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ARE INVESTORS LOSING OUT? THE IMPACT OF HIGH G&A COSTS ON AIM-LISTED COMPANIES

By SKS Business Services

Executive Summary

SKS Business Services has analysed the data from 89 AIM-listed oil and gas companies. The analysis highlights the continued problems in 2014 of excessive general and administrative spending, a persistent issue that emerged from the 2013 analysis of 134 AIM-listed companies also undertaken by SKS Business Services.

The research also serves to highlight the benefits of outsourcing (or right sourcing) the finance function of AIM-listed companies, to reduce G&A costs,to generate independent and more detailed and accurate management accounts and to improve the transparency reports to investors, who are often kept in the dark about where their money has been spent.

Introduction

“Even if you’re making pots of money, you should be looking hard at what you can do to reduce costs.  This is to cushion the business against market volatility, be it commodity prices changes in demand and supply or changes in customer behaviour. Companies involved in developing natural resources or undertaking research and development have long gestation periods and are thus funded by investors until they produce revenue.“Keeping G&A as low as possible makes for a sound business case as one would think that investors would back thrifty management given a choice.”

“All too often the analysis of G&A takes a back seat. Investors don’t have benchmarks to compare and challenge the costs and are therefore losing out on potential returns. This report aims to shed light on how improvements can be made.”


Sanjay Swarup
SKS Business Services

As competition becomes fiercer in a global economy, the traditional and widespread approach tomanaging finance for medium and small sized companies, is likely to change. Evidence continues to emergeof the difference that professionally prepared management accountsand ongoing reviews of G&A costs can make to profitability, cashflow and attracting good investments.

Currently, business growth is being stifled in too many medium-sized firms by a lack of financial insight into their own business and by a lack of focus on reducing non-core spend.Several AIM-listed companies in this research fail to look at an efficient operational model for their business and most of them appear to omit potentially useful detail about certain cost areas in their annual reports.

This analysis follows on closely from the research undertaken by SKS in 2013, which looked at 134 AIM-listed companies’ level of spending on their general and administrative (G&A) costs since 2008. Key findings from the research found:

  • Overhead costs had increased 21% since 2008 (compared to inflation of 12%, a real increase of 9%), while profits had fallen from an average of £9.6 million to an average loss of £1.52 million
  • In 2012 AIM-listed companies spent 5% more on non-core operations than in the previous year
  • Despite the rise in G&A expenses, only three of the 134 AIM companies analysed provided any explanation to investors as to why this rise took place or what they were doing about it
Sanjay Swarup
Sanjay Swarup

The findings highlighted the problems AIM-listed companies were facing due to a rise in G&A costs. As a result, SKS conducted deeper research this year into sector-specific AIM-listed companies, in this case the oil and gas industry. This new report analyses the annual reports from 2012 and 2013 of 89 AIM-listed oil and gas companies and identifies a significant continuing over-spend in G&A costs in both revenue-producing firms and those still in exploration stages.

SKS also suggests in this report that a change in a company’s finance function through outsourcing can not only reduce the cost of the finance function by 50%, but it will allow greater efficiency when regular monthly accounts highlight any excess levels of spending. Our findings indicate that by adopting further right sourcing methods, companies can save up to 20% of their overall G&A costs, which, for some of the organisations, could see the difference between making a profit or a loss.

This research looks closely at how AIM-listed companies are falling somewhat short of reporting closely on G&A costs in their reports and asks, how can investors be expected to make sound judgments about potential returns if such important information is lacking?

Section 1 – Investors are still being kept in the dark

General and administrative costs are the sets of expenses needed to administer a business. These costs are not related to the construction or sales of business goods/services. Examples include:

  • accounting staff wages and benefits
  • building rent
  • corporate management wages and benefits
  • depreciation of office equipment
  • office supplies
  • utilities
  • subscriptions
  • insurance
  • legal team’s wages and benefits.

These costs are a prime example of expenditure any business will have to endure before trading has started.

They are thenon-core costs which businesses are always under pressure to reduce. Yet in firms with a strong centralised command and control management system i.e. a head office, these costs will be larger than those that outsource different departments, like the finance function and legal team.

