Help capitalising costs into intangibles as per Paul's Fusionex blog

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31st May '17 by The Phoenix

8 comments 4482 reads

Hi all ace works as always by Paul yesterday re Fusionex.

Paul often mentions being on your game when you see large amount of costs being capitalised into intangibles.

As I'm a non accountant can anybody explain to me how you check this out (hopefully in layman's terms) and once you understand the percentage figure what percent would be classed as acceptable and what type of percent should have the red flags out.

Also is it possible to work it out from a few clicks on Stocko ?

Thanks in advance

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About the Author

The Phoenix

Premium Member

8 comments

steviej

31st May '17

Go to the cash flow statement, which is part of the annual results, usually sub-titled "Cash from Investing Activities" . Fusionex's last is here:

http://www.stockopedia.com/share-prices/fusionex-international-LON:FXI/news/rns/170315fxi4848z.htm/?title=preliminary-results

A quick and dirty check is Free Cash Flow, that is front and centre on the stock report.

If you are still unsure you can read the stocko guides and help sections or buy a good book on basic ratios. I'm sure you could find one on Amazon under a fiver.

Jonny shares

31st May '17

Can you compare the growth in intangible assets to amortisation year on year?

Carcosa

31st May '17

Capitalising a cost means that you do not charge it against the P&L but instead add it to the balance sheet as an intangible asset and then amortise it over time.

Thus it inflates stated profits since the costs are real cash items seen on the balance sheet.

By way of an example, if a company reports a post-tax profit of say £1m and has capitalised £1.5m of development costs then in reality it has actually made a loss of £0.5m. It has negative free cash-flow.

There is nothing wrong with capitalised expenditure provided it is treated fairly. If a company has spent a fortune on creating something new with a perceived economic benefit over say 10 years then it's reasonable to capitalise those development costs accordingly. However, if it needs to keep spending every year to keep the product competitive then it's not really new development work; it's ongoing everyday expenditure and therefore should be in the P&L.

The red flag to look out for is a company that consistently capitalises a development charge relative to profits.

So check Free Cash Flow. It should be positive and should also be in sync with post tax profits. I would suggest that it is annual trends you are really wanting to review rather than a specific year.

Wimbledonsprinter

31st May '17

The above comments look very sensible. One further point to add is to ask yourself questions if you see a company (1) amortising significant intangible development costs AND then (2) focusing on Adjusted profit numbers (before amortisation).

ambrosia

31st May '17

"So check Free Cash Flow. It should be positive and should also be in sync with post tax profits. I would suggest that it is annual trends you are really wanting to review rather than a specific year."

Am I getting this part very wrong, using stockpedia's figures and taking a random company say DFS (happen to be looking at right now)

times Price to Free Cashflow by price = free cash flow
9.68 x 273.5p = 2647
estimated net profit is going to be 50.8m

does that mean that half of that profit is suspect or am I as more likely getting my figures totally wrong

Carcosa

31st May '17

Hi Ambrosia,

FCF = Share price/FCF per Share. However I would not use the data you refer to because they are twelve month rolling forecasts. I would stick with reported results.

As a rough guide use the 'Free Cashflow ps' in the Financial Summary and multiply that by the shares in issue at the reporting date. That should give post tax profit and FCF in the same ballpark.

Have found a helpful note on Stockopedia:
Free Cash Flow per share should be compared with Earnings per Share in order to understand whether a company is able to turn its earnings into cash or not! Ultimately every company needs to make cash to survive and without free cash flow a company will have to go begging to shareholders or resort to borrowing. The best companies are 'cash machines' - you should look for companies that make more free cashflow than earnings.

N.B. Cashflow can be very 'lumpy' as capital expenditures are not consistent from year to year. Also growing companies may have to invest heavily ahead of cashflow to keep up with demand.

The Phoenix

1st Jun '17

Thanks for the pointers all.

Johnny2509

1st Jun '17

I found this article useful in explaining the difference between capitalizing vs. expensing.

https://www.cleverism.com/understanding-accounting-capitalizing-vs-expensing/

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Help capitalising costs into intangibles as per Paul's Fusionex blog

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About the Author

The Phoenix

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