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Analysis for Financial Management

Cat: ECO
Pub: 2004

Robert C. Higgins

up 15823

Analysis for Financial Management


ROE; ROA; ROIC; Common-size BS; Common-size PL; Ratio analysis variuos countries; Due to Keiretsu; Sustainable growth rate; Debt-rating; Beta risk; Diversification;

0. Preface

  • Financial statements are like fine perfume; to be sniffed but not swallowed.

0. 序文

  • 財務諸表は香水のようなもの。香りはあるが飲めない。

1. Interpreting Financial Statements

  • Cash Flow - Production Cycle (>Fig)
    • Inside cycle: purchase raw materials and makes the product and stores in inventory.
    • Outside cycle; over a period of time, the fixed assets are consumed in the creation of products. (depreciation). Cash is not realized until when the account receivable is collected. (operation, or working capital, cycle)
  • Profits don't equal cash flows:
    • The company may be insolvent, due to:
      1. lose control of accounts receivable
      2. too much investment; growing broke
  • Balance Sheet (BS):
    • BS is a snapshot at a point in time.
    • Assets = Liabilities + Shareholder' equity
      • Equity is on the liabilities side, which represents owners' claims against existing assets.
  • Income Statement (IS)
    • IS records the flow of resources over time.
    • Earnings = Net sales - cost of goods sold - Operating expenses - Nonoperating expenses - Taxes
    • IS is divided into 1) operating (major/ongoing activities) and 2) nonoperating (secondary activities)
      • Accrual Accounting: revenue is recognized as soon as the effort is substantially complete and there is a reasonable certainty that payment will be received.
      • Depreciation: charging the full cost of a long-term asset to one year distorts reported income. This is the allocation of past expenditures to future time periods to match revenues and expenses.
        • straight-line method; useful life; salvage value
        • accelerated depreciation; more depreciation in early years.
      • Taxes:
        • Depreciation accounting; to minimize current taxes by employing the most rapid depreciation.
        • liability accounts reflect tax not yet paid
        • asset account reflects prepayments.
        • EBIT: earnings before interest and taxes.
        • EBITDA: earnings before interest, taxes, depreciation, and amortization.
        • EIATBS: earnings ignoring all the bad stuff
      • R&D and marketing:
        • outlays promise benefits over future period.
        • but are difficult to estimate.
    • Increase or decrease of cash:
      • How to generate cash:
        • by reducing an asset or by increasing a liability:
      • How to use cash:
        • to increase an assent or to reduce a liability:
      • two-finger approach: put and trace two BS.
  • Cash Flow Statement (CF):
    • CF from Operating Activities: (CFOA)
      • add depreciation (didn't entail any CF)
      • some sales didn't increase CF because customers hadn't yet paid
      • some expenses didn't reduce CF because the company hadn't yet paid
      • Securitization of account receivable; sometimes a kind of off-BS financing.
      • some inventories was ignored, following the matching principle.
    • CF from Investing Activities: (CFIA)
    • CF from Financing Activities: (CFFA)
    • Free CF: (FCF)
      • Total cash available for distribution to owners and creditors after funding all worthwhile investment activities.
      • a fundamental determinant of the value of a business.
  • Market Value vs. Book Value: value problem
    • Accountants prefer to be precisely wrong rather than vaguely right.
    • Goodwill: typical intangible assets like brand names, patents; a kind or premium over the fair value.
  • Economic Income vs. Accounting Income
    • Imputed costs: Accountants are unwilling to recognize unrealized gains and losses (inaccurate estimate) and because they often ignore imputed costs.
    • Equity cost: creditors earn interest on loans, equity investors expect a return on their investments. (dividend?)

1. 財務諸表を解釈する:

  • Cash Flow - Production Cycle:



  • accountants are so rule-bound; their creativity runs a bit amok in naming words.

















