Statement piece: the importance of accurately reading financial accounts
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Statement piece: the importance of accurately reading financial accounts

At a glance

  • Despite admirable efforts there continues to be variance in how companies report their financial positions
  • Differences in reporting do not necessarily constitute actual variance – the differences to an accountant are not the same as they are to an investor
  • A full understanding of company financial statements should improve outcomes for investors

You won’t travel far if you can’t read the road signs (unless you have GPS, of course). Regardless, surely being able to read is better than not, and being able to read and understand financial statements is another form of literacy that can help with investing and earning the appropriate level of return for a given level of risk.

One might think that after all the years of debate and revisions, financial statements would be prepared in such a way that little interpretation or ability to “read” would be needed. Unfortunately, that is not the case. International standards have become more comparable, thanks to the efforts of the Financial Accounting Standards Board and the International Accounting Standards Board.

But even today, and within an agreed set of accounting standards, there are situations which require one to understand and account for differences – even among such similar firms as, for example, UPS and Fedex1, which both report according to US generally accepted accounting principles (US GAAP). Investors must understand these distinctions and how they affect the figures and ratios used for the purpose of comparing companies and assessing likely returns on investment. (To be clear, these are allowed, non-controversial items, but they cause material differences in reported results and can impact how a company appears over time, as well as how it compares to peers.)

Fedex and UPS are two of the largest parcel delivery companies in the US, and each are formidable competitors in many non-US markets. Fedex uses operating leases to obtain equipment and property to a much larger extent than UPS. Much of this leasing is for essential facilities, for example at airports. Fedex may not even have a choice about this – perhaps it is impossible to actually buy and finance these assets. Regardless, this is not a comment on how a company should or should not finance assets. It is simply to point out that where there is a difference in approach, one needs to understand the implications – not only on the balance sheet and income statement, but also the cashflow statement.

A company that uses lease financing will most likely report lower EBITDA (earnings before interest, taxes, depreciation, and amortisation), lower cash from operations and lower capital expenditure. In addition,  key ratios such as net debt to EBITDA and return on average assets will be different than if the same company were to use debt. For clarity, EBITDA is not a term used in generally accepted accounting principles, but it is commonly used by management teams and analysts. The differences are essentially that if a company owns assets and finances them, they will have a corresponding interest expense as well as the depreciation expense in future periods. If they use leases, those items are replaced by rental expense. All rental expense would be deducted when calculating EBITDA, and the same would be true for operating cashflow.

Figure 1 is an outline of how Fedex reported its results at its last year-end (May 2023) and how they would have been reported had they not used lease financing.

Figure 1: Fedex accounts, lease and on-lease
Fedex accounts

Source: Columbia Threadneedle Investments’ analysis of company reports, May 2024

Credit investors tend to care about net debt divided by EBITDA (nd/ebitda) – the lower the figure, the better. As per Figure 1, a number like 2.8x would ordinarily be considered much healthier than 3.5x. Margins are also looked at, and EBITDA multiples are commonly used in M&A discourse. “Cash is king” applies in credit as in other contexts and we can see from this example that operating cashflow is significantly affected by the choice of financing.

A change in Fedex’s policy – for example, to  replace a portion of the operating leases with debt – could give a misleading impression that the company was reducing leverage, as the nd/ebitda figure would improve. The EBITDA margin would also improve, implying – again incorrectly – that the company was becoming more efficient. And lastly, cash from operations would grow.

Another pitfall awaiting an unsuspecting financial statement user would be to compare the reported figures from Fedex and UPS and draw inappropriate conclusions. Figure 2 is based on the above Fedex figures and the corresponding data for UPS, unadjusted. UPS does use some leases, just to a much smaller degree. As can be seen, Fedex “as reported” has considerably higher leverage and lower margins than UPS. But adjusted, Fedex is considerably more similar to UPS.

Figure 2: Fedex accounts, lease and on-lease … and UPS
Fedex accounts and UPS

Source: Columbia Threadneedle Investments’ analysis of company reports, May 2024

How one considers the topic of asset financing may make the difference between viewing UPS and Fedex as companies with very similar businesses achieving fairly similar results, or seeing one as an efficient, disciplined capital allocator (UPS) and the other as a bit of a sloppy, highly indebted runner-up.  A more in-depth understanding will help the bond investor avoid overpaying for one while possibly ignoring the other entirely.

7 June 2024
Gregory Turnbull Schwartz
Senior Analyst, Fixed Income
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Statement piece: the importance of accurately reading financial accounts

1 The mention of specific stocks is not a recommendation to buy or sell

Important information

For use by professional clients and/or equivalent investor types in your jurisdiction (not to be used with or passed on to retail clients). For marketing purposes.

