This report consists of discussions on three important aspects of financial management. The three aspects covered are financial analysis of Petrochina, impact of Global financial crisis on global businesses and importance of independent audit in generating confidence. Petrochina is a major Chinese company involved in production and distribution of oil and gas. Financial analysis of Petrochina has been carried out with the help of ratio analysis on parameters of profitability, performance, liquidity, working capital and solvency for the periods 2015 and 2016. Financial analysis consists of evaluation of various quantitative and qualitative metrics for assessing the performance of an organization. Financial analysis is an important tool for not only judging a company’s own performance but it can also be used for relative comparison with peers and competitors (Lee, Lee and Lee, 2016). The report also covers the role of external audit in developing confidence and assurance. It discusses how the independent audit can help organizations in improving their efficiency and system. This point has also been discussed from the point of Petrochina. The views of its external auditors have been presented and their observations have discussed. The report also discusses the impact global financial crisis of 2007/2008 had on global business. The report presents how global businesses were severely impacted after the crisis and it took almost a decade for them to recover. The report also gives a view of what lessons were learned from the crisis. Lessons learned from the crisis have been discussed with respect to Petrochina. The report discusses how Petrochina modified its procedures after the crisis.
With the view of analysing and comparing the financial position of the Petrochina for the years 2015 & 2016, this report makes use of technique of ratio analysis. Ratio analysis is a process of calculating various quantitative ratios on the basis of financial statements for evaluating the performance of an organization (Tracy, 2012). Financial analysis of Petrochina has been carried out with respect to profitability, performance, liquidity, working capital and long term solvency.
Profitability is a measure of an organization’s ability to generate revenue in excess of its costs. It can be accessed by the help of net margin and return of equity ratios. Net margin is derived by dividing net profit by revenue. On the other had return on equity is arrived by dividing net profit by equity ( Peterson & Fabozzi, 1999).
In the case of Petrochina, both net profit margin and return on equity have decreased from 2015 to 2016. Net profit has decreased from 2.46% to 1.82% from 2015 to 2016 (Appendix 2). Similarly return on equity has also decreased from 3.15% to 2.14% (Appendix 2). Decrease in net profit margin and return of equity is due to decrease of net profit from 2015 to 2016. Although costs of operation have decreased but revenue has also declined from 2015 to 2016, this led to fall in net profit. Decrease in net profit implies that Petrochina’s ability to generate profit out of its revenues has decreased. On the other hand decrease in return on equity can be a signal for equity holders of declining returns. Overall profitability metric has shown a decline.
Figure 1: Profitability Ratios
Performance ratios can tell us how efficiently a company is running its operations and measure an enterprise’s ability to utilise its assets to generate revenues. Two commonly used ratios for performance measurement are fixed asset turnover and inventory turnover. Fixed asset turnover is derived by the ratio of revenue and fixed assets. On the other hand inventory turnover ratio is arrived by dividing cost of goods sold by inventory (Gibson, 2012).
Both the ratios have shown a decrease from 2015 to 2016. Fixed asset turnover has decreased from 2.532 to 2.410, while the other one has also reduced from 10.249 to 8.414 between two periods (Appendix 2). Decline in fixed asset turnover implies that Petrochina inefficiently utilised its fixed assets in 2016 as compared to 2015 and it is probably due to fall in revenues. On the other hand, inventory turnover reduced because of increase in inventory. It also show the Petrochina’s ability to process and generate cash out of inventory has decreased. Performance measures are showing also showing decline.
Figure 2 Performance Ratios
Liquidity measures an organization’s ability to meet its short term liabilities. Liquidity can be evaluated by the help of current ratio and quick ratio. Current ratio is evaluated by the ratio of current assets and current liabilities, while quick ratio does not take into consideration inventories while calculating the numerator consisting of current assets and is a conservative measure of liquidity (Leach, 2010).
In this report, Petrochina’s current ratio has increased from 0.741 to 0.764 (Appendix 2) between 2015 and 2016 indicating slight improvement in liquidity position but still current liabilities are more that assets. However, quick ratio has marginally declined from 0.472 to 0.470 between 2015 and 2016 (Appendix 2).Large difference between two is due to significant inventories in current assets. Low current ratio and quick ratio are indications of the fact that liquidity position of Petrochina is not good but has remained poor over both the years.
Figure 3 Liquidity Ratios
Working capital is derived by the difference of current assets and current liabilities. A positive working capital indicates that short term obligations can be met by short term assets. It is also a measure of funds required to run day to day operations of a company (Akoto, Awunyo-Vitor & Angmor, 2013).
In case of Petrochina, working capital was -122063 and -117598 in 2016 and 2015 respectively (Appendix 2). Though the figure has increased but it is still considerably negative due to high current liabilities as compared to current assets in both the years. Working capital conditions have not improved between years and Petrochina is probably using short term funding to meet costs of its day to day operations.