  • impute; assign a value from the value of the products; imputed interest 帰属利子


2. Evaluating Financial Performance:

  • ROE (Return on Equity): A measure of Efficiency: Managers have 3 levers for controlling ROE. >Top
  • ROE = P(%) × A(Asset Turnover; times) × T(Financial Leverage; times)
    ROE =(Net income) / (Shareholders' equity)
    = (Net income)/(Sales) × (Sales)/(Assets) × (Assets) / (Shareholders' equity)
    = (Profit Margin) ×(Asset Turnover) ×(Financial Leverage)
  • Profit Margin:
    • differs greatly among industries or the products sold.
    • 2001 ROE Profit Margin Asset Turnover Financial Leverage
        (%) P (%) A (times) T (times)
      Amgen (bio) 21.5 27.9 0.62 1.23
      Amtek (chemistry) 19.7 6.5 0.99 3.07
      Tiffany 16.7 10.8 0.99 1.57
      Whole Foods Market 16.6 3.0 2.74 2.03
      Microsoft (as reported) 15.5 29.0 0.43 1.25
      Microsoft (revised) * 36.0 26.8 0.82 1.63
      Florida Power 15.3 9.7 0.64 2.43
      National Semiconductor 13.9 11.6 0.89 1.34
      BankOne 13.0 10.8 0.09 13.30
      Southwest Airlines 12.7 9.2 0.62 2.24
      Krispy Kreme Doughnuts 11.7 4.9 1.75 1.37
      Chevron Texaco 9.7 3.4 1.26 2.28
    • Profit margin and asset turnover tend to vary inversely.
  • ROA (Return on Assets) >Top
    =(Profit margin) ×(Asset turnover) = (Net income)/(Assets)
    • a basic measure of the efficiency with which a company allocates and manages its resources.
  • Gross Margin = (Gross profit/(Sales)
    • Variable costs change as sales vary, while fixed costs remain constant.
    • a high proportion of fixed costs are more vulnerable to sales declines; they cannot reduce fixed costs as sales fall.
    • Gross margin enables us to distinguish between fixed and variable costs:
      Gross margin = Gross profit/Sales (=24% in a case of Ametek)
      where (Gross profit) = (Net sales) - (Cost of sales)
    • 24% of every sales dollar is available to pay for fixed costs and to add to profits.
  • Asset Turnover:
    • Company's value is in the income stream it generates, and its assets are simply a necessary means to this end; the ideal company would be one that produced income without any assets.
    • An asset-intensive steel mill will never have the asset turnover of a grocery store.
    • When product technology is similar among competitors, control of assets is often the margin between success and failure.
    • Self-liquidating: during upswing of a business cycle rising current assets will require loans, while during a downswing falling current assets will provide the cash to repay the loans. In bankers' jargon, such a loan is said to be self-liquidating; the money is put create the source of repayment.
  • Inventory Turnover:
    • = (Cost of goods sold)/(Ending inventory)
    • = inventory turnover per year (times)
    • alternative definitions exist; (Sales)/(Ending inventory), or (Cost of goods sold)/(Average inventory).
  • Collection Period:
    • = (Accounts receivable)/(Credit sales per day)
    • unit: days
    • this also says that the average time lag.
  • Payable Period:
    • is a control ratio for a liability.
    • = (Accounts payable)/(Credit purchase per day)
    • unit: days
  • Fixed-Asset Turnover:
    • = (Sales)/(Net property, plant, & equipment)
    • unit: times
  • Case of Microsoft (2001):
    • ROE: 15.5% (looks modest performance) as a monopolizing industry
    • Asset Turnover: only 0.43 times (like that of a steel mill or a public utility)
    • BS: 53% of assets were in cash and marketable securities. It is as if the company as if the company had merged with a mid-sized bank.
    • Leading technology companies to build huge war chests to facilitate possible acquisitions.
    • Imagine the company returned 90% of its cash and securities to shareholders as a giant dividend. This would cut assets and shareholders' equity by $28B, and assuming a modest 2% after tax return on cash and securities, would knock about $570M from net income. The resulting revised levers of performance appear below.
      • Asset turnover is now a more plausible 0.82 times, and ROE is up to 36%. These numbers more accurately reflect the economics of Microsoft's business.
  • Financial Leverage:
    • Unlike profit margin and asset turnover ratio, where more is preferred to less, financial leverage is not something management wants to maximize.
    • challenge of financial leverage is to strike a prudent balance between benefits and costs of debt.
    • ROA and financial leverage tend to be inversely relate.
  • BS Ratio:
    • Debt-to-assets ratio =(Total liabilities)/(Total assets)
    • Debt-to-equity ratio =(Total liabilities)/(Shareholders' equity)
    • Financial burden a company faces depends on its ability to meed the annual cash payments
    • BS Ratio is primary interest only in liquidation.
  • EBIT (Earnings before interest and taxes):
    • Times interest earned = EBIT/(Interest expense)
    • Times burden covered = EBIT/{(Interest + (Principal repayment/(1-Tax rate))}
    • Unlike interest payments, principal repayments are not a tax-deductible expense. (grossing up)
  • Market Value Leverage Ratio:
    • (Market value of debt)/(Market value of equity) =
    • (Market value of debt)/(Market value of assets) =
    • Rapidly growing start-up businesses believe future CF will be sufficient to service the debt. (like McCaw or Amazon.com)
  • Liquidity Ratios:
    • Current ration = (Current assets)/(Current liabilities)
    • Acid test (or quick ratio) = (Current assets - Inventory)/(Current liabilities)
  • Deficiencies of ROE: Timing problem, risk problem, and value problem
    • Timing Problem: ROE reflects myopic, one-period nature of the yardstick. it fails to capture the full impact of multiple decisions.
    • Risk Problem: 'eat well - sleep' well dilemma. ROE looks only at return while ignoring risk, it can be an inaccurate yardstick of financial performance.
      • ROIC (Return on Invested Capital) or RONA (Return on Net Assets)
        = {EBIT*(1-Tax rate)}/(Interest bearing debt + Equity) >Top
      • ROIC reflects the company's fundamental earning power before it is confounded by differences in financing strategies. (>Fig)
      • ROE of zero-leverage position generates lower, while ROA is biased in the other direction.
      • ROI is independent of the different financing schemes; reflecting the company's fundamental earning power before it it confounded by differences in financing strategies.
    • Value Problem: investment figure used is the book value of shareholders' equity, not the market value. This distinction is important.
    • Earnings Yield and P/E Ratio:
      • Earnings yield = (Net income)/(Market value of shareholders' equity)
        = EPS / Price per share
      • Stock price is very sensitive to investor expectation about the future; a bright future, a high stock price, and a low earning yields go together.
      • P/E ratio says little about a company's current financial performance, but it does indicate what investors believe about future prospects.
  • ROE or Market Price:
    • Stock price represents the value of the owners' investment in the firm.
    • But, practitioners remain skeptical of stock market.
      • how operating decisions affect stock price.
      • they think that they know more about their company than do outside investors.
      • stock price depends on a whole array of factors outside the company's control.