 

This document is intended for informational purposes only and should not be considered representative of any particular investment. This should not be considered an offer or solicitation to buy or sell any securities or other financial instruments, or to provide investment advice or services. Investing involves risk including the risk of loss of principal. Your capital is at risk. Market risk may affect a single issuer, sector of the economy, industry or the market as a whole. The value of investments is not guaranteed, and therefore an investor may not get back the amount invested. International investing involves certain risks and volatility due to potential political, economic or currency fluctuations and different financial and accounting standards. The securities included herein are for illustrative purposes only, subject to change and should not be construed as a recommendation to buy or sell. Securities discussed may or may not prove profitable. The views expressed are as of the date given, may change as market or other conditions change and may differ from views expressed by other Columbia Threadneedle Investments (Columbia Threadneedle) associates or affiliates. Actual investments or investment decisions made by Columbia Threadneedle and its affiliates, whether for its own account or on behalf of clients, may not necessarily reflect the views expressed. This information is not intended to provide investment advice and does not take into consideration individual investor circumstances. Investment decisions should always be made based on an investor’s specific financial needs, objectives, goals, time horizon and risk tolerance. Asset classes described may not be suitable for all investors. Past performance does not guarantee future results, and no forecast should be considered a guarantee either. Information and opinions provided by third parties have been obtained from sources believed to be reliable, but accuracy and completeness cannot be guaranteed. This document and its contents have not been reviewed by any regulatory authority.

 

In Australia: Issued by Threadneedle Investments Singapore (Pte.) Limited [“TIS”], ARBN 600 027 414. TIS is exempt from the requirement to hold an Australian financial services licence under the Corporations Act 2001 (Cth) and relies on Class Order 03/1102 in respect of the financial services it provides to wholesale clients in Australia. This document should only be distributed in Australia to “wholesale clients” as defined in Section 761G of the Corporations Act. TIS is regulated in Singapore (Registration number: 201101559W) by the Monetary Authority of Singapore under the Securities and Futures Act (Chapter 289), which differ from Australian laws.

 

In Singapore: Issued by Threadneedle Investments Singapore (Pte.) Limited, 3 Killiney Road, #07-07, Winsland House 1, Singapore 239519, which is regulated in Singapore by the Monetary Authority of Singapore under the Securities and Futures Act (Chapter 289). Registration number: 201101559W. This advertisement has not been reviewed by the Monetary Authority of Singapore.

 

In Hong Kong: Issued by Threadneedle Portfolio Services Hong Kong Limited 天利投資管理香港有限公司. Unit 3004, Two Exchange Square, 8 Connaught Place, Hong Kong, which is licensed by the Securities and Futures Commission (“SFC”) to conduct Type 1 regulated activities (CE:AQA779). Registered in Hong Kong under the Companies Ordinance (Chapter 622), No. 1173058.

 

In Japan: Issued by Columbia Threadneedle Investments Japan Co., Ltd. Financial Instruments Business Operator, The Director-General of Kanto Local Finance Bureau (FIBO) No.3281, and a member of Japan Investment Advisers Association and Type II Financial Instruments Firms Association.

 

In the UK: Issued by Threadneedle Asset Management Limited, No. 573204 and/or Columbia Threadneedle Management Limited, No. 517895, both registered in England and Wales and authorised and regulated in the UK by the Financial Conduct Authority.

 

In the EEA: Issued by Threadneedle Management Luxembourg S.A., registered with the Registre de Commerce et des Sociétés (Luxembourg), No. B 110242 and/or Columbia Threadneedle Netherlands B.V., regulated by the Dutch Authority for the Financial Markets (AFM), registered No. 08068841.

 

In Switzerland: Issued by Threadneedle Portfolio Services AG, an unregulated Swiss firm or Columbia Threadneedle Management (Swiss) GmbH, acting as representative office of Columbia Threadneedle Management Limited, authorised and regulated by the Swiss Financial Market Supervisory Authority (FINMA).

 

In the Middle East: This document is distributed by Columbia Threadneedle Investments (ME) Limited, which is regulated by the Dubai Financial Services Authority (DFSA). For Distributors: This document is intended to provide distributors with information about Group products and services and is not for further distribution. For Institutional Clients: The information in this document is not intended as financial
advice and is only intended for persons with appropriate investment knowledge and who meet the regulatory criteria to be classified as a Professional Client or Market Counterparties and no other Person should act upon it.

 

This document may be made available to you by an affiliated company which is part of the Columbia Threadneedle Investments group of companies: Columbia Threadneedle Management Limited in the UK; Columbia Threadneedle Netherlands B.V., regulated by the Dutch Authority for the Financial Markets (AFM), registered No. 08068841.

 

Columbia Threadneedle Investments is the global brand name of the Columbia and Threadneedle group of companies.

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Important information

For use by professional clients and/or equivalent investor types in your jurisdiction (not to be used with or passed on to retail clients). For marketing purposes.