The AIM-listed firms examined in this researchfall into four different categories when portraying their G&A costs:

Category 1

28% of these firmsreported total G&A spend for the year, with a minor explanation where costs have increased or decreased. For example, Madagascar Oil Limited, a revenue-producing firm, provided its explanation of G&A in 2013 as follows:

“Total general and administrative and VAT penalty expenses increased to US$10.0m (2012:US$9.6m). This is primarily due to VAT penalties recognised as a result of the tax dispute settlement and increased legal and professional fees relating to the Board restructuring and Houston office closure during 2013.”

Category 2

Another 28% reported G&A spend without explaining why it has changed. One revenue producing example does suggest further explanation on their G&A spend in the additional notes of the financial statement, yet no justificationis eventually provided.

Category 3

There are a small numberof firms (11%) whose reporting on G&A costs lacks clarity as only partialknowledge about the total amount being spent. For example one 2013 annual report states, “the group’s ongoing G&A expenditure is generally estimated to continue at between $1.5 million to $1.7 million gross per month.” This report not only fails to give accurate figures for the overall spending on G&A, it lacks the precision around what this spending constitutes.

Category 4

33% of firmsprovide a detailed picture of their spending, up from what was discovered last year. One non-revenue firm, Antrim Energy plc,is a good example, stating in 2013 that“general and administrative (“G&A”) costs decreased to $4.8 million in 2013 compared to $5.8 million in 2012. The decrease in G&A is primarily due to reduced employee compensation.” Further details are provided in their notes too.

In the 2013 research of general (as opposed to sector-specific) AIM-listed firms, only three had management discussion and analysis reports where the description around G&A costs alluded to an increase in spend, but not around how it was going to be reduced. Even though the number is larger within the oil and gas sector,this type of analysis did not increase our understanding of why the G&A has risen or fallen when two-thirds of these firms are not reporting enough information.

A greater level of detail should exist amongst those revenue-producing oil and gas firms in general, but even moreso forthose businessesthat are not making revenues and are only in the exploratory stages. It is here that reducing G&A costs is more important than ever, at least until revenues and profits are generated. If investors can clearly see where their money is being funnelled, it might increase the level of trust to invest more money, an obvious benefit for those early-stage companies.

Section 2 – Why AIM companies are losing money when revenues are up

After analysing the 89 oil and gas firms closely from their 2012 and 2013 information, it can be determined that for many of them there was a dramatic increase in revenues produced.Some have all dramatically hit oil with their revenue streams. This was mirrored in the overall rise in revenues for all 89 companies, with total revenues having risen by 28%.

SKS Business ServicesHowever, this positive revenue stream does not correlate with the level of profit made in 2013. The number of companies making a profit dropped from 16 in 2012 to 9 in 2013. Only Bankers Petroleum made a profit in both years and in 2012, 15 of the firms went from a profit to a loss in one year. Overall, losses in revenue streams increased by 45% in one year.

Last year’s research revealed a consistent rise inG&A costs since 2008. This year’sresearch found a drop in overall G&Aspend and although between 2012 and 2013 there was a reduction of 12% inG&A spend in these 89 firms, their losses increased by 83%. Clearly, more work needs to be done.

Last year’s research found a link between a reduction of profits and the large costs of G&A. This link is still apparent in the latest research: in 2012 there were 27 companies whose total spend on G&A was either more than or equal to their total loss in revenues. So if these firms were able to reduce all of their G&A spend (and in some cases like Max Petroleum and Infrastrata they would only need to reduce a percentage of their G&A) a loss making company would be profit making.

When looking at those oil and gas companies who moved from a profit to a total loss in revenues, seven of them had increased their G&A spend.

While there is anencouraging overall reduction in G&A spend, non-revenue producing firms actually saw a rise of 5.5% in G&A spend between 2012 and 2013. For firms not generating an income, keeping those costs down should be imperative. As we saw from Section 1, the companies provide no reason for where this rise is coming from and what can be done to make cuts.

For a select few, the G&A spend is an identifiable contributing factor to explaining a loss. However, for the rest, the average level of G&A spend has decreased, suggesting there are other contributing factors affecting these losses. One explanationmay be a rise in variable operational costs.

