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Carburton Street, London -- When looking at a set of accounts, entries for minorities and provisions can sometimes prove confusing. So, what exactly are minorities and provisions? And why should investors look at them? Minorities Minority interests occur when a parent company has one or more controlled subsidiaries that are not wholly owned. Because the other (minority) shareholders of these subsidiaries are entitled to a part of the profit (or loss) of their particular business, their profit share has to be deducted from the parent company's overall profit figure. Furthermore, assets relating to subsidiaries that are part owned by a minority have to be apportioned on the parent company's balance sheet. Allied Domecq (LSE: ALLD) provides a good example: Quoted companies are also obliged to list all subsidiary companies in their annual report. Shareholders can therefore determine which operations are partly owned by the minorities. The subsidiaries controlled by Allied Domecq that it does not fully own are highlighted below: So what are the important points concerning minorities? 1. They should be excluded from any profit-based calculation and valuation: Profits due to minority shareholders are not attributable to ordinary group shareholders. Earnings per share, for instance, must be calculated after deducting 'minority profits'. Furthermore, while the profit and loss account is adjusted for minority profits, the parent company's cash flow statement will only highlight the dividends paid out to the minority shareholders. Retained cash profits attributable to minority interests should therefore be excluded from the parent company's free cash flow figure. This is the relevant part of Allied Domecq's cash flow statement: After deducting £13m of 'minority profits' from group earnings (shown in the first table), but only paying £4m in minority dividends, Allied Domecq's cash profits are artificially boosted by £9m. 2. They should be excluded from any asset-based valuation: Assets apportioned to minorities should be ignored when using ratios such as price to book. In addition, return on shareholders' equity calculations should also exclude minority interests from the asset denominator. 3. You have to include them to calculate ratios such as gearing: The balance sheet doesn't reveal the types of assets (e.g. stocks, creditors, debt and so on) the minority interest actually owns. So comparisons between a particular type of asset and the overall asset base (e.g. the debt to equity ratio) for the parent company must include the minority-owned assets. Provisions A provision is (arduously) defined as an amount retained to provide for a liability or loss which is either likely to be incurred, or certain to be incurred but uncertain as to the amount or as to the date on which it will arise. Typical types of provisions include those covering company restructures, deferred tax and pension liabilities (although FRS17 will introduce a separate reporting mechanism for pensions). The accounts of Metal Bulletin (LSE: MTLB) highlight another potential provision type: Points So what are the important points concerning provisions? 1. Consider their size: Provisions that are relatively large in comparison to a company's profit or cash pile could spell shareholder trouble. Furthermore, chunky cash payouts to be made down the line will affect a company's current valuation. That low stock market rating could be due to a company having to spend forthcoming profits on some sort of major liability. 2. Add them back for return on equity calculations: Provisions represent money that has yet to be spent on a liability. As such, the company still generates a return on the cash (or equivalent) it has set aside for payment. Using the Metal Bulletin figures, a return on equity calculation would use £22.6m (£18.9m + £3.7m) as the adjusted amount of equity employed at the end of December 2000.Profit & Loss account
Year to 31st August 2001 2000
(£m) (£m)
Pre-tax profit 500 417
Tax (130) (108)
Post-tax profit 370 309
Minority interests (13) (13)
Profit attributable to shareholders 357 300
Balance sheet
Year to 31st August 2001 2000
(£m) (£m)
Net assets 462 256
Comprising of:
Shareholders' funds 394 190
Minority interests 68 66
462 256
Subsidiary Country Equity Interest
Jinro Ballatines Co. Limited South Korea 70%
Jinro Ballatines Import Co. Limited South Korea 70%
Points
Cash flow statement
Year to 31st August 2001 2000
(£m) (£m)
Returns on investments and servicing
of finance:
Interest received 6 4
Interest paid (78) (81)
Dividends paid to minority interests (4) (4)
Balance sheet
Year to 31st December 2000 1999
(£k) (£k)
Fixed assets 24,991 14,407
Net current assets 768 2,360
Long-term creditors (3,066) 0
Provisions for liabilities and charges (3,700) 0
Net assets 18,993 17,766
Where:
Provisions for liabilities and charges:
Deferred acquisition costs (due 2002) (2,090) 0
Deferred acquisition costs (due 2003/4) (1,610) 0
(3,700) 0