 

This document is intended for informational purposes only and should not be considered representative of any particular investment. This should not be considered an offer or solicitation to buy or sell any securities or other financial instruments, or to provide investment advice or services. Investing involves risk including the risk of loss of principal. Your capital is at risk. Market risk may affect a single issuer, sector of the economy, industry or the market as a whole. The value of investments is not guaranteed, and therefore an investor may not get back the amount invested. International investing involves certain risks and volatility due to potential political, economic or currency fluctuations and different financial and accounting standards. The securities included herein are for illustrative purposes only, subject to change and should not be construed as a recommendation to buy or sell. Securities discussed may or may not prove profitable. The views expressed are as of the date given, may change as market or other conditions change and may differ from views expressed by other Columbia Threadneedle Investments (Columbia Threadneedle) associates or affiliates. Actual investments or investment decisions made by Columbia Threadneedle and its affiliates, whether for its own account or on behalf of clients, may not necessarily reflect the views expressed. This information is not intended to provide investment advice and does not take into consideration individual investor circumstances. Investment decisions should always be made based on an investor’s specific financial needs, objectives, goals, time horizon and risk tolerance. Asset classes described may not be suitable for all investors. Past performance does not guarantee future results, and no forecast should be considered a guarantee either. Information and opinions provided by third parties have been obtained from sources believed to be reliable, but accuracy and completeness cannot be guaranteed. This document and its contents have not been reviewed by any regulatory authority.

 

In Australia: Issued by Threadneedle Investments Singapore (Pte.) Limited [“TIS”], ARBN 600 027 414. TIS is exempt from the requirement to hold an Australian financial services licence under the Corporations Act 2001 (Cth) and relies on Class Order 03/1102 in respect of the financial services it provides to wholesale clients in Australia. This document should only be distributed in Australia to “wholesale clients” as defined in Section 761G of the Corporations Act. TIS is regulated in Singapore (Registration number: 201101559W) by the Monetary Authority of Singapore under the Securities and Futures Act (Chapter 289), which differ from Australian laws.

 

In Singapore: Issued by Threadneedle Investments Singapore (Pte.) Limited, 3 Killiney Road, #07-07, Winsland House 1, Singapore 239519, which is regulated in Singapore by the Monetary Authority of Singapore under the Securities and Futures Act (Chapter 289). Registration number: 201101559W. This advertisement has not been reviewed by the Monetary Authority of Singapore.

 

In Hong Kong: Issued by Threadneedle Portfolio Services Hong Kong Limited 天利投資管理香港有限公司. Unit 3004, Two Exchange Square, 8 Connaught Place, Hong Kong, which is licensed by the Securities and Futures Commission (“SFC”) to conduct Type 1 regulated activities (CE:AQA779). Registered in Hong Kong under the Companies Ordinance (Chapter 622), No. 1173058.

 

In Japan: Issued by Columbia Threadneedle Investments Japan Co., Ltd. Financial Instruments Business Operator, The Director-General of Kanto Local Finance Bureau (FIBO) No.3281, and a member of Japan Investment Advisers Association and Type II Financial Instruments Firms Association.

 

In the UK: Issued by Threadneedle Asset Management Limited, No. 573204 and/or Columbia Threadneedle Management Limited, No. 517895, both registered in England and Wales and authorised and regulated in the UK by the Financial Conduct Authority.

 

In the EEA: Issued by Threadneedle Management Luxembourg S.A., registered with the Registre de Commerce et des Sociétés (Luxembourg), No. B 110242 and/or Columbia Threadneedle Netherlands B.V., regulated by the Dutch Authority for the Financial Markets (AFM), registered No. 08068841.

 

In Switzerland: Issued by Threadneedle Portfolio Services AG, an unregulated Swiss firm or Columbia Threadneedle Management (Swiss) GmbH, acting as representative office of Columbia Threadneedle Management Limited, authorised and regulated by the Swiss Financial Market Supervisory Authority (FINMA).

 

In the Middle East: This document is distributed by Columbia Threadneedle Investments (ME) Limited, which is regulated by the Dubai Financial Services Authority (DFSA). For Distributors: This document is intended to provide distributors with information about Group products and services and is not for further distribution. For Institutional Clients: The information in this document is not intended as financial
advice and is only intended for persons with appropriate investment knowledge and who meet the regulatory criteria to be classified as a Professional Client or Market Counterparties and no other Person should act upon it.

 

This document may be made available to you by an affiliated company which is part of the Columbia Threadneedle Investments group of companies: Columbia Threadneedle Management Limited in the UK; Columbia Threadneedle Netherlands B.V., regulated by the Dutch Authority for the Financial Markets (AFM), registered No. 08068841.

 

Columbia Threadneedle Investments is the global brand name of the Columbia and Threadneedle group of companies.

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