ANALYSIS OF COMPANY

FINANCIAL PERFORMANCE

"A company financial model is developed using factor

analysis and published accounting data expressing

financial performance as a single statistic

summarising and weighting company financial dimension"

BY

HAS SAN NIKRHAH BABAEI

B.Sc in Cost Accounting, Tehran, Iran, M.B.A, Texas, U.S.A.

A THESIS SUBMITTED TO THE UNIVERSITY OF BRADFORD

POSTGRADUATE SCHOOL OF STUDIES IN INDUSTRIAL TECHNOLOGY, IN

FULFILMENT OF THE REQUIREMENTS FOR THE DEGREE OF DOCTOR OF

PHILOSOPHY.

1988
DEDICATION

Shahnaz, Shahrooz, Farhood

I
 ACKNOWLEDGMENT

I would like to thank Dr. J. Betts and Dr. D. Belhoul

for their sincere and helpful advice and friendly assistance

throughout my research for which I am really grateful.

I also wish to thank the computer center advisers who were

very helpful to me.

II
ABSTRACT

Auditors and financial managers often need to have a

picture of companies' financial strengths and weaknesses which

is also required by shareholders. The necessary analysis has

been done well in some cases and failed in others because of

lack of evidence or lack of a scientific approach and

consequently it has not been possible to prevent companies

failing financially and ultimately going into receivership.

In Iran in recent years many companies have experienced

financial difficulties and some have gone into receivership,

because the owners were not aware of their company's

weaknesses and how to protect them at the relevant time. The

causes of these companies financial stress have been many and

varied, for instance; inflation, the influence of trade

unions, government regulations, social responsibilities,

pollution and increased competition. To avoid such stress

company owners need to be more careful about their activities.

They need up to date information about the past financial

performance of their companies. They need also to be able to

prepare reliable plans for the future based on the past data

and the current situation. This can be done by using

quantitative tools and financial models.

The aim of this research is to find a model for analysing

company's financial performance by using a quantitative

approach which can be easily computerised and applied. This

model could be used to indicate companies' financial strengths

III
and weaknesses and to anticipate and guide companies future

performance in such a way that ensures their continued

financial health and growth.

This thesis considers the use of financial ratios in the

analysis of company's overall performance. After a brief

introductory chapter, it reviews the historical background of

financial analysis in Chapter Two by looking at financial

ratios analysis in general. It then continues in Chapter

Three by identifying the most important financial ratios as

measurement tools. In Chapter Four these tools are grouped

and analysed using factor analysis and a financial model has

been constructed for measuring company's financial performance

using techniques described in the Chapter Five. Chapter Six

presents a company financial performance classification and

comparison. Chapter Seven describes a method by which

companies financial performance can be improved or stabilised.

IV
 Page No.

DEDICATION

ACKNOWLEDGMENT

ABSTRACT

TABLE OF CONTENTS V

LIST OF TABLES VIII

LIST OF FIGURES X

CHAPTER 1: INTRODUCTION

1.1 DEFINITION OF PRIMARY DATA 3

1.2 DEFINITION OF RATIOS 4

1.3 THE MANAGEMENT'S TOOLS 5

1.4 MEASUREMENT OF PERFORMANCE AND CORPORATE

ACCOUNTING 6

1.5 DEFINITION OF TREND 7

1.6 BANKRUPTCY AND LIQUIDATION 8

1.7 OUTLINE OF RESEARCH 9

1.8 CONCLUSION 11

CHAPTER 2: HISTORICAL BACKGROUND OF FINANCIAL ANALYSIS

2.1 CORPORATE FINANCIAL STATEMENTS 13

2.2 FINANCIAL ANALYSIS DEVELOPMENT 14

2.3 ADDED VALUE AS A PERFORMANCE MEASUREMENT 16

2.4 SECURITY ANALYSIS 27

2.5 RATIO CLASSIFICATION 31

2.6 INDUSTRIAL AVERAGE ANALYSIS 34

2.7 DISCRIMINANT ANALYSIS 38

2.8 FINANCIAL RATIOS IDENTIFICATION 44

2.9 SOME LIMITATIONS OF THE RATIO ANALYSIS 48

2.10 CONCLUSION 50

V
CHAPTER 3: BASIC TOOLS OF PERFORMANCE MEASUREMENT

3.1 CAUSES OF FAILURE 54

3.2 DETECTION OF FAILURE BY RATIOS 55

3.3 PROFITABILITY 56

3.4 MEASURING THE PROFITABILITY 60

3.5 BEHAVIOURAL EQUATIONS 63

3.6 PROFIT VS PROFITABILITY 65

3.7 RISK VS PROFITABILITY 66

3.8 RESTRAINTS IN PROFITABILITY ANALYSIS 69

3.9 PROFITABILITY RATIOS 71

3.10 MANAGERIAL PERFORMANCE 73

3.11 MANAGEMENT VS RISKINESS OF LOAN 75

3.12 MANAGERIAL PERFORMANCE RATIOS 76

3.13 OPTIMUM AMOUNT OF CASH 79

3.14 LEVERAGE ANALYSIS 89

3.15 SOLVENCY RATIOS 92

3.16 CONCLUSION 94

CHAPTER 4: METHODOLOGY OF FACTOR ANALYSIS

4.1 EXTAT LIMITATION 97

4.2 FACTOR ANALYSIS 102

4.3 CORRELATION COEFFICIENTS 104

4.4 THE MODEL OF FACTOR ANALYSIS 111

4.5 FACTOR EXTRACTION 117

4.6 FACTOR ROTATION 120

4.7 THE KAISER VARIMAX METHOD 124

4.8 INTERPRETATION OF FACTOR ANALYTIC RESULTS 132

4.9 CONCLUSION 134

VI
CHAPTER 5: DEVELOPING A FINANCIAL MODEL OF COMPANIES'

PERFORMANCE

5.1 FACTOR SCORE ESTIMATION 137

5.2 BUILDING COMPOSITE FACTOR SCORES FROM THE

FACTOR-SCORE COEFFICIENT MATRIX 141

5.3 TESTING THE EFFECTIVENESS OF THE MODEL 145

5.4 CONCLUSION 209

CHAPTER 6: PERFORMANCE CLASSIFICATION AND COMPARISON

6.1 CLASSIFICATION OF THE PERFORMANCES 211

6.2 FAILURE PREDICTION STUDIES 218

6.3 COMPARISON OF THE MODEL WITH SIMILAR

MODELS AND STUDIES 224

6.4 CONCLUSION 230

CHAPTER 7: PERFORMANCE STABILISATION

7.1 PERFORMANCE STABILISATION 232

7.2 PERFORMANCE IMPROVEMENT 238

7.3 A GRAPHICAL ILLUSTRATION OF IDEAL

PERFORMANCE 244

7.4 CONCLUSION 299

CHAPTER 8: CONCLUSIONS AND RECOMMENDATIONS

8.1 SUMMARY OF THE MAIN CONCLUSIONS 302

8.2 RECOMMENDATION FOR FURTHER STUDY

DYNAMIC ASPECT OF RATIOS 305

APPENDICES

1) GEOMETRIC PRESENTATION OF THE FACTOR MODEL 309

2) FACTOR ROTATION 319

3) FACTOR EXTRACTION BY THE CENTROID METHOD 323

COMPUTER PROGRAMS 330

LIST OF REFERENCES 345

VII
 LIST OF TABLES

Page No.

CHAPTER 2

2.3.1 Comparison of Return on Capital for four

Imaginary Companies 19

2.3.2 Manpower Productivity and Capital

Productivity 22

2.3.3 Primary Production Data from Payroll 23

2.3.4 Elementary Production Ratios 25

2.5.1 Ratio Classification 32

2.6.1 Ranges of Selected Ratios and Measures

by Industry taken from Dun & Bradstreet 36

CHAPTER 3

3.3.1 The Factor Combined to Yield Return

On Investment (ROI) 58

3.3.2 Submodels of Profitability 59

3.7.1 Typical Profitability Objectives for Companies

having different level of Risk 68

3.7.2 Influence of Profitability and Risk on the

Value of firm's stock 69

3.14.1 Company's Financial Structure 91

3.14.2 Company's Financial Structure 92

CHAPTER 4

4.3.1 Ratios with Volatile Standard Deviations 108

4.3.2 Ratios with the Highest Correlation

Coefficient 110

4.7.1 Varimax rotation of two (x,y) factors 127

VIII
 4.7.2 Ratios with the Highest Varimax Rotated

Factors after Rotation with Kaiser

Normalisation 129

4.7.3 Transforming the Table 4.7.2 131

4.8.1 Scale of Ratio-Factor Correlation 134

CHAPTER 5

5.1.1 Factor Score Coefficients 140

5.3.1 Classification of Companies Performance 146

5.3.2 Effectiveness of the Model 205

5.3.3 Overall Effectiveness of the Model 208

CHAPTER 6

6.1.1 Applying the New Classification to the Sample

Companies 215

6.2.1 The Altman's Predictive Accuracy 223

6.3.1 A Comparison of Current Ratios with differing

Levels of Overall Financial Performance 225

6.3.2 A Comparison of Profitability Ratios with

differing Levels of Overall Comapny's

Financial Performance 226

6.3.3 A Comparison of Cash Position Ratios with

differing Levels of Overall Company's

Financial Performance 227

6.3.4 The Classification Accuracy of some

Financial Performance Models 228

CHAPTER 7

7.1.1 Comparison of Ideal Path with its

Actual Path 236

7.2.1 Performance Improvement Recommendations 241

IX

▪

LIST OF FIGURES

CHAPTER 3 Page No.

3.13.1 Determine the Expected Number of Unit

Periods of Cash Stock 82

3.13.2 The Miller Model of Optimal Amount

of Cash 86

CHAPTER 5

5.3.1 Testing the Effectiveness of Model on General

Electric Co. 151

n
5.3.2 n " Coalite Group 152

n
5.3.3 " n " Allied Textile Co Plc 153

5.3.4 " ▪ " British Home Store Plc 154

5.3.5 " " Bell(Arthur) & Sons Plc 155

5.3.6 " " Wellcome Fundation 156

5.3.7 " " Benford Concrete Machinery Plc 157

5.3.8 11
" Beecham Group Plc 158

5.3.9 " If II "

Marks & Spencer 159

5.3.10 " Pearsons 160

5.3.11 ▪ " Racal Electronics 161

5.3.12 N " BPB Industries Plc 162

5.3.13 " Allied Colloids Plc 163

5.3.14 " Ash & Lacy Plc 164

5.3.15 " Boots Co Plc (THE) 165

5.3.16 " British Gas Corporation 166

5.3.17 " Anglia Television Group Plc 167

5.3.18 " " Goodyear Tyre & Rubber Co 168

5.3.19 " " " Babcock International Plc 169

5.3.20 " APV Holdings Plc 170

5.3.21 tt ft "
Ault & Wiborg Group Plc 171

X
5.3.22 " " " • Albright & Wilson Ltd 172
• • 173
5.3.23 ' " Barrow Hepburn Group Plc
• A • Pleasurama Plc 174
5.3.24 "

5.3.25 • " " British Railways Board 175

5.3.26 • • " • Anchor Chemical Group Plc 176

5.3.27 ° ° • ° Baker Perkins Holdings Plc 177

• • 178
5.3.28 " ° Ford Motor Co Ltd

5.3.29 ' ' " ° Adams & Gibbon Plc 179

/I If
5.3.30 ° ° Armitage Shanks Group Ltd 180

11 • Atkins Brothers Plc 181

5.3.31 ° N

• • ° Dunlop Holdings Plc

5.3.32 ° 182

5.3.33 • • • " Barno Industries Plc 183

X • 184
5.3.34 ° ° BBA Group Plc
• II ° Batleys of Yorkshire Plc 185
5•3.35 °
• • Bemrose Corporation Plc 186
5.3.36 • n

• • ° Bestobell Plc 187

5 .3.37 '

• • Brocks Group of Co Ltd 188

5.3.38 • •

II • ° Stone Platt Industries Plc 189

5.3.39 •

5.3.40 • • • • British Airways 190

5.3.41 • • • " Viners 191

5.3.42 ° • II ' Blackman & Conrad 192

• • ° Amalgamated Industrials 193
5.3•43 •

5.3.44 • • . • Blackwood, Morton & Sons 194

5.3.45 • • ° " Pickles (William) & Co 195

• •
5.3.46 • ' Burrell & Co. 196

5.3.47 ' • • ° Cawdaw Industrial HLDGS 197

5.3.48 • le U
• Airfix Industries 198

5.3.49 " " " ° Oxley Printing Group 199

5.3.50 ° • • ° Lesney Products & Co. 200

XI
 •

5.3.51 It
" Richards & Wallington Ind. 201
II

5.3.52 " Norvic Securities 202

ft
5.3.53 " " Austin (F.)(Leyton) 203

CHAPTER 6

6.1.1 Classification of Performing area 214

CHAPTER 7

7.2.1 Trajectories of Failing Company

Performance 238

7.3.1 A Graphical Illustration of Ideal

Performance of General Electric Co 247

7.3.2 " " Coalite Group 248

7.3.3 " • " Allied Textile Co Plc 249

7.3.4 ft ft "
British Home Stores 250

7.3.5 n
" n " Bell(Arthur) & Sons Plc 251

7.3.6 n
n " Wellcome Fundation 252

7.3.7 " ft
h " Benford Concrete Machinery Plc 253

7.3.8 ft Beecham Group Plc 254

7.3.9 " ft
" Marks & Spencer 255

7.3.10 ft" Pearsons 256

7.3.11 ft
" Racal Electronics 257

7.3.12 " ff
• " BPB Industries plc 258

7.3.13 " Allied Colloids Plc 259

7.3.14 " Ash & Lacy Plc 260

7.3.15 ft
• " Boots Co Plc (THE) 261

7.3.16 ft" British Gas Corporation 262

7.3.17 ft" Anglia Television Group Plc 263

7.3.18 " • " Goodyear Tyre & Rubber Co 264

7.3.19 • " Babcock International Plc 265

7.3.20 • " APV Holdings Plc 266

XII
7.3.21 " " Ault & Wiborg Group Plc 267

7.3.22 " Albright & Wilson Ltd 268

7.3.23 II II
n Barrow Hepburn Group Plc 269

7.3.24 . . " Pleasurama Plc 270

7.3.25 . . " British Railways Board 271

7.3.26 " " Anchor Chemical Group Plc 272

n n
7.3.27 " Baker Perkins Holdings Plc 273

7.3.28 " . . " Ford Motor Co Ltd 274

7.3.29 . . " Adams & Gibbon Plc 275

7.3.30 . . " Armitage Shanks Group Ltd 276

7.3.31 . " Atkins Brothers Plc 277

7.3.32 . . " Dunlop Holdings Plc 278

if N
7.3.33 " " Barno Industries Plc 279

7.3.34 " . . " BBA Group Plc 280

u n
7.3.35 " " Batleys of Yorkshite Plc 281

7.3.36 . " Bemrose Corporation Plc 282

7.3.37 " . . " Bestobell Plc 283

a n
7.3.38 " Brocks Group of Co Ltd 284

7.3.39 ° Stone Platt Industries Plc 285

7.3.40 . . " British Airways 286

7.3.41 . . " Viners 287

'I
7.3.42 " Blackman & Conrad 288

7.3.43 " N II
" Amalgamated Industrials 289

n
7.3.44 " of
" Blackwood, Morton & Sons 290

7.3.45 " . . " Burrell & Co 291

7.3.46 . . " Cawdaw Industrial HLDGS 292

7.3.47 " “ . " Airfix Industries 293

7.3.48 . N
" Oxley Printing Group 294

7.3.49 " " " " Lesney Products & Co 295

XIII
7.3.50 " “ “ " Richards & Wallington Ind 296
n “ " Norvic Securities 297
7.3.51 "

7.3.52 " . II "

Austin(F.)(Leyton) 298

XIV
CHAPTER 1

INTRODUCTION
CHAPTER 1: INTRODUCTION

The financial goals of manufacturing enterprises should be

1) The continuance of profit generation consistent

with their financial health.

2) To improve their competitiveness through the

reduction of costs generated internally by using

more cost effective production processes, and by

eliminating or improving costly systems.

3) Guarding against unusual and unnecessary changes.

4) Being alert to the possibility of generating new

profit centres.

5) To maximise the use of their resources.

Profit planning for the longer term must include action for

growth and survival, the maximisation of profits over the

short term is no guarantee of financial health. In fact, when

profits are maximised to the exclusiam of other

considerations, a company can get into serious difficulties.

The drive for high profits has forced many companies to the

brink of bankruptcy because of the strain placed on the

capital structure by supporting those drives. For example,

the company's financial structure may not be able to stand the

cost of new equipment or new expansion for making high

profits, because this will reduce the company's liquidity and

so interfere with their ability to pay their current

obligations promptly or in their due time.

1
 Today industrial competitiveness is improved by modifying

company's manufacturing processes and its productivity which

might have been neglected in the past. Increasing profit now

is possible by guarding against changes that do not increase a

company's productivity and from activating new profit centres.

Once a company has established itself, its survival might

not appear to be its primary goal. Its aim should be to

maximise the use of its resources. Companies often see this

as a completely different goal, although efficiency and

survival are closely interrelated, since a company not

utilising its resources efficiently will experience financial

trouble, and its financial viability will be in question

(Anthony, 1960).

Achieving these objectives is the task of management, who

have to be informed, skillful, balanced and able to act

swiftly for optimum good to the company.

To accomplish these tasks the manager must

1) Be in frequent and intimate con act with all

activities in his company.

2) Receive proper data by which he can evaluate

these activities, make decisions and project a

future plan. These data must be up to date and

accurate, and contain useful financial

information.

3) Feel secure with the data and free to spend time

on other activities for the good of the company.

4) Take action at the appropriate time.

2
 5) Consider action in any area not separately, but

as part of an organic whole.

Without proper tools, management is not able to accomplish

all these duties correctly and efficiently.

1.1 DEFINITION OF PRIMARY DATA

In general, data refers to factual material used as a basis

for discussion or decision making and in statistics it refers

to the numerical material available for analysis and

interpretation.

Primary data are defined as those data which can not in

themselves be used to predict or appraise performance

objectively. Primary data are used as the basis for making

the necessary predictions and evaluations. Primary financial

data are used as the ingredients for various types of measure

including financial ratios which can give economic meaning to

events and permit objective diagnoses and decision making. A

reportable primary data can be written as

Indirect labour has increased by 6%

Unusable waste is about 10%

Production activity is off 15%

Management must know about the elements causing these

events while they are happening so that he may be able to

influence the character of the reported data, and take the

proper action to correct a negative circumstance after it has

been reported.

3
1.2 DEFINITION OF RATIOS

Primary financial data in themselves need not necessarily

have any economic meaning. They can stand alone, being

unrelated to any thing else that they affect or that affects

them. A piece of isolated, unrelated primary data requires

another piece of primary data to which it can be compared.

Only when primary data are interrelated, can they become

meaningful to management. This allows management to take

action on what they reveal.

A common method of establishing financial relationships is

by constructing ratios between pieces of primary data. Thus

one piece is weighted against another for evaluation of

effect. Each ratio should be developed for a specific

purpose, for a particular area, and the desirable movement of

each ratio should be known in advance. Primary data are

absolute, and these data have no value unless they are related

to something else. In ratios, the primary data lose their

identity and are evaluated by effect, not magnitude.

For example current assets and current liabilities are both

primary data and do not have economic meaning unless they are

related to each other in the current ratio which is obtained

by dividing current assets by current liabilities. This ratio

measures the working capital of a company.

4
1.3 THE MANAGEMENT'S TOOLS

A tool commonly used by financial management is a set of

ratios from all departments or cost centres comprising a

company with which managers can observe positive and negative

movements in the company's performance. Since many activities

and events are related to each other, it is not easy for

management to know which movements are negative and which are

positive. For example the rise of indirect labour employed

may be positive if it is coupled with higher direct labour and

is negative if it is not. Similarly an event in sales will

have an impact in the sales department, but it will also have

an impact in production, and financial areas such as inventory

level, current assets and so on. These unlimited activities

and events which need to be reported, ought to have their

interelationships' analysed.

On the other hand, the manager must be able to carry on his

plans for the company which becomes increasingly difficult each

year. Thus, he will need more and better data with which to

manage his company so as to compete and survive in a highly

competitive environment. However, when there are proper

managerial tools, management can make valid appraisals

quickly. They can make decisions with the greatest confidence

and objectivity. They can also spend time on other vital

areas fruitfully.

The second managerial tool needed is some form of

visualisation of the way the movement of some ratios affect

5
other ratios and other performance aspects of the company.

Each company needs a kind of control chart which shows

interactions of movements. From these charts, management can

draw inferences and make decisions with maximum knowledge of

their effects.

1.4 MEASUREMENT OF PERFORMANCE AND CORPORATE ACCOUNTING

Although the individual items appearing on a balance sheet

are important, the basic objective behind all balance sheets

and income statements is performance measurement. Accounting

provides a historical perspective, which enables matching

against current achievement. In this way managers, owners,

creditors, governments and the general public can determine

how well or how poorly a company is doing. A better picture

of a company's underlying strengths and weaknesses can be

obtained from the balance sheet, where the assets are compared

with liabilities. For example, excessive borrowing has caused

many companies to seriously reduce their net w rth by paying

high interest, which can eventually lead to bankruptcy. Such

problem can be easily identified by correct scrutiny of the

company balance sheet. To do this and assess the performance

of a company it is necessary to understand corporate

accounting.

We must also understand the basic elements that make for

success or failure of various kinds of businesses, and how

fluctuations in the market effects their performance. We must

be able to find the facts, evaluate them critically, and act

6
on our conclusions with good judgement and a fair amount of

imagination.

The soundness of future performance of a company is

determined by future developments and not by past history or

statistics. However the future can not be analysed, we can

seek only to anticipate it intelligently and to prepare for it

prudently. Here past performance can be of help, because long

experience tells us that performance anticipations, like other

business anticipations, can not be sound or dependable unless

they relate themselves to past performance. In measuring past

performance we should give consideration to both trends and

averages.

1.5 DEFINITION OF TREND

A trend represents the relationship of the individual data

in a time series. Thus, like any statistical measure, it is

derived from the period selected, and is, of course, subject

to any fundamental distortions which exist in the data. The

fundamental difference between the use of a trend line to

measure past performance and its use as a means of projecting

future performance should be stressed. To estimate future

performance by projecting the past trend and then accepting

that projection as a basis for valuing the business may be

sound in specific instances, but it must be used with extreme

caution.

Figures and mathematical equation are involved in computing

a trend, and some people believe that for that reason a trend

7
projection is credible. But while a definite trend shown in

the past is a fact, "future trend" is only an assumption. It

is because there are so many events and uncontrollable changes

in future which can not be predicted, such as new acts and

regulations by the government to adjust or readjust the

business activities.

1.6 BANKRUPTCY AND LIQUIDATION

Bankruptcy in the UK refers to the realisation of the

assets of an insolvent individual in order to try to meet the

legitimate claims of his creditors. In the USA, the term

'bankruptcy' also applies to companies, but in the UK the term

'liquidation', or 'winding up' are used. The management of

the insolvent company is removed from the hands of its

directors, its assets are realised by a 'liquidator', and its

debts are paid, with any balance going to shareholders. A

company may be put into liquidation by a court order, by a

voluntary resolution of members of the company in a general

meeting, or by a voluntary resolution supervised by the court.

