here is it for those who dont have FT account...
Slater & Gordon has a problem, in addition to the ongoing regulatory inquiry into its accounting, a collapsed share price, and the consequences of buying a billion dollar basket case in the UK.
The Australian legal group recently published accounts in which some very important numbers to do with its debt and cashflow do not add up. Analysts, investors and journalists have all noticed and asked about it, but the explanation so far is incomplete.
Why is this a problem? We’ll get to the details in a moment, but the fundamental point to realise is how a cash flow statement and balance sheet must reconcile. Adjust a number on the former, and you’ll have to find, or lose, some cash flow elsewhere. The numbers in question are to do with the amount of debt Slater & Gordon said it had on June 30, when its financial year ended.
Long term debt was A$716m, and with short term borrowing total debt on the balance sheet at the end of the year was A$720m.
At the start of the financial year, total debt was A$128m.
Now turn the page to the cash flow statement.
During the financial year, according to the cashflow statement, debt increased by A$528m. Can you see the problem?
A$128m + A$528m = A$656m
There is A$64m more debt on the balance sheet than there should be.
We flagged this up in our look at several
questions raised by the financial figures, which are yet to be audited. The analysts at CLSA then asked similar questions of the company, and came at the net debt figure from a different angle, to get to a similar unreconciled figure of A$66m.
Despite pointing to pro forma net debt of ~A$537m as at 31 December 2014 following the PSD acquisition, net debt increased by ~A$86m or ~16% during the second half.
In the following chart, we set out a bridge of net debt from 31 December 2014 to 30 June 2015 with the following cash outflows (capital expenditure, dividends and deferred consideration, acquisitions) and cash inflows (operating cash flow). We have highlighted a reconciling number of A$66m which drives the majority of the increase in net debt to A$623m.
Some of the variance can be explained by foreign exchange movements. CLSA take the spot rate when the sterling debt for the UK acquisition of PSD, almost all of the UK-listed business Quindell, was drawn down on May 29. Movement in the exchange rate between then and the end of June comes to about A$10m.
Exchange rate movements on the rest of Slater & Gordon’s debt using spot rates for December 31 and June 30 explain another A$15m, or so, meaning about A$25m of the $66m variance can be attributed to currency, leaving a still unexplained A$41m.
Foreign currency, you may
recall, was one of the reasons the company gave when we first asked it about difficulty reconciling movements in cash flow and balance sheet figures in June. The company then announced a spreadsheet error was responsible for some double counting, and it would restate some previous figures which did not affect the crucial operating cash flow number.
When the CLSA note was published on September 3, the company hadn’t provided answers to questions the analysts needed before they could support a target price of almost $5 per share, when the stock was trading at about $3.
The Australian Financial Review
followed up, suggesting that Slater & Gordon may have used average exchange rates to calculate cash flows. The company told the AFR it does not comment on the work or commentary of one analyst. We’ve asked if it has any further comment, and will update this if it does.
The problem with the explanation of average exchange rates is that Australian accounting rules specify spot exchange rates. The relevant parts look to be AASB 121 paragraph 21:
A foreign currency transaction shall be recorded, on initial recognition in the functional currency, by applying to the foreign currency amount the spot exchange rate between the functional currency and the foreign currency at the date of the transaction
and AASB 121 paragraph 23a:
At each reporting date… foreign currency monetary items shall be translated using the closing rate
We should note that the debt reconciliation is far from the only question the company needs to answer on its accounts, however it is one of the most significant. The reason is the need for the cash flow statement and the balance sheet to, well, balance.
Cash at the beginning and end of the year should be easy to check – what were your bank balances? The other numbers there show the movements in various items which get you to the end of year total.
So if you were to increase the amount of cash raised through borrowing by A$41m, one/some of the other numbers on the cashflow statement would have to shrink by a corresponding A$41m.
To give a sense of the scale of that figure A$41m is, coincidently, the amount of cash Slater & Gordon said its operations produced last year.
