This report was made after a detailed examination of Dar Al Takafuls cash flow statement. This investigation was held to measure the soundness of an investment in the company. The cash flow statement was assessed to understand the financial stability and viability of the company in the banking-insurance sector as it essays down the company's ability to generate and acquire cash, which no other financial statement reveals, as cash cannot be created.
Most companies are obligated to prepare cash flow statements due to the prevailing accounting standard FRS1.
The information relating to the report was made in reference with the annual reports published by of the financial year of 2011.
The report highlights the performance of the company after it faced a major claim in 2008 and tries to investigate whether the company is recovering from it. It also attempts to see what the chances of a relapse are. The report explains in detail the impact of transactions on various activities that affect the business under operating and investing activities. Operating activities for the year report a cash usage but this usage is falling down consistently every year. Investing activities show cash inflows from its investment endeavors. The market conditions that Dar Al Takaful faces are in a constant state of flux which forces business managers to come up with new projects to compete and keep businesses relevant to modern consumers.
Industry Background
Theoretically, Takaful is perceived as cooperative or mutual insurance, where members contribute a certain sum of money to a common pool. The purpose of this system is not profits, but to uphold the principle of "bear ye one another's burden".
Since its arrival, the Takaful market has been growing consistently. It's only in the recent years that this type of insurance has started picking momentum in the insurance industry; especially in the past few years (5 years or so) many new entrants have emerged. Due to the increased competition, companies have to adopt various strategies and that has led to the creation of various industry leaders in the GCC region. The national investment in the UAE insurance sector has dramatically increased in the last few years with more than AED 5.1 billion (both traditional and Islamic) invested by the local companies against AED 1.7billion by foreign investors. Motor and life insurance form the largest share of the Takaful market in the UAE, with estimates which suggest that the current Takaful market is valued at US $23.4 million in the insurance premium income and will continue to grow. {The aforementioned information is developed based on the information up to 2009}, however this has changed drastically, as of 2012; more than 54 companies reported offering Takaful services.
Insurance regulation in the UAE is presently minimal and undergoing revisions. A new insurance law came into force in August 2007 thereby establishing the Insurance commission, a new regulatory body for locally incorporated companies. However, requirements for Takaful companies have not been decided yet. On the contrary, the Dubai International Financial Services Center (DIFC), an offshore financial center, requires Takaful firms operating within the DIFC to operate not according to the Prudential Insurance Rule book (followed by The GCC Takaful Industry conventional insurers) and to fulfill the requirements of the Islamic Financial Services Rulebook (IFS).
Insurance industry being in financial sector is directly impacted by problems in the financial sector. Insurance sector primarily depends on investment income and secondarily on its underwriting results. Economic growth increases insurance activity and negative or low growth in the economy directly affects insurers. Recession results in nil or low investment returns. Volumes in contributions/premiums dry up as there will be no new investments. Shareholders pressure on returns can result in compromised underwriting to increase volumes.
Company Profile
Dar Al Takaful PJSC, established in Dubai as a local insurance company in the year 2008 with an initial capital of AED 100 Million. The company was formed with the aim of providing Shariah related solutions for insurance needs by using the co-operative system called Takaful (togetherness). The objective of the investors was to provide unique Islamic insurance products & financial services, based on the principles mutual co-operation, solidarity, responsibility, assurance, protection & assistance, in order to secure & safeguard their policy holders from the vulnerable business environment & to ensure them, that they are in safe pair of hands. The strong group of supporting investors consists of Mawarid finance, IFS, Al Jazeera Financial services & MFI Investments. The company management headed by Saleh Al Hashimi (M.D), are committed towards sustaining long lasting relationships with its policy holders using features such as innovation, expert knowledge & moral ethics which are backed by a solid financial foundation & accurate cooperate decision making in order to survive the turbulent economic conditions.
Mission
To deliver innovative insurance products and value-added services built on sustainable lasting relationships within a Shariah-compliant framework.
Vision
To be a leading insurance company providing beneficial Takaful solutions to the public which are supported by a solid financial foundation.
IMPORTANT: THE COMPANY PRESENTS ITS TAKAFUL OPERATIONS'S/PARTICIPANT'S AND SHAREHOLDER'S INCOME STATEMENTS AND BALANCE SHEETS SEPARATELY.THIS IS A REQUIREMENT OF THE SHARIA LAW, AS FUNDS FROM THE TWO PARTIES CANNOT BE MIXED.
