Australian Vintage Limited and Treasury Wine Estate - Accounting Analysis and Financial Analysis - Example

Accounting Policies

Australian Vintage Limited (AVG) and Treasury wine estate (TWE) are both active players in the Australian wine industry. Therefore, financial strength and practices of each company determine its competitive advantage regarding market share and investments. Both AVG and TWE use different accounting policies when preparing their annual financial statements. First, both AVG and TWE measure their revenue at the fair value of the receivable, but is reduced based on returns, discounts, and other allowances. AVG only recognizes revenue after complete transfer of ownership to the buyer and the amount of revenue is reliably measured. Additionally, the cost of such sales must be measurable for recognition of revenue. Apart from sale of sales revenue, AVG earns from interests earned and rental income. On the contrary, TWE does not extend credit terms thereby making revenue earned as indicated on the invoices. Wine revenue are recognized upon transfer of ownership to buyers. Income from royalties are recognised on accrual basis while property income is earned when contract becomes unconditional.

Both AVG and TWE value their inventories at the lower cost and net realizable value, out of which cost include parts of the fixed and variables. Overhead expenses on the inventory are apportioned based on first in first out basis. Net realizable value is partly current selling prices less the cost of sale. AVG assess its inventory for obsolescence regularly and make necessary adjustments to net realizable value based on quality, age, and saleability.

AVG and TWE value their property, plant, and equipment at costs, which are reduced by depreciation and related impairment losses. Depreciation involves writing of the non-current assets to their residual value over the asset useful lifecycle. The companies use straight line method to depreciate assets with consideration on the nature of the asset. Depreciation expenses form part of the cost of sale and expenses in income statements.

Quality of Disclosure

The quality of information will be measured in based on a scale of 1-3.

• The company give information that makes it difficult to understand the quality criteria
• The company provides information but one has to be keen to find such information
• The company provides information directly and well classified that make it convenient to understand.

Factors

AVG rating

TWE rating

• Strategic choices: Does the company provide adequate disclosures to assess the firm's business strategy and its economic consequences?

2

3

• Accounting choices: Do the notes to the financial statements adequately explain the key accounting policies and assumptions and their logic?

3

3

• Discussion of financial performance: Does the firm adequately explain its current performance? (e.g. in the Management Report section of the annual report)

3

3

• Non-financial performance information: Does the firm provide adequate additional disclosure to help outsiders understand how these factors are being managed?

3

2

• Segment information: If a firm is in multiple business segments, what is the quality of segment disclosure?

3

3

• Bad news: How does the management disclose bad news?

2

2

• Investor relations: How good is the firm's investor relations program?

2

3

Red Flags

AVG financial statements shows regular transition from across the years without raising eyebrows in current assets inventory, biological assets and water licenses. The figures in current inventory falls within the average and reflects the true picture of trend. For instance, Australian dollar remain appreciated against other the currencies of nations where Australia exports in the period 2014-2015, which is reflected on the steady decline in inventory figures. Biological assets (grape vines) whose value depend on fair value does not indicate any abnormal shift in worth. Therefore, I think AVG does not have threatening red flags that deteriorates the quality of accounting policies applied.

Financial Analysis

Operating Management

The figure below shows EBIT margin and production efficiency for AVG and TWE in the financial years 2015, 2014, and 2013.

Figure 1: Production Efficiency and EBIT

In operating management, I select production efficiency, EBIT, NOPAT, and Operation efficiency ratios. Since AVG and TWE are production firms whose key performance indicator rely on how well it utilizes available resources to create wealth. Earnings before interest and tax (EBIT) indicates the ability of the firm to cover interest on loans as well as the tax burden, which in turn affects its operations. NOPAT indicates net income after all expenses have been sorted out. It is important because it contributes to efficiency of engaging other financial commitments. Lastly, I selected operation efficiency because it acts a measure of the effectiveness of the company in controlling its activities while maximizing shareholders wealth.

In figure 1, production efficiency for AVG is lower than that of TWE though it has been on an increasing trend since 2013. Notably, TWE experienced a large sharp increase in production efficiency in 2014 but slightly declined in 2015. However, earning before tax and interest for AVG has been higher than TWE's for the three years running since 2013. It evident that AVG is experiencing a steady decline in EBIT while TWE's case is unpredictable. Ideally, production efficiency measures the ability of a firm to produce items without wasting the scarce resources. In other words, all factors of production are balanced well to produce products at cost efficient manner. EBIT margin is the percentage of gross earnings available to cover the expenses. If a company EBIT is declining, then it implies that the firm cost of sale is high. Both production efficiency and EBIT reflect on operating efficiency of a company. AVG indicated better NOPTA than TWE across the three years because its product differentiation strategy seem to make its product distinct in the wine market. TWE experienced a bad year in 2014 that adversely impacted its operation efficiency and NOPAT due to drastic change in consumption pattern in the key markets.

Ledovskikh (2016) reports that the Australian wine manufacturers face competition from low-cost overseas wine manufacturers that impacted exports. Within the Australian domestic market, wine producers have the low bargaining power to retailers because of wine grapes oversupply (Varsei, & Polyakovskiy, 2016). Ledovskikh’s observation can explain the dwindling EBIT because companies have to spend more marketing expenses as well as quality production process to enhance the marketability of their products. Both AVG and TWE indicated low percentages in both ratios, which confirms Ledovskikh’s (2016) assertions.

Investment Management

Figure 2:

I opt to use net non-current turnover, net-non asset/sales, inventory turnover, and account receivable turnover. I think net non-current asset turnover and net non-current/sales indicate the performance of fixed assets. Since AVG and TWE create provisions for this fixed assets during their lifetime, assessing their return capacity determines whether they are viable investments or not. Additionally, inventory turnover indicates the frequency of stock movement, which influence sales return. A company can use to plan its inventory management practices as well as know fast moving inventory to stock. Lastly, I selected account receivable turnover because it indicates a company credit management practices, which influence bad debt collection.

