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Sources of Funds and Classification of Entities

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Sources of Funds and Classification of Entities for Reporting Purposes

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Introduction

A company is usually defined as a separate legal entity having a perpetual life. This means that the owners of the company and the organisation are two separate entities in the eyes of the law (Brigham and Houston, 2012). Thus, any business enterprise can raise funds in order to finance its overall operational activities over the course of its life. In addition to this, the status of being a separate entity also demands of such enterprises to comply with various reporting requirements. This project report aims to provide a comprehensive account on Sources of Funds which a company can access to finance itself as well as the classification of entities for reporting purpose. Furthermore, specific organisational analysis has been carried out throughout the report in order to facilitate easy understanding of concepts and other related information.

Main Body

Part A

A Source of Fund can be defined as financial resources which are usually in the form of money and are the sole subject of creating a business relationship between a firm and its clients. In the context of given case scenarios, two public companies that are listed on ASX which are operating in the Financial Services Sector of Australia have been taken into account. These are Macquarie Group Limited (MGL) (ASX:MQG) and National Australian Bank (ASX:NAB). Through the critical assessment of their annual reports of last three years, the following insights have been accumulated:

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(i) Discussing the items recorded on the Balance Sheet under Owners' Equity Section for MGL and NAB:

The Owners' Equity Section of both the companies have been attached in the 'Appendices' Section of this report and includes the following items:

Contributed Equity:

This item can be defined as the that constituent of total equity which is directly bought by the shareholders from the issuing company (De Almeida and Eid Jr, 2014).

Reserves:

Another important constituent of Owners' Equity Section of both Macquarie Group Limited and National Australian Bank relates to Reserves. This item is usually inclusive of all those funds which are earmarked for the purpose of being utilised in the near future. Also, it may include the additional earnings which have not been distributed among the shareholders yet.

Retained Earnings:

This item is usually inclusive of all the additional profits that have been accumulated over the years and are left with the company once all the shareholders have been paid dividends. A business may utilise their retained earnings in order to undertake new projects or business opportunities arising in the near future.

Non-Controlling Interests:

This item is also widely known as the 'Minority Interest' and is mainly concerned with the portrayal of all those shareholders having an ownership stake of less than 50% within the company (Velnampy and Niresh, 2012). It is important to note that due to their minority status, such shareholders do not have a control over the business decisions made by the company.

(ii) Assessing the Movements recorded for each item pertaining to the Owners' Equity Section for both companies:

Macquarie Group Limited (MGL):

Over the course of three years, MGL has been able to record a 6.33% (=(1094÷17270)/17270)*100) growth between 2016 and 2018. Additionally, a trivial increase has been recorded in its reserves of only 0.27% and a considerable amount of rise in Retained Earnings amounting to 24.50% in the stipulated period. On the other hand, the contributed equity as well as the non-controlling interest have reduced over the years by 1.73% and 64.67% respectively between 2016 to 2018. This is mainly due to the fact that there was a purchase of shares by MEREP trust in 2018 worth $373 million related to which any tax benefit or expense transferred from share-based payments resulted in a net loss of $84 million. As a result, these values have reduced in 2018 in comparison to 2017 and 2016 (Annual Report of MGL, 2018).

National Australian Bank:

Over the course of three years, NAB has recorded a mere 2.72% growth between 2016 and 2018 on its total equity. Contrary to MGL, the contributed equity of NAB has increased by almost 5% (=4.95%). This trend is followed by Reserves which have been heavily depleted in 2018, thus, making it reduce by 92.69%. This is due to the fact that during 2018, there was a transfer from equity-based compensation reserve worth $173 million which records the value of benefits that are provided to the company's employees as part of their remuneration (Annual Report of NAB, 2018). Also, the Retained Earnings have improved by 1.81% between 2016 and 2018 while the non-controlling interest remains unchanged since 2017. Thus, indicating that there is a widespread retaining of the profits earned over the years which can largely relate to any capital project undertaken or planning to be undertaken by NAB.