Investigation and Critical Analysis
Operating activities
These are cash flows from the principle activity of the business which in this case is providing insurance products which generate the revenue. During the year the company reports a cash usage of AED 13,636,952. There are various reasons as to which Dar Al Takaful has arrived at this figure. The company uses the indirect method of executing cash flows therefore they begin with loss and further add back non-cash expenditures .During the year the company reported a loss of AED 4,469,227 however it's too early to estimate that the loss is influential to the investment decision due to the various reasons. Firstly, the company was incorporated 4 years ago, so for certain businesses, especially insurance, it's understandable they incur losses in the initial years until they make profits. Moreover if upon comparison of losses over the years (Dar Takaful's accounting loss has consistently fallen since incorporation, i.e. from AED 9,023,998 in 2010, to the present loss of AED 4,469,227 which is almost by 50% and from 2009 to 10 it fell by 43%.) they have been consistently falling down by 40-50% approximately every consecutive year. Lastly, the company faced its 1st major claim i.e. AED 30 million within the first 4 months of its operation.
Upon further investigation of this loss, from the income statement, it's clear that for the first time the company made an operating surplus but of AED 26,112,927 and after that the company had to incur costs from General and administrative expenses by AED 20,050,498. The increase in administrative expenses was mainly due to increases in marketing and staffing costs which is justified as the company need to advertise and hire efficient staff especially after change in their name from Takaful house to Dar Al Takaful.
During the year depreciation was AED 1,540,983 and Amortization came to AED 566, 512. Both of these are non-cash expenses and hence they need to be added back as there is no negative cash movement. Depreciation for the year includes first time depreciation of new plant, property and equipment therefore the figure for depreciation in the company has increased by AED 402,912.
Amortization and depreciation is calculated on a straight line basis over the estimated useful lives of the assets. Depreciation for the year has increased mainly due to the additions in capital WIP which comes to AED 773,900, extracted from note 10.
Transfers recorded a 24.43% increase from the previous year, i.e. from AED 7,820 to AED 32,000. Transfers are made from WIP to furniture and fixtures. This increase evinces that management is sound in implementing decisions as 24% additional work has been completed and transferred in 2011.
Dar Al Takaful, reversed and existing provision by 29.2 million as the claim from re-insurers was settled by means of legal intervention as is evident from notes 5 and 17 respectively. It's evident from the company's published report that the company faced a claim of AED 30 million in the year 2008 and settled it in the same year but at the same time the company was reinsured for almost 29.2 million which was due from its re-insurers. The reinsurance companies refused the settlement and then the matter was taken to court, where the court ruled out in favour of Dar Al Takaful. The company had made a provision against this and reversed it in 2011 after they parties settled this amount.
Provision for doubtful receivables was AED 909,178.
Since the company doesn't have any deficits in Takaful operations, 2011 reports no provision against Qard Hassan rather evinces a reversal of an existing excess of the same by AED 7,564,441. Qard Hassan is a beautiful loan as its interest free and is given by the policy holders to the company in times of deficit and financial distress to the organization, there in no time limit under which the company needs to pay back. The company has reversed excess Qard Hassan as this year reports no operating deficit, rather has a surplus and company settles it. Therefore the balance provision that isn't required is now reversed.
Income from Wakala deposits was recorded at AED 935,352 which has been reduced as for the year no Wakala has been mentioned in the statement of financial position for Takaful Operators .Wakala is the Arabic term for agency, these are the income streams from the agent's deposits.
Any decreases in provisions are written back as there is literally no cash movement (gain) so they need to be subtracted to arrive at cash used or generated from operation.
There are many changes in the working capital requirements of the company which can be seen in the cash flow statement as changes in operating activities. Operating items such as receivables, payables may increase or decrease throughout the year. Increases in assets represent cash outflow as more and more ready cash is being tied up in investment. This can be seen in the case of Takaful receivables and ReTakaful assets, as an outflow by AED 5,640,874 and AED 2,466,233 respectively. Prepayments fell by AED 387,371, therefore more cash available. As in the case of liabilities, if they increase, they represent cash inflows as is the case with Takaful payables and other liabilities by AED 2,798,624 and AED 534,963 respectively.
