Comparing the development of two communication technology companies using financial statement analysis

Using examples of Huawei and Ericsson


Bachelor Thesis, 2017

101 Pages, Grade: 1.7


Excerpt

Table of Contents

Acknowledgments

Abbreviation

List of figures

List of tables

1. Introduction
1.1 Background and objectives of thesis
1.2 Tasks of thesis
1.3 Outline of thesis

2. Fundamentals of the concept of financial statement analysis
2.1 Definition
2.2 Objectives and functions
2.3 Procedure
2.4 Analysis areas and limitation

3. Comparison of companies
3.1 Huawei
3.1.1 Company profile
3.1.2 Accounting policies and changes
3.2 Ericsson
3.2.1 Company profile
3.2.2 Accounting policies and changes

4. Quantitative Evaluation
4.1 Reformulation of financial statement
4.1.1 Standard balance sheet
4.1.2 Reclassification of comprehensive income statement
4.2 Structure analysis
4.2.1 Asset side
4.2.2 Liability side
4.3 Liquidity analysis
4.3.1 Maturity matching analysis
4.3.2 Cash flow analysis
4.4 Performance analysis
4.4.1 Income structure analysis
4.4.2 Expenses structure analysis
4.4.3 Profitability analysis

5. Comparis`on of results
5.1 Asset situation
5.2 Financial situation
5.3 Profit situation

6. Conclusion

References

Appendix A

Appendix B

Acknowledgments

My deepest gratitude goes first and foremost to Professor Schneider and Pro- fessor Amely, my supervisors, for their constant encouragement and guidance. They have walked me through all the stages of the writing of this thesis. Without their consistent and illuminating instruction, this thesis could not have reached its present form.

Second, I would like to express my heartfelt gratitude to my college mate Mr. Wang, who gave me his help and time in listening to me and helping me work out my problems during the difficult course of the thesis. I am also greatly indebted to the friends in University Bonn, who have instructed and helped me a lot in English expression for the past three months.

Last but not least my thanks would go to my beloved family, especially my par- ents, for their loving considerations and great confidence in me all through this time.

Abbreviation

Abbildung in dieser Leseprobe nicht enthalten

List of figures

Figure 1 Outline of the thesis

Figure 2 Process of financial analysis

Figure 3 The development of balance sheet total (after reformulation)

Figure 4 Liquidity grade of Huawei and Ericsson from 2011 to 2016

Figure 5 Asset coverage 1 and 2 from 2011 to 2016

Figure 6 Changes in cash flow during the period 2011-2016

Figure 7 Development of revenue in Huawei and Ericsson from 2011 to 2016

Figure 8 Income structure analysis of Huawei and Ericsson from 2011 to 2016

Figure 9 Comparative Financial Data 2011 to 2016

Figure 10 Changes of expenses ratio during the six year period

Figure 11 Disaggregation of ROCE

Figure 12 Changes of three profitability indicator within six year period

Figure 13 Structure rate of change overview

Figure 14 Financial situation rate of change overview

Figure 15 Profit situation rate of change overview

List of tables

Table 1 Comparison of Huawei and Ericsson 2016

Table 2 Result of the adoption of revised IAS 19

Table 3 Standard balance sheet

Table 4 Categorization of income statement according to sources of income

Table 5 Categorization of income statement according to new income conceptions

Table 6 Development of asset intensity from 2011 to 2016

Table 7 Growth rate of Huawei and Ericsson from 2011 to 2016

Table 8 Development of equity and liabilities from 2011 to 2016

Table 9 Change of Working capital and net debt over 2011 to 2016

Table 10 Leverage ratios from 2011 to 2016 (adjusted)

1. Introduction

1.1 Background of thesis

In today’s rapidly changing world, the hyper growth of information technology has induced the emergence of new telecommunication companies and has promoted the development of global economic integration. Accounting for the largest market share, Huawei, as one of the newly emerged ICT companies, is moving from China to the world and gradually becoming a leader in the global ICT industry. Huawei, a Chinese multinational networking and telecommunications equipment and services company, is cutting the striking figure in the last decades and finally defeating its closest rival, Ericsson.

In 2012, after the conversion according to the annual average exchange rate, Huawei's operating income exceeded Ericsson’s for the first time. Before that, Ericsson was the world’s largest communications equipment manufacturers, followed by Huawei, Cisco, Nokia, and ZTE, but now the situation has changed. Meanwhile in July 2012, according to IDC, a Chinese market research, analysis and advisory firm, Huawei became the world's third largest smart phone maker, second only to Samsung and Apple. After that, in 2013 Infonetics Research, an international market research firm, released news that equipment supplier lead- ing company scorecard shows: Huawei ranked first, followed by Ericsson and Cisco. And according to 2016 annual year report of both companies, the size of Huawei is roughly equal to three Ericssons’ in terms of annual revenue.

