Analyzing PetroChina’s Financial Performance, Impact Of 2007/2008 Financial Crisis, And Importance Of External Auditing

Part 1: Analyzing PetroChina’s Financial Performance

The given report is divided into three parts. The first part will address the financial performance of the firm by analysing its performance with the help of various ratios. The second part of the report will throw light on the importance and usefulness of external auditing and the third part of the report is reflecting on the impact of the economical global crisis of 2007-2008 on the firm.

The given section shall analyse various aspects of Petro China like profitability, performance, liquidity, working capital and long term solvency by analyzing different ratios.

The profitability ratio helps a company to analyse the business performance. Once the performance of the business is observed, this ratio helps the company to take decisions related to diversification and expansion (Com & II, 2016). The profitability ratios which will be discussed are:

The gross profit ratio defines the effectiveness of a company`s capability in utilizing their materials and resources in order to generate profit for the organization. It also helps in measuring the efficiency of the firm during the process of production. The formula is gross profit divided by net sales (Avdjiev, McCauley & Shin, 2016).

The gross profit ratio of the group as a whole in 2016 was 3% as compared to 3.2% in 2015. On the other hand the gross profit ratio of the company in 2016 was a negative one as compared to 1.3 %in 2015.

It can be stated that the company has not been performing relatively well. It is less cost effective.

The Net Profit Ratio of the firm determines the amount of money which is left from each sale after all the expenses have been given away. A higher net profit ratio indicates that the business is quite efficient (Petrochina.com, 2018).

The net profit ratio of the group in 2016 was 1.8% as compared to 2.4%of 2015. This means that the performance of the firm has dropped since the last year. On the other hand the performance of the company in 2016 has been in negative of -0.015 as compared to 0.019 in 2015.

 Performance Ratios

The performance ratios are meant to measure the various aspects of the company`s operations. It refers to the efficient use of an organization`s resources in order to generate revenue for the firm (Bech, Gambacorta & Kharroubi, 2014). Two primary Performance Ratios will be discussed in the given case:

Fixed asset turnover

Part 2: Importance of External Auditing

The given ratio compares the revenue of the firm to its fixed assets. When the given ratio is high it indicates that the firm has a small asset base with a large sales income (Schoenmaker, 2017). This formula is the net sales divided by the net fixed assets.

The fixed asset turn over for the group in 2016 is 2.4 as compared to 2.5 in 2015. The ratio has fallen down since the last year. For the company, the fixed asset turnover is 2.9 as compared to 3.04 in 2015. It can be stated that the company has been performing well in the given case.

The given ratio makes an estimate about the revenues of the firm as compared to its employees. A high ratio in the given case indicates large amount of sales with fewer employees (Titman, Keown & Martin, 2017). The formula for the given ratio is net sales divided by the total employees who work permanently for the firm.

The ratio for Petro China could be taken out only for 2016 and for the group due to limited information. The ratio is 3.178 which indicate a good scenario for the firm.

The liquidity ratio of the firm decides the convenience of a firm to convert its assets into cash or generate enough cash for the firm. Various assets like the accounts receivable, securities and inventory are easy to convert in the short term and hence they go in the calculation of the given ratios (Esty, 2014). The following ratios have been discussed in the given scenario:

Current Ratio

The current ratio is calculated by dividing the current assets of the firm b the current liabilities. If the given ratio is high in number then the firm has a greater amount of assets as compared to its liabilities. This shall enable them firm to pay off its debts easily.

The current ratio for the Petro China group is 0.764 in 2016 whereas the ratio was 1.1 in 2015. For the company, the given ratio was 0.73 in 2016 as compared to 0.8 in 2015 (Van den Berg, 2016). Hence, it can be stated that the company does not have the capability to pay off the liabilities at present.

Quick Ratio

The quick ratio which is often known as the acid test ratio is considered to be stricter in calculation as compared to the current ratio. It uses the most liquid able assets in its numerators. The inventory aspect is not taken in the calculation of the given ratio. The given ratio is more conservative than the current ratio.

Part 3: Impact of the 2007/2008 Financial Crisis on Businesses Globally

Group has a quick ratio of 0.47 in 2016 as compared to 0.47 in 2015. This reflects that the ratio has not changed. For the company, the ratio has dropped to 0.42 in 2016 as compared to 0.58 in 2015.

Cash Ratio

The cash ratio is even more conservative than the other liquidity ratios. The given ratio just considers cash and its equivalents compared to current liabilities (Bodea & Hicks, 2014).