2. 財務実績を評価する:

  • 自己資本利益率(ROE)
    = 売上高利益率 ×総資産回転率 ×財務Leverage
    = 収益性 ×効率性 ×財務Leverage
    =利益率の高い商品開発 ×売上増 ×負債利用割合増
    = Speedmeter × Tachometer × Fuel gauge


  • 総資産利益率(ROA):







  • 在庫回転率


  • 回収期間


  • a
  • a
  • a
  • a




  • ROIC (Return on Invested Capital):
  A-Co. B-Co.
Debt 10% 900 0
Equity 100 1000
Total assets 1000 1000
EBIT 120 120
-Interest 90 0
Earn beTx 30 120
-Tax 40% 12 48
Earn afTx 18 72
ROE 18.0% 7.2%
ROA 1.8% 7.2%
ROIC 7.2% 7.2%
  • Ratios are clues in a detective story, when combined with other knowledge of a compnay, ratio analysis can tell a rvealing story.


  • Levers of Peformance:
Profit Margin Asset Trunover Financial Leverage
Gross margin Days' sales in cash Payables period
Tax rate Collection period Debt to assets
% income statement Inventory turnover Times interest earned
  Fixed asset turnover Times burden covered
  % balance sheet Current ratio
    Acid test



Ratio Analysis of Ametek, Inc. >Top

  1997 1998 1999 2000 2001 Industry median Remarks
Profitability Ratios            
ROE, % 31.7 24.0 28.1 24.4 19.7 16.6 steady decline, but above the industry median.
ROA, % 9.1 6.0 7.9 8.0 6.4 8.0  
ROIC, % 18.2 14.2 14.0 13.6 10.9 13.6 earning power is declining; more distressing pattern, below the median.
(P): Profit margin, % 5.9 5.4 5.6 6.7 6.5 7.8 P is upward slightly;
Gross margin, % 22.0 23.3 24.7 25.7 23.7 32.7 rising gross margin by aggressive pricing and better cost control in manufacturing
Price to earnings ratio 17.7 17.2 10.0 12.3 15.8 23.2  
Turnover Control Ratio            
(A): Asset turnover 1.5 1.3 1.2 1.2 1.0 1.0 A is deteriorated sharply;
Fixed asset turnover 4.5 4.3 4.2 4.8 4.8 5.2  
Inventory turnover 7.7 7.8 6.8 5.9 5.1 4.5 worrisome decline in inventory turnover
Collection period (d) 58.0 54.8 44.5 49.7 64.8 60.2 likely increased securitization in 1999, and reversal in 2001
Days' sales in cash (d) 4.3 6.6 6.1 5.4 8.0 8.4  
Payable period (d) 42.1 35.5 38.5 41.8 40.7 31.6  
Leverage & Liquidity Ratios            
(T): Assets to equity 3.5 4.0 3.6 3.1 3.1 1.8 T is much more than the median; aggressive debt financing; ROE would be 11.7%.
Debt to assets, % 71.4 75.1 71.9 67.3 67.4 45.5  
Debt to equity, % 249.1 302.1 255.3 205.9 207.2 83.3  
Times interest earned 5.1 4.4 4.8 4.6 4.0 10.1 interest coverage has worsened erratically, despite falling interest rates, and now less than half of the median. Reduced liquidity is clearly sailing closer to the wind than the median.
Times burden covered 4.8 2.3 4.8 4.3 3.8 4.6  
Debt to assets, mv, % 30.8 42.3 47.5 40.7 39.9 27.2 lagging stock price causes the debt relative to market values to rise
Debt to equity, mv, % 44.5 73.4 90.6 68.7 66.3 37.3 ditto
Current ratio 1.4 1.1 1.0 1.0 1.1 1.9 liquidity is down and below the median
Acid test 0.9 0.8 0.6 0.6 0.7 1.1 ditto
  • Common-Size BS, Ametek, Inc. 1997-2001 and Industry Averages, 2001 >Top
% 1997 1998 1999 2000 2001 Industry average  
Cash 0.1 1.4 1.1 0.8 1.4 9.1  
Marketable securities 1.7 1.0 0.9 0.9 0.8  
Accounts receivable 24.3 19.9 14.7 16.2 17.6 16.6  
Inventories 15.3 12.8 13.3 15.1 14.8 19.9  
Deferred income taxes 2.1 1.9 1.6 1.2 1.0 4.0  
Other current assets 1.3 1.2 1.8 1.0 1.3  
Total current assets 44.8 28.3 33.3