The net changes in working capital requirements are a big improvement from the previous year, where Dar Al Takaful has managed to improve its position from a negative AED 24,446,031 to a working capital surplus of AED 26,125,187 in 2011. This surplus was possible as the deficit in the participant's fund was funded by shareholders in accordance to the company's policy through a Qard Hassan. During the year the participant's fund reported a surplus amounting to 26,103,333 which was fully used to recover the Qard Hassan. Since Qard Hassan amount was fully redeemed by the participants, the amount was reconciled in the cash flow statement, which is responsible for the healthy performance of Working capital. This is good for the Company and great for the investor as, (Geoffrey Holmes, 2002) states " Watch the working capital. If it isn't kept under control it will gobble up company's cash like a hungry alligator."
Due to these reasons the company fails to generate any funds from operations rather has a usage of AED 13,636,952 which shows that the company is unable to generate funds from the area which is the prime purpose of the business's existence.
An important figure to reconcile is the operating profit to net cash from operations. Dar Al Takaful reports a net cash usage from operations at AED 13,636,952 whereas there is an operating surplus from the Takaful operations of AED 26,112,927. This means that almost 47.8 % of the operating surplus is realized in cash and the rest is accrued but not yet received. However, it's a major improvement from 2010, where the company reported operating deficits of AED 4,208,050 and operating cash usages of AED 25,485,103 as the company's working capital was performing badly.
Conversely, when the operating cash usage of AED 1,363,695 is almost 3 times the loss reported for year (AED 4,469,227), which can be traced back to the Income statement attributable to the shareholders.
Investing Activities
Cash Flows from Investing Activities is a measure of the total cash generated or lost by a company's investments .Typically included in this calculation are cash flows from stocks, bonds, physical property (such as plants and equipment) and money made (or lost) from the buying and selling of subsidiaries.
These showed an inflow of cash by AED 29,020,451.
During the year an outflow was recorded as there were additions to the company's plant, property and equipment. Additions to furniture, office equipment and work in progress were AED 359,586; AED 227,133 and AED 773,900.
Other significant outflows came in the form of making new Wakala deposits of AED 5,000,000. Purchase of other financial assets has also led to an outflow by AED 1,803,576.
The thing that led to inflows was from income pertaining to sale of trading securities which AED 1,159,608.Inflows was got a major boost when deposits worth AED 36,043,403 were en-cashed. It is vital to scrutinize the deliberation behind this. When the wakala deposits are identified from the shareholder's assets, the significant fall in the Wakala Deposits by 22.74% is identifiable i.e. from AED 37,375,263 in 2010 to AED 8,500,000 in 2011.The question that surfaces is that why did they en-cash such a huge amount. One way to look at it (strictly an assumption) is that Dar Al Takaful financed its Qard Hassan amount of AED 26,103,333 fully, through the cash it received after en-cashing the deposits. After the company has AED 9,940,070 worth of cash in hand which the company might have used to acquire investments worth AED 8,191,560( as is evident from the cash flow 1369619+18365+1803576+5000000), which leaves us with AED 1,748,510 cash. It's very likely that the company is trying to make their standing look better than it is , as the company is struggling to deliver its first set of profits.
First time impairments were recorded on available for sale financial assets by AED 415,947.This year changes in the fair value of available for sale financial assets was AED 36,660, which fell by 3 times when compared to last year mainly due to closeness in valuation of the financial instruments fair value and book value. The company values its financial instruments at quoted prices in active markets for identical assets or liabilities.
Note 12 further speaks about the valuation process. Financial assets measured using a valuation technique based on assumptions that are supported by prices from observable current market transactions are assets for which pricing is obtained via pricing services, but where prices have not been determined in an active market, financial assets with fair values based on broker quotes, investments in private equity funds with fair values obtained via fund managers and assets that are valued using the company's own models whereby the majority of assumptions are market observable.
Positive cash from investing activities generally means that the company is selling off more fixed assets than it is investing in. There could be many reasons for this e.g. the value of the asset has grown and the company wants to realize a profit or to meet operating or financial cash flow obligations. Despite the use of the word 'positive' is not always a good sign for a business. The important aspect over here is to understand whether this final cash inflow from investing activities is worthwhile or not as sometimes, one needs to invest which would call for huge cash outflows that again depend on the investment. Investment activities if generally are yielding positive results, imply that there has been disposal of assets.
Financing activities
The company chooses to finance its activities only through equity. The company has a issued and paid up capital of AED 100,000,000. It might seem advantageous as the company does not need to think about interest cover from operating cash flow, loan profile and reconcile its net debt to cash flow. While raising equity is a good way to exit the business, it becomes difficult for the interested promoter to retain control of the business. All shareholders of an enterprise have a say in electing the director board, including the CEO, and all major investments require the approval of a majority of the shareholders. If the promoter does not match the investments made by other investors, there is a chance of other investors acquiring more than 51 percent of the company shares and taking control of the company, forcing the promoter out. While profit and loss sharing protects the company during bad economic times and difficult cash flow periods, it also leads to a higher outgo to the investors during good economic times. The profit sharing in is proportion to the investment made by each investor, including the promoter, and the promoter would have to forego of a much higher amount when compared to repayment of bank loan with interest.
