on resources that represent receivables of cash in future. It is argued in the Framework that accounting on an accrual basis provides significantly better information about the transactions and other events for the purpose of decision making by users of financial statements than does the cash basis. C) The Going Concern Assumption According to the Framework, financial statements are prepared on the assumption that the existing entity is expected to continue operating into the future.

It is assumed that the assets of the entity will not be sold off and that the entity will continue its activities; hence, liquidation values (prices in a forced sale) of the entity assets are not generally reported in financial statements, as this assumes that an entity is to be wound up. When management plans the sale or liquidation of the entity, the going concern assumption is then set aside and the financial statements are prepared on he basis of estimated sales or liquidation values. The significance of the going concern assumption is in the valuation Page 7 of 19 placed on the assets of an entity in the mentis financial statements. The statements should identify clearly the basis upon which asset values are determined – going concern? Or liquidation? (d) The Period Assumption For financial reporting purposes, it is assumed that the total life of an entity can be divided into equal time intervals.

Hence, the financial performance of the entity can be determined for a given time period, and the financial session of the entity can be determined on the last day of that reporting period. As a result of this assumption, profit determination involves a process of recognizing the income for a period and deducting the expenses incurred for that same period. Together, the period assumption and accrual basis assumption lead to the requirement for making balance day adjustments on the last day of the reporting period. These adjustments will be considered in a later chapter.