In addition, at the end of July 2016, Ericsson, the Swedish maker of wire- less-networking equipment ousted their CEO Hans Vestberg, after revenue and profit decreased and an array of investigations at this company led to growing shareholders’ unease. Hans Vestberg is not the first CEO who was “killed” by the Ren Zhengfei, the CEO of Huawei. From July 1999 to now, there are at least four CEOs in Ericsson who were dismissed because of the failure in fierce competi- tion with Huawei.

Now Huawei acts as a leading company in telecommunication industry not only in China but also around the world and plays an increasingly important role in the worldwide competition. Thus, it is necessary to find out to what extent did Huawei achieve such success?

Financial statement analysis, as a traditional and important method of analyzing a company’s operation, provides valuable information about a company’s performance, and understanding the statement of a company is the crucial way to understand whether a company functions well or not. Therefore, by the conduct of a financial statement analysis of Huawei in compassion with that of Ericsson, we can find some valuable information.

1.2 Objectives and tasks of thesis

The general aim of this present thesis is to gain insight into the economic situa- tion of both companies from published annual reports and then into the devel- opment of Huawei and Ericsson within six years, since other sources of financial data are not available to outsiders, and the analysis of the consolidated financial statements of Huawei and Ericsson, which was prepared in accordance with IFRSs, within the six year period, gives insights into the economic situation of the two companies. To be more precise, the objectives of this essay are to ana- lyze the financial statements of those two communication technology companies using various financial indicators in order to evaluate both balance sheets’ structures, liquidity situations and performances, then to perform a comparison between those two companies in order to study the development of both com- panies during the last six years and to find out how Huawei overtook its rival Ericsson and whether this success and continuous growth is still sustainable in the current global economic recession and financial crisis as well as in the fu- ture.

This thesis’s main task is to compare the analytic results of the two firms from 2011 to 2016 in order to find out to what extent Huawei has surpassed Ericsson, using the instruments of financial statement analysis. First, using the principle of Küting and Weber, we reformulated the financial statements of the two compa- nies to make them more comparable, and then we calculated the necessary key ratios extracted from annual financial reporting so that we can make comparison and outline the company’s status in three aspects, i.e. structure, liquidity, and performance. At last, after comparison of ratios of the two companies conclusions were drawn.

1.3 Outline of thesis

Consisting of six parts, this thesis is structured as follows. The first chapter gives fundamental information about this essay, including the background information, its aims and tasks, and the outline of the whole essay. The second chapter is the theory part, which covers topics from the definition, tasks, objectives, procedure of financial statement analysis to limitations. The third part of this thesis is an overall comparison of the two companies, which includes topics from company profile to accounting policies and changes during the last six years in the com- pany. To be more specific, we give a short introduction of Huawei and Ericsson in terms of history, location, businesses, and ranking. The next chapter is the main part of this essay and takes a look at the comparison of the overall situa- tions between two companies, using a powerful tool: financial statement analysis, or to be more accurate, ratio analysis. First, a structured financial statement is constructed by adjusting some accounts according to different goals. Then it is divided into three categories that measure different aspects of a company, which are structure, liquidity, and performance. In each aspect, several important key ratios according to different aspects are introduced and criticized, at the same time they are calculated using the figures from the reformulated financial state- ments of both companies. After that, the analysis of two companies’ financial statements is illustrated by using the key ratios and the comparison of the key ratios between those companies is made. Chapter five is an overall summary of this comparison, which shows different rates of change in terms of various fi- nancial indicators and presents the overall situation. Las chapter is a conclusion of the whole thesis.

Appendix A presents the output of reformulation of the balance sheet and in- come statement from 2011 to 2015, and appendix B describes how the key ra- tios are calculated in two companies during the investigation period. Figure 1 shows an overview of the outline of the thesis.

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Figure 1 Outline of the thesis

2. Fundamentals of the concept of financial statement analysis

2.1 Definition

The financial statement analysis is a method to evaluate a company’s overall situation based on the information mainly obtained from available resources. The definition of financial statement analysis can be divided into broad and narrow senses. In the narrow sense, the financial statement analysis includes the preparation (reformulation) as well as the evaluation of knowledge-oriented company’s information from the financial statement by means of key figures, key figure systems and other methods,1 while in the last decade, the board definition has appeared - with the expansion of the pure financial reporting to generalized business reporting including management reporting, risk reporting, segment reporting, etc. Therefore, in terms of this definition, the financial statement analysis is related with value reporting in order to utilize the potential of success, which is also called qualitative analysis.2

Specifically, the financial statement consists of three main elements: balance sheet, which summarizes the company’s assets, liabilities and shareholders’ equity at a specific time point; income statement, which measures a company’s performance via revenue and expenses during a specific period; cash flow statement, which records the amount of cash and cash equivalents entering and leaving a company.3

What’s more, the most important instrument of the balance sheet analysis is the generation and processing of key figures extracted from the published financial statement and using time comparison, inter-company comparison, industry comparison and target-actual comparison to analyze and evaluate the calculat- ed key figures.