Research Findings and Inference
Investment Decision Analysis
Overall during the year the company reported a net increase in cash flows by AED 15,383,499 .Cash and its equivalents at the year-end were AED 17,985,630. Based on figures arrived at from operating and investing; certain things become apparent.
The performance of operating activities is highly debatable .On one hand there is a fund requirement of AED 13,636,952 which traditionally reflects poor management of available funds{ bad short term financial management} and evinces that funds are not being generated from the key purpose of the business i.e. mains operations don't yield cash return. On the other hand this is only the company's 3rd year since inception and it is normal for companies to be this way given the market conditions, the major claim of AED 29.2 million and the general lack of awareness regarding Islamic insurance. Operating cash flows represent the cash generated from sales of the product or service of your business. It is the real lifeblood of Dar Al Takaful and as it is generated internally, it is under the company's control. This cash flow is the only cash flow that is sustainable. If the company does not make surplus cash in this section, it is in a precarious position. Research has shown that companies that have a negative cash flow from operating activities for three years in succession stand a very good chance of being delisted or facing financial ruin. The company's receivables have increased significantly by 36.67%, which means more cash being tied up (AED 33,931,696); and if the company faces difficulty in its debt collection, its working capital cycle will lengthen making it difficult for the company as it's still young and classically would have a high requirement of working capital due to survival and expansion needs.
Investing activities portray an inflow of AED 29,020,451. Cash generated from this activity is not sustainable as it will rob the company of its ability to function if the company disposes key assets. In addition, one should also expect a company to spend cash on investing activities as the company should at the very least maintain its assets. For Dar Al Takaful, this should be the priority, however the proportion of cash spent to cash received from investing is 4.4: 1, which is unhealthy. If it has a strategy of growth, one would also expect the company to acquire new assets, which would be reflected here.
Despite this, Dar Al Takaful company is generating more cash than it is using, the company with time, will be able to increase its dividend, buy back some of its stock, reduce debt, or acquire another company. All of these are perceived to be good for stockholder value but when the main source of cash flow is coming from an ill source, i.e. positive investing activities the merits of it are certainly questionable.
Furthermore the global recession that hit Dubai resulted in stalling of ongoing construction projects, no new projects being taken up, falling market prices in property, reduced international trade, negative growth in automobile sales, loss of jobs which all directly impacted insurance company premiums/contributions in engineering, property, marine cargo, motor and employee benefit insurance.
From the financial statements of the company, most figures are improving from their previous year's value i.e. on a comparative basis figures like losses have reduced, assets have gone up.
On a brighter note, a healthy sign is that this year, is the first year that the company does not report an operating deficit and furthermore utilizes the arising surplus to settle the existing Qard Hassan. No, Qard Hassan means that the company has come out of its financial calamity as this type of loan is only available under such situations.In other words, it achieves its Takaful Participant's Breakeven in this year.
And according to findings of a well-read local newspaper, Khaleej Times the company is bound to improve and eyes 40 % growth by 2012.
Furthermore, in the research findings of ambest.com it was found that most new Takaful companies commencing during recession were finding it difficult to survive and compete with the already existing companies as business was low.
Based on the above reasons, one can infer that this investment is yet to prove its mettle, so one should not proceed with an investment, but at the same time, investors must closely watch this company, as its exhibits many healthy signs too , which might overtake the weaknesses and make the profitable.
Conclusion
With regard to the aforementioned analysis , it seems reasonable to not invest in this company rather wait and watch the company's performance and from time to time appraise its financial health as the company is really young and has just recovered from a hefty claim. Moreover with time as the company grows; most likely the returns from it also climb up as the investments of the company may start yielding return. As of now there is no dividend and more over as this is based on the principles of Islamic principles of solidarity and mutual co-operation there is diluted loss per share of AED 0.44, however this diluted loss per share has also consistently fallen. The company recorded a Return on equity of negative 12.96% for 2010, as compared to its competitors like abu dhabi national Takaful co and Methaq, which recorded ROE's of 16.63% and -11.16%.The company's operating margin stood at -32.08% in 2010.