The Liabilities' Section of both the companies have been attached in the 'Appendices' Section of this report and includes the following items:

NAB Items:

  • Deposits and Other Borrowings: This item shown on the Balance Sheet indicates the term deposits, Commercial Papers and other such borrowings including those securities which are meant to be sold under repurchase agreements (Abuzayed, 2012).
  • Hedging Derivatives: It includes those liabilities wherein the exposures are not automatically managed through NAB's broader Risk Management process.
  • Provisions: These can be defined as those those items which arise when a legal or constructive obligation exists that results in the outflow of cash-flow on a probable basis.
  • Bonds, notes and subordinated debt: This class of liabilities includes those bonds, notes and subordinated debt which have been initially recognised at Fair Value (FV) excluding any transactional costs for NAB.
  • Other Debt Issues: These include perpetual floating notes, convertible preference shares and notes that were initially recognised at fair value.

MGL Items:

  • Derivative Liabilities: These are those classes of liabilities which usually pertain a financial instrument whose value is determined based on the value of one or more underlying assets as well as notional amounts.
  • Deposits: This item shown on the Balance Sheet indicates the amount which is to repaid to the bank or depositor, usually on demand (Williams and Dobelman, 2017).
  • Cash Collateral on securities lent and repurchase agreements: A part of Payables to financial institutions, these relate to the borrowings made by MGL excluding any bank borrowings.
  • Margin money and settlement liabilities: These relate to the derivative liabilities that are possessed by Macquarie within its Balance Sheets.
  • Deferred Tax Liabilities: A tax payment expected to be made in near future and includes tax losses, temporary differences of various other assets and liabilities (Palepu and Healy, 2013).

Items appearing in common for both companies:

  • Bank borrowings/Payable to financial institutions: This item includes loans and other payables which are due to banks and other financial institutions.
  • Trading Liabilities: This item includes all those liabilities which are on short-term positions as well as loss on revaluation due to interest and For-Ex rates as well as other commodity and equity-based contracts.
  • Other Liabilities: This item is mainly related to security settlements, accruals, creditors and other related liabilities.
  • Deferred Tax Liabilities: This item is mainly related to security settlements, accruals, creditors and other related liabilities (Palepu, Healy and Peek, 2013).
  • Due to controlled entities or subsidiaries: This item pertains to any liabilities which are due by both Macquarie and National Australian Bank towards their subsidiaries. In both cases, there are no amounts related to such an item.
  • Other financial liabilities: It includes all those items related to financial liabilities which are mostly related to bonds, commercial papers and subordinated debt.

National Australian Bank (ASX:NAB)

Item

Movement between 2016-2018

Reason

Due to other banks

An overall decline by 13.01% between the stipulated period has been recorded. However, in 2018 such dues have increased for NAB by 4.11%.

Additional loans taken by NAB from Central Bank and other regulatory authorities.

Trading instruments

An overall decline by 46.17% has been recorded.

Selling of 14.21% of Bank's total Trading Derivatives for deriving returns has resulted in substantial decline within the stipulated period.

Other financial liabilities

An overall decline by 8.39% has been recorded. However, in 2018 such dues have increased for NAB by 2.72%.

The changes in such debts are also due to the changes in NAB's overall credit risk occurring in 2018 which resulted in a gain of $66 million.

Hedging derivatives

An overall decline by 21.51% has been recorded. However, in 2018 such dues have increased substantially for NAB by 52.15%.

The company's adoption to Hedge Accounting Requirements in AASB 9 Financial Instruments have resulted in such an increase in 2018 as compared to other years.

Deposits and other borrowings

An overall rise by 9.45% has been recorded. However, in 2018 such dues have increased only by 0.51%.

This incremental change can be attributed to a 1.47% rise in term deposits in 2018.

Current tax liabilities

A substantial decline of 65.32% has been recorded within the stipulated time-frame. Between 2017 and 2018 alone, there has been a reduction in Current Tax Liabilities by 55.22%.

This reduction is due to the repayment of such liabilities on a net basis by NAB.

Provisions

There has been a substantial increase of 55.35% in NAB's provisions between 2016 and 2018. 2017 accounted for 36.94% increase in Provisions whereas only 11.98% has been accounted for in 2018.

Such an incremental change is due to 2.84% rise in Employee Entitlements, 10.96% decline in Operational Risk Event losses and creation of provision for restructuring worth $285 million in 2018.