Financial statement analysis (in the narrow sense) is primarily concerned with the formation of key figures. There are, however, a number of different key fig- ures with slightly different definitions and minimum limits. Therefore, prior to a financial statement analysis, the objectives of the financial analysis must be clearly defined. With these, suitable key figures can now be identified. The number of these key figures should be appropriate. Too few key figures could give a false impression, and too many can jeopardize an overview.

From the perspective of the different information sources, the financial statement analysis can also be recognized as internal analysis and external analysis. Within the scope of the internal analysis, analysts have access to all information in the company which is free of restrictions. In comparison to internal analysis, the external analysts are only provided the information that is published or disclosed by the company management either by means of voluntary measures or by legal or normative regulations.4

In views of the above discussion, this thesis is mainly based on the narrow definition and all information is from external resources.

2.2 Objectives and functions

The general aim of the financial statements analysis is to obtain information that is relevant to decision-making about the current economic situation and to the future economic developments of an enterprise, but this information cannot be taken directly from the annual report and the management report.5 Thus, re- formulation is needed. With the help of the information obtained, it is possible to bring a much more comprehensive insight into the structural, financial and earnings situation of a company not only at the present but also at a future date.6 This insight is then essential for ensuring the further financial stability and prof- itability of the company.

Meanwhile, the subject of the balance sheet analysis is not only the balance sheet but the (consolidated) financial statements, consisting of the balance sheet, comprehensive income statement, and notes, as well as the management report for corporations (in the board sense).

Since recipients of a company’s financial statement are numerous, its signifi- cance for different recipients are also different and the main interested parties of a company’s financial report are its managers, shareholders, creditors and third parties, such as employees, customers, suppliers, and competitors. For the company managers, it is important to analyze the financial report in order to make dividend policies, assess credit rating, review analyst opinions and so on. The financial statement analysis will give shareholders information about the activities of the company management, the future disbursement of dividends and prospective performance of a company. The rating of a company is a crucial in- dex for creditors to evaluate a company’s creditworthiness. As for third parties, it is necessary for them to have a good idea regarding job security, the stability of contractor relationship and competitive situation in the whole industry.7

After discussing the aims of financial statement analysis, we will next discuss its functions. In the case of internal analysis, there are mainly four functions, namely information-function, control-function, management-function, and public- ity-function.8 The basis of financial statement analysis is to mine information and to find correlations among them, so the information-function refers to the infor- mation aggregation and aims to improve the persuasion of one’s own financial statement with actual data and in terms of specific operating problems. The an- alyst endeavors to exhaust the extensive information potential of financial statements with suitable methods.9 If the extensive information for comparison (benchmark) is prepared, the control-function can begin, which focuses on a retrospective analysis of operations. Because of influence from the public, all analysts work intensively in order to publish the analysis. Therefore it accounts for the publicity-function. Last but not least is the management-function. It is to be predicted that, without the use of key figures and other analytic knowledge, it is hard for a decision-maker to be able to compile all the analysis that is required in a company and to make all operational decisions.10 On the one hand, the de- ficiencies caused by insufficient information must be remedied by means of suitable measures, on the other hand, steps must be taken to exploit particularly favorable developments and secure them for the future.11

In the external analysis, the information- and the assessment- or interpretation-function of the balance sheet analysis dominate. On the one hand, similar to internal analysis, information is required to make decisions that are related to the analyzed company (for example, the acquisition or sale of shares, the granting, the prolongation or repayment of loans). And obtained information need to be interpreted properly to support decision making. On the other hand, the analysis of a company can be used to undertake benchmarking to assess the performance of the company and, if necessary, to argue in favor for a course correction of its own company policy. In this respect, a deduced control and control function can also be used for external analysis.12

In conclusion, the aim of the financial statement analysis is to give a judgment on the financial situation of a company and the main function of it is information, interpretation and controlling.

2.3 Procedure

A financial statement analysis begins with the collection and sorting of appropri- ate data in consideration of different goals. The balance sheet, income state- ment and cash flow statement including notes give a first impression of the rela- tionship between the figures. After we find all information that is needed, a gen- eralized profile of the company can be created, which provides basic information about a company, such as total asset, equity ratio, or revenue. Nevertheless, just using the figures collected from financial report directly is not accurate enough, so the adjustment of them is needed. As a result of the adjustment, a structured balance sheet and reclassified income statement can be constructed. At this point, the preliminary is already completed, and the real analysis starts.