Further to analyze any insurance company it's imperative to look up the performance of various years , so if the company has been in good shape for a year and hasn't shown improvement otherwise, its riskier than the one whose performance is consistent and stable. From the view point of an investor it is important to know whether the share price is being maximized and also about the profitability which is vague as the financing activities are missing.
Appendices
Appendix 1 : Basic SWOT analysis.
SWOT ANALYSIS
STRENGHTS
WEAKNESSES
Strong top-line performance, as the company despite economic downturn reports a cash surplus.
Wide product portfolio,
Geographic Concentration, the company is bases in Dubai.
New entrants, yet to carve their niche
Change of Name from Takaful House to Dar Al Takaful, means more advertising costs.
Lack of standardized accounting practices
OPPORTUNITIES
Growth and Expansion in adjacent emirates
Growing economy of U.A.E.
THREATS
Increased competition
Potential economic instability
Changing regulations
Appendix 2: Takaful Overview
What is Takaful?
In present times, Takaful is known as Islamic Insurance, and follows the rules and regulations of Islamic law. The term has its origin in the Arabic word Kafalah, which means "guaranteeing each other" or "joint guarantee". Therefore, the Takaful system is based on mutual co-operation, solidarity, responsibility, assurance, protection and assistance between groups of participants.
What is a Takaful contract for Dar Al Takaful?
A Takaful Contract is the document that describes the terms, conditions and procedures to be followed if a Policy-Holder suffers a loss and wishes to raise a claim for reimbursement from Dar Al Takaful. It is also called a Takaful Policy and it includes a proposal form, which should be completed and duly signed by a Policy-Holder. This proposal form is considered the basis of the contract between Dar Al Takaful and the Policy-Holder.
What are the principles of Takaful?
The main principles of Takaful are:
> Policy-Holders cooperate among themselves for their common good.
> Every Policy-Holder pays his subscription as contribution to help those that need assistance.
> Losses are shared and liabilities spread according to the community pooling system.
> There is no uncertainty with respect to subscription and compensation as all such payments are made through a unilateral contract.
> Takaful does not derive advantage at the cost of others.
Who are the parties in a Takaful Contract?
There are two broad types of contracts in Takaful:
· A unilateral contract between Participants and the Participants' Fund.
· A bilateral contract between the Participants' Fund and the Takaful Operator.
What the different types are of models in Takaful?
There are 3 models and several variations on how Takaful can be implemented.
Mudharabah (profit sharing) Model
Wakalah (agency) Model
Combination of both
The Takaful operator is the administrator of the fund and manages the fund in trust on behalf of the participants, and the contract between participants and the operator is governed under the contract of Mudharabah or Wakalah.
Mudharabah gives the right to the contracting parties to share profit, while liability for loses is borne by the participants; and under the Wakalah model, the Takaful operators earn a fee for services rendered while liability for losses is borne by participants. The fee may be varied based on the performance of the Takaful operator. It can be a fixed amount or based based on an agreed ratio of investments profit or surplus of the Takaful funds.
What is Qard Hassan?
This is a loan extended on a goodwill basis, and the debtor is only required to repay the amount borrowed. However, the debtor may, at his or her discretion, pay an extra amount beyond the principal amount of the loan (without promising it) as a token of appreciation to the creditor. In the case that the debtor does not pay an extra amount to the creditor, this transaction is a true interest-free loan.
Appendix 3: Financial statements of the company
Appendix 4: Methodology
This report is based on various fundamental techniques of evaluating investments. Throughout the analysis, effort has been expended to maintain the accuracy and quality of data. The key approach was to analyze the cash flow statement of the company during the year 2011. For convenience, information directly pertinent to decision making has been written in the following color IIIIIIIIIIIIIIIIIIIII.
Appendix 5: Bibliography
Abdel-Rahman Yousri Ahmed, T. E. (2009). In Principles Of Takaful. Manama: CII.
http://www.khaleejtimes.com/biz/inside.asp?xfile=/data/uaebusiness/2012/September/uaebusiness_September154.xml§ion=uaebusiness
http://www.accountingcourse.com
http://www.amwest.com
www.accountingcouch.com
www.brighthub.com
Interpreting Company Reports and Accounts by Holmes, Sudgen and Gee
The Financial Times GUIDE to USING AND INTERPRETING COMPANY ACCOUNTS by Wendy McKenzie
FINANCIAL ACCOUNTING AND REPORTING by Bill Collins AND John McKeith
