- any other use of the work is strictly prohibited. - Dynamics and Growth of the Business System 191 Leverage 192. - Even elementary analysis of this kind, when applied to a number of the new. - Here the potential deviation from economic re- sults is larger, and many companies are attempting to move closer to the cash flow measures we’ll discuss in the latter portion of the book. - There is also the issue of the time horizon over which incentives are established. - As we’ll discuss in the final chapters, valuation is a function of the expectations held by the company’s existing and potential investors, and by the securities markets in general. - try, and a judgment about the position and likely success of the company within this environment. - The external communication challenge similarly requires a systems view of the company’s performance and prospects. - A generalized overview of the key analytical processes used in. - interpreting the performance and value of the business system, grouped by three major viewpoints:. - The operation of the business using these resources.. - Over time, therefore, successful resource deployments should result in a net improvement in the economic position of the owners of the business. - The primary effect of value creation normally will be a higher valuation of the business. - If the company is privately held, its value will be reflected in the price offered by potential buyers of the business. - Figure 2–2 depicts the definition and purpose of the three interrelated decision areas.. - Decisions cause resource movements in various forms that ultimately change the cash flow pattern of the business as a whole. - The ultimate result of the complex set of. - Operating profit is shown as part of the bottom segment in the diagram, because profit represents one of the key elements of financing the business.. - Alternatively, of course, some of the enhanced funding potential can be used to reduce long-term debt, or to repurchase outstanding ownership shares in the market. - Figure 2–6 highlights key el- ements of the operations segment of the financial system.. - On the other hand, existing own- ership funds also can be returned through repurchase of the company’s shares in the open market, using some of the current funding potential. - Allow the manager or analyst to track the financial condition and operating results of the business.. - Major sources of the funds obtained are:. - Moreover, changes in the value of the currency in which the transactions are recorded can, over time, distort the balance sheet.. - Figure 2–8 is a simple conceptual picture of the balance sheet as it relates to the three areas of management decisions.. - Net impact of the period’s cash movements on the company’s cash balance.. - The cash flow statement thus offers a ready overview of the combined cash impact of all management decisions during the period. - The amount of detail can vary widely, depending on the nature of the business and the different types of movements emphasized.. - One aspect of the cash flow statement that requires some explanation is the treatment of accounting write-offs. - The reader will recall that we recog- nized the cash flow implications of the depreciation effect in the earlier discussion of the business system. - in evaluating the financial, and more importantly, the economic, performance of the business under review.. - The chapter served as a contextual preview of the various analytical con- cepts explored in the remainder of the book. - To illustrate the nature of the concept further, we’ll further explore the following three processes:. - Use of the plant and equipment is reflected in the form of a depreciation charge, which becomes part of the cost of the transformation process. - To complete the picture, we must examine the funds implications of the selling process.. - The operations segment in the center of the diagram now includes the main elements of an income statement:. - Here the reverse of the growth situation prevails. - A variant of the seasonal picture is the cyclical pattern of funds movements. - In Chapter 4, we’ll discuss these issues in the context of the tech- niques of forecasting funds requirements.. - However, some of the balance sheet cate- gories are too broad for our purpose. - As a result, several of the funds flows cannot be specifically delineated:. - We’ve provided some of these data in summarized form at the bottom of the income statement.. - An increase of $239 million in accounts receivable, reflecting volume growth and the impact of the acquisitions.. - reflecting new capital spending as well as disposals, and the impact of the. - As we’ll see, the published cash flow information provided by the company shows the details of the positive and negative movements in this area.. - This provides a preliminary picture of the effect of TRW management decisions in 1997.. - We also learn that the total cost of the acquisitions, net of cash acquired, was $1,270 million. - We achieved this by making some broad adjustments in several of the accounts. - We’ll now briefly discuss some of the key elements involved in managing operational funds.. - To be useful, both the meaning and the limitations of the ratio chosen have to be understood. - The objectives of the analysis.. - Next are the various owners of the business, who are especially interested in the current and long-term returns on their equity investment. - To judge how effectively the resources of the business are being used.. - way of highlighting the relative magnitude of the various categories in relation to the base of sales.. - Free cash flow Value of the firm. - The selling price of the product.. - Any variations in the product mix of the business.. - Any variation in the product/service mix of the business.. - In the case of TRW, the cost of goods sold and the gross margin shown in the annual report represented a consolidation of the two major business segments.. - The length of the time period chosen for such trend analysis depends on the nature of the business. - The choice of tax rates depends on the complexity of the company’s taxa- tion pattern. - It involves relating sales to the contribution margin of individual product groups or of the total business. - for more information see the references at the end of the chapter.. - The key interest of the owners of a business—the shareholders in the case of a corporation—is investment return. - Less frequently, there is even a deferred taxes account on the asset side of the balance sheet. - A somewhat more refined version of the calculation of return on the shareholders’. - The full economic benefit received by the shareholder is the sum of this stream of dividends plus any change in the price of the stock. - Comparable figures for the median of the segment were 37 percent for 1997 (16 percent for 1996), and 14 percent for the decade (11 percent for 1986 to 1996). - This is a measure of the return on the owners’ investment from cash divi- dends alone. - A variety of coverage ratios can be calculated, but they hardly differ from the ones we’ll take up in the discussion of the lender’s point of view.. - All of these affect the market’s expectations about the future success and cash flow generation potential of the company. - Value of the Firm. - the company’s shares is a function of the total value of the firm less the value of its debt:. - Several ratios are used to assess this protection by testing the liquidity of the business. - Presumably, the larger this ratio, the better the position of the debt holders.. - This is not necessarily a true test of the ability of the business to. - A more refined version of the debt proportion analysis involves the ratio of long- term debt to capitalization (total invested capital). - Du Pont was one of the first to do so early in the last century. - Careful definition of the issue being analyzed and the viewpoint to be taken.. - Depending on the importance of the issue being analyzed, the industry/. - Finally, performance analysis in the broadest sense has to be viewed in the context of the business system, as described in Chapter 2. - A manufacturing company might experience fluctuations that affect the recorded unit cost of the products inventoried. - This is deter- mined by dividing the cost of the asset (less the estimated salvage value) by its expected life. - Appendix IV contains a discussion of the basic con- cepts underlying the inflation phenomenon.. - Another area of distortion affects the viewpoint of the lender. - Principles of consolidation–The financial state- ments include the accounts of the company and its subsidiaries except for two insurance subsidiaries.. - Changes in market value of the contracts are generally included in the basis of the transactions. - During 1996, the company sold substantially all of the businesses in its Information Systems &. - The com- ponents of the charge include severance costs of. - The company matches employee contributions up to 3 percent of the participant’s qualified compensation. - The Act permits an individual to bring suit in the name of the United States and share in any recovery. - On February 19, 1998, the DOJ intervened in the litigation with respect to a limited number of the allegations.. - Sales to agencies of the U.S. - Cash flow statements provide the most dynamic view of the expected changes in the company’s funding picture, as we saw in Chapter 3.. - This effectively removes all traces of the machinery from the company’s books, while cash in the amount of $550,000 will have been received.. - As a net result of the two changes, accumulated depreciation will decline by $350,000. - $1.5 million during the quarter, and for payment of the balance in the year 2000.. - It should be clear by now that any changes in the various assumptions for the pro forma cash flow projections will directly affect the size of the funding gap.. - Figure 5–4 presents some of the basic data of the company’s oper- ations regarding sales, production, and purchases. - The lag effect can be demonstrated clearly in the first item of the cash re- ceipts, collection of receivables
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