Then the required data is extracted from the reformulated statements and ac- cording to the different definitions of key ratios and analysis goals. Key ratios will be formulated and calculated using the extracted data. For example, from the calculated ratios the structure and distribution of the proportions on the asset side can be deduced. At the same time, the same ratios of another company or the average ratios for the whole industry can also be similarly obtained. Once this task has been performed, one can start to do industry-wide comparisons, from which the situation of analyzed company, such as performance and sol- vency in relation to the industry in general, can be outlined. That is the whole procedure of financial statement analysis in the narrow sense and with the per- spective of the external analyst.

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Figure 2 Process of financial analysis

The implementation of any financial statement analysis is a dynamic process, and there are no rigidly specified procedures which the company must follow, but in practice, there are some recommendations as formal procedures to conduct the analysis. Figure 2 is an example of procedures of financial statement analy- sis.

2.4 Analysis areas and limitation

In a financial statement analysis three areas are usually analyzed. The structure analysis gives statements about assets and capital structure and the amount of equity. But it is limited to statements about potential over-indebtedness since the balance sheet asset is not breakup-oriented and determination of over-indebtedness has to be based on liquidation values of the company's as- sets.13 At the same time, the liquidity analysis discusses capital raising and al- location, liquidity means sufficient internal financing capacity and the ability of credit repayment. However, the liquidity analysis provides only limited state- ments about solvency and illiquidity risks, since static liquidity ratios negate the temporal dimension (solvency at all times) and only in the event of the company being destroyed, the figures in balance sheet assets influence the ability to meet financial obligations.14 In the end, the amount and availability of revenue and the ability to generate sustainable profit are demonstrated in the performance anal- ysis. The only limitation in statements is about the liquidity since the in-payment and out-payment are not necessarily correlated with the income and expenses in the financial statement.15

Besides the restrictions discussed above, there are some limitations that cannot be avoided that are stated as follow:

- Even if both companies employ the IFRS as accounting standards, without a specific framework like what in the HGB, it is difficult to distinguish all accounts concisely and clearly. And the options of IFRS distort the reality of the financial position.

- Huawei and Ericsson are international firms, which operate different divisions, so their scope of consolidation will have an influence on their financial statement.

- Statements about future developments of the company, which can be obtained externally by the comparison of several successive financial statements, are based on the assumption that a trend which is visible in the past can be extrap- olated into the future.16 However, the market is usually dynamic and the envi- ronment is changing, so the analysis of such information is not meaningful.

- Inflation might have badly distorted the two companies’ report. In this case, total assets and profits will be affected. Thus a ratio analysis of both companies over time and a comparative analysis of companies of different ages must be interpreted with correct judgment.

- Since the presentation currency of Huawei is CNY while the functional currency of Ericsson is SEK, the change of exchange rate over years can only be calculated approximately by an average rate in this year.

- A much more problematic situation is the discrepancies in the scope of accounting, as well as the option for balance sheet policy.17 Different accounting methods may impede the comparison between two companies.

- Just using financial ratios to evaluate whether a company functions well or not is not reliable. Besides quantitative evaluation, a qualitative assessment should also be considered. And as the external analyst, the information obtained is also limited.

Despite these limitations mentioned above and others that are not considered, a financial statement analysis can still provide valuable information about a company’s overall performance and therefore has been generally accepted as a useful method to evaluate a company.

3. Comparison of companies

Before we prepare and conduct financial analysis based on the selected com- panies, an overview of these two firms should be given in order to understand background information. Apart from that, accounting policies have a significant impact on the production and content of the financial statements, so before we analyze them, it is also necessary to clarify the accounting policies of both Huawei and Ericsson. Here we concentrate on the significant accounting policy in 2016. Since in this thesis, the developments over time of the two companies will also be discussed, changes in accounting policies in recent years will also be covered. Such acquired information is of great importance for the balance sheet analysis and allows a better assessment of the company.

3.1 Huawei

3.1.1 Company profile

Headquartered in Shenzhen, Guangdong, Huawei, with the full name Huawei Investment & Holding Co., Ltd., is a Chinese multinational networking and telecommunications equipment and services company, which was founded in 1987 by Ren Zhengfei, a former engineer in the People's Liberation Army.

