Economic development institute :third project evaluation course (general)

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ECONOMIC DEVELOPMENI' INSTITUTE

Third Project Evaluation Course (General)

2/3

Seminar 2: Performance Measurements Session

3:

Topic:

Readings:

Speakers:

Outline:

Work Problems:

Thursday, July 9

Elements of Financial Analysis (II)

Hunt, Williams and Donaldson, Basic Business Finance, Chapter 9

11Strife Among the Auditors", excerpt from The Economist of June 13₁ 1964 (attached)

Mr. Lipkowi tz and Mr. Upper Same as for Session 2/2

1. The Case of the Unidentified Industries, Case

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ⁱⁿBasic Business Finance, PP• 658 and 659 (Work Sheet attached)

2. Analysis of "Significant Trends Since Incorporation" of the Caterpillar Tractor Company (attached):

a) What has been the trend of wages in relation to value added in the post-war period (after 1945)

b) What inferences can you draw about the Company's financial policy (with regard to the distribution of dividends in relation to earnings and with regard to the proportion of capital expenditures financed internally) for the periods 1935-39, and 1955-63.

c) What other trends or periode do you consider of particular significance in the Comp~'s history? Why?

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Strif'e Among the Auditors Frœ a Correspondent in New York

Excerpt from

"The Econanist"

dated June ]J, 1964

A deep division bas appeared among public accountants which the

Council of the American Institute o.f Certified Public Accountants recently tried - and failed - to close. The debate turns on what an American accountant means when he certifies a company's annual report for, unlike his British

counterpart, he testifies not simply to its arithmetical accuracy but also to its "fairness" and its conformity with ¹¹generally accepted accounting principles.'' Unfortunately, the accounting profession - in spite of sincere and strenuous effcrts for many years - bas never been able to agree on

definitions

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^either^o.fthese terms. One faction would have the elders of the profession, the Accounting Pr:i.nciples Board, lay dawn rules which all would have to accept. The opposition, a minority but strong enough up to now to impose an effective

veto,

prefers the¹¹status quo", which allows management to account fcr its stewardship within a broad range of acceptable practices and does not attempt to enfcrce comparability among reports of different companies.

A strong board, with a clear mandate to end the controversy, rnight weil initiate important changes in reports to shareholders; in turn, these might affect the measurement of corporate profits and hence the priees o:t

individual shares. On the other hand₁ should the institute•s present paralysie continue, the government is likely to step in. The Securities

&

Exchange Commission has clear authority to prescribe the form and methods

to be followed in the preparation of company reports for the majori ty of publicly-owned American companies. This is a chore which, by and large, the SEC has preferred to leave to the accounting profession. Self regula- tion, after al.l, is the keystone of federal control of the securities markets. But recently the SEC bas made plain its annoyance with the institute•s endless bickering.

At least partly as a result

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this, in March the AICPA published a white paper proposing th at rulings by . the APB should be generally accepted after eighteen months, provided that they had not been countermanded by the institute•s counc:il. If a company did not follow these rules mem.bers o.f the institute, who include the overwhelming majority of public accountants, as distinct from those on company staffs, would be duty-bound to point out this departure :from generally accepted standards in certifying the company r s financial statement. The SEC, wi th which most publicly-owned companies must file certified reports each year, will not as a general rule accept a statement accanpanied by such a qualified certificate. But the strong language o.f the white paper - by far the most hopeful solution to the comparability of reports ever to gain top-level support in the institute - was shelved for a pious plea that accountants should merely "disclose material departures" from APB principles. The power

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a detennined and vocal minority - led in this instance by Priee Waterhouse & Company - was evident.

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The man who will suffer is the srnall shareho1der who has neither the t1me nor the training to reconcUe ambiguities in published i'inancial data.

I f company A reports earnings of $1 a share and company B

$1.50,

he tends to accept this and to be prepared to pay more for shares in company B.