36.9 49.7 1/3 of assets are short term of accounts receivable & inventories; watch working capital management.
Property & equipment 79.9 71.1 67.3 61.5 54.6 52.3  
less Accumulated depreciation 46.3 40.5 38.7 36.6 33.7 29.0  
Net property & equipment 33.6 30.6 28.6 24.9 20.8 23.3  
Goodwill 9.3 21.3 32.3


37.6 20.2 jumped over fourfold due to new acquisitions.
Investments 12.4 9.8 5.8 4.9 4.7 7.2  
Total assets 100 100 100 100 100 100  
Liabilities & Shareholders' equity        
Notes payable 2.3 9.2 13.0 14.7 16.1 3.5 steady increase of short-term notes payable.
Short-term debt 0.1 2.0 - 0.2 0.1 1.1  
Accounts payable 13.6 9.8 .6 10.2 8.4 6.7  
Income taxes payable 3.7 2.1 2.3 1.4 0.1 1.5  
Accrued liabilities 12.4 10.4 9.3 8.2 7.8 9.7  
Total current liabilities 32.2 33.4 34.2 34.6 32.7 22.5  
Long-term debt 27.4 32.4 30.2 27.2 29.5 13.  
Deferred income taxes 5.4 4.0 3.6 3.9 3.3 1.7  
Other long-term liabilities 6.3 5.3 3.9 1.6 2.1 6.8  
Total liabilities 71.4 75.1 71.9 67.3 67.4


decline of other people's money
Common stock 0.1 0.1 - - - 1.4  
Capital in excess of par value 0.6 0.7 0.3 0.3 0.1 5.6  
Retained earnings 34.8 32.5 37.0 38.5 37.8 56.0  
Other comprehensive losses -5.8 -4.5 -5.4 -3.5 -3.6 -7.2  
Treasury stock -1.0 -3.9 -3.7 -2.6 -1.7  
Total shareholders' equity 28.6 24.9 28.2


32.6 55.8  
Total liabilities & shareholders' equity 100 100 100 100 100 100  
  • Common Size PL, Ametek, Inc. 1997-2001 and Industry Averages, 2001 >Top
% 1997 1998 1999 2000 2001 Industry average  
Net sales 100 100 100 100 100 100  
Cost of sales 78.0 76.7 75.3 74.3 76.3 67.8  
Gross profit 22.0 23.3 24.7 25.7 23.7 32.2 gross margin is up nicely through 2000.
Administrative expenses 7.9 8.9 8.6 9.3 9.7 16.4  
Depreciation 3.2 4.1 3.3


3.3 4.1  
Total Operation expenses 11.1 12.9 11.9 12.4 12.9 20.5 rising operating expenses
Operating income 10.8 10.4 12.8 13.3 10.7 11.7  
Interest expenses 2.1 2.6 2.7 2.9 2.7 1.0  
Other expenses -0.5 -0.5 -0 0.1 -0.3 -0.8  
Total nonoperating expense 1.6 2.1 2.6 2.9 2.5 0.1 rising nonoperating expenses
Income before income taxes 9.2 8.3 10.2 10.4 8.3 9.9 income before taxes was only 8.3%; the rise in administrative expenses consumed more than 20% of profits.
Provision for income taxes 3.3 2.9 3.6 3.7 1.8 3.5  
Net income 5.9 5.4 6.6 6.7 6.5 6.4  
  • After 43 years of stable dividends, Ametek cut its dividend by 2/3, used excess cash to repurchase $150M of its own stock, and launched an acquisition program and to broaden the product mix into more exciting electronic instruments.
  • Ametek's annual compound growth rate in sales over the decade has been a mediocre 3%. Shareholders continue to receive dividend of 24 cents a share.