Initially, Huawei focused mainly on manufacturing phone switches, but now it has expanded its scope considerably such that it currently consist of three parts: consumer business, carrier business and enterprise business divisions, with the declared corporate mission of maintaining robust management, continuous in- novation, open cooperation, building end-to-end telecom operators, enterprises, terminals and cloud computing, and providing competitive information and communication technology (ICT) solutions, products and services for customers etc.

At the end of 2016, Huawei has more than 180,000 employees, and Huawei’s products and solutions have been applied to more than 170 countries around the world, serving over one-third of the world’s population.

It possesses 21 R&D institutes in various countries including China, the United States, Canada, the United Kingdom, Pakistan, Finland, France, Belgium, Germany, Colombia, Sweden, Ireland, India, Russia, Israel, and Turkey, and in 2016, approximately 80,000 employees were engaged in R&D, comprising around 45% of its total workforce. In addition, at December 31, 2016, Huawei has filed 57,632 patent applications in China and 39,613 outside China, with a total of 62,519 patents granted.

Huawei, now as the world's leading provider of information and communication technology (ICT) solutions, ranked 129 in Fortune Global 500 in 2016, compared with the previous year's 228 by leaps and bounds to upgrade 99.

3.1.2 Accounting policies and changes

As an international company, Huawei presented its full set of consolidated financial statements at the end of December 2016 in accordance with the International Financial Reporting Standards (IFRS).18 The functional currency of Huawei, the Renminbi (in units of millions) is used in all consolidated financial statements. All results, assets, liabilities and cash flow in all subsidies that the Group controls are consolidated in the financial statement.

IFRS CF 4 provides basic information about recognition of assets and liabilities. According to it, the consolidated financial statements have been prepared under the historical cost basis that is modified for the fair valuation of financial instruments classified as available-for-sale and held- for-trading.19

Goodwill represents the fair value and is not amortized but subjected to annual impairment tests, while other intangible assets are stated at cost less accumu- lated amortization and impairment losses, and the amortization is based on a straight line extrapolation within finite and estimated useful lives.(e.g. Software 3 years) PPE, including investment property and others, are also stated at cost less accumulated depreciation and impairment losses. Again depreciation uses a straight line extrapolation over their estimated useful lives, such as building 30 years, and internal or external information are used in order to find the impairment loss.

Financial instruments, comprising financial assets and liabilities, are all initially recognized at fair value and their measurement depends on their classification.20 Loans and receivables, financial liabilities are all measured at amortized cost using effective interests method.

Income tax of the year consists of current tax and movements in deferred tax assets and liabilities. Provided on temporary differences, deferred tax represents the difference between the carrying amounts of assets and liabilities for financial reporting purposes and their tax bases.

When the company has a legal or constructive obligation that is raised as a result of a past event, provisions are recognized as liabilities of uncertain timing or amount. Provisions are stated at the present value of the expenditure that is expected to settle the obligation, where the time value of money is material. The main types of them are provision for warranties, provision for onerous contracts and provision for product sales.

Considered received and receivable, revenue is also measured at fair value, which is from the flow of economic benefits and is recognized as the sale of good and provision of services and rental income from operating leases. And according to the report, non-controlling interests represent the carrying value of net assets of subsidiaries attributable to non-controlling shareholders. Foreign currency transactions during the year are translated to the respective functional currencies of company entities at the foreign exchange rates ruling at the transaction dates.

In order to enhance reporting quality, increase transparency and strengthen accountability, the IASB re-evaluates and revises the current IFRS requirements continuously. Every year the IASB changes articles or adds amendments to complete the existing standards and meanwhile many new standards come into effect.

Although in preparing consolidated financial statements both Huawei and Er- icsson did not refer to new standards, amendments to standards and interpretations that are not effective at the balance sheet date, new standards come into effect in each year which must be considered.

In the years 2016, 2015 and 2014, the IASB issued a great number of amend- ments to existing standards which came into effect in the current year, for ex- ample, amendments to IAS 19 employee benefits, annual improvements to IFRS in the 2011-2013 cycles, etc. but none of these had a material impact on the Huawei's financial reporting. And there were no other changes to accounting policies in these years.21

In 2013, the IASB issued a sum of new IFRSs and amendments to IFRSs, such as IFRS 10, 11, 12, 13, revised IAS 19 and amendments to IFRS 7, which are essential to the consolidated financial statements of Huawei, and due to the importance here change in revised IAS 19 which has been applied retrospectively with consequential adjustments to comparatives for the year ending December 31, 2012 are discussed22:

Table 1 Result of the adoption of revised IAS 19

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Source: Huawei Annual Report 2013, P. 77

As a result of the adoption of the revised IAS 19, the company has changed its accounting policy with respect to defined benefit plans, for which actuarial gains and losses were previously recognized in profit or loss.