The accountant and the professional security analyst know, however, that this is a dangerous assumption indeed. Far example, there is the case of the Atlantic Research Corporation, a producer of rocket fuels, which eimultaneously reported a net profit of $1 million to the public and

rougbly the sarne amotmt in net losa to the

sro

(the latter figure included a11 the company's subsidiaries). More general1y, there is a wide range of variation in accounting far taxes, depreciation, stocks and - in industries auch as oi1 - development costa, which the small investor cannot be expected to understand.

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Case 5

The Case of the Unidentified Industries

DF.SPITF. variation!' in operationnl and finanriul polic·ir~ and prar·.

liees und in opcratin~ re11ults h<'twrrn firm!l in thr snme inclutotry, thr nature of the inclustry has an important impac~t on the ~c·neral pat·

terns of the ll<'l'cl for funds ( as!lrt aiJoc:ation), the nwthmls of mertillJ!

thcsc necd~. and the finanr.ial rc·~ults of mo~t firms in thr indu .. try.

Pre~cntccl in Exhibit 1 are balarwr ~hct·ts. in pcrl'cnta~c~ form. and scl<'l'tcd ratio!l drawn from the hularwc llht'f't!l ancf opt'ratin~ !llatr- ments of ci~ht firms in eight .difTc·rc·nt irulu!'trif's. Ht'ro~nizin~ th<' (ad of certain clifTt•rf'nc·c!'O ))f'twet'n firms in the samt' indu .. try. cnch finn whose figure~ arc summnri:r.ed is l.rouclly typit·al of thn!'Ôc in its iruiU!O·

try.

S<'c if y ou can iclrntif y th P. i rlllli!Ot ry rt•prt'!'OI'nlrcl. Tlwn. he pn··

pnr<'d a~ bc!'Ot ynu t•an to cxplain the di!ltirwtin! asst•t strut.:lurcll and ratios of eal'h industry.

1. F.lrctrk utility 2. Hailroncl

3. Autonwhilt• manufacture 4. Bn~ir dwmirnls

5. Appnrrl mnnufac·ture 6. Tohncco mnnufnrture 7. Airr·raft manufacture

8. Retail grncery chain (leuing must of store premises)

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THE CASE OF THE UN/DENT/FIED INDUSTRIES 659

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THE CASE OF THE UNIDENTIFIED INDUSTRIES

lùillflu ShHt Ptrcmtll[,ll A B c ^D ^E ^p ^G ^H

Cash and marketable

securi ti es ....... 28.4 5.4 1.9 2.2 3.7 8.2 17.2 5.9 Receivables ........ 3.8 12.4 4.2 6.6 2.8 31.8 2.6 24.6

1 Inventories. . . 13.3 17.0 3.1 81.4 1.4 46.2 36.1 47.4 Other current as sets ...... 0.6 0.2 0.3 0.2 0.5 1.0 1.1 Plant and equipment (net). 39.4 62.5 88.7 8.4 69.9 13.1 42.1 20.2 Other assen. . . 14.5 2.7 1.9 1.1 22.0 0.2 1.0 0.8 Total Assets ...... 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0

-==

' Notes payable ........... 6.5 2.4 6.9 16.5 4.7

Ac:eounts payable ........ 9.4 3.5 2.5 0.1 3.5 25.6 16.5 11.1 Accrued taxes ............ 12.0 5.5 3.6 6.7 1.2 1.7 13.3 4.0 Other current liabilities ... 3.5 4.1 2.8 3.7 0.9 9.4 3.3 Long·term debt .......... 6.4 20.0 40.5 18.7 41.3 11.8 16.5 13.0

Other liabilities ........ 0.1 0.9 5.2 1.1 0.1

Capi tai stock and capital

JUrplus ........... 14.4 49.8 37.0 32.4 28.1 20.1 16.0 14.2 Retained eamings and

surplus reserves. . . • . 54.3 10.5 10.3 31.5 19.8 14.9 36.6 49.6 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 PNfit ""J USJ Ptrmlfll[,ll

Net revenues ........ 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 Operating costs and

expenses ........... 85.8 82.3 85.4 79.1 85.4 97.8 97.0 93.5 Opera ting profit... . . 14.2 17.7 14.6 20.9 14.6 2.2 3.0 6.5 Net nonoperating expenses __1:! 8.8 2.2 11.8 13.1 1.4 1.7 3.1 Net Income ..... 8.4 8.9 12.4 9.1 1.5 0.8 1.3 3.4

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...