Ratio Analysis of Various Countries: >Top

in 1996   UK Germany Japan Asia Latin-Am US
# of Companies Definitions 67 13 31 31 77 87
Profitability Ratios            
  ROE (%) Net income/Shareholders' equity 8.3 5.7 6.9 12.3 8.5 13.2
  ROA (%) Net income/Assets 3.4 2.3 2.3 5.5 4.1 4.1
  ROIC (%)   8.2 2.8 4.3 9.7 8.2 9.3
  Profit Margin (%) Net income/Sales 4.6 2.4 2.8 13.1 6.4 5.0
  Gross Margin (%) Gross profit/Sales 31.1 33.3 32.9 47.6 43.0 35.9
  Price to earnings Price per share/Earning per share 16.7 19.4 27.2 9.9 10.4 21.9
Turnover control Ratios            
  Asset Turnover Sales/Assets 0.7 0.8 0.9 0.5 0.5 0.8
  Fixed asset turnover Sales/Net property, plant & equip. 3.0 2.5 3.2 0.7 1.0 2.9
  Inventory turnover Cost of goods sold/Ending inventory 6.9 6.1 4.9 8.3 7.3 5.9
  Collection period (d) Accounts receivable/Sales 70.5 75.2 77.9 52.0 69.6 53.3
  Days' sales in cash (d) Cash & securities/Sales per day 36.4 20.7 59.7 85.7 41.7 20.7
  Payable period (d) Account payable/Cost of goods sold 50.1 47.4 77.7 63.8 71.7 44.9
Leverage & Liquidity Ratios            
  Assets to equity (%) Assets/Shareholders' equity 2.7 2.6 3.0 1.9 2.3 2.7
  Debt to assets (%) Total liabilities/Assets 63.4 59.8 66.3 46.5 56.7 64.2
  Debt to equity (%) Total liabilities/Shareholders' equity 167.1 153.1 196.7 85.5 127.8 174.2
  Times interest earned Earnings before interest & tax/Interest expenses 3.4 3.2 8.3 5.5 2.8 4.1
  Times burden covered   1.0 0.5 0.6 1.8 1.0 1.8
  Debt to assets (%)   37.8 49.0 50.9 40.3 48.2 35.3
  Debt to equity (%)   60.8 96.3 103.8 67.5 93.0 54.6
  Current ratio Current assets/Current liabilities 1.1 1.3 1.3 1.2 1.3 1.2
  Acid test (quick ratio) (Current assets-Inventory)/Current liabilities 0.8 0.9 1.0 1.0 0.9 0.9
      UK Germany Japan Asia Latin-Am US
  • Japanese firms:
    • have longer collection periods and payable periods.; also the highest debt-to-equity ratio and the highest interest coverage ratio; attributed to the importance of banks in financing. (keiretsu)
  • Accounting distortions:
    • German counties have a long tradition of secrecy.; Daimler-Benz needed to publish two sets of financial statements, one German and one for American authorities. (DM600M profits vs. DM1.7B loss in 1993)
  • Earnings Consolidation:
    • In US, a parent company owns 20% or more of other companies, the parent's consolidated earnings include include the earnings of those subsidiaries.
      The parent unconsolidated earnings include only the dividends received from subsidiary.
    • Japanese company is required to consolidate earnings of subsidiaries owned by not less than 50% by the parent companies. Given the extensive cross ownership of shares among Japanese companies, they can impart a significant downward bias to Japanese earnings relative to American earnings.
    • the discrepancy between Japanese and American P/E by almost one-half.
    • Due to Keiretsu: Top
      Japanese tax code allows companies to make annual tax-deductible contributions to a variety of special reserves for such future contingencies as 1) product returns, 2) payments on guarantees, and 3) employee retirement benefits.; Japanese companies use to reduce taxes also reduce reported income.; appear to have averaged about 4% of net income over 1975-1990 period. (系列の効用=純利益に4%)
  • Depreciation Accounting:
    • American companies use accelerated depreciation for tax purposes and straight-line depreciation for pubic reporting.
    • Japanese companies use accelerated depreciation for taxes and public reporting, which leads to an understatement of reported earnings.

3. Financial Forecasting:

  • Pro forma forecast to estimate a company's future need for external funding.
    • External funding required = Total asset - (Liabilities + Owners' equity)
    • External funding requires is often referred as the plug into the BS.
  • Percent-of-Sales Forecasting:
    • All variable costs and most current assets and current liabilities to vary directly with sales.
    • But some independent forecasts of individual items will be required.
  • Estimating the External Funding Required:
    • Operation executives; more interested in Income Statement, while Financial executives in BS.
    • The retained earnings account is the principal bridge between IS and BS; so as profits rise, retained earnings grown and loan needs decline.
  • Interest Expense:
    • The external funding depends in part on the amount of interest expense, it would appear one cannot be accurately estimated without the other.
    • should use the spreadsheet to solve these.
  • Seasonality:
    • should make monthly or quarterly forecast rather than annual ones.
    • if you know the date of peak financing need, you can simply make this date the forecast horizon.
  • Sensitivity Analysis:
    • 'What if' questions: enables managers to determine which assumptions most strongly affect the forecast and which are secondary. This allows them to concentrate their data-gathering and forecasting efforts the most critical assumptions.
  • Scenario Analysis:
    • Each scenario identified the second step is to carefully rethink the variables in the original forecast to either reaffirm the original assumption or substitute a new, more accurate one.
  • Simulation:
    • To perform a simulation, begin by assigning a probability distribution to each uncertain element in the forecast.
    • The distribution describes the possible values the variable could conceivably take on and states the probability of each value occurring.
    • This creates one trials. The output from a simulation is a table or, more often, a graph summarizing the results of many trials. (Distribution Gallery)

3. 財務の予測について:


