Archive for category Companies
Learn how to value corporate credit
Posted by admin in Business plans, Companies, bonds, budget, business, communication, consulting on October 29th, 2009
One of the most widely used indicators to value corporate credit is the equity market. The Merton model formalizes the relationship between leverage, equity prices, equity volatility and credit spreads. While the model permits an assessment of the relative valuation of equity and credit, it makes no explicit statement about which of the markets is currently priced correctly, or if both markets are in disequilibrium. In addition, focusing solely on equity prices and volatility neglects the effects of changes in leverage. However, equity-market performance contains information about the future state of the economy, the future cash flows and risk premium in the market. Stronger cash generation benefits corporate bonds since creditworthiness improves and the required risk premium is lower. Furthermore, as the equity cushion increases through rising equity prices and more IPOs and equity volatility decreases, default probabilities and spread levels tend to fall.
The ratio of sales to loans and assets
Posted by admin in Business plans, Companies, Money Tips, Taxes, communication, market demand, market forecasts, profit margin, understanding finances on October 28th, 2009
The ratio of sales to assets is an asset turnover ratio that measures the sales-generating capacity of a given asset base. Taking the nominal GDP of the nonfinancial corporate sector as a measure for sales. The ratio has started to turn up at the beginning of 2001. This pattern is normally consistent with periods of recovery. However, it should be noted that this ratio is near its historical low. The z-score for the nonfinancial corporate sector has collapsed dramatically since 2000, resting well below the critical level of 1.8 since the second quarter of 2002. For an individual firm this signals that the company is likely to fail within 2 years. On the macro level it indicates a high probability of rising default rates and widening credit spreads. Three points stand out:
- based on macroeconomic data the z-score has never been in the safe zone;
- the average score since 1952 is about 2;
- in the 1970s and 1980s, the z-score was permanently in the distress zone implying that corporate America should have gone bankrupt, but clearly it survived.
This leads to the conclusion that the weighting scheme is no longer appropriate to capture the vulnerability of the corporate sector. The relative importance of the individual factors changes over time. Therefore, it is necessary to adjust the weighting scheme on a regular basis, for example by using a regression methodology.
The ratio of credit earnings before tax, interest depreciation
Posted by admin in Companies, Investment Opportunities, budget, fixed costs, management skills, manufacturing, market demand, production cycles, profit margin on October 27th, 2009
A second metric for profitability is the ratio of earnings before tax, interest depreciation and amortization (EBITDA) to total assets. Using data from the national accounts of the United States we define earnings before tax and interest as pre-tax profits with inventory valuation and capital consumption adjustment plus net interest. This metric follows a similar path as the ratio of retained earnings to total assets, although on a higher level and with a higher volatility.
Measuring the extent to which a firm’s value can decline before its book value becomes negative and a firm becomes insolvent, the ratio of market value of equity to total debt represents the inverse of leverage. We have defined the value of equity as the market value of outstanding equities, total debt is defined as total credit market instruments. The tremendous equity bubble of the late 1990s has collapsed, but nevertheless the equity-to-debt ratio stays above the level reached in the 1970s and 1980s. Because of its higher volatility, the ratio is largely driven by the equity performance. As a result the equity-to-debt ratio usually rises at the end of a recession because equity markets already
anticipate stronger economic growth while many companies still deleverage their balance sheets. Here again, the 2001 recession makes an exception.
About one-and-a-half years after the end of the recession in November 2001 equity markets finally marked their lows.
Fundamental models for loans spreads
Posted by admin in Companies, Money Tips, consulting, credit, liability, management skills, manufacturing, material costs on October 25th, 2009
A popular approach to estimate the credit risk of an issuer is the use of z-scores. In this context, Altman’s five components framework has attracted particular interest. On the company level, it is based on the five metrics.
Replacing the company-specific metrics by macroeconomic factors yields a fundamental model for the credit market. Because of the required minimum history and data reliability we will focus on the US market. Data for this procedure is taken from the flow of funds statistics and the national accounts of the United States.
The ratio of working capital to total assets measures the net liquid assets of a firm relative to the sum of financial and tangible assets. We isolated net liquid assets for the US nonfinancial corporate sector from the flow of funds statistics by subtracting mortgages, consumer credit, trade receivables and miscellaneous assets from total assets and subsequently adding inventories, trade and tax receivables.
The large fall in 1974 is due to a significant decline in the value of trade payables. Usually, the ratio of working capital to total assets falls in a recession. But there also seems to be a secular downtrend in this ratio.
Do you have any business owning stocks?
Posted by admin in Companies, communication, economy, fixed costs on August 28th, 2009
At the micro level, a stock is an ownership interest in a business. The earnings from the business belong to the stockholders. Theoretically, the employees of the business, including top management, work for the stockholders.
In practice, the employees are self-interested. Every employee, from the CEO to the janitorial crew, wants as large a piece of the earnings as possible, leaving as little for you as can be justified. You may have emotional difficulty with this built-in conflict of interest.