John Freear(1980) found at the end of 1973, over 600000

companies were registered in Britain of which only around 3

percent were public, listed companies. In Britain in 1973,

about 1.3 percent (8000) were liquidated. In 1978, the number

had fallen to about 5000. In addition some companies merely

fade away without any positive action on the part of owners or

creditors, and are removed from the register. If these are

considered, a total of about 5 percent (30000) of all

8
registered companies in Britain disappear each year.

Freear lists the 'order of priority' for the payment of

money realised from the sale of assets.

List of payments in order of priority

1) The cost, charges and expenses of the liquidation.

2) Creditors secured by a fixed charge on property.

3) Preferential creditors

a) certain taxes, duties, national insurance

contributions and rates due to central and local

government.

b) wages and salaries of employees.

4) Creditors secured by a floating charges.

5) Other unsecured and non-preferential creditors-trade

creditors, the government (for some taxes).

6) Members of the company in proportion to the nominal

value of the shares held, as modified by the Articles

of Association of the company.

1.7 OUTLINE OF RESEARCH

A brief outline of aims of the research is given below

1) To develop a single statistic model for measuring

companies' financial performance.

2) To use this model:

2.1) To indicate companies' financial strength and

weaknesses.

9
 2.2) To anticipate and guide companies' future

performance in such a way that ensures their

health and continued growth.

2.3) To detect the causes of failure and success

in identifying individual changes and how these

individual changes affect overall company

performance.

2.4) To advise on financial planning taking

accounts for companies existing strengths and

weaknesses.

2.5) To determine ideal levels for important

financial dimensions such as current assets,

current liabilities, cash and so on.

2.6) To demonstrate the effectiveness of the model

compared to similar models available elsewhere.

3) A review of other models available and how they

compare against each other.

10
1.8 CONCLUSION

The difficulty with monetary units is that they tend to

change in value over a period of time; consequently, when

examining them in relationship with future plans, it is

essential to put them both on the same basis of valuation.

This problem can be overcome to a certain extent by the use of

percentages, that all values have been affected in the same

way and to the same degree. Because of this, in the

evaluation of a company's financial performance, percentages

and ratios are the key methods for measuring financial

performances.

The role played by and the reason for using financial

ratios has been discussed in this chapter. Hopefully it has

the
been established that it is in, interests of management to

recognise the advantages of ratio analysis and be aware of the

need to understand it. Once ratios have been computed, action

can be taken to influence a company's future performance.

11
 CHAPTER 2

HISTORICAL BACKGROUND OF

FINANCIAL ANALYSIS

12
CHAPTER 2: HISTORICAL BACKGROUND OF FINANCIAL ANALYSIS

Over the past fifty years a number of studies have been

undertaken to investigate the usefulness of financial ratios.

Most of these studies have concentrated on the predictive

aspect of ratios, especially with respect to their ability to

predict various types of corporate difficulties. A number of

other writers have advocated that certain ratios should be

used for particular areas of financial statement analysis.

Some of these studies were done by Tucker (1961), Nelson

(1963), Pringle (1973) and Laurent (1979).

2.1 CORPORATE FINANCIAL STATEMENTS

"In 1866 the Treasurer of the Delaware, Lackawanna,

and Western Railroad company, once reported to a

request for information from the New York Stock

Exchange by writing, 'the Delaware, Lackwanna RR CD.

make no reports and publish no statements and have

done nothing of the kind for last five years'."

Since last century corporate reporting has increasingly

improved. The first book to appear on this subject was that

of Graham and Dodd (1934). Entire sections of Graham and

Dodd's work are devoted to the fine points of recasting a

corporation's income statement and balance sheet into a more

meaningful form and explaining other techniques of financial

statement analysis. Security Analysis was first published in

the era of the Great Depression, when investors had good

13
reason to question whether a corporation with a high level of

bonded indebtedness would be able to re-finance its debt or

meet its interest payments as they fell due. Each investor

had to make his own assessment of the probability of a firm's

failure.

By the end of nineteenth century commercial banks started

requesting financial statements to "borrowers of money". Then

around the beginning of the twentieth century the comparison

of the current assets of firms to their current liabilities

became a widespread practice. Foulke (1961) states that a

current ratio of 2.5 was considered to be a reasonable margin

of protection in those times.

The conditions that prevailed when Graham and Dodd wrote

their work are not prevalent today, however. Various

companies acts like the corporate income tax law and the

heightened sophistication of the accounting profession have

gradually forced most businesses to keep better records and to

adopt more adequate accounting practices.

2.2 FINANCIAL ANALYSIS DEVELOPMENT

Since the end of World War 2, the discipline of corporate

finance has developed and made popular a large number of

analytical tools, including cash budgeting, profit planning,

and capital budgeting. The financial manager of a

corporation, who is trained in these techniques is now able to

anticipate cash flows and plan the earnings of a corporation

much more precisely. By obtaining reliable data about the

14
rate of return that the corporation is expected to earn, from

either the management of the corporation, its customers, or

its competitors, a proper valuation can be made.

Today some corporations reveal to their underwriters, the

major brokerage firms, and large shareholders limited amounts

of information about key developments that will influence the

corporation's expected rate of return. These parties, in

turn, frequently report their findings to the public at large.

A second major development that has had a profound impact

on the course of financial analysis is portfolio management as

a separate, distinct field of study. Questions were arising

for instance, How might one obtain the maximum return from the

portfolio as a whole, with a given variability in the return?

What is the meaning of diversification? What kinds of risk

can management guard against? To answer such questions, more

sophisticated techniques, such as factor analysis and

quadratic programming can be useful. The practical

application of these techniques has been made feasible by

computers. In short, to the permanent large investor, the

relationship among the securities within a portfolio is now a

matter of serious concern, for this reason portfolio

management has become an important field of study in its own

right.

The third major development that has influenced financial

analysis is the use of abstract models in the study of the

interrelationship of the firm and the market. To understand

these models a knowledge of calculus, matrix algebra, and

15
statistics is needed. In short, the field of financial

analysis has changed radically over the years. Sophisticated

tools have been developed to attack problem areas that were

previously thought to be impossible to solve. Wall & Dunning

(1928), Tamari (1966) and Shashua (1974) showed that the use

of financial ratios on an univariate basis presents some

shortcomings. This is because the interrelation between the

different ratios is not taken into account and they may

release conflicting signals. But the use of multivariate

analysis offers a solution to these problems in that several

weighted ratios are combined. Thus, at present, mathematical

models are being built, tested, and amended in the search for

interrelationships within the valuation process and the

financial analysis is becoming a professional discipline.

The tremendous changes in financial analysis can perhaps be

more readily appreciated by reviewing briefly its

developments.

2.3 ADDED VALUE AS A PERFORMANCE MEASUREMENT

The difference between the value of sales and the value of

purchases is called added value. Added value can be used to

measure business performance and productivity. Added value

was used by Harris (1968) to develop a new concept of "work

done and resources used", Raven (1971) used it as a profit

improvement and finally Hochman & Razin (1973) analysed

investment in terms of productive capital.

Return on capital ratios are useful for investors, but

16
added value ratios are important for both employees and

investors. Profit ratios can vary widely with accounting

practices, but added value figures are less readily distorted.

For measuring efficiency in the use of resources, the added

value concept has advantages over other techniques. It is

less distorted by inflation. Most important, it emphasises

the fundamental connection between capital investment,

manpower productivity and wages.

Wood (1978) indicated that the users of added value can be

grouped into four categories as follows:

1) For measuring output

a) Basis of national accounting

b) Measuring business performance

c) Measuring the productivity of manpower and

capital

2) For communication

a) Explaining what business is about

b) Presenting accounting information

C) Basis for employee participation

3) For rewarding employees

a) Basis for wages and salary policy

b) Basis for group bonus schemes

4) For business policy

a) Marketing strategy

b) Capital investment policy

c) Business ratios

He compares the profitability, as the traditional measure

of business performance with added value as a new concept for

17
performance measurement which he claims is more stable and

more reliable than the profitability. He says that the

profitability has the following serious defects.

a) As a measure of performance, it can be

misleading.

b) In the modern climate of public opinion, it takes

a somewhat narrow view.

C) It can not be applied to non-profit-seeking

organisations which nevertheless need to measure

and improve their performance.

One problem with profit is the difficulty of definition.

In theory, two companies could be identical in terms of the

types of products, sales revenue, materials used, numbers

employed, capital employed, etc, yet they could have deferent

profit figures that would arise from differences in

depreciation policy, sources of finance and level of wages.

See Table (2.3.1) for the analysis of four imaginary

companies.

18
 TABLE 2.3.1: An Example of Comparisons of Return on Capital

for four Imaginary Companies

COMPANY ( 000s) Al D

SALES I 1000 I
1000 I
1000 I 1000
PURCHASES I 400 I 400 I 400 I 400

ADDED VALUE 600 600 600 600

WAGES, etc 450 450 450 425

DEPRECIATION 100 75 75 75

INTEREST ON LOANS 25 25

PROFIT 50 75 50 75
CAPITAL 500 525 325 325

LOANS 200 200

RETURN ON CAPITAL Z 10 14.3 j 15.4 I 23 I

A further problem in comparing return on capital is that of

asset valuation. Expert opinions on the value of land and

buildings may vary widely. High rates of inflation have made

a mockery of balance sheet values based on historical costs.

Even without inflation it can be argued that the asset value

depends on the profit record and potential rather than on the

historical price or replacement cost. Finally, two companies

with identical total assets could show different figures of

capital employed if one has a higher proportion of external

liabilities in the form of creditors, overdraft and other

19
loans. This is because the capital employed is equal to total

assets minus current liabilities and there may be different

capital figures because of different current liabilities when

the total assets are identical.

Comparing one company with another in terms of return on

capital is difficult because of the above factors. Even

comparisons within one company over periods of time may be

distorted by some of the factors outlined above. Inflation

accounting techniques can help to reduce the distortion of

return on capital ratios, but profitability can be very

misleading as an index of company performance.

Wood claims that if the technical problems of defining

profit and capital could be overcome, there are emotional

problems of using return on capital to measure company

performance. This is because profit is seen by some people as

evil. The world is associated with the exploitation of

workers. The social climate has changed with the declining

power of individual capitalists and the rising power of the

trade unions and government. A wider view of business

performance is needed. It must take account not just of

investors but of employees, customers, suppliers and

governments.

If however profitability is not reliable or acceptable as a

measure of performance, what is the alternative?

Profitability relates a very small part of the output, the

profit, to only one of the factors of production, the capital

employed. What is needed is a broader measure relating the

20
total output to all the factors of production. The

appropriate word is productivity, the ratio of output to

input.

In order to establish a measure of performance, the output

must be divided by the inputs. The main inputs are materials,

manpower and capital. The use of added value for measuring

output discounts the cost of materials. So the main inputs

are manpower and capital. The index of productivity can then

be expressed in terms of the ratio below:

PRODUCTIVITY = OUTPUT/INPUT = ADDED VALUE/(MANPOWER

+ CAPITAL)

Unfortunately, there is no easy way of adding together

manpower and capital. Various ideas have been put forward for

converting the value of capital into manpower equivalent. But

no answer has yet proved to be acceptable.

Wood says that instead of attempting to achieve the

difficult task of adding together manpower and capital,

performance can be compared in terms of the trends of manpower

productivity and capital productivity over periods of time.

What matters is not so much the ratios in one particular

period, but the trends. If added value per employee is rising

and, at the same time, the added value per unit of capital is

also rising, the rewards to both employees and investors can

increase. If both ratios are falling, the reward to one or

both must suffer. One index rising and the other static is a

better situation than both static or one falling whilst the

other is static. There are nine possible combinations of

21
rising, static or falling productivity of manpower and capital

(Table 2.3.2).

Table 2.3.2: Manpower Productivity and Capital Productivity

MANPOWER PRODUCTIVITY CAPITAL PRODUCTIVITY

(ADDED VALUE PER (ADDED VALUE PER UNIT OF CAPITAL)

EMPLOYEE) RISING I
STATIC 1 FALLING 1

1 RISING EXCELLENT I GOOD POOR

STATIC GOOD I
STATIC I
BAD

FALLING POOR BAD 1 VERY BAD 1

As Wood has described, for obtaining a better picture of

the business performance we should evaluate the productivity

rather than profitability. For productivity analysis we must

have the proper analytical tools, which can be a set of

ratios. These ratios must focus on all the possible areas

that are directly or indirectly related to the productivity of

the company.

Spencer and Tucker(1961) constructed these needed ratios

between pieces of primary data which have been extracted from

payroll analysis (Table 2.3.3). The data they used come from

a plant engaged in the manufacture of a line of proprietary

consumer products and employed 275 people. This plant is

chosen as an example, because it has got almost the same

departments or cost centres as other plants and it can be

considered as a typical plant for productivity analysis.

22
Table 2.3.3: Primary Production Data from Payroll

Item 1 Pounds 1 Hours 1

1 code 1 code 1

total gross paid payroll 1 24

total clocked payroll 2 25

direct labour:

on standard: earned 3 26

on standard: clock 27

off standard: clock 4 28

Total direct labour 5 29

Indirect labour:

downtime: miscellaneous waits 6 30

for equipment repairs 7 31

for tool repairs 8 32

excess direct labour: Jig and die trouble 9 33

Equipment trouble 10 34

Material trouble 11 35

other: Tool and fixture making 12 36

Setup 13 37

Maintenance and repairs 14 38

Salvage, re-work, re-process 15 39

Service 16 40

Supervision 17 41

Factory engineering 18 42

Factory clerical 19 43

Total indirect labour 20 44

23
 Direct labour subsidy (lost) 21

Direct incentive premium (gained) 22

indirect incentive premium 23

Table 2.3.4 is a partial list of typical production ratios

that can be developed from the primary data appearing in table

2.3. To the right of the table 2.4 is the letter U or D.

This refers to whether an upward or downward movement of the

ratio value is considered positive.

24
Table 2.3.4: Elementary Production Ratios

t.1 Ratio title Formula 1P.D 1

1 no 1

gross productivity 26/27 U

1 1
; net productivity (27-45+46)/27 U

I 3 I work standards coverage 27/29 I U

I 4 I performance index (27-45+46)129 I U

I 5 I improvement index (27-45+46)125 I U

I 6 worker standards 45/46 D

II consistency

I 7 I indirect support 441(29+46) I D

I 8 indirect support cost 20/5 I D

I 9 I indirect usage 44/24 D

1 10 indirect usage cost 20/1 D

I 11 I subsidy 45/27 D

1 12 I excess cost (6+7+8+9+10+11+15+21)/5 D

I 13 down-time cost (6+7+8)/5 D

1 14 excess direct labour cost (9+10+11)/5 D

I 15 tool and fixture cost 12/5 D

1 16 I setup index 37/29 D

I 17 setup cost 13/5 D

1 18 I maintenance and repair 38/29 D

I I index

1 19 maintenance and repair 14/5 D

Icost

1 20 I service index 40/29 D

25
21 service cost 11/5

22 supervisory ratio 41/25

23 supervisory production 41/29

24 factory engineering cost 18/5

25 factory clerical cost 19/5

26 support index (40+41+42+43)/29

27 support cost (16+17+18+19)15

28 incentive support (46-45+47)/29

29 incentive cost (21+22+23)/5

30 setup effectiveness 37/26

31 maintenance effectiveness 38/26

32 productivity planning 22/6

33 direct usage cost 5/1

34 direct usage index 29+46/24

35 variable indirect 6+7+8+9+10+11+13+14+15/20

36 variable indirect-direct 6+7+8+9+10+11+13+14+15/5

37 premium avoidable cost 22/(14+15)

38 avoidable content (14+15)/5

39 machinery-labour economy (7 10+14)/5

40 production, indirect (44/24)(29/20)

41 service-payroll index 40/24

42 direct-productive index (29+46)/(44+45)

43 productivity yield index (27-45+46)/24

44 indirect yield index (27-45+46)/44

45 net payroll productivity (29-45+46)/24

46 gross payroll productivity (29-45+46)/25

47 service-wait index (6+16)/5

48 indirect payroll (44+45)/24

26
 So by evaluating all or a part of the above ratios

depending on the purpose of the analysis it is possible to

identify the strength or weaknesses in productivity or the

whole company performance. By improving and increasing the

manpower productivity and capital productivity we will achieve

the goals of the company and ensure its health and growth.

Although there is a debate on whether to use added value

instead of profit related ratios (Ball, 1968), the use of a

single ratio as a mean of evaluating performance is common

practice among managers, and are generally accompanied by some

measures of growth. However, this practice has been

criticised on the grounds that a single ratio can not reflect

every aspect of a company performance and sets of ratios have

been proposed to allow a better evaluation of the financial

profile of firms.

2.4 SECURITY ANALYSIS

As discussed in (2.1) security analysis was based on new

techniques and a sophisticated concept of financial statement

analysis for the first time in 1934 by Graham & Dood and then

in 1973 by Barnea & Dennis, which is discussed in further

detail in this section. Again in security analysis ratios are

used. By evaluating these ratios investors can have more

confidence and be more accurate investing their money in the

right place and at the right time.

Graham, Dood and Cottle(1962) tried to establish and

construct a new security analysis using ratios which are most

27
demanded by shareholders and creditors. The key ratios in

security analysis which assess the quality of a company are as

follows:

1- profitability ratios

2- growth ratios

3- stability ratios

4- payout ratios

5- credit ratios

6- price ratios

The first five groups measure the performance and financial

strength of a company, considered apart from the valuation

placed upon it in the market (ratio 6).

PROFITABILITY RATIOS

An important indicator of the success of a company is the

percentage earned on invested capital. That is the percentage

earned on the long-term (non-current) debt and preferred stock

plus the book value of the common stock. The fundamental

merit of return-on-invested capital ratio is that it measures

the basic or overall performance of a business in terms of the

total funds provided by all long-term investors rather than a

single class. Four ratios are used to measure this aspect:

Ratio 1- earnings before depreciation per pound of

capital funds

Ratio 2- earnings per pound of capital funds (return

on capital)

28
 Ratio 3- sales per pound of capital funds (sales

ratio)

Ratio 4- earnings per pound of sales (earnings

margin)

GROWTH RATIOS

The test of growth is most informative when they are made

between years representing about the same phase of successive

business cycles.

Ratio 5- pound sales=sales of 2nd business

cycle(BC)/sales of 1st BC

Ratio 6- net profit on total capital in pounds=net

profit after tax (NPAT) for 2nd BC/NPAT

for 1st BC

Ratio 7- earnings per share=EPS for 2nd BC/EPS for

1st BC

STABILITY RATIOS

In stability ratios the lowest year is measured against the

average of 3 previous years to indicate the stability of the

company's activity over time. For example the maximum decline

in rate of return or minimum coverage of charges indicate the

fluctuations or stability in activities.

Ratio 8- minimum coverage of senior charges

Ratio 9- maximum decline in earnings rate on total

capital

29
 The latter ratio may be supplemented by measuring the

maximum decline in the return earned on common-stock capital

and/or in per-share earnings.

Blum (1974) emphasised on including the stability of

earnings in the variables assessing companies' performance

where in his failing company model, the standard deviation of

the net income over a period of three years was among the

variable he selected and included in a discriminant function

identifying possible failures amongst going companies.

PAYOUT RATIO

The percentage of available earnings paid out in common

dividends often has an important effect upon the market's

attitude toward those issues not in the "growth-stock"

category.

Ratio 10- payout ratio=common dividends/net profit

for common shares

CREDIT RATIOS

The ability of company to meet its short and long term

obligations are measured here as credit ratios which are

listed as follow:

Ratio 11- working-capital ratio=working capital/

current assets

Ratio 12- common-stock ratio=common-stock equity/

total capital

30
 Ratio 13- coverage of senior charges = senior

charges/(fixed charges + preferred

dividend)

PRICE RATIOS

Evaluation of company based on its common stock at market

value are presented here as follows:

Ratio 14- sales per pound of common, at market =

sales/common stock at market value

Ratio 15- earnings per pound of common, at market

(earning yield) = net profit for common/

common stock at market value

Ratio 16- dividends per pound of common, at market

(dividend yield) = common dividends/common

stock at market value

Ratio 17- net assets per pound of common at market

(asset ratio) = common stock equity(book

value)/common stock at market value

2.5 RATIO CLASSIFICATION

The above set of ratios can be reduced in number because

many measure the same dimension of a company's performance.

The reduced set can then be classified. By classifying these

ratios it is possible to assess company performance and

therefore identify changes that could be made to improve

company performance.

31
 Weston and Brigham(1975) classified the useful ratios into

four fundamental types:

LIQUIDITY RATIOS

measure the firm's ability to meat its maturity short term

obligations.

a) current ratio= current assets/current liabilities

b) quick ratio= current assets - inventory/current

liabilities

Richard (1964) suggested some ranges for ratios to clarify

and indicate the extends of the company's financial strength

or weaknesses, such a classification can be done for any

company as below, R is equal to current assets/current

liabilities.

Table 2.5.1 Ratio Classification

Liquidity Ratio I Description Position

R > 2.0 overliquidity excellent

2.0 > R > 1.5 optimal liquidity very good

1.5 > R > 1.0 under liquidity good

R - 1.0 marginal liquidity sufficient

1.0 > R 0.5 payment difficulties deficient

R < 0.5 danger of bankruptcy insufficient

LEVERAGE RATIOS

measure the extent to which the firm has been financed by

debt.

C) debt ratio= total debts/total assets

d) time interest earned= EBIT/interest charges

e) fixed charge coverage =EBIT + lease/interest

charges + lease

ACTIVITY RATIOS

measure how effectively the firm is using its resources.

f) inventory turnover= sales/inventory

g) average collection period= receivables/sales per

day

h) fixed assets turnover= sales/net fixed assets

i) total assets turnover= sales/total assets

PROFITABILITY RATIOS

measure management's overall effectiveness as shown by the

returns generated on sales and investment.

k) profit margin= NPAT/sales

j) return on total assets= NPAT/total assets

m) return on net worth= NPAT/net worth

33
2.6 INDUSTRIAL AVERAGE ANALYSIS

Ball (1967) and Lev (1969) argued that inter-industry

differences exist among some financial ratios, but it is not

clear whether all the ratios are affected in the same

direction by industrial characteristics and whether this

influence is consistent over all the financial dimensions of

companies. Horrigan (1965) showed that financial ratios are

uncorrelated to size. The same conclusions were later reached

by Beaver (1967) and Singh & Whettington (1968). Edminster

(1972) carried out some studies with the aim of finding pairs

of companies which possessed as many common characteristics as

possible. Pair of companies should be drawn from the same

industrial sector, have the same size and come from the same

financial year. Although finding a significant number of

ideally paired companies is not impossible, the work involved

is enormous and costly. Edminster examined about 110'000

companies before finding 21 pairs.

Probably the most widely known and used of the industrial

average ratios are those compiled by Dun & Bradstreet, Inc. D

&B provides fourteen ratios calculated for a large number of

industries. Comprising 125 lines of business activity based

on their financial statements. The 125 types of business

activity consist of 71 manufacturing and construction

categories, 30 categories of wholesalers, and 24 categories of

retailers. Sample ratios and explanations are shown in Table

2.6.1. The complete data give the fourteen ratios. The

median ratios can be illustrated by an example. The median

34
ratio of current assets to current debt of manufacturers of

airplane parts and accessories were arranged in a graded

series, with the largest ratio at the top and the smallest at

the bottom. The median ratio of 1.81 is the ratio halfway

between the top and the bottom. To simplify the D & B tables,

we can consider:

LB & NR = Line of Business and Number of concerns

Reporting

CA = Current Assets

CD - Current Debt

NP - Net Profits

NS - Net Sales

TNW = Tangible Net Worth

NWC = Net Working Capital

CP = Collection Period

In - Inventory

FD = Funded Debts

FA = Fixed Assets

TD - Total Debt

D - Days

LR - Largest Ratio

MR - Median Ratio

SR = Smallest Ratio

35
 Table 2.6.1: Ranges of selected ratios and measures by

industry taken from Dun and Bradstreet.