4. Managing Growth:

  • Many executives see growth as something to be maximized; as growth increase, the market share and profits should rise as well? From a financial perspective, growth is not always a blessing.
    • Rapid growth can put considerable strain on a company's resources.
    • Rapid growth can lead to bankruptcy.; rapid growth has driven almost as many companies into bankruptcy as slow growth has.
  • Sustainable growth rate: an adage "it takes money to make money." >Top
    • maximum rate at which company sales can increase without depleting financial resources.
    • it may be necessary too limit growth to conserve financial strength.; the need to limit growth is a hard lesson for operating managers used to thinking that more is better.
    • predictable lifecycle:
      1. Start-up phase; company loses money while developing products and establishing a foothold in the market.
      2. Growth phase; company is profitable but is growing so rapidly that it needs regular infusions of outside financing.
      3. Maturity phase; characterized by a decline in growth and a switch from absorbing outside financing to generation more cash than the firm can profitably reinvest.
      4. Decline phase; company is marginally profitable, generates more cash than it can reinvest internally, and suffers declining sales.
  • Sustainable Growth Equation:
    • For this purpose, assume:
      1. The company wants to grown as rapidly as market permits.
      2. Management is unable or unwilling to sell new equity.
      3. The company wants to maintain target capital structure and target dividend policy.
    • Now, if the company wants to increase sales during the coming year, it must also increase asses such as inventory, accounts receivable, and productive capacity. (New assets supporting increased sales)
    • The cas required to pay for this increase in assets must come from retained profits and increase liabilities.
      • As equity grows, the firm can borrow more money without altering the capital structure.
      • After all what limits the growth rate in sales is the rate at which owners' equity expands.
      • Sustainable growth rate (g*) = ΔEquity/Equitybop
        • where, ΔEquity is change in equity, and Equitybop is beginning-of-period equity.
      • g* = (1-d) ROEbop = PARŤ
        • where, P is Profit margin, A is Asset turnover ratio, Ť is Asset to equity ratio (divided by beginning-of-period equity), and R is the firm' retention rate; d is dividend payout ratio.
        • This is the sustainable growth equation; P and A summarize the operation performance, and R and Ť describe the firm's principal financial policies.
        • When a company grows at a rate in excess of its sustainable growth rate, it had better improve operation (P or A) or prepare to alter its financial policies (R or Ť)
        • SMB may think that sales growth can be maximized and too little of the financial consequences. The faster they grow, the more cash they need, even when they are profitable. They can meet this need for a time by increasing leverage, but eventually they will reach their debt capacity.
    • Balanced Growth: ROA = PA
      • g* = RŤ ×ROA = 0.4 × ROA; where R assumes 25%, and Ť assumes 1.6
      • Sustainable growth (g*) varies linearly with return on asset (>Fig.)
        • All growth-return combinations lying off this line generate either cash deficits or cash surpluses.
        • Self-finance does not imply constant debt but rather a constant debt-to-equity ratio. Debt can increase but only in proportion to equity.
        • Other strategy would be to increase R, say 50% and Ť, say 2.8, thereby changing its sustainable growth equation to: g* = 1.4 × ROA
    • Source of capital to US nonfinancial corporations (1965-2001) (>Table):
      • Internal sources such as increases in retained earnings, depreciation accounts fro 60% of the total.
      • new equity has been not a source of capital at all but a use, meaning US corporations on average retired more stock than they issued over this period.
      • Many companies cannot or will not sell new stock, and consider other strategies for managing unsustainably rapid growth.
    • Increase Leverage:
      • One is to cut the dividend payout ration, and the other is to increase financial leverage.
      • Increasing leverage as the 'default' option;
    • Reduce the Payout Ratio:
      • if company investment opportunities do not promise attractive returns, a dividend cut will anger shareholders, prompting a decline in stock price.
    • Profitable Pruning:
      • Product diversification: companies could reduce risk by combining the income streams of businesses in different product markets.
      • Product pruning is the opposite of conglomerate merger. Better to sell off marginal operations and plow the money back into remaining businesses.
      • Product pruning reduces sustainable growth problems:
        • it generates cash directly through the sale of marginal businesses.
        • also prune out slow-paying customers or slow-turning inventory.
    • Sourcing:
      • can increase its sustainable growth rate by sourcing more and doing less in-house; it releases assets and increase its asset turnover.
      • The key to effective sourcing is to determine where the company's unique abilities; (core competencies)
    • Pricing:
      • Obvious inverse relationship exists between price and volume.
      • When sales growth is too high relative to a company's financing capabilities, it may be necessary to raise prices to reduce growth.
    • Merger:
      • Two types of companies are capable of supplying the needed cash.
        • mature company as a cash cow.
        • conservatively financed company that would bring liquidity and borrowing capacity.

4. 成長を管理する:

  • New sales requires new assets:
Assets Liabilities &
Owners' equity
New assets
supporting increased sales
New borrowings
Increase in
Owners' equity




  • Balanced Growth:


  • Sources of Capital to US Nonfinancial Corporations 1965-2001:
Retained profits 11.7%  
Depreciation 47.9  
Subtotal   59.6
Increased liabilities 47.1  
New equity issues -6.7  
Subtotal   40.4
Total   100