For purposes of performing external analysis, the information from the published report is not comprehensive, thus the changes of accounting policies of Huawei in 2012 and 2011 are unclear.

3.2 Ericsson

3.2.1 Company profile

Founded in 1876 by Lars Magnus Ericsson, Ericsson ( Telefonaktiebolaget L. M. Ericsson) is a multinational networking and telecommunications equipment and services company which is headquartered in Stockholm, Sweden. The company offers high performing solutions for Networks, IT & Cloud, and Media. which include services, traditional telecommunications and Internet Protocol (IP) networking equipment, software and infrastructure in information and communications technology (ICT) for telecommunications operators, mobile and fixed broadband, cable television, operations and business support services, IPTV, video systems, and an extensive services operation.

Compared with Huawei, Ericsson has approximately 111,000 employees with over 170 nationalities within the organization and customers in more than 180 countries at the end of the year 2016.

R&D is also at the heart of Ericsson’s business and approximately 24,100 em- ployees, accounting for around 22% of the total employees, are dedicated to its R&D activities, which is consistent with Ericsson’s vision for a Networked Society - one where everyone and everything is connected in real time. Furthermore, although the number of patents is less than Huawei’s, Ericsson has one of the industry's strongest patent portfolios with a total count of over 42,000 granted patents.

Over the past 140 years, Ericsson has been at the forefront of communications technology, but nowadays it has been surpassed by Huawei gradually. Accord- ing to Fortune Global 500 in 2016, it ranked only 357, much lower than Huawei’s ranking.

Even though there are differences between the two companies, they have one thing in common: they provide products and services covering the entire tele- communications spectrum and they earn almost the half of the world's revenues generated in the telecommunications equipment and services sector. The fol- lowing table shows a brief introduction about the background of the two compa- nies in 2016.

Table 2 Comparison of Huawei and Ericsson 2016 23

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3.2.2 Accounting policies and changes

The performance of Telefonaktiebolaget LM Ericsson, the parent company or Ericsson and its subsidiaries and the company’s interests in joint ventures and associated companies are reported in the consolidated financial statements of Ericsson, which have been prepared in accordance with the EU endorsed IFRS and RFR 1 “additional rules for Group Accounting” related interpretations issued by the Swedish Financial Reporting Board at the end of the year 2016. Subsidi- aries are recognized as all the companies for which Ericsson directly or indirectly is the parent. The statements are prepared in millions of Swedish Krona (SEK) and are prepared on the basis of historical cost, except for certain financial as- sets and liabilities that are stated at fair value.

Financial instruments include assets and liabilities. Carried at fair value through profit or loss, financial assets are initially recognized at fair value plus transaction costs, and transaction costs are expenses in the income statement.24 The im- pairment test is conducted at each balance sheet date to determine whether there are objective evidences that financial assets are impaired. Financial liabili- ties including borrowings and trade payables are initially recognized at fair value and subsequently stated at amortized cost using effective interest method.

Acquired intangible assets other than goodwill is presented at fair value at initial recognition, meanwhile capitalized development expenses and software are stated at cost. Subsequently, these intangible assets are stated at initially rec- ognized amounts less accumulated amortization and any impairment. Amortiza- tion of acquired intangible assets is made according to the straight-line method over their estimated useful lives, not exceeding ten years. Goodwill is performed in the same way as for intangible assets other than goodwill in terms of impair- ment test and recognition. PPE are stated at cost less accumulated depreciation and any impairment losses. Depreciation is based on a straight-line method over the estimated useful lifespan.

Income tax includes current tax and deferred tax. Current tax liability or asset are recognized for the estimated taxes payable or refundable for the current year or prior years, and deferred tax is “recognized for temporary differences between the book values of assets and liabilities and their tax values and for tax loss carry forwards.”25

The recognition of provisions of Ericsson is the same as Huawei. First, there are legal or constructive obligations as a result of past events. Second, it is probable that an outflow of resources will be required to settle the obligations and the amounts can be reliably estimated.26 They are normally related to warranty commitments, restructuring, customer projects and other obligations. And transactions with non-controlling interests are treated as transactions with equity owners of the company.

Like Huawei, Ericsson doesn’t use any new standards and amendments that are not effective at the end of the fiscal year. However, in contrast to Huawei, the changes in accounting policy from 2011 to 2016 have no significant impact on the financial result or position as well as disclosure of Ericsson.