LB CA NP NP NP NS NS 1

--- 1 CP 1

NR CD NS TNW NWC TNW NWC 1

DI

Agricultural LR 3.78 .0715 .2144 .3682 5.27 8.13 1 25 1

Implements & MR 2.27 .0412 .1459 .2068 3.21 4.6 1 39 1

Machinery (74) SR 1.52 .0323 .083 .1495 2.34 2.98 1 52 1

Airplane parts LR 2.4 .0812 .2778 .4496 4.46 8.27 1 34 1

& Accessories MR 1.81 .0525 .1811 .3221 3.43 5.29 1 46 1

(59) SR 1.42 .031 .119 .1776 2.72 4.2 1 61 1

Automobile LR 3.77 .0675 .1889 .3211 3.89 6.54 I 35 1

Parts & (84) MR 2.58 .0459 .146 .2032 2.99 4.63 I 42 1

Accessories SR 2.03 .0332 .0865 .1409 2.19 3.23 I 51 1

Bedsprings LR 3.6 .0269 .1153 .1503 5.85 8.52 30 1

& Mattresses MR 2.33 .0206 .0646 .1095 3.48 5.79 I 42 1

(49) SR 1.87 .008 .0271 .0511 2.61 4.34 I 55 1

LR 3.34 .0648 .1515 .6372 3.23 11.34 I 8 1

Breweries MR 2.59 .0475 .1038 .3427 2.49 8.51 1 16 1

(27) SR 1.88 .0128 .0255 .0823 1.72 5.13 1 24 1

Chemicals, LR 2.98 .0387 .1178 .4491 5.11 13.41 1 32 1

Agricultural MR 1.73 .0202 .0758 .1773 3.46 6.72 1 55 1

(33) SR 1.33 .0095 .0156 .028 1.98 4.15 1 87 1

36


Chemicals, ILR I 2.77 1. 0815 1.1 6 07 1.5001 I 3.09 7.05 1 39 1

Industrial MR I 2.28 p.0553 J.1245 1. 303 2 I 1.95 I 5.03 1 50 1

(60) ISR I 1.51 J.0393 1. 090 3 1.1795 I 1.52 I 3.39 1 59 1

Contractors, LR 2.06 .0314 .1904 .3304 12.51 20.41 1 b 1

Building (188) MR 1.49 .0138 .1239 .1638 8.09 11.52 1 b 1

construction SR 1.27 .0074 .0620 .0914 4.32 5.79 1 b 1

continues of Table 2.6.1

LB NS FA CD TD In CD 1 FD 1
--- --- 1 --- 1
NR In TNW TNW TNW NWC In 1 NWC I

Agricultural LR 6.1 .215 .225 .475 .713 .446 1 .178 1

Implements & MR 3.9 .335 .493 .800 1.049 .720 1 .370 1

Machinery (74) SR 3.1 .636 1.153 1.496 1.614 .984 1 .509 1

1 1
Airplane parts LR 8.6 .279 .432 1 .580 1 .738 I .879 1 .141 1
& Accessories MR I 5.9 I .484 .615 11.03511.034 I 1.00 1 .475 1
1 1
(59) SR 3.9 .755 1.125 11.791 1.547 1.419 .558
1

Automobile
.473 LR 8.0 .257 .235 .605 .585 1 .146 1
Parts & (84) MR 5.3 .396 .380 .778 .862 .797 1 .416 1

Accessories SR 4.2 .555 .634 1.169 1.005 1.137 1 .599 1

Bedsprings & LR 11.7 .156 .229 .487 .548 .556 1 .036 1

Mattresses MR 8.2 .281 .459 .728 .768 .936 1 .266 1

(49) SR 5.5 .493 .763 1.339 1.145 1.548 1 .521 1

1 1 1
Breweries 1LR I 21.6 I .537 I .131 1 .204 1 .333 11.082 1 .096 1
1MR 16.4 .594 I .213 I .386 1 .465 11.378 11.186 1

37
 (27) 1
1SR 11.4 1 .819 1 .341 1 .975 1 .877 11.949 1 762 1
II I I I I I
+ +
Chemicals, LR 10.4 .295 .336 .584 .621 .895 1 .241 1
Agricultural MR 6.6 .536 .731 1.11 1.066 1.229 1 .479 1
(33) SR 5.0 .712 1.23 1.659 1.605 2.373 1 .752 1

Chemicals, LR 10.1 .426 .201 .318 .652 .761 1 .440 1

Industrial MR 6.9 .688 .300 .589 .847 .985 1 .942 1
(60) SR 5.5 .889 .500 1.06 1.001 1.287 11.524 1

Constructors, LR b .095 .617 1.194 b 1 .119 1

Building (188) MR b .222 1.38 1.884 b 1 .274 1
Construction SR b .421 2.398 3.180 b 1 .834 1

b- Building trades constructors have no inventories in the

credit senses of the term. As a general rule, they have no

customary selling terms, such contracts being a special job

for which individual terms are arranged.

2.7 DISCRIMINANT ANALYSIS

The prediction of corporate performance using financial

ratios data and a multivariate statistical approach is a well

researched area in finance and accounting. The discriminant

analysis technique is a multivariate statistical procedure

with application aimed at distinguishing between the members

of two or more distinct populations on the basis of their

characteristics represented by vector variables. A set of

discriminant functions is derived using data from two or more

distinct groups. These functions can then be used to classify

38
further individuals whose data has been used in constructing

the discriminant functions. In the company bankruptcy

situation the two-groups are the samples of failed and

nonfailed firms.

Walter (1959) and Smith (1965) studied common share

analysis in the area of financial analysis. Smith used

discriminant analysis to classify common stocks into five

investment categories, namely, growth, stability, quality,

income and speculative. Walter selected from a sample of five

hundred companies the highest and the lowest fifty E. P.

(inverse of price- earning) ratio firms. He then analysed the

characteristics specific to each of these groups using

discriminant analysis.

Several analysis have attempted to reproduce bond ratings,

using multivariate methods. Although the first studies

employed multiple regression analysis as the base for their

predictive model, Horrigan (1965) and Pinches (1973) found

multiple discriminant analysis more appropria e to tackle the

problem.

The use of discriminant analysis in regard to the analysis

of company failure was done recently by Taffler (1976),

(1982), and Betts & Belhoul (1982) in the UK. Belhoul (1983)

investigated the financial performance of companies using

multiple discriminant analysis together with methods for the

identification of potential high performance companies.

Taffler (1977) and Mulondo (1981) have restricted their

analysis to companies quoted on the stock exchange, but many

39
studies related to comparison of performance have been carried

out on mixtures of quoted and unquoted companies by Roosta

(1979) and Pohlman & Hollinger (1981). Mulondo study was

concerned with industrial enterprises quoted on the London

Stock Exchange. The bankrupt set of firms from which the

discriminant model was derived consisted of all those

companies meeting certain conditions for inclusion which

failed between 1968 and 1973, a period of 6 years. Failure

was defined as liquidation for the benefit of creditors,

winding up by court order, or entry into receivership. All

told a total of 31 firms met the necessary requirement

although of these only 23, the FAILED23 set, provided turnover

figures in their last available income statement.

61 companies were chosen as the nonfailed firms, termed the

ALL61 set. However not all these could be considered

financially healthy and to arrive at the necessary solvent

subset, the investment analysis of the broking firm were

requested to rate each of them on an investment. 45 firms

were considered sound on the grounds of his fundamental

analysis, the G00D45 set. The remaining 16 were termed the

POOR16 set. Different discriminant functions were derived

using the G00D45 and ALL61 groups.

THE VARIABLES

The variables used in this study were selected on the basis

of effectiveness in previous and related studies, popularity

in the literature, theoretical arguments based on the liquid

40
assets flow model of the firm of Beaver and Blum (1974)

adapted from Walter and suggestions by financial analysts

based on their experience. Three classes of variable were

initially developed, conventional ratios computed from income

statement and balance sheet items, four year trend measures

and ratios computed from the funds statement.

However, despite the theoretical arguments in the

literature asserting the utility of the funds flow ratios,

measuring changes in working capital, turned out without

exception to be highly volatile from one year to the next and

as a result not amenable to any form of statistical analysis.

Consequently they were not considered further. The

distributions of the remaining ratios were carefully examined

for the failed and continuing groups separately and

appropriately transformed to improve normality. Outliers

beyond 4 standard deviations from the mean of the remaining

observations in each case were replaced by the mean and those

between 2.5s and 4s by the appropriate 2.5s limit. Because a

number of these ratios were highly non-n rmal, they were

rejected. When they were removed 52 ratios were left for

further analysis together with 26 trend measures.

Initial discriminant runs using the FAILED23 and G00D45

sets were then undertaken to examine whether trend measures

added anything to the power of the discriminant model.

However the trend measure did not contribute to discrimination

and so were not used in further analysis. Of the remaining 52

measures certain were omitted from subsequent discriminant

runs on the advice of knowledgeable financial analysts as

41
being potentially industry dependent, particularly many of the

turnover ratios, others were added and definitions of some

were changed on the basis of experience gained in the earlier

examinations. This reduced the numbers to 50 as follows:

1. FUNDS FLOW(GROSS TRADING PROFIT)/TOTAL ASSETS

2. FUNDS FLOW/NET WORTH

3. FUNDS FLOW/TOTAL LIABILITIES

4. FUNDS FLOW/CURRENT LIABILITIES

5. FUNDS FLOW/NET TRADING CAPITAL(EQUITY+TOTAL

LIABILITIES-CASH)

6. FUNDS FLOW/NET CAPITAL EMPLOYED(EQUITY+LONG TERM

LIABILITIES)

7. EBIT/TOTAL ASSETS

8. EBIT/NET WORTH(EQUITY)

9. EBIT/TOTAL LIABILITIES

10. EBIT/CURRENT LIABILITIES

11. EBIT/NET TRADING CAPITAL

12. EBIT/NET CAPITAL EMPLOYED

13. CASH FLOW(RETAINED PROFITS - EXCEPTIONAL ITEMS

+ DEPRECIATION)/TOTAL ASSETS

14. CASH FLOW/NET WORTH

15. CASH FLOW/TOTAL LIABILITIES

16. CASH FLOW/CURRENT LIABILITIES

17. CASH FLOW/NET TRADING CAPITAL

18. CASH FLOW/NET CAPITAL EMPLOYED

19. TOTAL LIABILITIES/NET WORTH

20. log (FIXED ASSETS/NET WORTH)

21. FIXED ASSETS/NET CAPITAL EMPLOYED

22. TOTAL LIABILITIES/CURRENT ASSETS

42
23. CURRENT LIABILITIES/TOTAL ASSETS

24. TOTAL LIABILITIES/TOTAL ASSETS

25. TOTAL LIABILITIES/NET CAPITAL EMPLOYED

26. DEBT/EQUITY

27. log (QUICK ASSETS/CURRENT LIABILITIES)

28. (CURRENT ASSETS/CURRENT LIABILITIES)

29. (QUICK ASSETS/TOTAL ASSETS)

30. (CURRENT ASSETS/TOTAL ASSETS)

31. (WORKING CAPITAL/TOTAL ASSETS)

32. log (QUICK ASSETS/NET WORTH)

33. log (CURRENT ASSETS/NET WORTH)

34. WORKING CAPITAL/NET WORTH

35. (QUICK ASSETS/TOTAL LIABILITIES)

36. log (QUICK ASSETS/NET CAPITAL EMPLOYED)

37. log (CURRENT ASSETS/NET CAPITAL EMPLOYED)

38. WORKING CAPITAL/NET CAPITAL EMPLOYED

39. log (INVENTORY/WORKING CAPITAL + SHORT TERM

LOANS - CASH)

40. log (SALES/WC+SHORT TERM LOANS-CASH)

41. SALES/AVERAGE INVENTORY

42. DAYS DEBTORS

43. DAYS CREDITORS

44. log (READY ASSETS(CASH+7 DAYS DEBTORS)/CURRENT

LIABILITIES

45. log (READY ASSETS/TOTAL ASSETS)

46. log (READY ASSETS/NET WORTH)

47. log (READY ASSETS/TOTAL LIABILITIES)

48. READY ASSETS/NET CAPITAL EMPLOYED

43
 49. log [(ACCOUNTS RECEIVABLE+INVENTORY)/ACCOUNTS

PAYABLE]

50. (WC+SHORT TERM LOANS-CASH)/NET TRADING CAPITAL

2.8 FINANCIAL RATIOS IDENTIFICATION

In selecting financial ratios for investigation we must

ensure that the chosen set covers all the aspects of the

company. If any financial dimension is not considered the

overall conclusions are not reliable because the ratio profile

is not complete. One of the earlier efforts to identify these

ratios was by Courtis(1978). Such identification enables the

analyst to modify his own preferred set of ratios or if he

chooses not to, at least it will place him in a sounder

position to justify to clients (and himself) his reliance upon

specific ratios when giving investment advice. Identification

of financial ratios which have been found to be more

significant are summarised below.

PROFITABILITY RATIOS

(a) Return on Investment

net income to total assets

net income to net worth

net income to working capital

EBIT to total assets

EPS to price per share

NI minus pref. dividends to common OE

earning per share

44
 gross profit to total assets

dividends to net income

dividends to cash flow

dividends per share

net income to total debt

(b) Profit Margin

net income to sales

gross profit to sales

(C) Capital Turnover

sales to total assets

sales to net worth

sales to working capital

sales to fixed assets

MANAGERIAL PERFORMANCE

(a) Inventory

sales to inventory

inventory to current assets

current liabilities to inventory

cost of sales to average goods inventory

inventory to total assets

inventory to working capital

days in period to inventory turnover

(b) Credit Policy

accounts receivable to sales per day

45
 sales to accounts receivable

accounts payable to average purchases per day

(c) Administration

operating expenses plus cost of sales to sales

operating expenses to gross margin

cost of sales to sales

operating expenses to total assets

(d) Asset Equity Structure

debt to total debts

working capital to net worth

retained earnings to total assets

debt to working capital

current liabilities to working capital

cash current asset to total current assets

net worth to total assets

fixed assets to net worth

fixed assets to debt

fixed assets to total assets

book value per share

total debt plus pref. stock to total assets

debt to total assets

current liabilities to total assets

retained earnings to net income

SOLVENCY

46
(a) Short Term Liquidity

current assets to current liabilities

current liabilities to net worth

working capital to total assets

no credit interval

cash to total assets

cash to sales

quick assets to current liabilities

cash to current liabilities

basic defensive interval

quick assets to total assets

current assets to total assets

quick assets to sales

current assets to sales

cash interval

reduced sales interval

reduced operations interval

(b) Long Term Solvency

total debts to net worth

net worth to fixed assets

EBIT to interest

total debt to total assets

market value of equity to book value of total debt

EBIT to fixed charges

unsubordinated debt to capital funds

(c) Cash Flow

47
 cash flow to total debt

annuals funds flow to current liabilities

cash flow per common share

cash flow to current liabilities

working capital to cash flow

cash flow to sales

cash flow to total assets

cash flow to net worth

cash flow to current maturities of long term debt

Courtis (1978) indicated that empirical research into

predictive ability of financial ratios has been concerned only

with preselected phenomena, for example, specifics such as,

default experience over corporate bond issues, loan defaults,

corporate failure, small business failure, corporate

bankruptcy, corporate bond ratings, corporate rate of return

rankings, and corporate take overs. Generalising the

predictive ability of this ratios beyond the context of their

specific studies ought to be tempered with caution.

Nevertheless, the analyst has available a batt ry of financial

ratios with some experience in filtering corporate financial

characteristics.

2.9 SOME LIMITATIONS OF RATIO ANALYSIS

1- Ratios are constructed from accounting data, and

accounting data are subject to different interpretations and

even to manipulation. For example two firms may use different

depreciation methods or inventory evaluation methods.

48
 2- Similar differences can be encountered in the treatment

of research and development expenditures, pension plan costs,

mergers, product warranties, and bad-debt reserves.

3- If firms use different fiscal years, and if seasonal

factors are important, this can influence the comparative

ratios.

4- A high inventory turnover ratio could indicate efficient

inventory management, but it could also indicate a serious

shortage of inventories and suggest the likelihood of stock-

outs.

5- Absence of clearly defined accounting standards,

covering all reporting of company data, makes it possible that

two companies report similar economic events in different

ways.

6- While ratios do provide information about the current

status of the firm, they do not contain information about the

alternative strategies and the intervening economic conditions

confronting management and investors, such as mergers and

deferral of payments.

7- The value of human factors and customer loyalty are not

included in financial analysis. The problem with these two

factors is that they are totally intangible and impossible to

measure exactly.

8- Intangible assets are normally omitted because the value

utilised in the business in respect of these assets is

uncertain.

49
 Ratios, then are extremely useful tools. But as with other

analytical methods, they must be used with judgment and

caution, not in an unthinking, mechanical manner.

2.10 CONCLUSION

In the first decade of the twentieth century, financial

ratios began to be increasingly used because credit evaluation

became of major importance. Initially the most frequently

used ratio was the current ratio which was used to determine

the firm's solvency position. However, because of the

limitation of this ratio as an indicator, it was realised that

additional ratios were needed to provide a more comprehensive

view of the firm's economic situation. Since then, anal,sis

by means of the calculation of a series of ratios rapidly

became a popular method of analysis of financial statements.

In spite of considerable advantages of using the added

value technique over profitability methods of measuring

companies' financial performances, it is obvious that a single

measure such as added value can not reflect every aspect of

company performance and so sets of ratios have been proposed

to allow a better evaluation of the financial performance of a

company.

An additional advantage of using financial ratios is that

they allow comparisons of company performance for companies of

different sizes and even in different industrial sectors.

More recently multivariate techniques such as discriminant

50
analysis and factor analysis have been gaining in popularity.

This is because of the increased accessibility of the

necessary hardware and software required to carry out such

analysis.

51
 CHAPTER 3

BASIC TOOLS OF

PERFORMANCE MEASUREMENT

52
CHAPTER 3: BASIC TOOLS OF PERFORMANCE MEASUREMENT

The business failures can be categorised in four different

types:

1) Economic failures- A business is an enterprise

organised for profit. It may be said therefore, that a

business that does not make a profit and has no reasonable

expectancy of profitable operations is a failure. This is

true even though it has been successful in meeting its

obligations to creditors.

2) Legal failures- The classification of business

failures that follows relates to difficulties of a company

with its creditors. The business has difficulty in meeting,

or can not meet, the legally enforceable obligations due its

creditors.

3) Financial insolvency- When there has been a

decline of current asset values to an extent requiring new

money, or necessary conversion of fixed assets into cash, or

sacrifices by creditors to correct the situation, the company

is sometimes called financially insolvent.

4) Total insolvency- Total assets, tangible and

intangible, are less than obligations due to creditors.

Obviously, the most drastic remedies are necessary here.

Perhaps the only hope of creditors is to bring about a

liquidation and forced sale of assets under a bankruptcy

proceeding.

53
3.1 CAUSES OF FAILURE

The causes of failure in a specific situation are, like the

reasons for success, difficult to isolate. Failures seem

frequently to occur from a 'complex of diseases', rather than

from one outstanding cause. Lack of working capital is often

named as a cause for failure. It is, however, merely a

symptom of some more deep-rooted ailement that has brought

about the resulting condition. Although incompetence on the

part of the management may in general be cited as the cause of

practically all business failures. Lack of capital, so often

cited as the immediate cause, usually indicates lack of skill

in planning. A brief classification of the causes of business

failures were done by Bonneville, Dewey and Kelly (1959) as

follows:

1) uneconomic or defective initial promotion

2) weak production or distribution policies

3) unwise dividend policy, and paying dividends from

capital

4) over expansion

5) cutthroat competition

6) poor financial planning

7) unforeseen and severe economic readjustment,

brought about by a sudden cessation of demand for

the product, revolutionary or unusual

legislation, wars, radical tariff changes and so

on.

8) operation of the business cycle

54
 9) disasters, such as, earthquakes, fires, floods.

10) dishonesty and fraud

3.2 DETECTION OF FAILURE BY RATIOS

One of the most important means of checking progress and

detecting tendencies in a business failure is through the

preparation and study of significant ratios, which indicate

relationships between important items reported in the balance

sheets and profit and loss statements of a business. Usually

a number of ratios must be used and to be of value must be

compared with the same ratios which have been prepared from

financial statements for several periods in the past. In this

way, changes may be observed, their causes analysed, and

trends detected. Johnson (1970) was concerned with failure

predictive aspects of financial ratios analysis.

As we have seen in previous discussions the main causes of

company's failure are classified into three basic categories:

1) profitability deficiency

2) management deficiency

3) solvency deficiency

On the other hand if we accept the premise that

shareholders are interested in increasing the value of their

capital investment, and that the long-run survival of the

company is an essential goal, then interested parties might

ask three vital questions.

1) Is the company making any money? (profitability)

55
 2) Is the management any good? (managerial

performance)

3) Is the company going to stay in business?

(solvency)

In so far as these questions can be answered at all from

financial analysis, ratios measuring "profitability",

"managerial performance" and "solvency" were selected.

For a complete and overall performance analysis and

detecting the causes of failures and successes we need to look

at all possible ratios as measurement tools. In this way

individual changes can be identified and quantified and the

way in which these individual changes affect overall company

performance analysed. Finally it would seen desirable to

develop a statistic that summarised those different effects.

This single statistic could then be used to assess company's

financial health.

3.3 PROFITABILITY

As has been stated one of the main types of business

failure is called 'economic failure', which means that the

company can not make adequate profit. Making a profit is what

business is all about. Profits are adequate when they return

to business owners the cost of their personally contributed

resources, a reward for their enterpreneurship, and

compensation for the risks involved. The adequacy of profits

is generally measured in terms of profitability as a return on

invested capital (ROI) which is demonstrated by the popular

56
due Pont system in Table 3.3.1 in which certain ratios are

interrelated meaningfully. The changes and trends in each of

the components affect the family of ratios as a whole. There

has been some other studies such as Haugen (1970),

Litzenberger & Joy (1971), Whittington (1972) and Vickers

(1966) which were analysing the rate of return as a

measurement of profitability.

57
 Table 3.3.1 The factors combined to yield Return on

Investment (ROI)

WORKINGI FIXED
I FIXED I I I 'LABOR' 'MATERIALS' 'VARIABLE
CAPITAL' 'INVESTMENT' 'CHARGE RATEI I I I
(OVERHEAD I

I PLUS I I
TIMES I I PLUS I PLUS I

I FIXED I (VARIABLE I

I COSTS I I COSTS I

PLUS

I TOTAL I I NET I I TOTAL I

I
I I I I I

'INVESTMENT I I SALES I I COST I

I DIVIDED INTO I MINUS

IPRETAX I I INCOME

'PROFIT I I TAXES

MINUS

I NET I

(PROFIT '

DIVIDED INTO

I CAPITAL I 'PROFIT I

I TURNOVER RATE I 'MARGIN I

TIMES

I RETURN ON I

IINVESTMENT I

58
 Submodels provide another means of analysis. A

profitability model can be broken down into a group of

separate and distinct submodels, which are shown in the

following Table(3.3.2).