5. Financial Instruments and Markets

  • A major part of a financial executive's job is to raise money to finance current operations and future growth.
    • Financial executive must select or design a financial security that meets the needs of the company and is attractive to potential creditors and investors.
  • Bonds:
    • a fixed-income security; the holder receives a specified annual interest income and a specified amount at maturity in small increments; $1000 per bond.
    • 3 variables characterize a bond; 1) par value, 2) coupon rate, and 3) maturity date. On the issue date, the company will set the coupon rate equal to the prevailing interest rate.
    • E.g.: interest payment; $90 ($1000 ×9%); semiannual payment of $45 each. On the maturity date, the company will pay $1000 per bond.
    • when interest rates rise, bod prices fall, and vice versa.
    • Various options:
      • Sinking fund: is a direct payment to creditors that reduces principal.
      • Floating-rate debt: 1% over the 90-day bill rate.
      • Call provisions: gives the issuing company the option to retire the bonds prior to maturity.
      • Delayed call: the issuer may not call the bond until it has been outstanding for a specified period, usually 5-10 years.
        • But if rates rise, investors have no similar option. They must either accept the low interest income or sell their bonds at a loss.
      • Covenants:through protective covenants specified in the indenture agreement.
        • includes a lower limit on the company's current ratio, an upper limit on its debt-to-equity ratio, and a requirement that the company not acquire or sell major assets without prior creditor approval.
      • Rights in Liquidation: rights of absolute priority. Among investors, the first to be repaid are senior creditors, then general creditors, and finally subordinated creditors. Preferred stockholders and common shareholders bring up the rear.
      • Secure Creditors: a form of senior credit.
      • Bonds as an Investment:
    • Bond Ratings: (>Table)
        • Junk Bonds: are rate less than 'investment', usually defined as BBB. Below investment grade bonds are known as speculative, high-yield, or simply junk bonds.
  • Common Stock:
    • is a residual income security. If the company prospers, stockholders are the chief beneficiaries; if it falters, they are the chief losers.
    • Shareholder Control: In many others, there is no dominant shareholder group, and management has been able to control the board.
      • The actions managers take to compete effectively in product markets are consistent with shareholder interests.
      • German banks can hold unlimited equity stakes, while Japanese banks cannot more than 5%, but Japan's keiretsu form function similar to those in Germany. German & Japanese model may facilitate a direct shareholder voice in company affairs; a clubby, old-boy approach to corporate governance that can be inimical to change and innovation.
    • Common Stock as an Investment:
      • the stock holder's annual income is:
        d0 + P1 -P0, where d0 is the dividends per share during the year, and P0 and P1 are boy (beginning-of-year) and eoy (end-of-year) stock price.
      • Dividing by boy stock price, the annual return is:
        d0/P0 + (P1-P0)/P0
      • Over 1928-2001 period, equity investors in large company common stocks received average dividend yield 4.1% and average capital appreciation of 7.7%.
        • 1899-2000: average annual return was 12%
        • 1973-1981: average annual nominal return was 5.2%, and prices rose 9.2%; this implies a negative return of about 4%.
        • if you invested $1 inn 1900, then nominal returns in 2000:
          • Stocks: $16,797
          • LT Gov. bond: $119
          • Inflation: $24
  • Preferred Stock:
    • is a hybrid security, like debt is a fixed income security, like equity the company need not distribute this dividend unless it chooses.
    • Also like equity, preferred dividend payments are not a deductible expense for corporate tax. (debt with a tax disadvantage)
    • preferred shareholders have priority over common shareholders with respect to dividend payments.
    • if a firm passes a preferred dividend, the arrearage accumulated and must be paid in full before common dividend payments.
  • Private Equity:
    • Venture capitalists:
      • 'Angels'; wealthy individuals
      • professional venture capital companies; high-risk, equity investments deemed capable of rapid growth and high returns. Their goal is to liquidate their investment in 5-6 yeas when the company goes public or sells out to another firm.
        • VC firms consider a many as 100 candidates for every investment and expect to suffer a number of failures for each investment success. In return, they expect winners to return 5-10 times their initial investment.
        • Acting as the general partner, VC raises a pool of money from institutional investors, such as pension funds, college endowments, and insurance companies, who become the limited partners.
        • VC then invests the money, manages the portfolio of startups, liquidated the portfolio, and returns the proceeds to the limited partners; also charges the limited partners an annual management fee of 1-2% of their original investment, plus carried interest, typically 20% of any capital appreciation of portfolio companies.
        • seek high-risk high-return investment; vulture investment
        • 1995-2000: investment volume exploded to more than $100B
  • Initial Public Offering (IPO):
    • IPO; will provide desired liquidity to existing owners a well as supplying necessary funding.
    • Investment Banking:
      • they are finance specialists; including stock and bond brokerage, investment counseling, M&A analysis, and corporate consulting.
      • members of the underwriting syndicate in effect act as wholesalers, purchasing all of the securities from the company at a guaranteed price and sell to the public at a higher price.
    • International Markets:
      • issuers may believe foreign-denominated liabilities will prove cheaper than domestic ones in view of anticipated exchange rate changes.
    • Issue Costs:
      • on a public issue, there are legal, accounting, and printing fees, plus those paid to the managing underwriter (spread).