Bonds, notes and subordinated debt

There has been a 9.60% increase in NAB's liabilities related to such class between 2016 and 2018. While in 2017 there was a slight decline of 2.4%, a subsequent rise of 12.29% has been accounted for in 2018.

The subsequent rise in such bonds and subordinated debts relate to a 18.50% and 18.10% increase in the Medium-term and Securitisation notes possessed by the bank respectively.

Other debt issues

A mere 1.44% decline has been recorded between 2016-18. With only 0.98% reduction in 2017 and a further decrease in such liabilities by 0.47% in 2018.

Mainly, such decline can be attributed to 27.89% reduction in Perpetual floating rate notes in 2017-18.

Other Liabilities

NAB has recorded a mere 3.15% decline in its 'Other Liabilities' for the last three years with a maximum decline in its value (by 7.72%) in 2017 and a 4.96% rise in such liabilities between 2017-18.

This can be attributed to a 11.69% rise in Accrued Interest Payables in 2018 and a 33.78% rise in cash collateral received from third parties between 2017-18.

Macquarie Group Limited (MGL) (ASX:MQG)

Cash collateral on securities lent and
repurchase agreements

Between 2016-19, there has been a significant decrease of 30.36% in cash collaterals and repurchase agreements undertaken by MGL. The maximum change in this class of liabilities occurred in 2017 when such debts declined by 22.51%. Only 10.12% decrease has been recorded in 2018.

There reduction can be attributed as the repayment of such liabilities by the Company over the years (Kang and Gray, 2013).

Trading liabilities

Between 2016-19, a significant increase of 60.02% has been recorded with maximum change in this class observed in 2017 at 59.09% rise.

A low change of 0.58% in 2018 is due to the fact that Corporate loans and securities have been paid off along with foreign government securities, while Listed Equity Securities have increased.

Margin money and settlement liabilities

Within 2017-18, there has been an increase in such liabilities by 8.13% whereas no prior information regarding the same exists in the company's balance sheets.

Such an increase is due to the rise in call margin placed by financial institutions in CGM.

Derivative liabilities

Overall increase of 13.81% recorded between 2016 and 2019.

Undertaking such liabilities in 2018 has resulted in their overall increase.

Deposits

An overall decline by 2.63% has been recorded. However, in 2018 such dues have decreased by 5.42%.

This due to rise in term deposits by MQG in 2018.

Held for sale liabilities

MGL has experienced a massive increase in such liabilities at 1209.42%. Majority of such rise is seen in 2018 where this item increased by 1201.91%.

This is due to liabilities arising from the disposal of Macquarie Air Finance (MAF) which was classified as held for sale in 2018.

Other liabilities

MGL has recorded a decline of 55.19% decline in the last three years with a maximum decline in its value (by 58.13%%) in 2018.

A substantial decline of 87.23% in its aircraft and rail maintenance liabilities has resulted in such a downturn for MGL in 2018.

Bank borrowings/Payable to financial institutions

A substantial decline of 45.42% in bank borrowings with 39.65% downtrend experienced in 2018 itself.

Such a reduction in bank borrowings is due to the reclassification of aviation business held for sale and its related liabilities.

Debt issued at amortised cost

Such debts have been eliminated from balance sheet by the end of 2018.

There 100% repayment in 2018 has resulted in such an elimination.

Other debt issued/ Financial Liabilities at fair value through profit or loss

Such debts have been eliminated from balance sheet by the end of 2018.

There 100% repayment in 2018 has resulted in such an elimination.

Debt issued

There has been a 10% decline in such liabilities between 2016-18.

Reduction is mainly attributed to the repayment of Securitisations.

Deferred tax liabilities

An overall decline of 31.56% in such liabilities wherein 43.26% has been carried out in 2018 itself.

Offset of such liabilities on loan and derivative assets (at 88.12%) has resulted in such a decline.

Loan Capital

Overall increase of 21.14% recorded in last three years. Wherein 29.14% have been accounted for in 2018 itself.

Such an increase can be attributed to the net issuance of Macquarie Capital Notes during 2018.