Regardless, the level of variable operational costs does not reduce the scale of the effect G&A costs have on overall spending. As seen in Section 1, a detailed analysis of G&A costs can help to highlight areas where non-operational savings could be made, thus potentially reducing the loss in revenues.

Section 3 – Is there an answer?

While a central office is able to integrate the businesses, various departmental functions do not necessarily need to be carried out on site. The finance function is a prime example. Too many businesses will have accounting teams on staff, yet they only carry out simple book-keeping tasks and produce report content for the CFO to review.

Outsourcing the finance function will of course create more freedom and opportunity to create more regular management accounts, and independent business advice, which will clearly identify where the over-spending on G&A costs is coming from. Without this analysis it is clear that a level of puppy fat is surrounding these businesses, where easy savings could otherwise be made.

Revenue-producing firms would normally build up higher levels of G&A costs as these businesses will have extra staff and offices to support the production of oil and gas. It is easy to see that certain aspects of these businesses would not be essential for non-revenue producing firms. For those firms, keeping non-essential costs down is crucial, especially when informing investors of their research progress.

Having accounting staff in-house means paying for services which require spending furniture, office supplies and utilities. Through outsourcing, these costs will vanish overnight without diminishing the quality of the work. This can be taken to a higher level where the finance, legal and HR functions are all right-sourced. An example of this operational modelcan be found at an SKS client. The mining firm is listed on the Toronto Stock Exchange andmaintains flexibility by operating without a head office. The CEO and CFO are based in London, the COO works from the U.S and the Auditor from Canada.

Several aspects of its business benefit from this model, from management to finance function to operations– all being outsourced to different countries. It is estimated this company has saved over $300 K on G&A costs by moving the finance function and at least three times this amount on overall G&A costs.

A simple way of finding cost savings is through regular management accounting and external business advice. Regular independent management accounts can address spending on all aspects of the business, from planning for future investment to achieving cost savings. The benefits of having monthly accounts allow for decisions to be made in advance instead of making a rather late assessment of the budget when compiling year-end accounts. These savings would then be explicit in the annual statements, highlighting cost reduction and improved profit forecasting.

Too many companies are failing to grow because they are unable or unwilling to invest in structuring/managing their finance function better. All too often the cause is simply a lack of understanding of what skilled financial analysis and forward-looking management accounts can deliver. The oil and gas companies analysed here could clearly benefit from closer analysis to discover why their revenues have increased, but they continue to incur a loss.

Conclusion

The purpose of this research was to highlight how a group of AIM-listed oil and gas companies are missing a fairly straightforward opportunity to maximise precious resourcesand, in some cases,avoid losses in revenues.They do not seem to be reviewing their non-core G&A costs or adopting tested and emerging shared services or outsourcing models to reduce these non-essential costs.Their financial statements typically reveal a significant lack of information about where investments are being spent. Investors are losing out as a result, unable to analyse whether their financial contribution will be a solid return on investment. And without regular, more detailed analysis of how the business operates, it is easy for these oil and gas firms to miss potential profits.

It is becoming easier to cut costs through the better use of technology and to negotiate better terms with suppliers. Technology can make it easier to outsource areas of the business like the accounting and legal teams to other locations, firms or countries, which in turn will reduce G&A costs. Indeed some companies stand to reduce their finance function spend by 50% by addressing this more closely.On top of this, with the right application of further right-sourcing methods, companies can reduce their overall G&A spend by 20%. Many of the 89 oil and gas companies would benefit from this approach. It would appear that their focus on developing an industry reputation for innovation takes necessary attention away from controlling general running costs more keenly.

The oil and gas sector is unpredictable; businesseshave a limited lifespan before natural resources run out. Without effective business and financial analysis, these firms will fail to keep control of lossesin revenue. Addressing this is surely imperative for non-revenue-producing firms, who seek further investors to aid their exploration.

If these companies can demonstrate a solid business plan with keen monetary projections it will help toconvince investors to spend more on a worthy project. Only once these firms start addressing this fact and outsourcing more sensibly, they will not only reduce their G&A spend, but keep those valuable investors happy at the same time.

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