5. 財務手法と市場:

  • Heads I win, tails you lose.
  • Rate of Return on Selected Securities, 1900-2000:
Security Return
Common stocks 12%
LT corporate bonds 5.7
LT Gov. bonds 5.1
ST Gov. bills 4.1
CPI 3.3
  • Standard & Poor's Debt-Rating: >Top
AAA highest ranking
AA very strong capacity to meet its financial commitment
A strong capacity
BBB adequate capacity to pay interest and repay principal
BB less vulnerable in near term
B more vulnerable
CCC currently vulnerable
CC currently highly vulnerable
C highly vulnerable, perhaps in bankruptcy still continuing
R under regulatory supervision
SD selectively defaulted
D defaulted on obligations
NR not rated




6. Financing Decision:

  • how much external capital is required.
    • management estimates sales growth, the need for new assets, and the money available internally.
    • to select or design the instrument to be sold.
  • Financial Leverage:
    • two-edged sword, increasing owners' risk as well as return.
    • Cf.: Operating leverage: defined as the substitution of fixed-cost methods of production for variable-cost methods. Replacing hourly workers with a robot; robot's initial cost pushed up fixed costs, while the robot work longer hours without additional pay; reduces variable costs.
    • substitution of debt for equity increases fixed costs, but also reduces variable costs.
      • ROE = (Profit after tax)/Equity
      • Profit after tax = (EBIT - iD) ×(1-t)
        • where, i is interest, D is debt, t is tax rate.

6. 財務意思決定:


7. Risk Analysis in Investment Decision:

  • Expected Rate of Return on a risky asset can be written as;
    • Expected return on risk asset = Interest rate on Gov. bonds + Risk premium
    • typically, company's common stock:
      • Expected return on typical company's common stock = i + (Rm - ib)
        • where i is prevailing interest rate of Gov. bond; in 2001 i was 5.1%
        • ib is average annual return of Gov. bond.
        • Rm is average annual return on a well-diversified portfolio of common stocks over a long period; Rm was 12% over the past century,
          thus (Rm-ib) was 6.9%
    • >Top Beta Risk:
      Expected return on risky asset j = Interest rate on Gov. bond + βrisk asset j × Risk premium; Rj = i + βj (Rm - ib)
      • where, βj is known as the asset's βrisk, or its volatility.
      • βj = (Risk of asset j) / (Risk of portfolio m)
      • if the risk of asset j is equal to that of a typical company' common stock, βj=1.0
      • βrisk has become an important factor in security analysis.
  • Asset Beta as capital cost:
    • Shareholders face two distinct risks:
      1. risk in the market
      2. financial risk created by the use of debt financing.
    • Asset beta measures the business risk, while equity beta reflects the combined effect of business and financial risks.
      • when a company is all-equity financed, financial risk is zero and equity beta necessarily equals asset beta; asset beta is commonly referred to as unlevered beta.
      • βa = [1/{1+(1-t)×D/E}]×βe
        • where, βa is asset beta, βe is equity beta, t is the marginal tax rate, and D/E is the firm's market value debt to equity ratio.
        • βa=βe when debt is zero and βe rises above βa by a growing amount as leverage increases.

6. 投資意思決定のリスク分析:

  • Representative Industry & Company β:
Industry median β β Company β β
Cp equipmt 1.83 Dell Cp 2.14
Cp program, data process 1.73 AMD 2.06
Radio, TV 1.37 CA 1.84
Cp office equip 1.29 Microsoft 1.74
Air transport 1.24 Intel 1.66
Electronic compo 1.22 Apple 1.55
General merchandise 1.02 HP 1.45
Apparel 0.98 Alaska Air 1.04
Motor vehcle 0.89 WalMart 0.98
Commercial Bank 0.74 BOA 0.97
Chemicals 0.68


Petroleum refining 0.67 Aetna 0.69
Aircraft 0.58 Pepsico 0.68
Motion picture 0.55 Burlington 0.66
Food stores 0.55 Shevron 0.62


>Top Diversification Reduces Risk:

Investment Weather Probability Outcome Weighted outcome
Ice cream stand Sun 0.40 $600 $240
  Rain 0.60 -200 -120
    Expected outcome $120
Umbrella shop Sun 0.40 -$300 -$120
  Rain 0.60 500 300
    Expected outcome $180
Portfolio: Ice cream stand & umbrella shop Sun 0.40 $300 $120
Rain 0.60 300 180
    Expected outcome $300
  • In a portfolio, the losses and gains from the two investments counterbalance each other in each state so that regardless of tomorrow's weather, the outcome is riskless $300
    • some of the asset's CF variability is offset by variability in the portfolio's CF.
    • an 'averaging out" process occurs when assets are added to a portfolio that reduces risk.
  • Don't overlook real options, such as the option to abandon or the option to expand, when evaluating corporate investment opportunities.
  • EVA: equals a business unit's operating income after tax less a charge for the opportunity cost of the capital employed.
  • Proper technique is never a substitute for thought: People, not analysis, get things done.
  • ROE = PAT, where Profit Margin is the target direction of driving, Asset turnover is the velocity, and T (Financial leverage) is the sufficient cargo or payload.
  • Effective company looks like an effective vehicle; CEO or the captain need drive the vehicle effectively.
  • 自己資本利益率とは

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