Figure 4 Working Capital
This metric analyses enterprise’s potential to fulfil its long term obligations. It is generally measured by long term debt to equity ratio. This arrived by the dividing long term debt by equity (Bull, 2007).
This is the only ratio in case of Petrochina which has shown improvement. The ratio has declined from 0.323 to 0.272 (Appendix 2), thus indicating improving solvency from 2015 to 2016. Although there is increase in amount of debentures but long term borrowings have declined substantially from 329461RMB millions (Appendix 1) to 243675 RMB (Appendix 1) millions between the years. This implies that Petrochina has paid its long term borrowings. Therefore it can be interpreted that Petrochina’s capacity to pay to its long term obligations has increased from 2015 to 2016.
Figure 5 Solvency
An independent audit is evaluation financial records, systems of accounting, internal controls and transactions of an organization by an external auditor. Primary purpose of such a practice is to protect the interest of shareholders and carry out audit without any bias. These audits are carried out by external auditors who are generally certified accountants and are mandatory for organizations. They ensure better systemic procedures, increase efficiency and accountability of the enterprisese (Knapp, 2012).
Independent audit is a important for building assurance and generating confidence in the management of an organization. Independent auditor ensures that audits are carried out without any conflict of interest. They help in identifying discrepancies in accounts and lack of compliance. By following their advices, an organization can comply with regulations of the country and avoid unnecessary legal procedures. Credibility of organizations is increase manifold when an independent auditor gives a positive feedback. Shareholders are also satisfied by positive recommendation. External and internal stakeholders develop confidence in the enterprise. It is very often seen that large frauds are done by insiders in an organization in conjunction with internal auditors. These fraudsters are often very difficult to detect and know the procedures of the organization. External auditors help in identifying such frauds and do not have any relationships with insiders. Frauds decrease brand value of a company. By preventing frauds, these audits increase confidence of the management. Apart from these external auditors can be helpful in modifying and advancing the processes of the organization. These people may advice for better systemic controls and improve management efficiency (Lever, 2015). These audits help in maintaining financial stability. Governance standards of organizations are also improved by regular oversight of the external auditors. These people verify all the records, tally transactions and verify gentility of statements. In order to do these organizations maintain and update records in a structured manner. This ensures proper maintenance of records. It helps in safeguarding the hard work and efforts of all the stakeholders. These audits also help in building confidence in auditors for the systems of organizations. Creditors can lend and transact with companies in hassle free environment (Lehman, 2010).
In case of Petrochina, importance of external audit is manifold. The company has appointed KPMG Huazhen LLP as domestic independent auditor and KPMG Certified Public Accountants as overseas independent auditor for 4 years in 2016. In the audit conducted in 2016 the auditors had provided a positive feedback for the operations and management of the company. They confirmed that Board of Directors approved all the transactions. The also observed that the pricing policies of the group were followed in connected transactions with respect to goods or services provided by the group. Materiality was maintained in these transactions and all prior legal aspects were followed in the transactions. No breach of agreement took place. The auditors also report that these transactions were within pre-defined limits and did not breach the caps. The annual report also makes a note about enhancement of internal control testing and identification of risks, and strengthening of communication systems with external auditors. Petrochina’s internal report and internal audit report were disclosed separately to the external auditor KPMG Hauzhen LLP. In the end after verifying the internal systems and efficiency of controls in financial reporting Petrochina was issued standard and unqualified opinion. Independent Board of directors of had meeting with external auditors before the yearly auditing. This shows there is good coordination between Independent Board of directors and auditors in improving processes of the company. (Petrochina, 2016).
Thus this shows us that in case of Petrochina independent audit was carried out in an effective manner. Disclosures by external auditors in annual report of the company show us that it followed all legal procedures with integrity. A qualified and standard opinion issued by the auditors of Petrochina has increased the confidence of management and external stakeholders. It has also created assurances for partners dealing with the enterprise.
Independent audits serve as a benchmark for organizations and help in identifying gaps in their daily operating processes. They critique the organizations, help in modifying processes and increase efficiency of the business. They also help in government compliance, scam prevention, building controls and improving compliance. Thus the process of independent audit helps in enhancing the confidence of all the entities dealing with a company and they also help creating an environment of trust, and generating assurance for all stakeholders (Miettinen, 2008).
Global financial crisis of 2000/2008 which emanated from USA was as a result of a real asset bubble and sub-prime crisis. With globalization and development of technology world had become a small place to live in 21st century, results of this crisis not only devastated organizations in USA and its neighbouring countries but had its effect on Europe, Australia and Asia (Ciro, 2016). Signals of upcoming crisis could be seen as early as in 2006 but it became inevitable with fall of Lehman Brothers in September 2008.