Table 3.3.2 Submodels of Profitability

(UNITS SOLD)(NET PRICE PER UNIT)= NET SALES

1) MARKET OR

INCOME NET SALES - SELLING COSTS = NET INCOME FROM SALES

UNIT COST(MATERIAL+LABOR+VARIABLE OVERHEAD)(UNITS

2) MANUFACTUR- PRODUCED) = DIRECT MANUFACTURING COST (DMC)

-ING COST DMC + FIXED OVERHEAD + CAPITAL CHARGES

0 = TOTAL MANUFACTURING COSTS

DEPRECIABLE INVESTMENT(BUILDINGS AND EQUIPMENT)+

A EXPENSES & AMORTISED INVESTMENT(ENGINEERING, R & D,I

3) INVESTMENT STARTUP)+LAND+WORKING CAPITAL

(RECEIVABLE & INVENTORY)=TOTAL CAPITAL REQUIREMENT

(TOTAL DEPRECIABLE INVESTMENT)(DEPRECIATION RATE)

4)DEPRECIATION

= ANNUAL DEPRECIATION CHARGE

NET INCOME FROM SALES - TOTAL MANUFACTURING COST

59
 5) PROFIT — NET OPERATING INCOME (NOI)

NOI - DEPRECIATION - EXCEPTIONAL ITEMS

= NET PROFIT BEFORE INCOME TAXES - INCOME TAXES

= NET PROFIT AFTER TAXES

NET PROFIT AFTER TAXES+DEPRECIATION+EXCEPTIONAL

6) CASH FLOW ITEMS = NET CASH INFLOW

NET CASH INFLOW - NET CASH OUTFLOW(TOTAL CAPITAL

REQUIREMENT) = NET CASH FLOW

3.4 MEASURING THE PROFITABILITY

The return on asset ratio is regarded by many financial

analysts as an adequate measure of overall efficiency. This

view has been shared in many studies such as Harrington (1977)

and Fadel (1977). However, other measures of overall

efficiency have been opposed to EBIT/total assets ratio on the

ground that it only evaluate the contribution of capital

resources.

The rate of return on invested assets (r) sometimes

referred to as the return on investment or ROI, can be defined

as follow

r (profits/sales)(sales/assets)

The first item on the right hand side of the identity is

termed the profit margin and the second item the turnover

ratio. The profit margin is intended to serve as a measure of

the relative efficiency with which the firm produces its

60
output, whereas the turnover figure is designed to measure the

efficiency with which the firm utilises its plant and

equipment. Lerner and Carlton (1966) extracted profits from

the above equation which is

P (1-T)(rA-iL)

where

P Profits

T ... corporate tax rate

3 - rate of return on assets (EBIT/assets)

A - level of assets

i = interest rate paid on debts (I/L)

L = liabilities (borrowed funds)

To modify this expression somewhat further if we let the

symbol E equity. Since A = L+E, the equation can also read

P (1-T)[rL+rE-iL]

or P = (1-T)[r+(r-i)L/E]E

or P I E = (1-T)[r+(r-i)L/E]

Assume that the goal of the corporation is to maximise the

rate of return on shareholder's equity,P/E. Management would

then have to determine what capital structure (LIE) will lead

to this result. Taking the partial derivative of the rate of

return on equity (P/E) with respect to the L/E ratio, and

setting it equal to zero.

d(P/E)/d(L/E) = (1-T)(r-i) = 0

Since (1-T) > 0

Therefore (r-i) = 0

and r = i

61
 This is that the corporation should expand its ratio of

debt to equity (LIE) until the rate of return on assets (r) is

equal to the rate of interest. This has also been used as a

"rule" for determining the cut-off point for the use of debt.

The theory is that the use of funds by a company and, in

particular, funds obtained by borrowing, should be no more

than the amount that yields a rate of return, r, equal to the

rate of interest, i.

Unfortunately, there are two serious difficulties with this

conclusion

1) In taking the derivative of P/E with respect to

LIE we treated the values of 'r' and 'i' as constants rather

than as function of other economic variables. But if they are

constants, there is no mechanism that permits the values of

'r' and 'i' to be identical!

2) If the firm should find that its rate of return

on assets equal the interest rate it pays on debt, it still

would have no idea whether the rate of return on equity was a

maximum or a minimum value, for equation (P/E) is linear and

therefore has second and higher derivatives identically equal

to zero.

How then can the optimal relationship between the rate of

return on equity and the capital structure be determined? One

widely used method is to treat i as a function of some other

variable. For example assuming that the interest rate is a

rising function of the ratio of debt to equity, and the rate

of return is independent of changes in the firm's size and

capital structure.

62
 P/E = (1-T)[r+(r-i)L/E]

i f(L/E) dL/B ===> d > 0

r r
0

by substituting

P/E (1-T)[r + Cr -dL/B)L/E]

0 0
2
P/E (1-T)[r + r LIE - d(L/E) ]
0 0

d(P/E)/d(L/E)= (1-T)(r -2dL/E) = 0

0

r 2dL/E = 2i
0

L/E r /2d
0

Since the second derivative of this expression with respect

to LIE is -2d(1-T) the rate of return on equity with respect

to changes in capital structure (LIE) will be a maximum when

the first derivative equals zero.

3.5 BEHAVIOURAL EQUATIONS

The information available to the financial analyst consists

primarily of the corporation's historical accounting records,

the task of financial analysis is to go behind such data to

reveal the economic structure of the corporation's

performance. The task of going behind corporate financial

records to uncover the underlying economic processes is

complicated by the presence of two closely related problems:

63
 First the complex interdependence of the relevant

variables.

Second, the presence of a high degree of uncertainty

in the corporation's decision making environment.

To attack the problem of interdependence, accounting

statement equations (such as A = L + E) must be combined with

statements specifying the economic relationships between

variables (such as the rate of return (r) is a declining

function of the rate of growth (g) of corporate assets). The

economic statements will be called "behavioural statements",

"behavioural equations", or "behavioural constraints". The

behavioural aspects of accounting data was investigated using

multivariate procedures and regression analysis by Chambers

(1966), Benston (1966) and Burns (1970). When the accounting

and behavioural statements are combined, they result in a

model or a system of equations that can be used both as a

frame of reference and as a tool for analyzing observed data.

accounting equation= P/E= (1-T)[r+ (r-i)L/E]

behavioural equation= i= dL/E

exogenous variable= r= r
0

It is impossible to derive behavioural relationships that

describe completely all details of reality, the analytic power

of reasonable approximations brought together in a systematic

way can be immense.

Including the relevant variables in appropriate functional

form can never be complete, there will always remain

64
unexplained influences on the behaviour of corporate profits.

The effects of such residual influences, which together can

often be important, are usually taken into account by the

inclusion of a random error term in the behavioural

relationship. Thus

i= dL/E

is rewritten as i= dL/E + u

where u is a random variable. The statistical properties

of u are very important.

As we have seen so far it is almost impossible to evaluate

corporate profitability just by a single criterion. It might

be better to evaluate and analyse all the possible financial

ratios which are directly or indirectly related to

profitability.

3.6 PROFIT VS PROFITABILITY

Profitability is a concern of high-level management but

requires conscious attention at all levels of an organisation

if it is to be attained. Profit and profitability are

different concepts. Accounting principles determine the

measure of profit. Profit is fundamentally a short-term

evaluation that is an income statement for 1 year- and is

therefore amenable to distortion. It is possible for a

company to show a profit for 1 year when in truth it is losing

money over the long run. The recognition of time as a

fundamental constituent of profitability is paramount, and

profitability is a long-term concept.

65
 Profitability can be evaluated only after time has elapsed

and future profitability can only be estimated. For example

the automobile industry showed a profit for the late 1970s,

but it failed to tool up for the oncoming demand for small,

economical automobiles. The year 1980 was a disaster for

profits and revealed in retrospect that the profits of the

late 1970s were false because the investment necessary for

change and modernisation had been disregarded. Again nothing

should be given an ultimate judgement on a short-term basis,

and even a short-term venture should be evaluated on the basis

of its long-term effect since it will influence the future

beyond its termination.

3.7 RISK VS PROFITABILITY

Risks may be of either a technical or economic nature.

Some risks must be taken, because they are too inviting to

forego. While some risks are too great to be taken. In any

event, the primary concern should not be with eliminating

risks, but with selecting the right risks to be taken. The

only way to avoid risk is to do nothing, which is actually the

greatest risk of all in business. Actually, risks in business

can never be avoided. Even a course of action that minimises

risk is not always desirable. According to Friend & Blume

(1970) and Wagner & Lau (1971) studies, there are several ways

that risk and uncertainty can be anticipated and handled so

that their possible harmful effects can be minimised.

66
 The calculation of desired profitability or ROI of a

company should consider three major elements:

1) pure interest

2) compensation for management

3) compensation for risk

The pure interest represents the return that could be

realised by placing the available funds in some alternative

secure, interest-paying investment. This alternative

investment might be certificates of deposit, treasury bills,

high-grade bonds, or other investment media. In general, the

rate of pure interest applicable to invested funds fluctuates

between 8 and 10 percent, depending on the condition of the

money market. Another 1 or 2 percent should be included in

the ROI as reward for management's seeking out, evaluating,

and reaching a decision on where the funds could best be

placed. Finally, the risk portion of the business return must

be added. This is strictly a judgment factor and can range

from 1 to 40 percent or more, depending on the particular

business. Typically, a business having average risk should

earn from 6 to 10 percent just on the basis of its risk, plus

another 8 to 10 percent for pure interest a d 1 to 2 percent

allowance for investment management. The average business,

then, should earn from 15 to 20 percent, after taxes,

averaging about 18% ROI.

67
 Table 3.7.1 Typical profitability objectives for companies

having different levels of risk.

Allowance for
Total Typical 1
Risk level Interest !Management Risk return return 1

(2) (2) 1 (2) (2) (2) 1

1) very low 8-10 0-1 1-3 9-14 11 1

2) below average 8-10 1-2 2-6 11-18 15 1

3) average 8-10 1-2 6-10 15-22 18 I

4) above average 8-10 1-2 12-20 21-32 25 1

5) high 8-10 1-2 20-40 29-52 41 1

Another consideration about risk and profitability

relationship is that financial decisions affect the value of a

firm's stock by influencing both profitability and riskiness

of the firm. This relationships are illustrated in Figure

3.7.2.

68
 Table 3.7.2 Influence of profitability and risk on the

value of firm's stock.

CONSTRAINTS POLICY DECISIONS

Antitrust Line of business

Product safety size of firm

-
Hiring --- type of equipment Value of Firm

Pollution control use of debt

and so on Liquidity position Risk

and so on

An increase in the cash position, for instance, reduces

risk, however, since cash is not an earning asset, converting

other assets to cash also reduce profitability. Similarly,

the use of additional debt raises the rate of return, or the

profitability, on the stockholders' net worth, at the same

time, more debt means more risk. The financial manager seeks

to strike the particular balance between risk and

profitability that will maximise the wealth of the firm's

stock holders. Wippern (1966) and Elliott (1972) are

recommended for further study.

3.8 RESTRAINTS IN PROFITABILITY ANALYSIS

1) A single criterion is inadequate for a full

evaluation of profitability.

2) The most important estimates in the evaluation of

profitability are the predictions of cash flows, with sales

69
volume and sales price being the most critical factors. The

possibility of enormous changes in raw materials costs and

availability are becoming commonplace in a world that seems to

be running short of everything.

3) Operating costs are more critical than investment

since the former are repetitive and the latter is made only

once.

4) Some restraint should be used when comparing cash

flows. Although it is not a definition, cash flow is

principally the sum of profit plus depreciation. A high cash

flow may merely signify a high depreciation expense, that is,

a high cost for wear and tear of equipment caused by frequent

replacement.

5) Future improvement in quality control must be

anticipated since a competitor may offer a superior product.

Reliability of production may be a factor, involving attention

to inventories from raw materials.

6) Allocation of overhead costs can have an

important influence on apparent costs and profitability of

individual products and services.

7) The influence of government is important. Plants

have closed because they were unable to meet for example

antipollution requirements.

8) During periods of inflation, there is a

temptation to capitalise expenses. A fixed amount, written

off in part of or wholly as a future expenses, will appear to

be less at a future time, when the value of the money is less.

9) There are different ideas among researchers

regarding which value to use as denominator of ratio related

70
to profitability and the possible mathematical pitfalls

accompanying the use of ratios. Recently, some financial

researchers, such as Taffler (1976) and Mao (1976) among

others, have advocated the use of average or beginning of year

figures rather than the usual year-end figures for items

placed in the denominator of profitability and turnover

ratios.

The essential ingredients for profitability for a company

are as follows:

1) profitability should be judged on a long-term

basis.

2) operations must be as efficient as possible,

recognising that technology is always in flux.

3) the diffusion effect of peripheral activities

should be held to a minimum.

3.9 PROFITABILITY RATIOS

Profitability ratios are intended to indicate whether there

has been a satisfactory rate of return for being in business.

To achieving this goal, all the profitability ratios which

have been studied in chapter 2 are summarised here as a

primary ratios for financial analysis.

R NPAT/SALES
1
R NPAT/TOTAL ASSETS
2
R NPAT/NET WORTH(SHAREHOLDERS' FUND)
3
R NPAT/WORKING CAPITAL
4

71
R = NPAT/TOTAL DEBT(TA-SF)
5
R = NPAT/CURRENT ASSETS
6
R = NPAT/FIXED ASSETS
7
R = NPAT/(PREF.DIVIDENDS+COMMON DIVIDENDS)
8
R = NPAT/(TOTAL ASSETS - CURRENT LIABILITIES)
9
R = (NPAT-PREF. DIVIDENDS)/COMMON STOCK
10
R = EARNING BEFORE INTEREST AND TAX(EBIT)/TOTAL ASSETS
11
R = EBIT/SALES
12
R = EBIT/NET WORTH(SF)
13
R = EBIT/(TOTAL LIABILITIES - CURRENT LIABILITIES)
14
R = (EBIT + DEPRECIATION)/NET WORTH(SF)
15
R = (EBIT + DEPRE.)/(TOTAL LIABILITIES - CURRENT LIABILITIES)
16
R = NET PROFIT FOR COMMON/COMMON STOCK AT MARKET VALUE
17
R = EARNING PER SHARE(EPS)/PRICE PER SHARE
18
R = EPS
19
R = SALES/(LONG TERM DEBTS+PREF. STK+COMMON STK)
20
R = SALES/TOTAL ASSETS
21
R = SALES/NET WORTH
22
R = SALES/WORKING CAPITAL
23
R = SALES/FIXED ASSETS
24
R = SALES/CURRENT ASSETS
25
R = SALES/TOTAL DEBT(TA-SF)
26
R = (SALES-VARIABLE COSTS)/EBIT
27
R = DIVIDENDS/NPAT
28
R = DIVIDENDS/NET CASH FLOW(NPAT+DEPRE. +EI)
29
R = DIVIDENDS PER SHARE
30
R = NET PROFIT PER SHARE OF COMMON FOR 2nd B.C/
31 NPPS OF COMMON FOR 1ST BC

R = LOWEST NPAD-AVERAGE 3 PREVIOUS YEARS OF NPAD/

32 AVERAGE 3 PREVIOUS YEARS OF NPAD

72
R (DEPRECIATION+TOTAL INTEREST+TOTAL TAX)/(TOTAL CAPITAL)
33

3.10 MANAGERIAL PERFORMANCE

Sharpe (1963), Radnor, Rubenstein & Ben (1968) and Thornton

& Byham (1982) were concerned in their studies with the

managerial performance assessment. A study in the USA by Dun

and Bradstreet (1973) came to the conclusion that 93 percent

of the causes of failure stemmed from, managerial inexperience

and incompetence, the rest being 'neglect' 2 percent, 'fraud'

2 percent, 'disaster' 1 percent, and 'unknown' 2 percent, the

evidence for 'bad management' was

a) Inadequate sales 44 percent

b) Competitive weakness 24 percent

C) Heavy operating expenditure 9 percent

d) Inadequate control of debtors 8 percent

e) Excessive fixed assets 4 percent

f) Inadequate inventory control 4 percent

g) Poor geographical location 2 percent

h) Others 4 percent

Argenti (1976) identified five characteristics of bad

management:

1) One-man rule (not by any means necessarily a one-

man business)

2) A non-participating board of directors

3) An unbalanced team of managers (in the functional

and personality senses)

4) A weak finance function

73
 5) A company in which the chairman and chief

executive are the same person

The consequences of the poor management are:

1) Deficient accountancy information

2) Not responding to changes

3) Overtrading

4) Launching a big project

5) Rising company's gearing

The deficiencies in the accountancy information system

relate particularly to inadequate budgetary control, cash flow

forecasts and costing system. Because there is no established

way of planning for changes, change- or failure- will be

forced on the company. In the last few months before failure,

the symptoms of failure become more frequently observable and

more severe. The stock market will already have reduced the

price of the company's securities, but even now, Argenti

claimed, 'top managers are protesting that all is well, that

the embarrassment is temporary or non-existent'. Argenti

quoted Sir Denning Pearson, chairman of Rolls Royce Ltd as

saying, seven months before the company's insolvency in 1971,

'the company is in good shape'. Normal dividends are often

paid, and the accounts continue to show that things are not as

bad as other indicators suggest. By this time, the owners of

the company have almost certainly lost their money, and the

creditors are well on the way to losing theirs.

74
3.11 MANAGEMENT VS RISKINESS OF LOAN

The supply of funds that a lender will advance to a

corporation is not unlimited. Rather, the supply is a

function of both the interest rate the lender receives and the

riskiness of the loan. The higher the interest rate, the

greater the quantity of funds that a lender will advance, on

the other hand, the higher the risk exposure, the lower the

quantity offered. Both of these variables, the gross interest

rate and the riskiness of the loan, are functions of other

variables:

Gross interest rate is a function of:

1) competitive conditions

2) growth of the markets serviced by the lending

institutions

3) monetary and fiscal policy of the notion

Riskiness of a loan is the function of:

1) ability of the corporation's management

2) debt/equity

In general, the better the management, the less risky the

loan, for the likelihood that the loan will be repaid is

greater. As the ratio of debt to equity rises, however, the

loan becomes more risky. A company with a low debt-equity

ratio may still fall into bankruptcy if its liabilities fall

due at a time when its assets are unsalable. Nevertheless, we

may safely assume that in most cases the smaller the debt-

equity ratio of any one firm, the less likely it is that the

firm will encounter financial difficulty. To summarise this,

75
the risk exposure of a loan (e) can be expressed as a function

of both Firm's management ability and its debt-equity ratio.

e = f(M, LIE)

where

M - an index of management ability

the partial derivatives are

de/dM = f <0 and de/d(L/E) = f >0

1 2

Since f is negative, the risk exposure of a loan will fall as

1

management improves, since f is positive, the risk exposure

2

will rise as debt-equity ratio increases.

3.12 MANAGERIAL PERFORMANCE RATIOS

From 1966 to 1978, some studies were undertaken to

investigate the usefulness of financial ratios in measuring

the managerial performance by Page & Canaway (1966), Prasad

(1966), Stokes (1968), Berkwitt (1971), Simons (1974), Jones

(1976) and Beer, Dawson & Kauanagh (1978).

Although it may be argued that all ratios in some way help

to asses the efficiency of management's actions, there are

specific management functions which can be investigated

directly by ratios. Frequently referred to as efficiency or

activity ratios, they embrace such issues as the time it takes

to receive payment from customers, the time taken to pay

suppliers, the length of the cash conversion cycle, the

76
 turnover of inventory, the cost efficiency of operations, and

relative "balance" of debt-equity -working capital-assets

components within the overall structure of financial position.

All these ratios are summarised as:

R SALES/INVENTORY
34
R SALES/DEBTORS
35
R = SALES/ACCOUNT RECEIVABLES
36
R = SALES/COMMON STOCK AT MARKET PRICE
37
R SALES/AVERAGE ACCOUNT RECEIVABLES
38
R = SALES OF 2nd BUSINESS CYCLE/SALES OF 1st BUSINESS CYCLE
39
R (SALES + CHANG IN INVENTORY)/INVENTORY
40
R INVENTORY/TOTAL ASSETS
41
R INVENTORY/WORKING CAPITAL
42
R INVENTORY/SALES
43
R INVENTORY/CURRENT LIABILITIES
44
R INVENTORY/(TOTAL ASSETS - CURRENT LIABILITIES)
45
R INVENTORY/CURRENT ASSETS
46
R DEBT/WORKING CAPITAL
47
R - CURRENT LIABILITIES/INVENTORY
48
R = CURRENT LIABILITIES/WORKING CAPITAL
49
R - CURRENT LIABILITIES/TOTAL ASSETS
50
R - (TOTAL LIABILITIES + PREF. STOCK)/TOTAL ASSETS
51
R - COMMON DIVIDENDS/COMMON STOCK AT MARKET VALUE
52
R COMMON DIVIDENDS/NET PROFIT FOR COMMON
53
R COMMON DIVIDENDS/NPAT
54
R - COMMON STOCK (BOOK VALUE)/TOTAL CAPITAL
55
R COMMON STOCK (BOOK VALUE) /COMMON STOCK (MARKET VALUE)
56

77
R ... COMMON STOCK/NET WORTH
57
R = FIXED ASSETS/NET WORTH
58
R = FIXED ASSETS/DEBT
59
R ... FIXED ASSETS/TOTAL ASSETS
60
R - FIXED ASSETS/(TOTAL ASSETS - CURRENT LIABILITIES)
61
R =. RECEIVABLES/SALES PER DAY
62
R = RETAINED EARNINGS/TOTAL ASSETS
63
R ... RETAINED EARNINGS/NPAT
64
R ... RETAINED EARNINGS/NET WORTH
65
R = ACCOUNT PAYABLE/PURCHASE PER DAY
66
R ... OPERATING EXPENSES/GROWTH MARGIN
67
R = OPERATING EXPENSES/TOTAL ASSETS
68
R ... (OPERATING EXPENSES+COST OF SALES)/SALES
69
R = COST OF SALES/AVERAGE GOODS INVENTORY
70
R = COST OF SALES/SALES
71
R = DAYS IN PERIOD/INVENTORY TURNOVER
72
R = CASH/CURRENT ASSETS
73
R = NET WORTH/TOTAL ASSETS
74
R - TOTAL INTEREST/TOTAL ASSETS
75
R = TOTAL INTEREST/EBIT
76
R - TOTAL TAX/NPAT
77
R = (PBT+INTEREST CHARGES+LEASE CHARGES)I(INTEREST CHARGES
78 + LEASE)

R ... BOOK VALUE PER SHARE

79

78
3.13 OPTIMUM AMOUNT OF CASH

The manager's objective is to maintain sufficient cash on

hand or at short call to meet any normally predictable expense

without resorting to expensive overdrafts or other costly

emergency measures. Ideally, however, he will gauge matters

so finely that he never actually has more cash on hand than

will be needed, because surplus cash is an idle asset, and as

such it incurs an opportunity cost: the cost to the company of

what it could earn if invested elsewhere in securities or in

longer-term deposits. The extent to which cash is put to

effective use within the business will reflect agreeably in

the profit level: the more the better, to put it simply. But

there are limits. The loss of liquidity due to maintaining

very low cash balances could lead the company into

difficulties. The key to the management of cash and of all

working capital is therefore a matter of striking a balance

between liquidity and profitability. The success of working

capital management or cash management depends upon knowledge

of the cash flow position of the company.

Bierman (1960), Archer (1966), Wright (1973) and Samuels &

Wilkes (1975) developed some models and quantitative

techniques for determination of company cash balance. Samuels

and Wilkes(1975) suggested that a decision on the optimum

amount of cash a company should hold is a similar question to

the decision on the optimum amount of inventory.

Let

Q- Optimum amount of cash-like assets to be obtained

from outside sources.

