The financial statement of National Central Cooling Co. PJSC (Tabreed) for 2006, published on their web site, gives certain lessons for us in management of current assets, accounting and disclosures.
Tabreed reportwd Dh470 million in sales revenue in 2006 and Dh401 million in 2005 a growth of 1.17 times.
The 'current assets' accounted for Dh1.998 billion in 2006 while the same was at Dh895 million in 2005, an overriding growth of 2.23 times over the 1.17 times of sales growth.
Trade receivables grew by 4.23 times from Dh208 million in 2005 to Dh880 million in 2006, while the rest of the current assets grew as follows: inventory by 1.54 times, financial assets by 1.42 times, contract work-in-progress by 1.62 times, pre-payments by 1.29 times and bank balances and cash by 1.67 times.
Across the head of accounts, all constituents of current assets grew above the sales revenue growth, while receivables grew significantly.
The 'Notes on Accounts' disclosed the accounting policies at Tabreed as, "Accounts receivable are stated at original invoice amount, less a provision for any uncollectible amount. An estimate for doubtful debts is made when collection of the full amount is no longer probable. Bad debts are written off when there is no possibility of recovery. Fair enough.
'Contract work in progress' represents cost plus attributable profit, less provision for foreseeable losses and progress payments received and receivable. Fair enough.
Revenue recognition
Sales are recognised when the significant risks and rewards of ownership of the goods and services have been passed on to the buyer and the amount of revenue can be measured reliably. For sale of chilled water, revenue comprises available capacity and variable output provided to customers, and is recognised when services are provided. Fair enough.
Contract revenue represents the total sales value of work performed during the year, including the estimated sales value of contracts in progress assessed on a percentage of completion method, measured by reference to total cost incurred to date and estimated total cost of the contract. Provision is made for any known losses and contingencies. Fair enough.
Interest revenue is recognized as the interest accruals (using the effective interest method, ie the rate that exactly discounts estimated future cash receipts through the expected life of the financial instruments to the net carrying amount of the financial asset). Fair enough too.
Having browsed the Notes and the Accounting Policies, I switch back to the receivables. The Note 14 on accounts discloses that there is a receivable of Dh525 million from a related party on disposal of property, plant and equipment. Hence, of the Dh880 million of receivables, that corresponding to the sales is probably Dh355 million and hence, so the normalized receivables grew by 1.71 times instead. The receivables turnover was 1.32 times of sales in 2006, taking an average of nine months to convert from sales invoice to cash collection. The receivables turnover was 1.92 times in 2005, with an average collection period of 6.25 months. This long receivables cycle time needs more disclosure and financial control.
I have seen some auditors pressing for the ageing of the receivables summarized in the Notes. This could be fairer to the investor. If the debts' age was less than 30 days, then we know that much sale was recognized in the last month of the year, so on and so forth.
The disclosure is expected in the next quarter interim results to be posted on the DFM web site.
I think, the auditors, Earnest & Young Abu Dhabi, needs to press for more disclosure on the Notes on Accounts.
Bean counting apart, the strategic solution to enhance shareholder value is financial control leadership, and this needs to be the focus of the management of Tabreed.
The business model, business processes, revenue recognition, terms of contracts and sales terms with customers of Tabreed would have contributed to the longer receivables cycle time.
For a marginal investor in the stocks, higher receivables collection period is reducing the return on investment, by keeping the investments up, and drains shareholder value.
One way by which the marginal investor can find solutions outside Tabreed is to buy a proportionate stock of the listed shares of the customer of Tabreed. The higher the investment in the receivables of Tabreed, lesser the investment by the customer of Tabreed! But that is a complex use of financial engineering to balance the return to the shareholder. That wild option aside, the management of Tabreed and corporate governance in action, need to find solutions through its internal business processes, asserting its bargaining power on its customers.
Prima facie, the customers of Tabreed seem to have asserted their bargaining power and succeeded in getting more credit terms from Tabreed, than that is permissible by a marginal investor, who is neutral across the market.
Taming its customers and fine-tuning its sales contract terms and business processes will yield more returns to the marginal shareholder of Tabreed. There is work to do, there is more to disclose, to raise the return on gross assets from the 'cold' 2.6 per cent in 2005 (68/2643) and 3 per cent in 2006 (125/4185).
E. Michael Johnson is a member of the UAE Chapter of ICWAI. The views expressed are his personal, as a marginal investor in the financial markets.
By E. Michael Johnson
© The Business Weekly 2007