(v) Relative Advantages and Disadvantages of each source of fund for selected corporations:

Essentially, the Sources of Funds that are usually available for companies include Debt and Equity Financing related options. Both NAB and MGL utilise such financing options. There relative advantages and disadvantages have been discussed as under:

Equity Financing:

This source of finance is mainly concerned with the accumulation of additional capital through the sale of shares of the company. Both NAB and MGL have considerable amount of Equity Financed sources provided in their balance sheet with majority of their equity financing done through Contributed Equity (De Villiers, Unerman and Rinaldi, 2014).

  • Advantages: These enable the selected companies to enjoy lesser risk, elimination of any credit problems specifically related to debt.
  • Disadvantages: Dilution of Ownership resulting in loss of control and expensiveness of such source of funds results in owner's incurring additional cost even higher then debt financing.

Debt Financing:

This source of finance is mainly concerned with the accumulation of additional capital through the borrowing of loans from banks and other such financial enterprises. Both NAB and MGL have considerable amount of Debt Financed sources provided in their balance sheet with majority of their debt financing done through Trading Liabilities, derivatives and borrowings from financial institutions among others.

  • Advantages: These enable the selected companies to enjoy complete control over their business activities and their interest repayments can be easily treated as a business expense which provides them tax-shields while filing their returns.
  • Disadvantages: Repayment of both principal and interest may create a financial burden for the businesses. Also, insufficiency to repay such liabilities may result in sale of assets of the organisation (Barraket and Yousefpour, 2013).

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Part B

Critical examination of proprietary companies and reporting entities along with their implications in terms of compliance and reporting requirements:

A company, in terms of compliance and reporting requirements may be divided into two classes, viz. Large and Small. While a Large Proprietary company may be one which satisfies two of the following three criterion:

  • annual consolidated revenue of the company exceeds $50 million;
  • consolidated gross assets held at the end of the year by such enterprise and any entity it controls exceeds $25 million;
  • company and its subsidiaries have more than 100 employees at the end of financial year (ASIC and Large/Small Proprietary Company,2019).

On the other hand, a Small Proprietary company may be one which does not meet at least two of the aforementioned criteria. In both cases, the company is required to prepare financial statements and report within a proper compliance and reporting framework. Lastly, a reporting entity can said to be one where it is reasonable to expect existence of various users of financial information who utilise such insights in order to make economic business decisions (Reporting Entities, 2019).

Implications associated with either of these companies in terms of compliance and reporting requirements results in imposition of heavy fines by Court in pursuance of breach of Corporations Act, 2001. This may also result in officeholders being sent to prison in various instances. These actions may be broadly identified as civil, criminal and administrative in nature and may be utilised in combination by deciding authorities (ASIC and Penalties, 2019).

Conclusion

From the above report it can be concluded that a company has mainly two sources of finance which it can resort to, viz. Equity and Debt. Based on the structure, size, nature and complexity of such organisations, the degree and source of financing varies from companies to companies. Furthermore, the reporting entities may be bifurcated on the basis of reporting requirements and may result in bearing heavy penalties regarding the same. Thus, it is crucial for businesses to comply with legal requirements, especially those related to reporting of organisational profits and corporate performance.

References

  • Brigham, E. F. and Houston, J. F., 2012. Fundamentals of financial management. Cengage Learning.
  • De Almeida, J. R. and Eid Jr, W., 2014. Access to finance, working capital management and company value: Evidences from Brazilian companies listed on BM&FBOVESPA. Journal of Business Research. 67(5). pp.924-934.
  • Velnampy, T. and Niresh, J. A., 2012. The relationship between capital structure and profitability. Global Journal of Management and Business Research. 12(13).
  • Abuzayed, B., 2012. Working capital management and firms’ performance in emerging markets: the case of Jordan. International Journal of Managerial Finance. 8(2). pp.155-179.
  • Williams, E. E. and Dobelman, J. A., 2017. Financial statement analysis. World Scientific Book Chapters. pp.109-169.
  • Palepu, K. G. and Healy, P. M., 2013. Business analysis and valuation: Using financial statements, text and cases.
  • Palepu, K. G., Healy, P. M. and Peek, E., 2013. Business analysis and valuation: IFRS edition. Cengage learning.
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