Step 1 Assigment 2

Chapter 5 Predicting the Future

I must admit, this chapter of reading had me quite stressed. I had to read, and re-read over the content quite a few times.

As I read the opening quote from Xenophanes describing that there is no certain truth, only a lot of guesses, I felt quite anxious that this second half of the unit would be quite subjective, and I would have to make assumptions, judgements and decisions on my company’s future. I tend to enjoy black and white outcomes, and clear cut certainties.

The past is a trip already taken, but looking forward what do we expect to happen? It’s extremely hard to know, and there are lots of reasons that could influence outcomes externally, even if we can with more certainty predict internally what might happen. The situation we currently face in 2020 with COVID-19 is unique but has impacted a lot of organisations in both positive and negative ways, but was unpredictable on an economic level.

The idea is to gain insights better than others, and to do that we need to become good at analysing firms and making judgements. The greater the RNOA the more economic profit will be available to equity investors, and exponentially future growth.

I find I am conservative with decisions in life. I have always been of the opinion to under promise and over deliver in my client relationships. We need to be sensible when forecasting, but with confidence. To do that we need to understand the drivers of RNOA and NOA - being able to look at those drivers and work out how things might change with the future plans of my firm.

5.1 Forecasting RNOA

In order to estimate the effect of future returns on net operating assets, we need to engage with the restated financial statements, and analyse profitability and efficiency based on historical data. Then from the present moving into the future we need to make judgements that take that information and pivot the position of the company into the future depending on various aspects including the economy, industry, and managements plans for the future.

5.2 Accounting ‘Drivers’ of NOA

The primary driver for the change in book value of net operating assets is a growth in sales which makes sense – it’s why people are in business to start with. Trying to understand negative sales growth took me some time to process. The old me would have thought that all increases in income would be a good thing, however, if more investments in assets has to happen for that increase that will affect Asset Turnover and have a negative impact on RNOA.

True economic profit is RNOA in excess of its cost of capital (WACC) x NOA invested. It is really the interaction between sales and ATO that will produce a favourable outcome. I still find some of the formulas unclear at times, and know I will need to work on establishing exactly what information each tells me about my company. I also understand that organisations may have various types of income streams and each would have its own impact on future returns.

5.3 Economic & Business Drivers of NOA

An essential step to ask myself, is how might the drivers change in the future? I need to use hands on approach to understand how SEEK Ltd generates its various income streams. Being an online based business, it shouldn’t be too difficult to do my version of a ‘mystery shop’. When looking at relevant economic and industry data such as market demand, reputation, capacity, regulatory environment and industry competition a lot of that information should be easily available on their website and in news articles and journals.

The part of this exercise that I may struggle with is making predictions about the future that I can quantify based on the qualitative changes I forecast.

5.4 Forecasting NOA

In forecasting net operating assets, the main focus needs to be on future sales growth, and the amount of NOA expected to support that level of growth (1/ATO). Future risks also need to be identified and consideration given into their effect on the economic realities of the firm.

Chapter 6 Focus on the Enterprise

Reading about simplifying our life and relating that to analysis of a company was a great analogy I could relate to. We need to eliminate the unnecessary parts of the financial statements that don’t help us to predict the future and focus on the parts of the business that add value. The elimination of the firms financing activities and only looking at operations stalled me initially because I thought that would matter in making predictions for the future, but when I realised that financing is purely just a balance of leverage between creditors and equity I understood why.

From here on in I was lost - utterly and totally lost if I am to be honest. I try to excel at my study in amongst the juggle of work and family commitments but this chapter reading had me very overwhelmed. I read, and re-read the content, tried to talk it through with other students online, read the examples provided, but nothing. I’ve been working in accounting for at least 17 years and I got quite downhearted not being able to grasp this chapter’s content. I resigned myself to the fact that since I learn by doing, it may sink in as I move through the practical side of assignment 2.

The main take away I got from this chapter is the risks that may impact my company’s economic profit framework (competitors, customers, suppliers, technology, customer taste, demographics, weather, economic factors, exchange rates, tax rules). Each of these I can breakdown and make judgements and predictions about how they may impact the future of my organisation.

I hope moving forward through the last few weeks of Financial Statement Analysis I will be able to look back at this week’s readings and find that they start to become clear. There is something rewarding in being able to review the unit and seeing how far I have come in my knowledge of the topics.