79
 D = The amount of cash to be used in the next time

period

IC= Fixed cost of financial transactions involved in

obtaining new funds.

k- The interest cost of holding cash

D is amount of cash to be used in each of a number of

succeeding time periods and Q is the total amount to be raised

to provide for this, therefore

T = Q/D (no of periods involved)

So The average fixed cost per period will be

KIT KD/Q

The second cost, representing the interest lost through

holding cash-like assets, has an average cost that increases

as the amount of money raised at each attempt increases. The

cash on hand at the beginning of the period is the amount

raised Q, at the time the next amount of cash is raised, the

stock of cash will have fallen to zero and so the average

level of cash is

1/2(Q+0) = 1/2(Q)

the average cost of carrying cash = (kQ)/2

The average total cost incurred per period in maintaining a

certain average level of cash is therefore:

C =kQ/2 + KD/Q

As shown in the section on inventories, using differential

calculus the optimum value of Q is:

80
 = \/(2KD/k)

This analysis has assumed that the amount of cash required

during a period is known with certainty. It assumes that, it

is possible to forecast the amount that will be required over

the period. In reality it may not be possible to predict with

certainty the amounts that will be required. There may well

be a cost attached to running out of cash. There are also the

normal cost of holding cash. In a situation of uncertainty,

formulation of an optimum policy involves weighting the costs

of carrying funds against the costs of running out of cash.

More precisely, where uncertainty exist the usual objective is

to minimise 'expected' costs per period of time.

Expected Costs (EC) . Expected transactions cost per

period + expected holding cost per period + expected shortage

cost per period

Where the transactions cost is a known constant K, as

are k(the interest cost of holding 1 pound for one period)

and c(the cost of being short of 1 pound for one period)

we should expect c>k.

The calculation of expected costs implies that the

probability distribution of costs are known. It is also

assumed to be the same for each time period. Often there is

a lag between deciding new funds are required and them

materialising. Here the lag is given the symbol L

81
 If the expected demand rate is D so the expected cycle
length is

EC - Kii + kP + cP /i
1 2
where
P the expected number of unit periods of cash stock
1
P the expected number of unit periods of cash shortage
2

Figure 3.13.1 can help to determine the expected number of

unit periods of cash stock.

Figure 3.13.1

Time

R - the 're-order point'

n

P 1/2TQ + i(R-h)

h - expected leadtime demand - LD

D - distribution

EH (expected holding cost per period) = i(iT/2+R-LE)K/i

S =, expected number of shortage

EC - KE/ii + k( l if2+R-L17)) + cl(-151/&)

82
 Which should be minimised witb respect to R. Usually this

would involve an enumerative procedure selecting various

values of R and drawings from the distribution of D rather

than mathematical minimisation.

83
THE MILLER MODEL

The Miller (1975) model has four sets of assumptions.

1.1) The firm has two types of asset-cash and a separately

managed portfolio of liquid assets whose marginal and average

yield is u per pound per day.

1.2) transfers between the two asset accounts can take

place, at a marginal cost of y per transfer.

1.3) such a transfer takes place instantaneously, there is

no leadtime

2) there is a minimum level below which a firm's bank

balance is not permitted to fall.

3) Let 1/t = some small fraction of working day- thus 1(8=

one hour. During this time the cash balance will either

increase by 'm' pounds with probability p, or decrease by 'm'

pounds with probability q = 1-p.

4) It is assumed the firm wishes to minimise its long-run

average cost of managing its cash balance. The cash balance

will be allowed to wander freely between an upper and a lower

limit. As long as the balance is within these limits no

action will be taken, but when the balance reaches the upper

limit (h) above the safety level or the lower limit, a

transfer will take place between the two asset accounts, to

restore the balance to a required level (z) above the safety

level.

84
 Let

E(M) = average daily cash balance

E(N) = expected number of portfolio transfers

(in either direction)

y = cost per transfer

u = daily rate of interest earned on a portfolio

2
sd = variance of the daily demand for cash

Then cost per day of managing the firm's cash balance over

a finite planning horizon of T is

E(C) = y[E(N)/T] + u[E(M)]

The objective is to minimise this function - this is, the

cost per day. The result is that (starred variables represent

optimum values)

* 3,/ 2
Z = \ (3ysd t/4u)

* *
h = 3Z

The model obtains a relationship between the average cash

holding of the firm and the three explanatory variables of the

form

2
M = 413\ 3ysd /4u

Where M is the average cash balance the firm wishes to

maintain for transaction purposes. The control actions are:

(a) When the balance held for transaction purposes falls to

85
 *
the safety level, sell securities of amount Z pounds.

(b) When the balance held for transaction purposes rises to

*
h above the safety level, buy securities of amount 2Z pounds.

Figure 3.13.2 The Miller Model of Optimum Amount of Cash

CRI1
•.....
a)
C.)
g
M
H _ . 1_
0 x
..0
.4
m 2z
as h
C.)

PI
-
H
• rl
0
z
1::)

Safety leve

A B (1
Time
At the time A the transaction balance reached zero, so

securities to the value of Z pounds were sold. At time B

transaction balance went below the safety level so the

securities to the amount of (z+a) pounds were sold. At the

time C the balance exceeded the safety level by L pound, so

cash was used to buy securities to the value of 2Z pounds,

thereby reducing the transaction balance to Z pounds above the

safety level.

MATHEMATICAL PROGRAMMING APPROACH

The mathematical programming technique was developed by

Haley (1967), Calman (1968), Rao (1973), and Charnes, Cooper &

Miller (1975). Charnes, Cooper & Miller stated that the

amount of cash available might be limited by the sales and

purchases.

86
purchases.

The amount of cash available at any time opening

balance(inventory) + sales - purchases

Let
TP - total profits up to the planning horizon

n - the number of periods in the planning horizon

P estimated selling price(per ton) in period j

C - estimated purchase price(per ton) in period j

Y - the quantity to be sold in period j (tons)

X - the quantity to be purchased in period j (tons)

B - warehouse capacity (tons)

A - initial stock at warehouse (tons)

The objective is to maximise:

TP =t13 Y -ItCX
j j j=1 j j

subject to

i-1
- <B- A (i = 1,2,3,....,n)
j = 1 j j-1 j

i-1
Y -X <A (i = 1,2,3,....,n)
j=1 j 3=0 j

X ,Y > 0 (j - 1,2,3 ..... ,n)

j j
At any time (i), purchases in the period (X ), shall not

exceed the warehouse capacity initially available (B - A) plus

i-1
sales up to i ( k__ Y ) minus previous purchases ( X ).
j=1 j j=1 j

87
for example if i = 2

X <B-A+Y +Y - X (buying constraints)

2 1 2 1

On the other hand the amount available for sale is the

initial stock A plus total purchases up to and including the

i-1
previous period (C: X ) minus total sales up to and including
j=1 j

i-1
the previous j = 1 period ( Y )
j=1 j

for example if i = 3

Y <A+X+X-Y- Y (selling constraints)

3 1 2 1 2

M - the initial cash balance

0

M - the minimum cash balance permissible

and write

i-1

CX- 7-- PY<M- M (i = 1,2,3,....,n)
j=1 j j j=1 j j 0

Financial constraints require that the value of purchases

in a period shall not exceed the excess of the initial cash

balance over the requisite minimum cash balance (M -M) plus

0

the total value of sales up to and including the previous

i-1
period (=IP Y ) minus the total value of purchases up to
j=1 j j

i-1
and including the previous period (ZC X ).
j=1 j j

For example in the third period it is required that

C X <M-M+PY+PY -CX -CX

33 0 11 22 11 22

88
 In the above it is being assumed that collection of debts

takes one period but allowance can be made for lags in both

the collection of debts and the payment of creditors. If it

is assumed that payments are made g periods after purchase,

and cash is collected r periods after the sale, then the

financial constraints can be written as

C X -P Y <M -M
j=1 j-g j-g j=1 j-r j-r 0

3.14 LEVERAGE ANALYSIS

The major financial markets available to corporations

include corporate bonds, corporate equities, commercial bank

loans, and commercial paper. Corporate bonds, equities, and

bank loans constitute the most important sources of long-term

capital used in financing companies. Bank loans and

commercial paper are employed extensively as sources of

relatively short-term working capital.

Park and Jackson (1984) determined the annual interest cost

of a bond as:

1) Current market price

2) Redemption or maturity value

3) Coupon rate or annual interest payment

4) Years to maturity

Given price, coupon rate, and maturity date, the present

value can be determined to establish the attractiveness of the

bond as an investment.
89
 P = M/(1+R) + C[((l+R) -1)/R(1+R) ]

Where

P = present value

M = redemption or maturity value

C = annual interest payment determined by the coupon

rate

R = an appropriate discount rate

N = number of years until the bond matures

A 1000 pound bond maturing in 16 years and bearing a 5

percent coupon (yielding 50 pound annually) is, at a 7 percent

discount rate, worth

16
P = 1000/(1.07) + 50[(1.07)-1]/0.07(1.07) = 339 + 472 = 811

The present value of this bond's redemption value is 339

pound, and the annual interest payments are worth 472 pound at

the 7 percent discount rate.

Under these conditions, if the bond is sold for less than

811 pound it will yield(or cost its issuer) more than 72

annually, similarly, if the bond is priced above 811 pound it

will yield or cost less than 7% annually over its remaining

life.

90
 Optimal financial and capital structure was studied by

Lintner (1963) and Krouse (1972). Consider a company having

the following financial structure.

Table 3.14.1 Company's Financial Structure

I I

1
1 PERCENT OF AFTER TAX(a) I WEIGHTED
I 'TOTAL CAPITAL I COST (Z) I COST (Z)
1
+

SHORT TERM DEBT 5.0 6.0 0.30

LONG TERM DEBT 15.0 8.0 1.20

SHAREHOLDERS' EQUITY 80.0 10.0 8.0 1

+ +

1
TOTAL 100.0 9.50 I
+ +

a) Interest paid is deductible from gross income, dividends

are not.

1) Shareholders' equity = Capital stock(common+pref)

+ retained earnings + other long term reserves

2) Cost of debt=average market rate for short term

debt = 6%

3) Cost of debt=average market rate for long term

debt - 8%

4) Overall cost of capital - 9.5%

 If we change the above capital structure to:

Table 3.14.2 Company's Financial Structure

SHORT TERM DEBT 10 6.0 .60 1

LONG TERM DEBT 30 8.0 2.4 1

SHAREHOLDERS' EQUITY 60 10.0 6.0 1

TOTAL 100.0 9.0 1

The overall cost of capital would drop to 9%. This company

obviously would prefer debt to equity financing.

3.15 SOLVENCY RATIOS

In the third category, ratios are used in an attempt to

assess the question of whether current debts will be paid on

their due dates, and the capability of meeting both the

principal and interest payment on long-term obligations. In

addition to liquidity aspects, analysts calculate

capitalisation ratios to determine the extent to which a firm

is trading on its equity and the resultant financial leverage.

Accordingly there is an attempt to assess the financial risk

associated with common owners' equity.

R - CURRENT ASSETS/CURRENT LIABILITIES

80
R CURRENT ASSETS/TOTAL ASSETS
81
R - CURRENT ASSETS/SALES
82

92
R = CURRENT ASSETS/NET WORTH
83
R = (CURRENT ASSETS - INVENTORY)/TOTAL ASSETS
84
R = (CURRENT ASSETS - INVENTORY)/SALES
85
R = (CURRENT ASSETS - INVENTORY)/CURRENT LIABILITIES
86
R = CASH/(TOTAL ASSETS - CURRENT LIABILITIES)
87
R = CASH/SALES
88
R = CASH/CURRENT LIABILITIES
89
R = CASH INTERVAL
90
R - CASH FLOW/SALES
91
R = CASH FLOW/TOTAL ASSETS
92
R = CASH FLOW/NET WORTH
93
R = CASH FLOW/CURRENT MATURITIES OF LONG TERM DEBT
94
R = CASH FLOW/CURRENT LIABILITIES
95
R = CASH FLOW PER COMMON SHARE
96
R - CASH FLOW/TOTAL LIABILITIES
97
R = WORKING CAPITAL/INVENTORY
98
R = WORKING CAPITAL/FIXED ASSETS
99
R = WORKING CAPITAL/TOTAL ASSETS
100
R - WORKING CAPITAL/CASH FLOW
101
R = WORKING CAPITAL/SALES
102
R = WORKING CAPITAL/NET WORTH
103
R = CURRENT LIABILITIES/TOTAL LIABILITIES(TA-SF)
104
R = CURRENT LIABILITIES/(CURRENT ASSETS - INVENTORY)
105
R = CURRENT LIABILITIES/NET WORTH(SF)
106
R = CURRENT LIABILITIES/CURRENT ASSETS
107
R = TOTAL LIABILITIES/TOTAL ASSETS
108
R = TOTAL LIABILITIES/NET WORTH
109

93
 R = TOTAL LIABILITIES/CURRENT ASSETS
110
R = NET WORTH/FIXED ASSETS
111
R = NET WORTH/TOTAL LIABILITIES
112
R = EBIT/INTEREST
113
R = EBIT/FIXED CHARGES
114
R NO CREDIT INTERVAL
115
R = ANNUAL FUNDS FLOW/CURRENT LIABILITIES
116
R = REDUCED SALES INTERVAL
117
R - REDUCED OPERATIONS INTERVAL
118
R DEBITORS/CAPITAL FUNDS
119
R = LONG TERM LIABILITIES/(STOCK+SURPLUS-INTANGIBLE ASSETS)
120
R = DEPRECIATION/TOTAL ASSETS
121
R = CREDITS/NET WORTH
122
R = BASIC DEFENSIVE INTERVAL
123
R = MARKET VALUE OF EQUITY/TOTAL LIABILITIES
124
R - MARKET VALUE OF EQUITY/LONG TERM LIABILITIES
125
R = (CASH+MARKET SECURITIES-CURRENT LIABILITIES)/PROJECTED
126 DAILY OPERATING EXPENDITURE

3.16 CONCLUSION

An analysis of the literature discussed in Chapter Two

reveals that 33 different profitability ratios, 46 different

managerial performance ratios and 47 different liquidity

ratios have been used as the main variables for financial

performance analysis.

The mechanics of these ratios were discussed and

demonstrated in the preceding chapter. An examination of the

94
literature reveals that the techniques available in the past

were wholly inadequate for proper analysis. Also an almost

complete lack of theory pointed to the need to develop further

both the theory and practice of financial analysis. These

aspects of financial analysis and the problems of their

application have been discussed in this chapter; particularly,

the desirability of a shift from univariate to multivariate

financial analysis.

The three dimensions represented by profitability,

managerial and solvency ratios which were discussed in this

chapter jointly measure nearly every aspect of a company's

performance. This indicates that companies' financial affairs

can be effectively controlled by concentrating on these three

dimensions only. Considering just one aspect does not mean

that a company is necessarily doing very well as a whole. For

example if a company is profitable it may not necessarily be

performing well as a whole.

At their best, these three categories of financial ratios

provide a meaningful and quantitative representation of the

results of decisions and the effects of external conditions.

They can and do serve as tools for detecting irregularities in

managerial behaviour and company performance.

95
 CHAPTER 4

METHODOLOGY OF FACTOR ANALYSIS

96
CHAPTER 4: METHODOLOGY OF FACTOR ANALYSIS

Considering all the ratios from three different categories

which have been described in Chapter Three, there are 126

different ratios in total. These ratios will comprise the

main source of initial variables which are going to be

analysed and investigated throughout this thesis.

In analysing all these ratios in an attempt to arrive at

some underlying conclusions there is a need to select the most

important and most reliable ratios. In other words, not all

of the ratios identified in the three categories are essential

for initial analysis, because of correlation between ratios.

We should select those ratios, which we use in forming a

profile of corporate financial characteristics. Correlation

of the various ratios with each other, can be expected to

exist simply because ratios use common components as their

numerators and their denominators. Because of this

statistical property only a small number of ratios can provide

a lots of information. Two or three ratios selected from each

category should be sufficient for at east the initial

analysis of a firm's financial statements. Undue

concentration of ratios from one category could bias an

overall appraisal of a firm's position.

4.1 EXSTAT LIMITATION

EXSTAT is a service- provided by Extel Statistical Service

97
Plc- of company data in a computer readable form. It covers

over 3000 British, other European, Australian and Japanese

quoted and unquoted concerns. Information included in EXSTAT

for all companies is as reported in the individual company's

accounts.

The main problem in using the EXSTAT data in the computer

centre at University of Bradford is that not all the financial

data have been made available, such as, market value of

equity, credit interval, cash interval,operating expenditures,

common stock at market value, EPS, price per share, dividend

per share, net profit per share, purchase per day, cost of

sales and so on.

By eliminating uncomputable ratios then we have the

following 86 ratios left which are the whole battery of ratios

for further analysis.

R = NI/SALES
1
R = NI/TA
2
R = NI/SF
3
R = NI/(CA-CL)
4
R = NI/(TA-SF)
5
R = NI/CA
6
R = NI/FA
7
R = NI/(PD+CD)
8
R = NI/(TA-CL)
9
R = (NI-PD)/0C
10
R (PBT+TI)/TA
11

98
R = (PBT+TI)/SALES
12
R = (PBT+TI)/SF
13
R = (PBT+TI)/(TL-CL)
14
R = (PBT+TI+DEPRE)/SF
15
R = (PBT+TI+DEPRE)/(TL-CL)
16
R = SALES/(TL-CL)
20
R = SALES/TA
21
R = SALES/SF
22
R - SALES/(CA-CL)
23
R = SALES/FA
24
R = SALES/CA
25
R = SALES/(TA-SF)
26
R - (PD+CD)/NI
28
R - (PD+CD)/(NI+DEPRE+EI)
29
R - CD/SF
30
R = (DEPRE+TI+TT)/(P5+0C+DC)
33
R = SALES/INVENT
34
R = SALES/DEBTS
35
R = INVENT/TA
41
R = INVENT/(CA-CL)
42
R = INVENT/SALES
43
R = INVENT/CL
44
R = INVENT/ (TA-CL)
45
R = INVENT/CA
46
R = (TA-SF)/(CA-CL)
47
R = CL/INVENT
48
R - CL/TA
50

99
 R = (TA+PS)/TA
51
R = CD/NI
54
R = OC/SF
57
R = FA/SF
58
R = FA/(TA-SF)
59
R = FA/TA
60
R = RE/TA
63
R = RE/NI
64
R = RE/SF
65
R = CASH/CA
73
R = SF/TA
74
R = TI/TA
75
R = TI/(PBT+TI)
76
R = TT/NI
77
R = CA/CL
80
R = CA/TA
81
R = CA/SALES
82
R = CA/SF
83
R = (CA-INVENT)/TA
84
R = (CA-INVENT)/SALES
85
R = (CA-INVENT)/CL
86
R = CASH/(TA-CL)
87
R = CASH/SALES
88
R = CASH/CL
89
R = (NI+DEPRE+EI)/SALES
91
R = (NI+DEPRE+EI)/TA
92
R = (NI+DEPRE+EI)/SF
93

100
 R = (NI+DEPRE+EI)/(TA-SF)
94
R = (NI+DEPRE+EI)/CL
95
R = (CA-CL)/INVENT
98
R = (CA-CL)/FA
99
R = (CA-CL)/TA
100
R (CA-CL)/(NI+DEPRE+EI)
101
R = (CA-CL)/SALES
102
R = (CA-CL)/SF
103
R = CL/(TA-SF)
104
R = CL/(CA-INVENT)
105
R = CL/SF
106
R = CL/CA
107
R = (TA-SF)/TA
108
R (TA-SF)/SF
109
R = (TA-SF)/CA
110
R = SF/FA
111
R = SF/(TA-SF)
112
R = (PBT+TI)/TI
113
R DEBITS/SF
119
R = DEPRE/TA
121
R = CREDITS/SF
122

One of the best techniques for summarising these ratios is

Factor Analysis which extracts a relatively small number of

factor constructs that serve as satisfactory substitutes for a

much larger number of variables. These factor constructs are

themselves variables that may prove to be more useful than the

original variables from which they were derived.

101
4.2 FACTOR ANALYSIS

Factor analysis is a technique for analysing the

interrelationships of a set of variables using different

multivariate procedures. To recognise the interrelationships

between the ratios is particularly important in our type of

study since multivariate methods have the ability of

exploiting the information content of seemingly insignificant

ratios on an univariate basis (Cooly & Lohnes, 1962, Altman,

1969).

The earliest studies in factor analysis was in Psychology

by Burts & Baks (1947), Thomson (1951), Harley & Cattel

(1962), Hendrickson & White (1964) and Turcker, Koopman & Linn

(1969). These studies were based upon a theory of general

intelligence whereby, in a battery of intellectual activity

tests there exists a factor that is measured by all the tests.

Then it was developed rapidly to investigate the

interrelationships among multivariate data.

In some scientific fields the variables are less precisely

defined, there is not so much agreement among scientists

concerning the interrelationship between variables.

Factor analysis is increasingly being used in these less

developed sciences. Factor analytic methods can help

scientists to define their variables more precisely, and

decide which variables they should study and relate to each

other in the attempt to develop the knowledge of their science

to a higher level. Factor analytic methods can also help

102
these scientists to gain a better understanding of the complex

and poorly defined interrelationships among a large number of

imprecisely measured variables.

MAJOR STEPS IN FACTOR ANALYSIS

Comrey (1973) classified factor analysis into five major

steps as follows:

1) Selecting the ratios.

2) Computing the matrix of correlations among the

ratios.

3) Extracting the unrotated factors.

4) Rotating the factors.

5) Interpreting the rotated factor matrix.

When the correlation matrix has substantial correlation

coefficients in it, this indicates that the ratios involved

are related to each other, or overlap in what they measure,

just as weight, for example, is related to height. On

average, tall people are heavier and short people are lighter,

giving a correlation between height and weight in the

neighbourhood of .60. With a large number of ratios, of which

many can be highly correlated it is difficult to identify

their interrelationships. Factor analysis provides a way of

thinking about these interrelationships by positing the

existence of underlying "factors" or "factor constructs" that

account for the value appearing in the matrix of

intercorrelations among these ratios. For example, a "factor"

of "Bigness" could be used to account for the correlation

103
between height and weight. Both height and weight would be

substantially correlated with the factor of Bigness. The

correlation between height and weight would be accounted for

by the fact that they both share a relationship to the

hypothetical factor of bigness. For further information see

Maxwell (1961), Joreskog (1963), Horst (1965), Mattsson,

Olsson & Rosen (1966), Guertin & Bailey (1970), Lawley &

Maxwell (1971) and Comrey (1973).

4.3 CORRELATION COEFFICIENTS

Factor analysis is based on the assumption that there are a

number of general factors which cause the different relations

between the ratios to arise. Such interdependence can be

regarded as a kind of basic pattern of interrelations between

the ratios in question. As Schilderinck (1977) defined the

aim of factor analysis is to group by means of a kind of

transformation the unarranged empirical data of the ratios

under examination in such a way that:

a) A smaller whole is obtained from the original

ratios, whereby all the information given is

reproduced in summarised form.

b) Factors are obtained which each produce a

separate pattern of motion or relation between

the ratios.

C) The pattern of motion can be interpreted

logically.

In general, factor analysis does not begin with the

104
original observations of the ratios. It sets about

normalising them in a certain way in order to make a mutual

comparison possible. Normalization is done by expressing the

deviations from the original observations with regard to their

arithmetical mean and their standard deviations. Some

researchers such as Afifi (1973) and Bartlett (1937) have

developed several tests for multivariate normality, but most

of them are difficult to implement.