4. Quantitative Evaluation

Quantitative analysis is the use of mathematic measurements and calculations to understand or predict the behavior or events in a company and key figures are highly quantified quantitative measurements, which report as relative or absolute numbers in a concentrated form about a fact that can be measured in num- bers.27 Absolute numbers - also called basic numbers - indicate how many el- ements a specified amount has, while relative numbers, also called ratio num- bers, states two absolute numbers are related to each other in a quotient form.28

For relative numbers, there are three categories, namely vertical key ratios, horizontal ratios and lateral ratios. Vertical key ratios are the proportion to two figures from one balance sheet side or both in the income statement and hori- zontal ratios mean the ratios of figures that one is from asset side and the other from liability side. In the end, the lateral ratios present the relationship between two figures with one from the balance sheet, another from the income state- ment.29

As the main part of this thesis, this chapter will examine the financial statement in great depth. However, before we proceed with the actual analysis, we need to reformulate the reported financial statements so that they are somewhat com- parable. And then, the different key ratios will be discussed including the defini- tion, the purpose of using these key ratios and the criticism about them, and the focus of this thesis is the discussion of relative numbers, i.e. ratios. After that we analyze the overall development of Huawei from the above mentioned three aspects, using the calculated key ratios and using Ericsson as a benchmark.

4.1 Reformulation of financial statement

Every company is different and has its own market environment with different conditions, which could lead to the distortion of information obtained from pub- lished report and hence cause failure to meet the requirements of rigorous fi- nancial statement analysis. In order to minimize these adverse influences, comparable and persuasive financial statements must be assembled before the company is analyzed. For this purpose, the reformulated balance sheet and comprehensive income statement are established in which every item is the same and identical standards are used for both companies. The preparation of the reformulated balance sheet and income statement makes the formulation of key ratios easier than before.

The instrument of reformulation can be divided into two parts - reclassification and revaluation, and the reclassification consists of regrouping, re-recognition, disintegration, balancing and expansion.30 The for key figure calculation reformulated balance sheet is called structural balance sheet.

The reformulation takes two steps. First is the correction of the individual statement items from the original annual financial statements by revaluation and reclassification of individual items. Then, subsequent consolidation and summa- rization of all items, which may have been corrected in the first step, can lead to meaningful and quantitatively usable variables in the key figure calculation.31 Sometimes the accumulation of numbers, items and figures in the notes makes the desired insight into the relevant structures for the analysis more difficult, and therefore a comprehensive overview is necessary. This, on the one hand, is the advantage of the structural balance sheet. On the other hand, at the same time, it is disadvantageous that the structural balance can only reflect a simplified re- ality, not the real one.32

For balance sheets and income statements prepared in accordance with IAS, there is only a marginal need to prepare the structured balance sheet and profit and loss statement, since the objective of these financial statements is to provide information relevant to the decision-making which should help the reader to assess, whether and when and with what probability a company is able to generate cash and cash equivalents.33

4.1.1 Standard balance sheet

The active side of the balance sheet shows an overview of the company's assets for a reporting date using an account form; the passive side provides information about the sources of the operational resources. In the preparation of the stand- ard balance sheet, assets and liabilities are expediently grouped into two cate- gories - the analytic non-current assets and current assets on the asset side as well as the balance sheet analytic equity and liabilities on the liabilities side.

In this section, we will use the Huawei’s and Ericsson’s financial statement of 2016 as an example to explain the reformulation, additional reformulated structured balance sheets from the year 2011 to 2015 in Huawei and Ericsson can be found in Appendix A.

We start from the asset side. The first item that needs to be considered is the internally generated intangible assets, but in the context of an industry compar- ison, here the telecommunication industry, these corrections can be left be- hind.34

The second one is the derivative goodwill that can be found on the assets side. The goodwill should not be allocated to the assets of the structured balance sheet according to IFRS due to the associated balance sheet policy discretion, the controversial value and the lack of meaningfulness of these amounts, and the unequal treatment of externally and internally growing companies.35 Thus, it is advisable to offset the derivative goodwill with equity.

The next item is the property, plant and equipment and intangible assets using fair value measurement. The disclosure requirements allow an adjustment of the revaluation carried out by an external analyst. When compiling the balance sheet, the newly assessed assets should, therefore, be reduced by the propor- tionate amount of the revaluation surplus as well as the corresponding deferred tax liabilities, and the equity capital should be reduced by the amount of the re- valuation surplus.36 However, the annual report of Huawei gives no information about the purchase- or production costs of PPE and other intangible assets.

Therefore, the revaluation reserve remains unclear, and since we do not adjust Huawei’s PPE, the same item of Ericsson is also not adjusted. So is the Investment property.

With regards to financial assets, according to IFRS, these are often stated at fair value, which is based on a market price or the result of a discounted cash flow valuation. Financial assets, especially those available for sale, should be offset in the light of the unrealized "fair value reserve". However, this does not apply if there is a negative "fair value reserve" because this implies a reversal of the impairment which was not present at the balance sheet date.37 The changes of fair value can be found in note 13 in Huawei’s financial statement and consoli- dated statement of comprehensive income of Ericsson, but there is no infor- mation about whether the financial instrument (available for sale) belong to cur- rent assets or non-current assets, so here we regard it as current assets. And this value is negative, so no correction is needed in 2016.

