August 20, 2017

Cash generating units: size matters

The investment community and mining and oil and gas companies are at odds as to what the optimal size of a cash generating unit (CGU) should be, but, ultimately size does count.

But what is a CGU? In auditing terms, a CGU is the smallest group of assets that can generate a cash flow independently, and Investors typically motivate for smaller and smaller units, since they prefer a more granular view of the companies in which they invest.

The size of the CGU may have an influence on whether impairments are made and how often these are made. An impairment ensures that an entity’s assets are not carried at more than their recoverable amount (in other words, the higher of fair value less costs of disposal and value in use).

Mining and oil and gas companies, however, traditionally try and motivate for larger CGUs, with some companies including all assets and smelters in a CGU, and others including all assets and a sales unit in a CGU.

Typically, auditors then make a decision as to whether the size of the CGU is appropriate for the business that they are auditing and use the concept to determine whether it should be impaired.

For investors, the concern is that a larger CGU will mask non-profitable mines, gas fields and units since the lower cash flows will be hidden by the higher cash flows of the more profitable assets.

But this concern is not justified as financials will highlight the contributions of the non-profitable assets.

“Nonetheless, it is worrying that companies prefer to have larger CGUs. We would prefer that smaller units are made, and that the values of these assets can be more transparent. This is crucial for a sound appreciation of the company’s intrinsic value,” says Venmyn Deloitte MD, Andy Clay.

Information credits: Deloitte South Africa

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