If the number of observations ranges from 1 to T and the

number of ratios from 1 to n, and Zi represents a ratio for

which the observations have been normalised, then the

following formula is obtained:

Z x /Sx
it it i

Where

x = X - X (i=1,2,3,...,n, t=1,2,3 .... . ,T)

it it i

-Tx IT
i t=1 it

2 /T 2
Sx = = \//k11(X - X ) /T = \/ x /T
t=1 it i t=1 it

The ratios, normalised satisfy therefore the conditions:

_ T
Z =Z IT ===x /TSx =(Z=X -TX =(TR)/TSx -TX )/TSx =0
i t=1 it t=1 it i t=1 it i i i i

2 T 2 T 2 2 2 2
S z Z /T =Z:x /TS x = S x IS x = 1 (i=1,2,3,..,n)
i t=1 it t=1 it i

Herewith all the ratios are expressed in the same, uniform

105
way and made mutually comparable. The actual normalization

occurs not for each ratio individually but by calculating the

correlation matrix of all ratios together.

The simple correlation coefficient between two ratios

equals the sum of the products of their corresponding

normalised observations, divided by the number of

observations.

T 2 T 2
Sz z = C--2
Z /T= Z:x x /TSx Sx ===x x / V/C:x x
i k t=1 it kt t=1 it kt i k t=1 it kt t=1 it t=1 kt

Sz z =r
i k ik

Which equals the simple correlation coefficient between

the ratios X and X . If i=k, then the variance of Z is

obtained, which equals one, thus

2 T T 2 2 2 2
S z ===Z Z /T =Z: x /TS x = S x /S x = 1 = r
i t=1 it it t=1 it i i i

If now, the product of the matrices of the normalised

observations of the ratios under examination is determined, we

get:

Z,....,Z Z=Z Z Z
11 n1 t=1 it it t=1 it nt

Z,....,Z :=Z Z ,...., --Z Z

1T nT t=i nt it ti nt nt

106
 ITr , ,Tr I 1r , ,r 1

1 11 1n1 1 11 1n1
. 1
1= T 1 I= TR
1Tr „Tr 1 1r , ,r 1
I nl nnl ml nn1

The matrix of simple correlation coefficients is equal to:

R ZZ//T

As a consequence of (SZ Z =r ) the matrix R is to be regarded

i k ik

as a normalised matrix of variance and covariances. As a

2
consequence of (S z = 1 = r ) the element of the main diagonal
i ii

equal one.

Ratios should not be based only on measures of central

tendency and it is necessary to consider not only the extent

and direction of the deviation from the measure of central

tendency but also the dispersion and shape of the distribution

from which the measure of central tendency was calculated

(volatile).

The following ratios are eliminated from the whole battery

because of their volatile standard deviation as shown in Table

4.3.1. These standard deviations have been calculated from

for about 600 different companies throughout UR. For example

the minimum standard deviation for R4 in 1985 is .86 and its

maximum value for 1973 is 148.

107
TABLE 4.3.1: RATIOS WITH VOLATILE STANDARD DEVIATIONS

+
II
'RATIOS 11971
1 1 1 1 1 1 1
172 173 174 175 176 177 178 179 180 181 182 183 184 185
1 1 1 1 1
1
+ +

R4 3.7 4.3 148 9.4 2.8 53 5.8 3.1 6.3 1.9 10 2.1 5.413.81.861
R8 293 3.8 3.4 134 66 12 96 5.3 6.1 23 62 88 65 142 126 1

R10 3 2.5 2.8 3.8 3.1 6.6 4.7 5 12 283 13 22 13 115 1.581

R20 4.1 3.5 11 3.2 3 3.9 3.3 2.7 2.9 3.1 4.2 26 5.512.612.11

R22 5.3 4.7 79 4.5 4.7 5.6 5 4.1 3.9 3.9 5.1 26 5.515.712.71

R23 67 139 64 249 44 50 378 46 48 63 159 65 116157 193 1

R24 23 14 18 13 10 9 10 9.1 8.5 8.4 8.7 12 25 112 15•71

R28 404 .9 .67 1.7 .45 11 .61 .29 1.3 100 3.3 2 .761.8911.51

R33 3.7 3.1 3.9 4.7 3.8 4.2 4 5.2 12 7.9 8.1 11 12 110 1.751

R34 49 24 31 27 30 51 34 17 16 15 16 14 16 154 16.31

R35 12 55 28 22 19 26 25 34 33 56 25 18 24 123 121 1

R42 8 20 170 47 6.1 120 39 5.3 20 5.3 17 8.8 21 124 111 1

R47 29 58 43 109 25 27 81 27 17 23 51 22 48 124 129 1

R48 13 13 17 13 15 14 12 9.3 3.2 3.6 4.4 5.5 6.5133 11.61

R54 356 .68 .66 .98 .43 10 .55 .28 1.2 100 3.2 1.9 .711.8411.21

R64 .41 .91 .7 3.6 .46 33 .83 .3 1.3 1.5 3.8 2.1 .781.8911.61

R76 .7 .58 .51 .71 .43 12 1.1 1.4 3.3 1.6 6.2 8.2 1.415.41.551

R99 1.7 1.2 2 1.2 1.9 1.8 1.5 1.7 1.6 1.8 1.8 8.3 48 158 11.31

R101 3.5 18 5.6 16 33 7.5 5.9 34 9.8 67 58 18 15 125 18.51

R105 17 37 37 84 14 215 73 22 11 15 29 19 61 119 127 1

R106 1.3 .97 22 1.9 1.4 1.9 1.5 .94 3.9 1.3 1.6 10 1.711.41.731

R109 1.6 1.3 23 2.5 1.6 2.2 1.8 1.3 10 1.6 1.9 10 1.912.11 1 1

R113 385 166 404 106 267 173 185 217 183 184 145 116 81 168 145 1

+ +

108
 When all the interdependence correlation between ratios

have been calculated and the correlation coefficient matrix

has been obtained, then the next step is to identify those

ratios with high correlations. These ratios can be used as

surrogate for each other and therefore many of them can be

eliminated. For example as shown on table 4.3.2, R1 has the

highest correlation with R2,R6, R11,R12,R63,R91,R94 and R95,

it means that all these ratios are nearly identical with R1

and they all contain almost the same information. Therefore

they can be replaced by each other and we can keep R1 and

eliminate the others from the whole battery and from the

model. By the same way we can eliminate the other identical

ratios and come up finally with 27 ratios which are almost

independent to each other and have the lowest correlation.

109
TABLE 4.3.2: RATIOS WITH THE HIGHEST CORRELATION COEFFICIENT

+ +
1 1 1 1
1 RATIOS !YEAR 1N0 COI R2 R6 R11 I R12 I R91 R63 IR95I R94 1
+ +
1 1
1 R1 11971 339 .79 I .62 I .78 .98 .92 I .67 .76 I .67 1
1 R1 11972 j 607 II .71 I .14 I .26 I .94 I .33 I .54 I .47 1

1 R1 11973 I 562 III .49 I .96 I .93 I .46 I .62 I .52 1

1 R1 11974 I 561 I .68 .79 I .56 I .90 I .91 I .62 I .72 I .58 1

1 R1 11975 I544I .75 I .73 .65 .92 .88 J .69 .75 I .64 1

1 R1 11976 I 541 I .77 I .71 I .69 .94 I .85 I .71 I .72 I .65 1

1 R1 11977 I 574 .66 I .65 I .56 I .94 J .87 .59 I .72 I .70 1

1 R1 11978 I 548 I .67 I .66 I •57 I .91 .89 I .60 I .63 .62 1

1 R1 11979 517 I .72 I .28 I .65 I .92 I .91 I .64 I .72 I .69 1

1 R1 11980 490 .82 I .79 I .77 I .93 .87 I I .74 .71 1

1 R1 11981 I I .79 I .76 I .74 I .93 I .90 I .74 I .70 I .68 1

1 R1 11982 I 496 .81 .81 I .76 I .92 .88 I .66 I .66 .64 1

1 R1 11983 I 509 I .72 .75 I .67 I .93 I .89 I .69 I .67 .65 1

1 R1 11984 I493I .77 I .80 I .70 I .91 .89 I .71 I .65 I .60 1

1 R1 11985 I 142 I .65 .93 .54 I .91 I .89 J .62 I .80 .68 1
1 1
+ +

The remaining ratios are as follows:

R = NI/SALES
1
R = NI/SF
2
R = NI/(TA-SF)
5
R = NI/FA
7
R = SALES/(TA-SF)
26

110
 R - (PD+CD)/(NI+DEPRE+EI)
29
R - CD/ SF
30
R - (DEPRE+TI+TT)/(PS+0C+DC)
33
R = INVENT/CA
46
R - CL/TA
50
R = (TL+PS)/TA
51
R - OC/SF
57
R - FA/SF
58
R = FA/(TA-SF)
59
R -. CASH/CA
73
R = TI/TA
75
R = TT/NI
77
R = CA/CL
80
R - CA/SALES
82
R - CA/SF
83
R - (CA-INVENT)/TA
84
R - CASH! (TA-CL)
87
R = (CA-CL)/INVENT
98
R = (CA-CL)/(NI+DEPRE+EI)
101
R - (CA-CL)/SF
103
R - CL/(CA-INVENT)
105
R = DEPRE/TA
121

4.4 THE MODEL OF FACTOR ANALYSIS

Factor analysis is based specifically on inter-

correlations. It examines the effect of the general factors

which are present in more than one ratio at the same time.

111
 According to Schilderinck (1977), the factors which the

ratios can influence will be classified into three categories.

a) Common factors. F (j=1,2,3, ,n) factors which

i
influence several ratios Z (i=1,2 .... . ,n) simultaneously.
i
b) Specific factors. S (i=1,2,3, ,n) factors
i
which influence only one ratio at a time.

C) Error factors. e (1=1,2,3, ,n) factors to

i
which errors in the observation material are related.

There are two differences between the common factor and the

other two categories of factors.

1) a common factor affects several ratios Z (i=1,2 n) at

i
the same time - thereby producing one special pattern of

relations among the ratios- a specific and an error factor

affect only one ratio at the same time.

2) a ratio Z can at the same time be dependent on more than one

i
common factor, but only on one specific and one error factor.

Taking account of the three categories of factors the model

of factor analysis- expressed in normalised observations Z of

it

ratio Z - may be written as follows:

i
Z = aF +aF +....+aF +bS+C e (5)
it il it i2 2t im mt i it i it

112
 (i = 1,2,3, ,n), (t = 1,2,3, ,T)

where a (j=1,2,3 ,....,m), b and c are the coefficients

ij

corresponding to the three separate categories of factors. The

factor f , S and e can be regarded as the new, theoretical

i i

ratios. There are assumed to be normalised and mutually

independent of each other so that they must satisfy the

conditions:

T f /T = 0
j t=1 it

2 T 2
a s f f /T = 1
j t=1 jt

sf f = (f f )/T = 0
j j' t=1 jt j't

=s /T = 0
i t=1 it

2 T 2
b= Ss =s /T = 1
i t=1 it

Ss s = (s s )/T = 0
i t=1 it i't

E(e ) = e IT = 0
i t=1 it

T 2
Var(e ) = e IT = 1
i t=1 it

Cov(e e ) = ( e e )/T = 0
i t=1 it i't

113
 Sf s = E(f s )/T = 0
j i t=1 jt it

Sf e (f e )/T = 0
i i t
=1 jt it

Ss e :•(s e )/T = 0
ii t=1 it it

2
From (SZ = 1 =r ), considering (Z =af +af+....+
i ii it lilt i2 2t

af +bs +ce) and (a), (b), (c), (d), it follows that

im mt i it i it

for finite sums

2
S Z =Z:(Z Z )/T =1/T(Z:(a f +a f +...+ a f + b s +
i t=1 it it t=1 ii it i2 2t im mt i it

2 m2 T2 2 T 2 2 T 2
C e ) ) =a (==f /T) + b ( --S /T) + c (==e /T) +
i it j=1 ij t=1 jt i t=1 it i t=1 it

m m
2Z: a a (Z:f f /T) + 2b Z:a (==f s /T)
j-1 j 1 =1 ij ij' t=1 it j't i j=1 ij t=1 jt it

+ 2c Z:a (Z:f e /T) + 2b c (17. e e /T) =

i j=1 ij t=1 jt it i i t=1 it it

m2 2 2
+b +c (i=1,2,3 ,....,n)
j=1 ij i i

so that

2 2 2 2
Sz = h +b +c
i i
where

2
a) h represents that part of the total variance which

114
associates with the variance of other ratios. This part of the

variance belonging to the common factors is known as the

common variance or communality.

2
b) b is the part of the total variance, which shows no

association with the variance of other ratios, this part

belonging to the specific factor is the specific variance or

uniqueness.

2
c) c is the part of the total variance which is due to

errors in the observation material or to the ratios relevant

to the examination which have not been taken into

consideration, this is called disturbance term or error factor.

In factor analysis, little attention is paid to specific

and error factors so that the applied factor analysis is

concerned exclusively with common factors and the corresponding

coefficients, which indicate the degree to which Z is related

to the factor f .

However, the neglect of specific or errors in applied

factor analysis is not always justified. The presence of a

variable with a high specific or error variance component can

be an indication that this variable is probably related to

variables not yet involved in the study.

If, however, the variable with the high specific or error

variance component proves to be important, then other, new,

variables should be added.

115
 As mentioned previously, factor analysis aims in fact at

the analysis of the common factors f and their corresponding

coefficients, which we call factor loading. The practical

working model of factor analysis expressed in normalised

observation is therefore:

Z -a f +a f+ + a f (i1,2,3,. ..,n)
it il it i2 2t im mt

Where b and c of model (5) are assumed to be zero.

In matrix notation this is

Z = AF

or in detail

IZ , ,Z 1 la „a (I f , ,f I

I 11
1TI 1 11 iml I 11 iTI
1 1=1 11 1

12 , , Z la
1 „a lif , If 1

1nl nTI nl 1 nmll ml mT1

Where

Z = The matrix of the normalised ratios Z (i=1,..,n, t=1,..,T)

it

A = The matrix of factor loadings a (i=1,.. ,n, j=1,..,m)

ij

F = The matrix of factors f with elements f (j=1,..,m,t=1,..,T)

Substituting (Z=AF) in (R=ZZ / /T) gives us the relation

between the correlation matrix R of the normalised ratios Z

it

and the matrix of the factor loadings A.

R = ZZ 1 /T = AF(AF) / /T = A(FF / /T)A 1 = AA/

The product FF I /T is a matrix of the correlation

coefficients between the factors themselves. As these factors

are also in normalised form the product-matrix is:

116
 FF 1 = Z:f f l = TRf fi
t=1 jt jt

According to condition (a) the factors f are not correlated

thus Rf f i becomes an identity matrix so that

ii
FF / TI and FF / /T I

Equation (R=AA 1 ) shows that the product of AA / again

reproduces a correlation matrix.

4.5 FACTOR EXTRACTION

After the correlation matrix R has been computed, the next

step in the factor analysis is to determine how many factor

constructs are needed to account for the pattern of values

found in R. This is done through a process called 'factor

extraction' which constitutes the third major step in a factor

analysis. This process involves a numerical procedure that

uses the coefficients in the entire R matrix to produce a

column of coefficients relating the ratios included in the

factor analysis to a hypothetical factor construct variable.

The procedure usually followed is to "extract" factors from

the correlation matrix R until there is no appreciable

variance left, that is, until the "residual" correlations are

all so close to zero that they are presumed to be of

negligible importance. There are many methods of extracting a

factor but they all end up with a column of numbers, one for

each ratio, that represent the "loading" of the ratios on that

117
factor. These loadings represent the extent to which the

ratios are related to the hypothetical factor. For most

factor extraction methods, these loadings may be thought of as

correlations between the ratios and the factor. The most well

known factor extraction are Thurston's (1947) centroid method,

Hotelling's (1933) iterative procedure and more recently by

Francis (1965) known as Q. R. method. If a ratio has an

extracted factor loading of .7 on the factor, then its

correlation is to the extent of .7 with that hypothetical

factor construct. Another ratio might have a substantial

negative loading on the factor, indicating that it is

negatively correlated with the factor construct.

To reproduce the R matrix exactly with real data ordinarily

requires as many factors as there are data variables. It is

usually possible, however, to reproduce approximately the R

matrix with AA' where A has a number of common factors m such

that m is considerably smaller than n, the number of ratios in

R. For example

.16 .32 .28 .24 .41

.32 .64 .56 .48 = .81x[.4 .8 .7 .6]

.28 .56 .49 .42 •71

.24 .48 .42 .36 .61

Methods of factor extraction, designed to produce the A

matrix, usually seek to account for as much of the total

extracted variance as possible on each successive extracted

factor. That is, a factor is sought at each step for which

the sum of squares of the factor loadings is as large as

possible.
118
 The total variance extracted in a factor analysis is

represented by the sum of the computed communalities that is

m2
where m is the number of common factors. All the data
il ij

variable variance is not ordinarily extracted. In our case each

ratio has a variance of 1, so the total ratios variance that

could theoretically be extracted is n x 1, or n, where n is the

n2

number of ratios. If a represent the sum of squares of
i=1 ik

loading on factor k, the proportion of the total extracted

variance due to factor k is obtained by dividing this total by

the sum of the communalities.

Since n is the total variance for all ratios combined, that

is, the sum of the diagonal elements of R, then dividing the

sum of the communalities by n gives the proportion of the

total variance that is accounted for by common factors.

After the first factor has been determined, its

contribution to reproducing the R matrix is removed from R by

the operation R R-A A i , where A represents the first factor

1 11 1

vector (a ,a ,....,a ) and A l is the transpose of A , R is

11 21 n1 1 1 1

called the residual matrix after extraction of factor 1 or

the first residual matrix. It contains the residual

correlations after the contribution to those correlations by

factor 1 has been removed. If one factor is insufficient to

119
reproduce the correlations in R, then R will have same
1

values which are substantially different from zero. If this

is the case, another factor will be extracted from the first

residual matrix by the equation R =R -A A l . Thus, the second

2 1 22

extracted factor is removed from the first factor residuals.

In general, this process is continued, extracting the mth

factor from the residuals left after taking out factor m-1,

until the residuals are too small to yield another factor.

Since at each step as much variance is extracted as possible,

the successive factors become smaller and smaller from first

to last as shown by the sum of squares of the loadings in the

successive column of A. This initial A matrix does not

represent the final factor solution, however. These factors

are "rotated" from their original positions by methods which

are explained in the following section.

4.6 FACTOR ROTATION

Factor analysis in general and factor extraction methods in

particular do not provide a unique solution to the matrix

equation R AA'. One of the reasons is that the R matrix is

only approximately reproduced in practice and experimenters

may differ on how closely they feel they must approximate R.

This will lead to their using different numbers of factors.

Also, different methods of determining A may give slightly

different results. An even more important reason for lack of

unique solutions, however, is the fact that even for A

120
matrices of the same number of factors, there are infinitely

many different A matrices which will reproduce the R matrix

equally well. Comrey (1973) considered the following:

a a V v
11 12 11 12
a a
'cos a sin a 1 V v
21 22 xl I= 21 22
a a 1-sin a cos a I V v
31 32 31 32
a a V v
41 42 41 42

A V

The schematic matrix operation may be expressed as a matrix

equation

If R-AA I , then it is also true that R=VV • since if we

transpose the product AV, it may be rewritten as

(AV) 1 =V 1

Since the transpose of a product is the product of

transpose in reverse order, then

- V/

VV 1 = A A Al Ai

But ISM, included in the middle of the matrix product

gives an identity matrix, as follows:

cos a sin a xlcos a -sin al = 11 01

1 -sin a cos a isin a cos al 10 11

The reason for this is that the diagonal terms of the product

121
 2 2
matrix are equal to cos a+sin a, which equals 1 for all 'a' and

the off-diagonal elements are equal to sin a cos a -sin a cos a

which equals zero. As a result the above equation simplifies to

R = AA'

Since multiplying by an identity matrix does not alter the

matrix, that is

AIA I = AA'

As long as the matrix is of such a form that ACV= I,

then A A will reproduce the R matrix as well as A itself.

Since the value of 'a' is not specified, this means that there

are as many "matrices that will do this as there are value of

'a'.

This particular A matrix was of size 2 x 2, or order 2,

because only two factors were involved in the A matrix. If

there had been three factors the A matrix, the A matrix

required would be of size 3 x 3. In general, if there are m

factors in the A matrix, the "matrix will be of size m x m.

Any such (\matrix must meet the following requirements.

1) the sums of squares of the rows must equal 1

2) the sums of squares of the co umn must equal 1

3) the inner product of one row by another row must

equal zero for all pairs of non identical rows

4) the inner product of one column by another column

must equal zero for all pairs of non-identical

columns.

If these conditions are met, then An , . I = CV A. If

122
these conditions are not met, then AA' is not equal to the

identity matrix and A A will not substitute for A in

reproducing the R matrix in the same way that A will. The

values in a given column of A will be different from those

of A itself. This means that different constructs are

involved. Matrix A represents one set of constructs for

accounting for the data. Matrix A A represents a different

set of constructs which account for the data equally well in

the mathematical sense that both reproduce the R matrix

equally well. The rotational process in factor analysis

involves finding a matrix A such that AV will represent an

optimum set of constructs for scientific purposes.

"Since what is optimum for one investigator may not

be optimum for another, this particular phase of the

factor analytic process provides a fertile source of

differences among investigators in the way they view

the data. But, just as the artist, the engineer,

the geologist, and the farmer may all describe a

given piece of real estate accurately in very

different ways, so can various transformations of

'A' provide equally accurate but different

descriptions of a body of data."

With the advent of high speed computers analytical

solutions for the rotation problem were made feasible. The

Quartimax-type methods were firstly developed by Saunders

(1953) in which the focus was on simplifying the rows of the

pattern matrix A. Each variable would have high loadings on

the fewest possible factors and zero or close to zero loading

123
on the others. Several other methods were suggested by Mulaik

(1972) involving oblique as well as orthogonal rotation.

4.7 THE KAISER VARIMAX METHOD

The Varimax (1959) method is based on the idea that the

interpretable factor has high and low but few intermediate-

sized loadings. Such a factor would have a large variance of

the squared loadings since the values are maximally spread

out. Using the square of the formula for the standard

deviation, the variance of the squared loadings on factor j

may be symbolised as follows:

2 n 2 2 2 n 2 2
Sd = 1/nZ:(a ) - 1/n (==a )
i=1 ij i=1 ij

The variance should be large for factors, so an orthogonal

solution is sought where V is a maximum, V being defined as

follows:

m 2
V = Sd
j=1 j

In practice, V is not maximised in one operation. Rather

factors are rotated with each other systematically, two at a

2 2
time in all possible pairs, each time maximising Sd +Sd . After
i j

each factor has been rotated with each of the other factors,

completing a cycle, V is computed, and another cycle is begun.