For Petro China, the cash ratio for the group is 0.19 in 2016 as compared to 0.15 in 2015. For the firm, the ratio is a low rate of 0.04 in 2016 as compared to 0.03 in 2015. Although the ratio has improved from 2015, the ratio is still not up to the industry standard.

The working capital ratio is very similar to the current ratio of the firm. The working capital ratio of less than 1.0 is not considered to be adequate for the firm. A ratio above 2 is taken to be good for the firm.

For Petro China the given ratio is less than one in a range of 0.75-0.8 for the given two years.

The solvency ratio is measured as the enterprises capability of the firm to meet the debts and various other obligations with reference to the long term and short term liabilities (Chi?u, Eichengreen & Mehl, 2013). The lower ratio of the firm is indicative of its default to perform the debt obligations of the firm. The formula is calculated by dividing the net income and depreciation of the firm by the short term as well as the long term liabilities.The company`s solvency ratio in 2015is 0.29 as compared to the ratio of 0.36 in 2016. 

Refer to the Appendix for calculations.

An external audit can be described as a periodic auditing or reviewing of the books of accounts undertaken by a qualified auditor who belongs to the external environment and works independently. The primary purpose of this kind of an audit is to ensure whether the accounting system of the business is accurate and up to date. The reason why external audit is an important part of assurance and confidence are given below:

It ensures compliance

The external auditing helps in determining whether all compliances have been met with sufficiently. Accounting laws, standards and policies need to be followed at all times and it has to be ensured that a business is conducting its operations legally (Michael, Arthur & David, 2016). Therefore, as an external auditor is not a member of the organization, they will be able to redirect the working of the company without any threat of repercussions of future circumstances (Petrochina.com, 2018). It is usually easier for an external auditor to understand minor problems and solve them easily

Provides Credibility

A review by an external auditor increases the creditability of the business operations as the financial statements go under an external review who certifies the accuracy of them. Creditability provides assurance to the owners of the business regarding the honesty of the management and helps them in gaining confidence in them (Haas & Lelyveld, 2014).

The internal audit cannot undertake the auditing of the internal processes in an accurate manner as they are the members of the organization. On the other hand, the external auditors have the capability of observing the books of the accounts from the outside perspective and this can cause a better analysis of the results. He will also be able to advise the company as to how the waste must be reduced and how to implement accounting practices in the firm effectively (Claessens & Kodres, 2014).

Re-check the internal audit

The internal auditors often perform their duties well but since they are extremely close to the business they tend to lack the accounting experience to audit the financial statements of the firm (Bénétrix, Lane & Shambaugh, 2015). The external auditors will be looking at the internal as well as the external factors in order to ensure that the work done is accurate and double checked. It ensures that the owners have enough confidence in the accuracy of the business and that they are assured that the business has been functioning properly.

Helps in identification of weaknesses in the internal control of the business.

The review of the internal control helps in analysing the various paperwork trails of the financial statements and systems which are used to document the various transactions. It also checks upon the responsibility of the business finance manager and helps in ensuring that the manager has been performing his task effectively.

Provides unbiased and expert recommendations

The external auditors are trained specifically in order to ensure that the focus is on the improvement of the various processes of the business and the risk is reduced of any misinterpretation (Deegan, 2013). He is not concerned about the dislikes and likes of the business enterprise such as the aversion towards changes or the favourite employees of the organization. The only purpose of n external auditor is to ensure that the firm improves greatly.

Once the external auditors clear the case and state that all the books of accounts are accurate it helps in providing confidence to both the employees as well as the owners regarding their work (Scott, 2015).

The company had hired an external auditing company KPMG Huazhen LLP.  Although an auditing company had been set up for the company, the management felt that there is a need to hire external auditors in order to ensure that all the policies have been met with accordingly and that the firm has a clear image in the given field.

The external auditors belonged to both international as well as the domestic domain thereby seeing to it that all the aspects of the firm has been covered adequately covered (Williams, 2014). 

The company was also advised to improve its internal control testing and identification of the risk. They also advised the company to strengthen the internal control training and also provide enough support to the team members to ensure that the accountability process is accurate and supervision of the employees is sufficient.

• They had analysed the documents like the consolidated balance sheets, the income statements, the consolidated company statements and the statements representing shareholder`s equity.
• According to them the financial statements of the company are very fair with respect to all material aspects (Schaltegger & Burritt, 2017).
• Their various financial statements have been presented with accordance to the requirements of Accounting Standards for Business Enterprises issued by the Ministry of Finance of the People’s Republic of China.
• Their auditing procedure was conducted in accordance with China Standards on Auditing for Certified Public Accountants.

