How is financial analysis different when it comes to consolidated accounts?
On the whole, financial analysis of consolidated accounts
is comparable to that of parent company accounts. The sample financial analysis
that we recommend does not differ from individual or consolidated accounts.
However, some items exist only in consolidated accounts. These must be well
understood and clearly reflected in financial analysis.
One example is goodwill, which reflects the difference between the price paid for an asset and its revalued book value. Goodwill treatment varies considerably depending on the accounting standards (e.g. not amortised, amortised over 5 to 40 years, subtracted from shareholders' equity). In financial analysis, the main problem is in calculating returns: charging goodwill off equity, for example, via pooling of interests or writing it down sharply, could result in artificially inflated returns (as the company would have shrunk its equity and thus capital employed).
Associate undertakings, or consolidation via
the equity method, is a way of consolidating subsidiaries over which the parent
company exercises considerable influence (generally when it owns between 20%
and 50%). With going too much into detail, this method amounts to revaluing
the stake at the level of the subsidiary's equity value. On the P&L, associates
make it possible to book a share of earnings instead of just the dividends received.
Subsidiaries booked as associates pose the following problems:
- calculating returns: associates are not included in consolidated operating profit; if capital employed is considered to be a fixed asset + its working capital requirement, ROE is false!
- How cash flow is to be booked: the company receives dividends but does not have direct access to the associate's cash flow; this is reflected in the consolidated cash flow statement.
Minority interests come from the full consolidation of companies in which the parent company does not hold 100% of the shares. On the P&L, minority interests represent the fraction of total net profit from minority shareholders in these subsidiaries, while, on the balance sheet, it is the portion of shareholders' equity belonging to them. Minority interests are considered differently, depending on whether financial analysis aims to assess the company's solvency (the creditor's point of view) or to assessing equity value (shareholders' point of view).
From the creditor's point of view, minority interests do indeed strengthen the group's solvency. They are indeed equity. But minority interests do not "belong" to parent company shareholders and should therefore be excluded from its equity valuation.
One more thing: it is worth pointing out that the accounting principles that apply to consolidated accounts can differ from those used for drawing up parent company accounts, which are often heavily dependent on tax concerns.