124
These cycles are repeated until V fails to get any larger. The

fundamental problem, then, is to find an orthogonal

transformation matrix A that will rotate two factors such that

2 2
Sd +Sd for the rotated factors will be as large as possible.
i j

Consider the following:

x y X Y
11 ii
x y 'cos a-sin al X Y
22 x I 1= 22
x y 'sin a cos al X Y
33 33
. .
x y X Y
n n n n

V1 A V2

Where V1 is a matrix of factor loadings to be rotated to

2 2
maximise Sd + Sd, V2 is the matrix of factor loadings for which

2 2
Sd +Sd is a maximum, and A is the orthogonal transformation
ii

matrix that will accomplish this desired rotation. The values

in V1 are known. The values in V2 are not. The values in V2,

however, are functions of the angle 'a' and the values in V1 as

follows:

X = x cos a + y sin a

Y = -x sin a + y cos a

2 2 2 2
tan 4a = 2[n::(x - y )(2xy) - 7_1(x - y ) ( 2xy)]/n

2 22 2 2 22 2
6::[(x - y ) - ( 2xY) ]} - {[:— ( x - y )] [(2xY)] }

The value of 'a' must chosen such that the above equation

125
is maximised. To ensure that the value of 'a' gives a maximum

rather than a minimum or a point of inflection, however,

requires that the second derivative of above equation with

respect to 'a' shall be negative when evaluated at 'a'. The

angle of rotation that will accomplish this result may be

determined as follows:

tan 4a = sin 4a/cos 4a = num/denom

The angle 4a will be in the first quadrant if both

numerator and denominator of above equation are positive, and

the angle of rotation will be 'a' itself. If both numerator

and denominator are negative, the tangent will still be

positive but the required angle of rotation is

-1/4(180-4a) = -(45-a)

Since the sin and cos are both negative in the third

quadrant. If the numerator is negative and the denominator is

positive, the angle 4a will be in the fourth quadrant and the

angle of rotation will be -a. Finally, if the numerator of

the above equation is positive and the denominator is

negative, 4a will be in the second quadrant and the angle of

rotation will be

1/4(180-4a) = (45-a)

If we assume that:

2 2
A - (x - y )

2 2 2
B = [(x - y )]

C = 2xy

126
 2
D = (2xy)

then we can provide Table 4.7.1 as follow

Table 4.7.1 varimax rotation of two(x,y) factors

A AC A- D 1

.578 .562 .0182 .6497 .0003 .4221 .0118 -.4218 1

.531 .344 .1636 .3653 .0268 .1334 .0598 -.1066 1

.687 -.422 .2939 -.5798 .0864 .3362 -.1704 -.2498 1

.765 -.484 .8267 -.7405 .1232 .5483 -.2509 -.4251 1

1.8 266 7 7 1-.30531.2367 11.440 -.3587 I

-1.2033 1

Tan 4a = 2[4(-.3587)-(.8267)(-.3053)]/4((-1.2033)}-

{(.8267)- (-.3053) } = .47374

The absolute value of tan 4a is .47374 giving an angle of

0 ,
25 2 / for 4a. The angle 'a' is 6 20'. With a negative
a
denominator, the angle of rotation will be (45 - a) or 380 41/

which is rounded(39) numerator and denominator negative, the

transformation matrix is as follows:

.578 .56201 .10 .80

.531 .34401 1.7771 .62931 .20 .60

l x 1 1=
.687 -.4221 1-.629 .77711 .80 .10

.765 -.4841 .90 .11

0
Where Cos 39 = .7771 and Sin 39 = .6293
 The varimax rotation tends to possess invariance property.

This fact is pointed out by Harman (1970) when he states that,

although varimax factors do not have a greater explanatory

meaning than those obtained from other methods, those:

"obtained in a sample will have a greater likelihood of

portraying the universe of varimax factors".

So in our case, if we want to analyse and verify the

remaining ratios by factor analysis, and to find out the most

wanted and the most significant ratios among the whole 27

ratios, we should compute their Varimax rotated factors. This

has been done by using the Fortran computer language tother

with the Statistical Package for Social Sciences (SPSS).The

following tables show the highest rotated factors for each

ratio.

128
 TABLE 4.7.2 RATIOS WITH THE HIGHEST VARIMAX ROTATED FACTORS

AFTER ROTATION WITH KAISER NORMALIZATION

1 1 I I I I I I I 1 I

'RATIOS 11971 172 173 174 175 176 177 178 179 180 181 182 183 184 185 1

I I I I I I I I I I I

R1 I
.84 .641.481.7 1.811.751.851.741.851.911.831.781•721•921•951
R2 I
.76 .771-.91.841-.91-.61-.81-.71.991-.91-.91-.71.711.791.791

R5 I 1.7 1.511.8 1.811.861.731.781.811.881.851•931•881•681.691

R7 .7 .431.711.431.601.601.321.291.341.351.591.3 1.791.881.651

R26 I
.76 .811.841.831.8 1.851.741.831.831.831.841.861.681.761-.71

R29 J .9 I.99L 6 1.651.981•771.711.831.081.311.8 1.691.611.921.551

R30 I •79 .651.881.8 1•431.5 1.731.731.351.461.411.791.451.361.821

R33 .47 .741-.31.341.331.611.481.461.081.121.121.081.131.171.771

R46 1 -.9 1-.91-.81-.81.7 1-.81-.81-.71.711-.61-.61.8 1.8 1-.81-.91

R50 1 .84 1.861.781.8 1.841.891.9 1.941.741.891.911.811•871.831•971

R51 1 -.3 1-.31-.21-.21-.21-.21-.21.111.141-.21-.21-.11.1 1-.21-.21

R57 1 -.5 1-•31•9 1-.21.731.821.791.681-.91.811.881.741.5 1.351-.61

R58 1 -.6 1-.61.971-.91-.71.811•561.591-.81.721.771.951-.61.861-.71

R59 I - .8 1-.71-.81-.7I--51-.81--71--71-.61-.51-.81-.71-.51-.61-.81

R73 1 .52 1.791.881.881.891.891.851.851.851.821.851.851.871.861.941

R75 1 .41 1.371•351-.31-.41-.51.3 1.331.791-.41-.41-•41-.41•441.451

R77 1 .17 1.241-.11-.11-.11.111.191-.3 .131.091-.11.171.051.211.291

R80 1 .79 1.821.871.951-.81.721.7 1•761.8 1.651.6 1.721.551.931.831

R82 1 -.6 1-.71-.71-.71.811-.71-.61-.51-.51.6 1.721.641.431.461•591

R83 1 .66 1.841.991.571.571.511.631.671.831.831.551.971.891.881.771

R84 1 .71 1.721.8 1.791-.71.761.821.871-.81.871.861- . 71- .8 1 .7 1.691

R87 1 .93 1.881.831.9 1.891.861.821.821.851.831.821.8 2 1 .89 1 .9 1.91(

R98 1 .35 1.281.3 1.281.661.321.311.351-.31.331.321.221-.71.281.651

129
1 R101 1 .74 1.971.471.041.941-.71.441.6 1.231.251.8 1.741.351. 1.411

1 R103 1 .83 1.791-.91.651.7 1.711.831.831.981.761.811-.91.761.931.881

1 R105 1 -.6 1-.51.6 1-.61.761-.51-.51-.41.621-.41-.51.651.481-.51-.61

1 R121 1 -.3 1-.31-.51-.31-.41-.41.251-.41-.41-.41-.31-.31-.41.511-.41

1 1 1 1 1 1 1 1 1 I 1 1 1 1

If we assume that

A = 1.00 - .90

B = .90 - .80

C = .80 - .70

D - .70 - .60

E - .60 - .50

F= .50- .00

Then we can illustrate the above table as follow



Table 4.7.3 Transforming the Table 4.7.2

+
I 1
I 1 1 1 1 1 1 1 1 1 1 1
'RATIOS 11971 172 173 174 175 176 177 178 179 180 181 182 183 184 185
+
1 11111111 1 I 1
R1 I B ID FICIBIC BIC BIA BIC CIAIA
R2 I C IC AIBIAID BIC AIA BIC CIBB

R5 I B IC EIBIBIB CIB BIB BIA BICC

R7 I C IF CIFIDID FIF FIF EIF BIAD

R26ICIB BIB BIB CIB BIB B B D CC

PAl DID III C I B FIFI B C D lAPE

R30 BID I AIB FIE I CIC I FIF I F B FIFB

I

R33 F1C FIF FID FIF FIF F F FIFC

R46 A BBB CIBIBIC CID DIBIB BA

R50 I B I BBB lBIAIAIA CIA AIBIB I BA

R51 F FFF FIFIFIF F F F FIF FF

R57 I E IFAFICIBBIDABBCEFD

R58 D DABICIBEIDBCCADBC

R59 B D B CIE1B C DIE E DID EDD

R73 E I B I ABIBIA B I BIB I B I BIB I B I BA

R75 F F F FIFIE F FIB FIFIF F FIF

R77 F F F FIFIF F FIFIFIFIF F FIF

R80 I BIB I B IIICI CI C1BID IDI C I E IAIB

R82 DIC C CIBIC E EIEID CID FIFD

R83 I D IB I AIEIEIE I DIDIBIB I EIA I AIAB

R84 C IC BIBICIC BIBIBIBIBICIBICC

I BIBIBIBIBIBIAIAA
R87 I A IAI BIAIA1B

R98 F IF FIFIDIF FIFIFIFIFIFICIFD

R101 I C IA FIFIAIC FIDIFIFIBICIFIFIF

131

I R103 1 B IBIAIDICI C IBI B I A I C I B I A I C 1 1A1

I R105 1
D IEIDIDICIEIFIFIDIFIEID1F1E1E1

I

R121 1
F IFIFIFIFIFIFIFIFIFIFIFIFIEIF1
1 1 1 1 1 1 1 1 1 1 1 1 1 1

+ +

After subtracting the ratios with low rotated factors from

the whole ratios we have the following ratios which can be

considered as significant ratios with high reliability and

high stability.

R = NI/SALES
1
R - NI/SF
2
R = NI/(TA-SF)
5
R = SALES/(TA-SF)
26
R = INVENT/CA
46
R = CL/TA
50
R = CASH/CA
73
R = CA/CL
80
R = (CA-INVENT)/TA
84
R = CASH/(TA-CL)
87
R = (CA-CL)/SF
103

4.8 INTERPRETATION OF FACTOR ANALYTIC RESULTS

The usual procedures followed in factor iterpretation are

deceptively simple. Those ratios with high factor loadings

are considered to be "like" the factor in some sense and those

with zero or near zero loadings are treated as being "not

132
like" the factor, whatever it is. Those ratios that are

"like" the factor, that is, have high loadings on the factor,

are examined to find out what they have in common that could

be the basis for the factor that has emerged. High loading in

both the positive and negative direction are considered. If a

ratio were to correlate perfectly with a factor, it would

ordinarily be considered identical with the factor in what it

measures. Since ratios are not perfectly reliable, they can

not correlate perfectly with a factor, of course, but with a

factor loading of .90 would indicate a total overlap in true

variance between the ratio and the factor.

A question that frequently arises is how high the

correlation between a ratio and a factor must be before it can

be regarded as significant for interpretive purposes? There

can be no answer to this question in any precise statistical

sense since there is not available at the present time any

statistical test that can establish the significance level of

a rotated factor loading. The loading of a given ratio on a

factor can be altered easily by rotating the factor a little

closer to or a little farther away from the particular ratio

vector in question. A crude index of the sability of a given

ratios for interpretive purposes is the square of the

correlation between the factor and the ratios.

A fairly commonly used cutoff level for orthogonal factor

loadings is .30, that is, no ratio with a factor loading below

.30 is listed among those ratios defining the factor. A

squared value (.30) gives .09, which indicates that a ratio

correlating with the factor less than .30 has less than 10

133
percent of its variance in common with the factor. The other

90 plus percent lies elsewhere, in specific and common factors

plus error. Whereas loadings of .30 and above have commonly

been listed among those high enough to provide some

interpretive value, such loadings certainly can not be relied

upon to provide a very good basis for factor interpretation.

Table 4.8.1 Scale of ratio-factor correlation

1 ORTHOGONAL FACTOR LOADING 'PERCENT OF VARIANCE' RATING

.71 50 EXCELLENT
.63 40 VERY GOOD

.55 30 GOOD

.45 20 FAIR

.32 10 POOR

4.9 CONCLUSION

Courtis (1978) and Laurent (1979) have looked at ways of

reducing the number of ratios in use without losing

significant amounts of information. One of the important

result of these studies was that there is a significant degree

of correlation between different ratios and that one or two

ratios selected from each area should be sufficient at least

for the initial review of the firm's performance. One of the

best techniques which can be used to study the correlation

between the ratios is factor analysis that enable management

134
to choose the most significant and reliable ratios among the

others.

This chapter has described the prime difficulty of using

ratios which is deciding which ratio to use. However, it has

been established that this problem is overcome by the use of

factor analysis.

135
 CHAPTER 5

DEVELOPING A FINANCIAL MODEL

o COMPADIES' waymmInn

136
CHAPTER 5: DEVELOPING FINANCIAL MODEL OF COMPANIES' PERFORMANCE

5.1 FACTOR SCORE ESTIMATION

There are different methods of factor score estimation

using multivariate analysis which were described in detail by

Anderson (1958), Duckworth (1968), Goodman (1970), overall &

Klett (1972), Dunn & Clark (1974), Harvis (1975), Afifi & Azen

(1979) and Linderman, Merenda & Gold (1980).

Comrey (1973) has employed multiple regression methods to

estimate factor scores, using the following basic equation:

Zf =b2 4112 +1)2+ b

i 1 li 22i 33i n ni

where

Zf is a standard score of factor f for subject i

Z is a standard score of ratio 1 for subject i

ii

2 is a standard score of ratio 2 for subject i

2i

b is the standard regression coefficient for ratio i

The standard scores on the n ratios (in our case 27) used

to predict the factor scores are known, these ratios could

consist of all the ratios in the factor analysis, in which

case many of the bi weights would be very low because their

loadings on the factor would be low, or the ratios included

could be a subset of these, restricted to only those with

137
loadings above a selected cut off point. This development,

however, will presume that all ratios are being used.

Equation (5.1.1) is like the standard multiple regression

equation where n ratios are being used to predict a single

criterion variable. To obtain the bi weights for this

equation, it is sufficient to know the correlations among the

ratios and the correlation of the ratios with the criterion,

that is, the validity coefficients. In the application to the

problem of estimating factor scores, the factor scores become

the predicted criterion scores, the ratios in the factor

analysis are the predictors, and the orthogonal factor

loadings or oblique structure coefficients, are the validity

coefficients. The unknown bi weights are obtained through the

solution of the following normal equations derived using the

principle of least squares:

b +br +br + + b r =r

1 212 313 n ln
if

br +b+br+ +br =r (5.1.2)

121 2 323 n 2n 2f

br +br +b + + b r =r

131 232 3 n 3n 3f

br +br +br+ +b =r
1 n1 2n2 3n3 n nf

The above equation may be expressed in matrix form as

Rb = rf (5.1.3)

Where R is the matrix of known correlations among ratios 1

through n in Eq.(5.1.2), b is a column vector containing the

unknown bi weights, and rf is a column vector of correlations

138
between the ratios and the factors, that is, orthogonal factor

loadings of oblique structure coefficients. Provided the

matrix R has an inverse, Eq.(5.1.3) and hence Eqs.(5.1.2) may

be solved as follows:

-1

b R rf (5.1.4)

Thus, the column of bi weights to be used in Eq.(5.1.1) for

predicting the factor scores from the ratio scores is obtained

by multiplying the inverse of the matrix of correlations among

the ratios by the column vector of correlations of the ratios

with the factors.

In our case, the factor score coefficients(b) are computed

by the SPSS(1975) for all the 27 ratios (n =27) for each of 530

companies and 14 years of activities (7420 cases) as follows:

139
TABLE 5.1.1 FACTOR SCORE COEFFICIENTS

I. -1-
I I I I I I I I I

R Fl 1 F2 1 F3 1F4 1 F5 1 F6 1 F7 1 F8 1F9 1 F10 1 Fll 1

-V
1
I I I I I I I I

1R1 .04411.12011.04851.44811-.0481.04391-.0671-.1811.09491-.0941-.0591
1R2 -.0831.08971-.3771.30961-.0211.11021-.0351.00521.03711.66511-.0131

1R5 .00551-.0651.04031.51201-.0171.08431-.0171.17361-.2461.09301-.0031

1R7 1-.0011.02751-.0011.01671.00181-.0251.00871-.0141-.1791-.0051.05801

1R261-.0431-.1011-.0241.04101.01091.11991-.0311.5110i.1561i-.061i-.024i

1R291-.0001-.0051-.0021.00841.00551.01061-.0181.00011-.0101.03251.31411

1R301.00481.00731.00121.04151-.0011.01631-.0011-.0061.01281.10111.01501

1R331.00481.00791.00561-.0001-.0041-.0071.02971-.0031-.0121.10311-.0091

1R461.06531.37691-.0131.00091-.0041.29501.38121.10721-.0721.01471.03641

1R501-.0201.45101-.0301.08791.05141.49841-.4201.03331.13821.13391-.0181

1R511-.0031-.0031.00511-.0091-.0061-.0151-.0141.04701.00641-.1241-.0431

1R571-1.121.13611-.6571.25341-.0041.11621.11031-.0891-.2261.62931-.0041

1R581-.0121-.1351.22161.00131-.0441-.0091-.0481-.0041.23661.67261.04001

1R591-.0161-.1011.01681.01751-.0001-.0391-.0751.15361.18861-.1871.02941

1R731-.0151-.0061-.0451-.0241.54021.04151.03381-.0291.02871.05961-.0211

1R751.00101.00311.00021-.0091-.0061-.0111.00581-.0111-.0071.03021-.0121

1R771-.0001.00281.00111-.0011-.0001-.0041-.0021.00501-.0061-.0141.00191

1R801.01451.01071.02361-.0511.01641.19831.54781.07131.18801.20571.07131

1R821-.0221-.0021-.0101.06591.00451.14261.01991-.3461.36611-.1481.08071

1R831-.1721.19481.56871.11181.01891.00961.20881-.0381-.3411-.2761-.0011

1R841.09531.61241.05801.08041-.1251-.8341.23351.32441.28751-.0071.04581

1R871.01421-.0161.00611-.0321.49221.14541.03451-.0241-.0791-.0331-.0081

1R981.00191-.0261-.0041.00521-.0001.05451-.0181-.0051.17811.00601-.0081

11011-.0031-.0011.00011-.0031.00501.00261-.0131.00291-.0341-.0241.36291

140


11031-.0701.09111-.1891-.0601.02131.03601.19001-.1371-.3371.1014 00311

11051-.0091.03001.00721.05541.01241.10481-.0371.06681.15801-.0131.00061

11211-.0111-.0281.00561-.0001-.0171-.0291.01531.00991.04241.22601-.0441
I I I I I I I I I I I
+ +

5.2 BUILDING COMPOSITE FACTOR SCORES FROM THE FACTOR-SCORE COEFFICIENT

After the final solution is obtained we may wish to have

composite scales built that represent the theoretical

dimensions associated with the respective factors. The factor

scores for the individual data cases are calculated from the

factor-score coefficient matrix.

As SPSS specified, the factor-score coefficient matrix (F)

is:

F = (A IA) A (5.2.1)

Where A is the rotated factor pattern matrix and A i is the

transpose of A. In our case the factor-score coefficient

matrix F has been calculated from the:

F = S R (5.2.2)

Where S is the rotated factor structure matrix and R is the

correlation matrix. A composite scale (factor score) is then

built for each factor in the final solution. For each data

case a vector of factor f is calculated:

f = Fz (5.2.3)

Where F is the factor-score coefficient matrix and z is the

vector of standardised values of the ratios which have been

factor analysed.

141
 For example, from the factor-score coefficient matrix in

Table (5.1) we may construct a case's factor-score fl, which

is a composite scale representing Factor 1, as follows:

f = .0441z - .0371z + .0055z - .001z - .043z - .000z +

1 1 2 5 7 26 29

.0048z + .0048z + .0653z - .02z - .003z - 1.12z -

30 33 46 50 51 57

.012z - .016z - .015z + .001z -.000z + .01145z -

58 59 73 75 77 80

.022z - .172z + .0953z + .0142z +.0019z - .003z -

82 83 84 87 98 101

.07z - .009z - .011z

103 105 121

Where z represents the standardised values of ratios, or

z = (R - mean of R )/standard deviation of R

1 1 1 1

Note that the composite factor-score variables produced by

SPSS include a term for each variable in the factor analysis.

It has been customary to build factor scores employing only

those variables that have substantial loadings on a given

factor. By this shorter method we can modify the above

equation to:

f = - 1.11449z
1 57

f = .61235z
2 84

f = .568742
3 83

f = .44807z + .512z
4 1 5

142
f = .54025z + .49215z
5 73 87

f = .49844z
6 50

f = .38124z + .54781z + .19001z

7 46 80 103

f = .51104z
8 26

f = -.17859z + .18855z + .36611z + .15803z + .17812z

9 7 59 82 105 98

f = .66508z + .67259z + .10113z + .22604z - .0144z +

10 2 58 30 121 77

.03017z + .10307z - .124z

75 33 51

f - .31409z + .30982z
11 29 101

By adding all the above equations together we will have:

f +f+f+f+f+f+f+f+f+f +f=
1 2 3 4 5 6 7 8 9 10 11

.44807z + .66508z + .512z - .17859z + .51104z + .31409z +

1 2 5 7 26 29

.10113z +.10307z +.38124z + .49844z - .12400z - 1.1145z +

30 33 46 50 51 57

.672602 + .18855z + .5403z + .0302z - .0144z + .5478z +

58 59 73 75 77 80

.36611z + .56874z + .6124z + .49215z + .17812z - .3098z +

82 83 84 87 98 101

.19z + .15803z + .56874z

103 105 121

Let Y be the name of the total values of factor scores (f)

and substitute the standardised score of ratios (z) with their

initial and original values, then we have:

Y = .44807(R - .04)/.0537 + .66508(R - .1063)/.5458 + .512

1 2

143
(R - .1116)1.1209 - .17859(R - .2196)/3.0873 +.51104(R -3.0922)
5 7 26

/1.7032 + .31409(R - .1534)15.8897 + .38124(R - .4517)/.1749 +

29 47

.49844(R - .3785)1.1413 + .67259(R - .7736)/.7898 + .18855(R -

50 58 59

.7355).6126+.54025(R -.0631)/.0978+.54781(R - 1.7276)/.7931 +

73 80

.3661(R - .4456)/.2759+.56874(R - 1.5767)/6.2481+ .61235(R -

82 83 84

.319)/.1273+.19(R -.468)/1.1866+.30982(R -3.412)/28.862- 1.1145

103 101

(R -.2585)/2.2488+.10113(R -.0398)/.0571 +.22604(R - .0322)1

57 30 121

.0221+.49215(R -.06)1.112 - .0144(R - 1.2021)/22.951 + .15803

87 77

(R -1.4809)/2.1847+.17812(R -.983)14.5205+ .03017(R - .0207)

105 98 75

.0755 + .10307(R - 1.4741)/7.2896 - .124(R - 1.0119)/.0239

33 51

Or simply

Y = 8.344R +1.218R +4.235R -.0578R +.300R +.0533R +1.77R +

1 2 5 7 26 29 30

.014R +2.18R -2.969R -5.188R -.496R +.852R +.308R +

33 46 50 51 57 58 59

5.524R +.4R -.0006R +.691R +1.327R +.091R +4.81R +

73 75 77 80 82 83 84

4.394R +.0394R +.011R +.16R +.072R +10.23R -1.989

87 98 101 103 105 121

By eliminating the ratios with low loadings which have been

discussed in Chapter 4 (Table 4.3) from the above equation

then we have:

Y = 8.344N1/SALES + 1.218NI/SF + 4.235NI/(TA - SF) +

.3SALES/ (TA - SF) - 2.969CL/TA + 5.524CASH/CA

+ .691CA/CL + 4.81(CA - INVENT)/TA + .16(CA -

144
 CL)/SF + 4.394CASH/(TA - CL) - 1.989
(5.2.4)

Where

NI = NET INCOME

SF = SHAREHOLDERS' FUND

TA = TOTAL ASSETS

CA =, CURRENT ASSETS

CL = CURRENT LIABILITIES

INVENT = INVENTORY

5.3 TESTING THE EFFECTIVENESS OF THE MODEL

From initial 600 UK companies, 53 companies have been

chosen randomly to test the effectiveness of the model. First

of all it should be noted that the mean value of Y is zero.