The last item that needs to be reformulated is deferred tax assets. From an external analyst’s point of view the tax rate is unknowable, so the corresponding items which are reformulated in the balance will not be corrected with either deferred tax assets or deferred tax liabilities. Thus, the deferred tax is recognized as a whole. Deferred tax assets must be recognized in the consolidated financial statements according to IFRS. This position should be balanced with the deferred tax liabilities in the balance sheet analysis. A possible existing capital surplus can ultimately be offset by equity.

From the financial statements in 2016 of Huawei, detailed information about which assets in the other assets account belong to current or non-current is unclear. Therefore, all other assets in non-current portion are regarded as financial assets. On the other hand, trade receivables and customer finance in Ericsson’s reporting are added and recognized as trade and bills receivables.

After the correction of asset side, the liability side also needs to be adjusted. The first item is deferred government grants, which are regarded as deferred items and are reclassified as long-term loans and borrowings.

[...]


1 Cf. Küting/Weber, Die Bilanzanlyse, 2015, P. 1

2 Cf. Coenenberg, Haller, Schultze, Jahresabschluss und Jahresabschlussanalyse, 2016, P. 1023

3 Cf. Heakal, What is a cash flow statement? 2017

4 Cf. Küting/Weber, Die Bilanzanlyse, 2015, PP. 3-4

5 Cf. Wehrheim, Schmitz, Jahresabschlussanalyse, 2009, P. 146

6 Cf. Ibid.

7 Cf. Schneider, Jahresabschluss und Jahresabschlussanalyse, 2014, PP. 465.

8 Ibid.

9 Ibid.

10 Ibid.

11 Cf. Schneider, Jahresabschluss und Jahresabschlussanalyse, 2014, PP. 465

12 Cf. Küting/Weber, Die Bilanzanlyse, 2015, PP. 10-11

13 Cf. Schneider, Jahresabschluss und Jahresabschlussanalyse, 2014, P. 468.

14 Cf. Schneider, Jahresabschluss und Jahresabschlussanalyse, 2014, P. 470

15 Cf. Schneider, Jahresabschluss und Jahresabschlussanalyse, 2014, P. 471

16 Cf. Coenenberg, Haller, Schultze, Jahresabschluss und Jahresabschlussanalyse, 2016, P. 1029

17 Cf. Coenenberg, Haller, Schultze, Jahresabschluss und Jahresabschlussanalyse, 2016, P. 1030

18 Cf. Huawei annual report 2016, P. 60

19 Ibid.

20 Cf. Huawei annual report 2016, P. 62

21 Cf. Huawei Annual Report 2016,2015,2014

22 Cf. Huawei Annual Report 2013, P. 76

23 Fortune global 500 2016

24 Cf. Ericsson annual report 2016, P. 63

25 Ericsson annual report 2016, P. 65

26 Cf. Ericsson annual report 2016, P65

27 Cf. Küting/Weber, Die Bilanzanlyse, 2015, P. 51

28 Cf. Küting/Weber, Die Bilanzanlyse, 2015, P. 52

29 Cf. Schneider, Jahresabschluss und Jahresabschlussanalyse, 2014, P. 516

30 Cf. Küting/Weber, Die Bilanzanlyse, 2015, P. 81

31 Ibid.

32 Cf. Küting/Weber, Die Bilanzanlyse, 2015, P. 83

33 Cf. Born, Bilanzanalyse international, 2001, P. 285

34 Cf. Küting/Weber, Die Bilanzanlyse, 2015, P. 101

35 Cf. Brösel, Bilanzanalyse, 2014, P. 116

36 Cf. Küting/Weber, Die Bilanzanlyse, 2015, P. 102

37 Cf. Brösel, Bilanzanalyse, 2014, P. 118

Excerpt out of 101 pages

Details

Title
Comparing the development of two communication technology companies using financial statement analysis
Subtitle
Using examples of Huawei and Ericsson
College
Fachhochschule Bonn-Rhein-Sieg
Grade
1.7
Author
Year
2017
Pages
101
Catalog Number
V377962
ISBN (eBook)
9783668557321
ISBN (Book)
9783668557338
File size
939 KB
Language
English
Tags
Financial Analysis
Quote paper
Zihan Gong (Author), 2017, Comparing the development of two communication technology companies using financial statement analysis, Munich, GRIN Verlag, https://www.grin.com/document/377962

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