Therefore, as observed, the company has made it a point to conduct the auditing procedure internally as well as externally (May, 2013).  This ensured that all the accounting records were recorded adequately and not transparency existed in the books of the accounts. The external auditors were hired in order to ensure that the recordings had been done in accordance with the accounting board standards.

When the auditing was done in compliance with the various boards, the image of the company increases in the eyes of the stakeholders and this encourages confidence in the company from the point of view of the customers. On the other hand, as stated previously it also provides the company a sense of assurance that all its financial statements are as per the laws stated and the organization can achieve its goal with enthusiasm.

In the autumn of 2008, the global economic /financial crisis had shocked the world. Almost all sectors were affected by the crisis. The global economic crisis had an impact on the international business and the multinationals as they were not able to compete with the growth of the different companies with respect to the period of 2001-2008.

Due to the crisis, the condition of the economy was in an extremely bad state, such that many international companies had put their various expansion plans on hold. As many business houses often rely on the global trade in order to provide help to them to sustain from the shrinking of the economy, this downfall failed all their hopes. The Global Baltic Dry Index, which measures the different shipping activities which take place around the globe, went into a negative range which reflected that the growth of trade between the different companies had actually dropped to a negative range as compared to the previous rates of different years (Henderson et al., 2015).

Some impacts and leanings that can be taken from the crisis are given as follows:

Lack of sufficient Cash flow

Due to the downturn various companies experienced a lack of cash flow from various business operations due to two main primary reasons. The primary reason was that the customers of the business enterprises tend to control their various spending due to the existent recession and hence the cash flow coming from these sources. Secondly, the lenders had also implemented extremely strict guidelines with respect to the borrowing of money and therefore, the businesses could not obtain loans.

Unemployment and Lay offs

Since the income of the different firms reduced to a great extent, the business enterprises had to cut down on their employees and send some of them for early retirement. The number of employees that had been laid off recorded the highest during the period of 2007-2008.

Flexibility

The credit crisis had led to businesses operating in a sphere which they had not operated in earlier (Warren & Jones, 2018). The primary effect was that the enterprises became more flexible in their functioning’s when compared to the way the operated before the crises occurred.  These measures included closing down on some additional days in a week and designing new methods of payment with the customers.

Property defaults

Various businesses owner properties on highly adjustable price rates which rose up when the crisis occurred. As stated earlier, the lending guidelines became increasingly strict and therefore, the mortgage payments of the business rose in a manner which was unaffordable for the enterprises (Arens, Elder & Beasley, 2013). Certain businesses, who were involved in the leasing of properties, lost their standing as the bank had foreclosed the properties which are why these businesses came to an end.

Increased creativity

The boon in disguise in the given scenario was that the crisis forced the entrepreneurs and the business owners to give rise to creative ways in order to ensure that the businesses stay in the field. Certain businesses converted their buying terms with their suppliers and many employees who were appointed for part time , were earlier working as full time employees.

China had shown tremendous growth in the two decades prior to the global economic crisis. It had surpassed Japan and became the second largest growing economy and it was expected that it will be only a short period of time before they became even bigger than United States of America. Due to the financial crisis occurring in the United States, several impacts were observed in the stock market around the globe (Traistaru & Cotoc, 2013). Various financial institutions failed and the economies drowned in depression and recession. All sectors of the economy which ranged from real estate to other economies were in deep crisis.

The Foreign Direct Investments in China had been greatly affected due to lack of flows (Petrochina.com, 2018). The stock market of China was also hit badly due to the financial crisis. The crisis`s impact was initially underestimated by the different economists which led to a further default in the various parts of the economy. The demand of the exports from China also fell down due to the decreased demand from the prime importers which include United States of America and Europe (Biondi & Zambon, 2013).

• Adaptation is the key- The companies became more creative in their approach and they realized that in the new era of business, adaptation is the key to success. The global environment is ever changing and it has been realized that if a company is unable to extend its operations according to the need of the hour, it will not be able to survive
• Underwriting Matters- Another important lesson learnt by global companies like Petro China was that underwriting is a very important issue and that it should be conducted regularly before lending out money. Underwriting is process which tends to determine the credit worthiness of the borrowers. Had proper creditworthiness been conducted earlier, it would have lead to the prevention of any crisis.

Conclusion

Therefore, from the given report, it can be stated that the company Petro China is in a weak situation. After analysing the financial reports, it could be figured that the company has not being doing well and that it needs to improve its operational strategy. From the second part of the report it could be figured that external auditing is extremely important for the firm to provide it confidence and assurance. The last part of the report reflects on the leanings from the global financial crisis and how it has impacted various companies.

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