TWE reported a higher inventory turnover compared to AVG. For example, the inventory turnover for TWE is 1.901, 1.711, and 1.825 in 2015, 2014, and 2015 respectively. Averagely, the inventory days for TWE is 200, which is far much lower than that of AVG. High inventory days for AVG could be due to intense rivalry from other firms, especially TWE that controls significant Australian market share. With the slow growth of 0.2% in Australian wine industry, it is possible for oversupply to influence inventory movement.

Accounts receivable turnover for AVG is at an average 5.4 while that of TWE is an average of 3.9 for 2013-2015. Notably, there is no clear trend for account receivable turnover except that the value for 2014 was relatively higher than 2013 and 2015 for both companies. Account receivable turnover for AVG is high possible because of its smaller size that enables it to manage its credit effectively. However, TWE has segments in the US, New Zealand, and Italy with markets overseas. These markets are influenced by dollar exchange rates and economy variation. It is possible that receivable days could be high for TWE.

Net non-current asset/ Sales for AVG 1.017 and 1.088 in 2015 and 2014 respectively. Net non-current asset turnover is 0.983 and 0.919 in 2015 and 2014 respectively. However, TWE recorded net non-current asset/sales figure of 1.26 and 1.424 in 2015 and 2014 respectively, which are higher than that of AVG. Net non-current asset turnover is 0.788 and 0.702 in 2015 and 2014 respectively; a lower figure that that of AVG. Both companies record asset turnover of less than 1. One possible explanation for the observation is the ease with which new entrants join the wine business. Australia is known globally known for producing wine and starting companies rely on the Australian wine brand to market their products overseas. Therefore, increased domestic and international competition reduces net income for AVG and TWE, which in turn reduce asset turnover. Prices are going down, and bargaining power of retailers is on a rising due to many choices. Unless new markets open up, AVG and TWE will continue to incur low asset turnover. Low alcohol consumption behavior within Australia is also on the rise thereby reducing the demand for wine.

Financial Leverage Ratios

Figure 2: Critical financial management ratios.

I selected cash and current ration because they show level of a firm’s liquidity. For instance, current ration compares current assets to current liabilities to assess whether a company can pay salaries, dividends, suppliers, and tax among other obligations. However, cash ratio measures the actual cash equivalent available. Due to uncertainty of inventories and trade receivables, cash ratio show the actual cash equivalent available against current liabilities. AVG is investing in other activities or have borrowings that earn interest. Therefore, interest coverage determines how comfortable a firm can pay interest without risking its financial position. Liability to equity indicates how much owner’s equity can pay liabilities in case worst case happens. Therefore, the four ratios indicates key financial stability of a firm in shielding itself against financial crisis.

AVG has higher current and liability to equity ratio than TWE throughout the three years. However, TWE has higher cash ratio and interest EBIT coverage ratio than AVG through the years. TWE has diversified investments portfolio and specializes in selling premium wine. The unique market segmentation ensures it gets clients who can pay for premium value and luxury that comes with it. It's stable cash ratio, and EBIT interest coverage is due to strong cash flows from its globally diversified operations. In 2014 financial year reporting, TWE realized negative figure in interest EBIT coverage ratio because of a sharp decline in prices and a shift in consumer demands among the major markets such as the UK and the US (Grant et al., 2015; Viassone, Vrontis, & Papasolomou, 2016). Despite dwindling financial management performance in 2014, TWE reorganized its practices to realize impressive comeback in 2015. Additionally, TWE keeps lower equity to debt ratio that AVG, which implies that AVG relies on liabilities to finance its operations.

A low liability-to-equity ratio and high-interest EBIT coverage indicate financial stability. Similarly, high current and cash ratio imply better cash flows that allow companies to meet their immediate financial obligations. Based on figure 2, TWE is in a better financial position that AVG. However, both AVG and TWE have to brace for challenging times ahead because they export wine in different jurisdictions where tax rates and interest rates also differ.

Profitability Ratios

Figure 2: Profitability Ratios

Profitability ratios indicate the level of return from business operations. I select ROA, asset turnover, return on asset, and profit margin as key indicators of profitability. Return on Assets and asset turnover assess how a company manages its assets to create wealth based on sales. Return on Equity (ROE) evaluates how sales revenue gives back to the owner’s wealth. Profit margin indicates safety net available after eliminating the cost of sales and other expenses. A firm with high return on assets and high profit margin is creating significant wealth using existing resources. Therefore, I think the above rations best indicate profitability level and can be used in making strategic decisions.

From the above data, AVG records positive asset turnover, return on asset, return on equity, and profit margin. However, it is clear that profitability performance decrease as each subsequent year. TWE indicates a shaky trend of profitability ratios with ROE, profit margin, and ROA hitting a bottom low in 2014 results. However, the company gained stability in 2015 but it did not exceed profitability index of AVG.

IBIS (2016) reported that demand of wine substitutes are on the rise with substances such as mead, perry, and fortified niche bargaining significant market share. Oversupply of wine in Australia push down prices and make it difficult to market wines domestically. Reputation of Australia is reducing as result of manufacturers sacrificing quality to wine to reduce expenses. Shift in global demand patterns of wine, especially in key markets such as the UK and Italy minimize market share for Australian companies. Still, tax expenses keep on increasing that reduce the net profit earned due to huge tax burden. In other words, all the above factors combine to reduce sales revenue, which in turn reduce profitability of AVG and TWE. Sharp decline in prices of TWE is partly due to its acquisition challenges in 2014 and failure to prepare for the global market shift of wine consumption.