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Sti«tftl R•tios = = = =

Curren t Assets

1.85 I.n 0.82 5.19 1.42 1.63 1.90 3.44

Current Liabilicies <

Cash, Marketable Secu·

rities, and Receivables '

1.30 0,91 0.53 0,56 0,91 0.75 0.66 1.33 ¹^. Current Liabilities

Total Debt

... 0.313 0.397 0,527 0.361 0.521 0.650 0.474 0.362 Total Assets

Net Sales

··· ^1.37 ^0.82 ^0.34 ^1.44 ^0.42 ^2.71 ^5.52 ^1.57

Total Assen Net Profits

··· ^0.12 ^0,07 ^0.042 ^0.08 ^0.006 ^0.01 ^0,07 ^0.05

Total Assen Net Profit

0.17 0.12 0.086 0.12 0.013 0.06 0.15 0.08 Total Net Worth '

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CATE"PILLA" TRACTO" CO. AND CONSOUOATED SUBSIDIA"Y COMPANIES

Y ar 1925 1926 1927 1928 1929 1930 1931 1932 1933 1934 1935 1936 1937 1938 1939 1940 1941 1942 1943 1944 1945 1946 1947 1948 1949 1950 1951 1952 1953 1954 1955 1956 1957 1958 1959 1960 1961 1962 1963

w..

s ^13.8

20.7 26.9 35.1 51.8 45.4 24.1 13.3 14.4 23.8 36.4 54.1 63.2 48.2 58.4 73.1 102.0 142.2 171.4 242.2 230.6 128.4 189.1 218.0 254.9 337.3 394.3 480.8 437.8 406.7 533.0 685.9 649.9 585.2 742.3 716.0 734.3 827.0 966.1

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4.3 5.7 8.7 12.4 9.1 1.6 (1.6)

.4 3.8 6.2 10.2 10.6 3.2 6.0 7.8 7.7 7.0 7.6 7.3 6.5 6.1 13.5 17.5 17.2 29.2 15.8 22.7 20.6 25.9 36.0 55.5 40.0 32.2 46.5 42.6 55.8 61.9 77.3

23.68%

20.86 21.28 24.86 23.96 20.05 6.50 (12.23)

2.46 15.98 17.15 18.90 16.72 6.71 10.28 10.71 7.60 4.93 4.42 3.03 2.82 4.76 7.13 8.00 6.74 8.67 4.01 4.72 4.71 6.37 6.76 8.09 6.16 5.51 6.27 5.95 7.60 7.49 8.00

Ptt ahare al

COIDIDOD atoc:k( 1)

s ^.17

.22 .29 .42 .55 .40 .07 (.07)

.02 .17 .28 .45 .45 .12 .24 .35

.34 .31 .33 .32 .29 .27 .60 .77 .74 1.25 .65 .94 .82 1.00 1.40 2.03 1.45 1.16 1.68 1.54 2.02 2.25 2.83

Amount

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1.6 2.7 4.2 5.6 7.5 5.<i 1.2 .2 2.4 3.8 3.8 3.8 3.8 3.8 3.8 3.8 3.8 3.8 3.8 4.7 5.6 5.6 5.6 6.6 8.5 11.3 11.5 9.6 8.0 13.3 16.9 21.6 21.6 24.4 27.2 27.2 27.2 31.4

Ptt ahare( 1)

s ^.03

.0~

.14 .21 .25 .33 .25

.os

.01 .10 .17 .17(2) .17(2) .17 .17 .17 .17 .17 .17 .17 .21 .25 .25 .25 .29 .38

.50 .50 .42(3) .33(3) .53 .65 .80 .80 .90 1.00 1.00 1.00 1.15

Makrialo, oupplioa, oerviao

purchMCd, etc.

s 5.1 12.4 14.9 22.9 28.1 21.7 7.6 5.8 7.7 11.4 18.0 27.7 33.5 20.5 30.0 36.9 57.6 78.1 87.5 146.5 139.4 78.0 110.4 121.2 147.4 187.7 279.6 254.3 237.0 195.1 306.3 381.3 380.0 275.5 409.2 383.5 370.6 415.5 491.7

(1) Amount thown il in doUars'pcrthare after adjUJtmeDt for ttock splits in 1926, 1949, 1955 and 1959.