Global financial crisis had a severe effect on economies and businesses around the world. Almost all the sectors and industries had become a part of this crisis. Banks were the ones that were affected most severely. It was believed that they were too big to fail. But this thought did not prevail after this. Financial institutions like Bank of America, Merrill Lynch and Royal Bank of Scotland were bailed out. Due to this credit by private sector plunged and business confidence declined ( Elliot, 2011). With the fall flow of credit and falling sales, the profits of organizations started falling. International trade was deteriorated and economic growth collapsed. There were job losses and falling profits led to decline in share prices. There were increase in inventories and accounts receivables of companies were at all-time high. Prior of the crisis, business had built huge capacities due to high growth period of 2004-2007, but crisis led to capacity underutilization and increasing fixed costs. This was felt in case of large automobile manufactures like General Motors and Ford facing severe loses (Nieuwenhuis & Wells, 2015).
Rising unemployment and decreasing incomes led to further fall in demand of goods and delayed purchases. All this led to a deflationary situation for businesses. In deflationary conditions, consumers delay their purchases, which further leads to falling demand for goods. This condition was particularly very concerning for low credit rating firms and there cost of funding increased further, thus putting a severe strain on their business models. It was believed that this crisis would not affect the business in developing countries. But these businesses were affected due to trade relationships with developed countries. Export business in developing countries were affected due to slowing global demand. Large commodity exporting businesses in Brazil and Russia suffered massively due fall in food and non-food commodity prices (Batten & Szillagyi, 2011). However, there were few industries such as healthcare and education that were comparatively less affected by the crisis. Certain countries like India and China survived because of domestic demand. Thought the growth rates of these countries also dropped but the business in these nations were comparatively less affected by the crisis. The financial crisis was a once in a century event after the great depression of 1930s (Kates, 2011). Though there were improvements in business sentiments from 2010 onwards but it almost took a decade for global growth to take off.
Petrochina is one the largest oil companies in the world and plays a significant role in china in production and distribution of oil and natural gas in China. China is a large exported of goods and massive consumer of oil. Petrochina was also affected by global financial crisis as demand from developed world fell and oil import to China was greatly reduced. Petrochina’s revenue and profit declined in 2008 and 2009 after the crisis (Petochina, 2009).
Global financial crisis changes the way business used to think and conduct their operations. Prior to it the main crux of business and management was on numbers and generating profits. It showed that businesses need to develop sustainable models and change their methods of measurement (Webb, 2009). Global businesses realised the importance of connected world and now were taking decisions considering financial prudence. Businesses were now taking note of systemic as well as non-systemic risks while developing processes. During financial crisis credit rating agencies came under fire because of their inappropriate rating procedures. Large businesses trusted these agencies in conducting their businesses. After the crisis, businesses started doing their assessments of business conditions and partners more diligently (Naciri, 2016).
For a company like Petrochina that too suffered during the crisis there were lessons too. Petrochina realised that its operations are dependent on global commodity cycle particularly that of oil. Massive excessive capacity that was build prior to crisis by the company was underutilised as Chinese economy also slowed down. This called for improvement in management and increasing efficiency of operations. Petrochina improved its efficiency and increased control over investments. The company also rebalanced its portfolio of investments. It also adopted latest techniques and followed a scientific approach for production. It also enhanced the company’s orientation towards the market. The company also increased its application and enhanced coordination between production, transportation and marketing. Business planning was more robust and new policies were planned taking into strategic concerns in consideration. By the year 2009 the financials had suffered but they were better than expected (Petrochina, 2009)
Conclusion
This report covers the analysis of Petrochina, a Chinese petroleum company with respect to its financial performance. Financial performance assessment has been carried out for the years 2015 and 2016 using ratio analysis. It is concluded that profitability, performance, liquidity of the company had deteriorated from 2015 to 2016. Most importantly net profit margin declined from 2.46% in 2016 to 1.82% in 2015. Only parameter of financial analysis that showed improvement was solvency. Long term debt to equity ratio decreased during the period of study from 0.323 to 0.272. There is also a discussion in the on independent audits in organizations. It is discussed how independent audit help in increasing confidence and assurance of all stakeholders of the organization. In the end, few points about independent audit of Petrochina of 2016 have been discussed with respect to transactions related to the group. The company was issued an unqualified and standard opinion by the auditors. This kind of opinion increases the confidence of shareholders and gives assurance to all organizations and individuals involved in any manner with this company. In the end, this report also presents the impact global financial crisis had on businesses globally. Global crisis led to collapse of some major business all around, decreased revenues for business, increase in unemployment and even affected developing countries. The report also covers discussion on lesson learned by companies like Petrochina from the crisis. The report tells how Petrochina and other organizations improved their processes, increased efficiency and planned more diligently for better management and success.
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