Elaborate schemes are routinely employed to siphon off your interests. In the old days, two-thirds of profits were paid out as dividends, giving you direct control of a large portion of earnings. Today, dividends are cut or eliminated so employees can use profits as they see fit. Fewer than half of today’s stocks pay any dividends at all. Every year the number of dividend payers declines. Even those that pay dividends pay only token amounts. Instead, employees grant themselves raises and bonuses without consulting shareholders. Insider boards of directors grant themselves profit-sharing plans, stock, and stock options, all to your deficit. Board remuneration committees offer excessive pay for executives in exchange for excessive pay for themselves.
The few profits that are left are often squandered on ill-advised acquisitions and other schemes. Hundreds of examples could be cited including the recent debacles at Enron, Lucent, Rite Aid, Millennium, Color Tile, Dow Chemical, Sunbeam, Trump Hotels & Casinos, Reliance Groups, and many Internet, tech, and telecom firms that crashed in 2000-2001.
Understanding Debits and Credits – part 1
Posted by admin in Business plans, Companies, communication, consulting, understanding finances on August 3rd, 2009
You’ll find in subsequent chapters that the accounting function has many steps and components. Although they may vary in complexity, all bookkeeping and accounting systems are essentially the same.
The concept behind accounting, what makes it more than merely adding and subtracting, revolves around a basic core consisting of debits and credits. This is an accounting system’s soul, and understanding it will help managers better handle their share of responsibility for the firm’s finances.
In some ways, debits and credits are more complex in theory than in practice. Debits and credits form the basis of all accounting functions, including the company’s balance sheet. They are the two types of activity that can affect any financial account of any type— assets, liabilities, equity, income, or expenses.
The balance sheet is one of the primary accounting statements for any company. It’s a list of assets, liabilities, and owners’ equity—ownership value, if you will—in the business as of a specific date, usually the end of the financial month or fiscal year. Its ultimate goal is to keep all accounts in balance.
Managers’ Great Expectations and Accounting
Posted by admin in Companies, consulting, financial information, revenue, variable costs on August 3rd, 2009
The essence of managerial expectations is found in what’s called basic accounting ARTS—meaning that in reporting financial data, the accounting function should be Accurate, Relevant, Timely, and Simple.
Given the important role of accounting, it only stands to reason that managers have certain expectations of the accounting function, including the following basic principles:
The accounting system must accurately reflect the company’s current financial condition. And it must do so in a timely fashion.
The system must be clear, logical, and easy to use. Information should be understandable to all company officers and executive staff without the need for complex interpretation by the accountant.
The system must provide useful information that officers and staff can use in making decisions and achieving the company’s goals.
But even if the company’s accountants are the best in the world, it won’t matter much if the nonfinancial managers around them basically take the information in their reports and file it away—either horizontally or vertically—because they don’t have much idea how the numbers were generated or what they mean.
Fixed and Variable Costs in fiction – part 2
Posted by admin in Companies, effective budgeting, equity, material costs, profit margin on August 1st, 2009
But now let’s say each one of these units requires $3 worth of raw materials and another $2 in assembly charges to create, or $5 per unit. Since those costs are based on the number of units being produced, those costs are variable with the production flow. If you produce 5,000 units, that’s a variable cost of $25,000. Add to that your $10,000 per year in fixed costs, and you have overall production costs of $35,000, or $7 per unit. At a sales price of $9, the profit margin is $2 per unit.
But let’s increase production to 10,000 at $5 per unit in materials and assembly charges. That’s $50,000 in variable costs, plus $10,000 in fixed costs, for a total of $60,000 for 10,000 units. The price per unit is now $6, which yields a profit margin of $3 per unit.
Word About Costs When Creating a Budget Plan – part 1
Posted by admin in Companies, effective budgeting, fixed costs, management skills, market forecasts, short-term income on August 1st, 2009
When budgeting for labor costs, the distinction to keep in mind is between direct and indirect. Direct labor costs are those incurred in any work on products or services that can be tracked readily, such as wages for assembly line workers. Indirect labor costs are for activities related to products or services that are not readily tracked, such as salaries for supervisors and support personnel. Both direct and indirect labor costs can be either fixed or variable.
Let’s look at the three types of costs that make up the expenses part of a budget.
Fixed costs are perhaps the most important costs to manage. They are the costs that remain constant throughout and are impervious to the cycle of business. The rent you pay from month to month is a fixed cost because it doesn’t vary no matter what your sales pattern might be. To a large degree, salaries also are fixed costs, although they may have variable components in terms of performance bonuses. Utility costs are the same way. Any expense that remains constant no matter what the cycle of business is a fixed cost.
Defining Budget Type – part 2
Posted by admin in Companies, Money Tips, expenditures, financial growth, production cycles on July 30th, 2009
Longer business cycles require longer-lived budgets. Even though they may be subject to review and revisions, some items or operations unfold more fully over a longer time period. This results in a longer-term or strategic budget. While the operational budget anticipates financial flow for a year or less, the strategic budget reacts more intrinsically with a company’s long-term business plan. The net effect may be a less precise, but more comprehensive approach to financial management.
Not all companies need to create a strategic budget. Your company may be one of those happy to project from year to year, knowing that retained earnings and reserves may be all you need to set the stage for the subsequent year’s financial growth. On the other hand, if the company is involved in major capital acquisition that will depreciate over time, includes extensive research and development that runs up expenses for years before any revenue might be realized from the project, or involves extensive investment plans that will take several years to bear fruit, then a strategic budget may be more appropriate.