(2) In addition, dividends were paid al7/200 of a sh~ ol prcfcrred stock for each ahan: of common in 1936 and 3/100 of a shan: of

~~~ ~Ï 9)9h;!•;tc::ki~!:~ti~~~~~-the 1936 dividend wu payable in cash at the option of the shareholder (3) ln addition, dividend.s oC 4% were paid in common stock in 1953 and in 1954.

(AU dollar amountJ are expresse<~ in millions except thosc givcn on a sharc basis.)

Waga, oalariea and cootributions r ...

employee bene611

s ^2.9

4.8 5.8 7.8 11.5 10.6 6.7 5.3 5.2 8.0 11.2 17.4 21.7 16.7 19.7 23.5 34.0 43.9 51.4 70.4 62.2 52.2 65.0 71.4 76.8 90.0 11.3 37.9 35.0 25.9 74.2 )5.4 16.5 i4.0 15.6 14.0

~9.2

>0.2 :o.9

s .3 .7 .9 1.1 1.5 .9 .2

.5 1.1 1.8 1.8 .9 1.3 3.8 8.4 15.3 18.2 17.6 9.3 2.5 7.9 10.3 10.8 33.2 20.5 46.0 36.3 28.0 39.3 59.7 40.1 26.1 39.7 31.3 51.6 52.2 81.6

2.04%

3.31 3.32 3.24 2.82 2.02 .79

.17 2.30 2.94 3.26 2.86 1.92 2.27 5.25 8.21 10.75 10.59 7.27 4.02 1.92 4.17 4.74 4.25 9.84 5.20 9.58 8.29 6.88 7.37 8.70 6.17 4.46 5.35 4.38 7.02 6.31 8.45

Land, builcliup, machiDtty and

equipment purduooèd

s .6 1.1 2.3 5.6 7.1 2.8 1.1 .9 .9 1.0 2.0 4.7 3.8 2.4 2.2 4.4 5.0 3.2 1.2 1.3 3.7 11.1 21.7 18.1 8.3 17.4 26.5 17.2 33.9 21.7 30.9 31.4 73.6 54.6 59.1 53.2 27.9 31.9 44.9

s ^.3

.5 .7 .9 1.3 1.7 1.6 1.7 1.8 1.8 1.8 1.9 2.2 2.4 2.5 2.6 3.7 4.5 4.9 5.4 4.6 1.4 2.3 3.8 4.9 5.5 7.9 10.6 12.8 16.0 18.6 22.3 21.8 27.7 28.0 28.3 31.6 39.8 41.2

2,537 2,931 3,511 4,897 6,875 6,282 3,737 3,247 3,501 5,586 7,488 11,168 12,234 9,432 10,671 11,781 15,292 16,488 18,252 20,455 18,609 19,755 20,925 21,638 22,795 24,746 28,633 31,678 29,643 25,783 31,400 37,909 39,491 31,060 42,120 40,638 35,810 36,364 38,527

No.ller"'

...

al~.a.

..,.. ...

1,919 2,556 4,597 6,851 10,820 12,812 15,983 17,451 15,668 15,014 15,063 15,062 15,626 16,553 16,838 17,175 17,224 17,225 17,455 17,464 18,383 18,799 18,991 18,662 18,863 19,211 19,171 19,348 19,597 19,515 21,274 26,376 27,555 27,330 28,694 33,460 34,262 34,139 33,138

v-

1925 1926 1927 1921 1929 1930 1931 1932 1933 1934 1935 1936 1937 1931 1939 1940 1941 1942 1943 1944 1945 1946 1947

i948

1949 1950 1951 1952 1953 1954 1955 1956 1957 1958 1959 1960 1961 1962 1963