It means that all the companies with Y score above and higher

than zero are classified as the going concern or well

performing companies, and those with Y-score lower than zero

are classified as the poor performing group of companies some

of which are actually failing.

One of the simplest ways of testing th model is to find

out how well the model can classify those companies whose data

were used to construct the model, then doing the same test for

the other companies as well and finally compare the results or

testing both groups simultaneously. This can be done by

computing the Y-scores for all the 53 companies which include

20 of initial 600 companies under investigation and 33

companies out of the model constructing companies, then

145
classify them according to their Y-scores. On the other hand

the companies with positive Y-scores are classified as the

going concerns and those with negative Y-scores as failed or

poor performing companies, then compare the results with the

actual cases. The results are shown below:

Table 5.3.1 Classification of companies performance

1 1 FAILED
1 CLASSIFICATION 1 NO OF I I GOING 1
I 1 COMPANIES RECEIVERSHIP 1 OTHERS I 1
1 1 I I
+ +

1 1
1 FAILED I 18 13 2 31
I GOING 1 35 o 0 35 1
1 1
+ +

One of the 2 "others" had a sort of compulsory liquidation

and the second one had a voluntary liquidation, the 3 going

concern in failed group had some other drastical changes

because of the financial difficulties. As it can be seen from

the above table the results are quite good and it can be said

at this stage the model has a high and considerable

effectiveness in measuring the companies' performance.

The second method and one of the import nt ways of testing

the effectiveness of the model is to plot the Y-score against

time and compare it with actual profitability, working

capital, and liquidity of the companies. We can classify the

ten ratios comprising the model into three separate groups as

follows:

a) profitability ratios

146
 1) NI/SALES

2) NI/SF

3) NI/(TA-SF)

4) SALES/(TA-SF)

b) working capital ratios

5) CA/CL

6) CL/TA

7) (CA-CL)/SF

C) LIQUIDITY RATIOS

8) CASH/CA

9) CASH/(TA-CL)

10) (CA-INVENT)/TA

By multiplying the coefficient of the above three group

ratios by their mean values then dividing the total values for

each group by the total values of the three groups, we can

identify the total variance of each group in the whole model.

The results of above computation are

1) profitability 30%

2) working capital 37%

3) liquidity 33%

This means that the model almost contains the same

percentage of variance for each of the three important factors

of the company's performance.

The model was applied to all 53 companies selected from the

Exstat tape accessible at computer centre of University of

Bradford and the 'Y-value' for all of them was computed for

each year (for which data was available) and plotted against

147
time. In the following pages, we have compared the 'Y-value'

as a performance index with three main factors; profitability,

working capital, and liquidity(cash position) for each of the

53 companies, using Simple Plot(1985) which is available at

University of Bradford. The aim of this exercise was to

demonstrate the effectiveness of the model in measuring

performance, and to see how it responds when changes occur to

these three important financial dimensions. This sort of

comparison can be done for well, fair and poor performing

companies separately as follows:

5.3.1 DEMONSTRATION OF THE MODEL'S EFFECTIVENESS ON WELL PERFORMING COMPANIES

The General Electric Co is well known, and accepted as a

well performing company. Figure 5.3.1 comprises four graphs.

The top left graph is a plot of General Electric's 'Y-value'

from 1973 until 1984. The top right graph is a plot of the

same company's profitability over time, while the bottom left

graph shows the company's cash position and the bottom right

graph the company's working capital position. All these

financial dimensions are plotted over the same time period as

the 'Y-values'. The 'Y-value' as well a profitability, and

cash position is rising while the working capital is static.

This means that in General Electric Co the performance (Y-

value) is responding quickly to any changes occurring in

companies cash position and profitability if working capital

remains unchanged.
5.3.2 DEMONSTRATION OF THE MODEL'S EFFECTIVENESS ON FAIR PERFORMING COMPANIES

According to the classified performances in Chapter 6

(6.1), the Anglia Television Group is generally accepted as a

fair performing company for which the relevant graphs are

presented in Figure 5.3.17. As it can be seen from

performance graph, it was well performing from 1972 to 1978

and then rapidly deteriorates from 1978 to 1984. At the same

time the three other financial dimensions are falling as well.

This means that the performance of Anglia Television Group is

declining when companies' profitability, cash position and

working capital are falling. But still its performance is

above the safety level.

5.3.3 DEMONSTRATION OF THE MODEL'S EFFECTIVENESS ON POOR PERFORMING COMPANIES

Burrell & Co is one of the failed companies whose

performance has been analysed. The relevant graphs are shown

in Figure 5.3.46. Its 'Y-value' as well as its profitability,

cash position and working capital is falling. This means that

Burrell & Co was failing because its profitability ,cash

position and working capital were declining which is affected

its 'Y-value'. In fact this assumes a negative value in 1979

indicating that the company has a failed company financial

profile. Burrell's historic performance led to a receiver

being appointed on 4th of August 1980.

The same sort of evaluation can be applied to the other

companies and the results demonstrate the effectiveness of the

149
model. The main conclusion is that in most well performing

companies, the performance model is rising and all of them are

well above the ideal level. In fair performance companies

the performance model is going up and down but they all are

above the safety level. And in poor performing companies the

performance model for all of them is declining and its overall

performance is below the safety level.

150
 0.22

0.200
6.0

0.175
5.5

0.150

E4.5

4.0 0.100
/'
3.5 0.075

3.0 0.050

1974 1976' 197EI 198d 1982r 1984' 1974- 1976 1978 1980 1982 1984
YEAR YEAR

0.401

1 2.0 N.
0.35

0.30 // n\ //. 1.5

\\ / 4 \\ (_)
1.0 _-
z:
cc •-••••

0.5

0.1

1974' 19b 1978' 1980 1982t. 1984'

0.10 YEAR

1974 '. 1976 1978' 1980' 1982' 1984'

YEAR

GENERAL ELECTRIC CO

Y VALUE
--NI/SFILES
-NI/SF
-NI/TA-SF
--CASH/SF
Figure 5.3.1 Testing the Effectiveness of the Model -CASH/TA-CL
CA/CL
-{i1C/SF
CL/TA

151


0.40
6-
0.35

0.30-

*L-j• 0.25
1/4
1/4 1/4

tz
ilf\f \

2 \/\
0.10
\-)
0.05-
1974 1976 1978 1980 1982: 1984' 1974' 1976 1978 1980 1982 1984
YEAR YEAR

0.2

0.20
2.0
// I
F--
E'T 1.5

'-' 1 . 0 /

0.5
0.05
1974 1.976 1.978 1980 1.982 1984
YEAR
1974 1976 1978 1380 1982 1984
YEAR

COALITE GROUP
---
Y VALUE

-NI/SF
-NI/TA-SF
CRSH/SF
Figure 5.3.2 Testing the Effectiveness of the Model CRSH/TA-CL
------CF1/CL
WC/SF
CL/TA

152


4.5

V,-

0.06

0.04

1.0 ,
1972. 1974 1976 ' 1978' 1980 1982. 1984 1972 197.4 . 1976 1978 1980 1982 1984
YEAR YEAR

0.1 3.5

0.14 3.

0.12 2.T

0.10 0.
cc
01-11
0..
-
r0.08 1.5
tr)
cc

0.06 1.0

0.04 0.5

972. 1.974 1976 1978 1980 1982 1984

__YEAR
1972. 197.4 1976 1978 1980 1982 198.4
YEAR

ALLIED TEXTILE CO PLC Y

VALUE
-NI/SALES
-NI/SF
-NI/TA-SF
-------CASH/SF
Figure 5.3.3 Testing the Effectiveness of the Model -CASH/TA -CL
----CA/CL
-WC/SF
CL/TA

153


7. Q

6.5 0.40

6.0 0.35"

./ •

0.30

1.0 0.25-
7-\\ ,--\
13-- 4.5 a. 0.20-

4 .0- 0.15

0. 10-

3.0
0. 05-
1974 1976' 1978 1980 1982 1984 1974' 1976 1978' 1980' 1982' 1984'
YEAR YEAR

0.5
\
\
./
2.5"
0.4- /I
E / -
I
/
/
tr10.3- ILi
1.5

0.2 I //"/ °
1.0

0.1-
I \\ Jj 0.5
11 S.
S.

1974 1976 1976' 1980. 1982 1984' 1574 1976 1978. 1980 1.982 1984
YEAR YEAR

BRITISH HOME STORES PLC VALUE

- - - - - -
NI/SALES
-NI/SF
-NI/TA-SF
— —CASH/SF
Figure 5.3.4 Testing the Effectiveness of the Model -CASH/TA-CL
— — CA/CL
-WC/SF

154
 0.30
fN, i, \ ,f
6

0.25
I \-/' "i , \‘‘ %

5 I I

,i)
, 0.z,, ,, , 1
,-c. , , i n\
0.15 /......_.., A ! / ----/\
o / \ \\L/ \
\ ,
0.10 . ,,,..
s„,„,‘
, , , • _. _ ,. . „. _, , ,
2

0.05 ii \
/
1972 1974 1976 197d mid 19E4 1984' 1972: 1974' 1976 1978 1980 198 1984
YEAR YEAR

0.18 4.5-

0.16 4.0

0.14
3.5
g0.12
3.0
cm „

(I) 0.08
L_1

0.06

0.04

0.02 1.0

1972 1974 1976 1978 1980 1982 1984 • 1972 1974- 1976 197d 198d 1982: 1984'
YEAR YEAR

BELL (ARTHUR) & SONS PLC

Y VALUE
-NI/SALES
-N1/SF
-N1/TR-SF
Figure 5.3 . 5 Testing the Effectiveness of the Model -CASH/TA-ft
CA/CL
-112/SF

155


0.14'

0.12-
In r
AJ/
‘‘: v\
/ \
.
n ... s- n
,--, 1
". n t \
\, I \
i ...
\,1
0_04'

1972 1974 1976 1978 1980 1982 1984 1972.- 1974 1976 1978 1980 19821 1984
YEAR YEAR

0.200"

0.175'

m0.150"

'417)10 .125-
&
o_
nt
E 0.100
9
0.075
0.5

0.050
972 1.974- 1976 1978 1980 19821 1984
0 025 YEAR V_

972 1974 1976 1976 19ed 1982 196.4'

YEAR

WELLCOME FUNDAT I ON

Y VALUE
-NI/SALES
-NI/SF
-NI/TA-SF
Figure 5.3.6 Testing the Effectiveness of the Model -CASH/TA-CL
---CIA/CL
-WC/SF
-CL/TA

156

F-
 0.40

0.35

0.30

:1125

0.15
4.0
0.10'

3.5 0.05
1972 1974 1976' 1978' 198d 1982 1984 97 1974 1976k 1978' 1980 1982 1984
YEAR YEAR

0.00f1

0.007 /
tr\ /-‘
\,/
0.006 /
\J /

20.005 /
co

20.004'
in
cc

'O.003

0.002-

1972 1974 1976 1978 1980 1982 1984 1974 1976' 1978' 198d 1982 1984
YEAR YEAR

BENFORD CONCRETE MACHINERY PLC

Y VALUE
-NI/SALES
-NI/SF
-NI /TR-SF
Figure 5.3.7 Testing the Effectiveness of the Model --------CASH/SF
-CASH/TA-CL
--- - -CA/CL
-IC/SF

157


5.5'" 0.250F

5.0 0.225 '

/
)(\\ 20.200F.----„, j:\

-..7
'-]
14. 0
i 1:
E 0.150-
3.0 0.125'

/ 5.

0.075-
1974 1976 1976 1980 1982: 1984 1974 197d 1978' 198d 1982 1984
YEAR YEAR

2.50-
/-- -'-- N
0.250-
/ .
/ \
0.225-
-N
/ \_-
/ \
/ /
0.20T / \
0.175-

(20.150

D A 25

0.1.00

0.075
O. 75-1
0.050
0.50 7-`----"Y
1974 1976' 1978' 198d 1382' 1984' 1974 197d 1978' 198d 1982' 1984
YEAR YEAR

BEECHAM GROUP PLC

- - -
VALUE
-N I /SFILES
-NI/SF
-NI/TA-SF
----CASH/g
Figure 5.3.8 Testing the Effectiveness of the Model -CASH/TA-CL
-----CA/CL
-1./JC/SF

158
 0.35-

6.0
0.36 \
5.5

0.25
5_0
t.L1

g4.5 - 30.20
:k

60_4.0
a-0.15
3.5

0.10
3_0

2.5 _
0.05
1974 1976 1978 1980 1982 1984 1974 1976' 1978' 1986 1982 1984'
YEAR YEAR

(LT

1.0

0.8
er.
-j

• _ - 0.6
Li
LE) CD
FL; 0.4
ct
0.2
0.2

197A 197G -1 43 1-9811----1-9E-1•984,'

0.1 YEAR
0-,2
1974.- 1976' 1978' 1980' 1982' 1984'
YEAR

MARKS & SPENCER Y VALUE

NI/SALES
-NI/SF
-NUTA-SF
CASH/SF
Figure 5.3.9 Testing the Effectiveness of the Model -CASWITFCL
-111C/SF
-CUM

159


0.18'

lr
0. 18'
i , \I\ 0Z
0.14 n
" n \ 7
DO12
-.-\
.t /\ / \/j/I
\\ \ i /
-1'1On0..10 \ '
t

E %1

2.0 .
008 ‘V/ //-
k \
t /
--. \ /
0.06' / /
1.5

0.04-
972. 1974. 1976' 1978' 1980' 1982' 1984 1972 1974' 1976 1978' 198d 1982 19E4
YEAR YEAR

2.00-
f' .-
0.200 \ 1.
1A1, 50 - ......
0.175
N
t i .....- ,.
1 --1 1.25'
6 0.150 ii1 1 cc
t.-,.
\ 'cc 1.00
/ 7.1-
7 -,\ ,,./1 I IL)
t..
% ,......
0.75'
/ .I /
.,: %...-- . 1 1 cc
0. 100
..- J / '9 0.50'

0.075 0.25"

0.050 972 1974' 1976 1978' 1980k 1982 1984'

YEAR
0-.25-
0.025
19 12.- 1974 1976 197B 1980 1982. 1 .984
YEAR

PEARSONS Y VALUE
- NI/SALES
-NI/SF
-NI/TA-SF
CASH/SF
Figure 5.3.10 Testing the Effectiveness of the Model -CF1SH/TR-CL
— CA/CL
-111C/SF
--CUTR

160
 7
0.4

0.35

0.30

:EcEl 0.25
Lj

1974: 197e 1978' 198d 1982: 1984: 1.974 1976 1978 1.980 1982 1984
Y.EAR YEAR

/
0. 25-
—
0. 20:- 11\ 2 .0- \

I-...' 0-
Ct

cn 1.0
V
CC
LJ
0.10 _
0.5

0.05-
1974 1979 1978: 1980: 1982: 1984

19 -4 1979. 1979 i980: 1982': 1984' 0-. 5
YEAR

RACAL ELECTRONICS

1 VALUE
-NI/SALES
— -NI /SF
-NI/IA-SF
—CASH/SF
Figure 5.3.11 Testing the Effectiveness of the Model - CRSII/TR-CL
— — — CA/CL
-NC/SF
CL/ TA

161

F-
 4.0
0.3C

3.5
0.25
LL13.0
'21 _
17;0.20

IL
ES2.5
0_
c-0.15
c

2.0
0.10 /

••
1.5 •
0.05 _

1974 19767, 197d- 1980' 198 1984' 1974 1976' 1978' 1980' 1982' 1984'
YEAR YEAR

0.200-
r
1.8 /
0.175- \\ / \_,--

0.150-

.90.125
If
n
Ro.100-
"
'0.075
0.8
0.050

0.02.5

1974 1976' 1978' 1980' 1982' 1984' 1974 1976 1978 1980 1982 1984
YEAR YEAR

BPB INDUSTRIES PLC

Y VALUE
-NI/SALES
------NI/SF
-NI/TA-SF
-------CASH/SF
Figure 5.3.12 Testing the Effectiveness of the Model -CASH/TA-CL
CA/CL
-WC/SF

162


5.0

4,5

tA.1 4.0

I3.5'

'at' 3.0

\ , --- , .
\ / / \
\ / ,--- \ /
0.1 .
---_-- -' /,
0"
\
1_5 \ /
1974 1976' 1978 1980 1982 1984 1974. 1976' 1978 1980 1982: 1984'
YEAR YEAR

,\
/
/
a.0 / \ / \
/
/ 1 / \
,--... / \ /
_,L.5' ," ----.
F-
Im .....
L:
ES
,9 1.0
z
--\
' '..\
115-

1974 1976 1978 1980' 1982' 1984

YEAR

1974 1976 1978 1980 1982 1984 0-.5

YEAR

ALLIED COLLOIDS PLC

Y VALUE
-NI/SALES
411/SF
-NI/TA-SF
Figure 5.3.13 Testing the Effectiveness of the Model -CASH/TA-CL
— CA/CL
-WC/SF
-CL/TA

163
 4.0 0.30

0.25

PE

8E 0. 15- \)/
Th
2.. d
0.10

1 .5-

19721 1.974 1976' 1978' 1980 1982 1984 19721 1974' 1976' 1978' 1988' 19821 1984'
YEAR YEAR

0.05'
2_75 f\
2.50-
I\
I 1
1
1 \
0.04L
2.25- I \ 1 \
1 V
a.4. 2_00-

E. / ,
•175' / \
I
/
cm
i)\ z. / \_„..•
1.50
c m
i=i ..
1.25
/
1.00 t
0..01 \
.. ._
0.75'

9721 1974 1976 . 1978: 0.509721 1974' 1976 1978' 1980' 198211984'
YEAR YEAR

ASH & LACY PLC

Y VALUE
-NI/SALES
--NI/SF
-NI/TA-SF
---CASH/SF
Figure 5.3.14 Testing the Effectiveness of the Model -CASH/TR-n_
CA/CL
-WC/SF

164
 0.35
t

6.0 I

0.30
5.5 (
5.0 =0.25 (\

4-5
0.20
6`
SE
0.15

0.10 /

0.05
1974 1976 1978 1980 1982 1984 1974 1976 1978 1980 1982 1984
YEAR YEAR

/ '.- ---..N.
,, / \ \ /----
\ /
1.6- \ /

0.6-

0.4
N.

1974 1976 1978 1980
1982 1984 1971 1976 1978' 1980' 1982' 1984'
YEAR YEAR

Y VALVE
BOOTS CO PLC (THE) -NI/SALES
- --111/SF
-N I /TFE-SF
---CASH/SF
Figure 5.3.15 Testing the Effectiveness of the Model -CRSH/TR-CL
CA/CL
-111C/SF

165


0.6

0.4
/ /-\
.--\\
- -KW" • '-
74 197 978 1980
„

0 -.4

76 1978 1980 1982 1984

YEAR 0-.6

0.05-

0.04-

6
_
_.
i- l \
La,...
cL. / I
z 1 ,
5)
0.02 / ii, (/ \\
,
\J , , \ f_
, ,
,
0.01 •
,.... ...
_,
1974 1976 1978 198d 1982' 1984 1974 1976' 197d 1980' 1982 1984
YEAR YEAR

BRITISH GAS CORPORATION Y VALUE

- ------ -NI/SALES
NI/SF
-NI/TA-SF
CASH/SF
Figure 5.3.16 Testing the Effectiveness of the Model -CASH/TA-CL

-WC/SF

166


0.50

0.45-
8- 0.40
•
0.35

0.30

1E0.25

-0.20

0.15

0.10 •
- //-\
0.05
1972 1974 1976 1978 1980 1982 1984 1972 1974 1976 1.878 1980 1982! 1984
YEAR YEAR

0.4 2.5
/-•
0.40

-
0.30

E0.25

0.m

0.15
___

0.10
972! 1974 1976! 19?8 1980 1982 1984
0.05 YEAR

1972 1974 1976 1978 1980 1982 1.984

YEAR

ANGLIR TELEVISION GROUP PLC

- - - -
URLUE
-NI/SRLES
-NI/SF
-NI/TA--SF
IRSH/SF
Figure 5.3.17 Testing the Effectiveness of the Model -CRSH/TR-CL
CA/CL
-MC/SF
CL/TA

167
 0.1

YEAR
97 1978 1981 198

0 , .....„ , •
r 0- . 1 - ' 1
\ s- - - I ‘\\, 11
7
,.! \,._i L__/
I
0-.3
\I
0-.4 \J

0-.5

0.050
I'
2.25-

0.045- I
/
I , \ 2.00-
I
0.040- 1
• I l\, 1
0.035-
c%
li
7
E0.030-
cn
o
0... _
0.025 /I \\

cut'
1
Li0.020-
II

0.0,5-
L\
_
i
0.75-
!I_
0.010- _I

-.1.
\\ , r. - 0.50-
0.005" '.-.-
972 1974 1976 1978
198d 1982' 1.972 1974 '
1976 1978 198d ' 1982'
YEAR YEAR

GOODYEAR TYRE & RUBBER CO. Y VALUE

----- .- NI/SALES
-N1/SF
-NI/TA-SF
Figure 5.3.18 Testing the Effectiveness of the Model -CASH/TA-CL
CA/CL
-WC/SF

168
 0.18

0.16

0.14

[1.12

R0.08

n
0.02
197 1974 1976' 1978 198( 1982' 1984 197 1974 1976' 1978' 198d 19E2 1984
YEAR YEAR

N
\ _ __ N z
1.4
0.16-
\ / '

0.14 1.2 \. /

=
co
60.M

0.0 6 /
-- 7
/
0.04
z 0.4

972' 1974 1976 1978' 1

98d 198 1984 1972' 1974 1976' 1978 1980' 1982' 1984
YEAR YEAR

BABCOCK INTERNATIONAL PLC

VALUE
-NI/SALES
-NI/SF
-NI/TB-SF
-------CRSH/SF
Figure 5.3.19 Testing the Effectiveness of the Model -CASH/TA-CL
CA/CL
-WC/SF

169
 1972 1974 1976 1.918 1980 1982 1984 972 1974 1976 1978 1980 1982 1984
YEAR YEAR

0.12- 2.0-` / NJ

972 1974 19/6 1978 1980 1982 1984

0.04- YEAR

1972 1974 1976 1978 1980 1982: 1984'

YEAR

APV HOLDINGS PLC

Y VALUE
-NI/SALES
-NI/TA--SF

Figure 5.3.20 Testing the Effectiveness of the Model -CRSH/TR-CL

— ClitCL
-WC/SF
CL/TA

17 0


2.5
0.200-

0.175
2.0
>_ 0.150

iTa.125-

0.100-

0.075-

0.5- 0.050

0.025-
1972 1974 197d 1978 198 • 1982. 198.4 972. 197.4 1976 19714 1980 1982. 198.4
YEAR YEAR

0.07

0.06-
/ !
A / \._ _ / I \
0.05- 1.6- / --
z-: I

in 0.04 Li
\

3 0.03

0.02- 0.8

0.6- , ----", / \ I
0.01- X %

0.4-
1972 1974 1976 197d 1980 1982. 1984' 1972 1974' 1976 1978' 198d 1982' 198.4
YEAR YEAR

AULT & WIBORG GROUP PLC Y VALUE

-NI/SALES
-N1/SF
-NI/TA-SF
— —CASH/SF
Figure 5.3.21 Testing the Effectiveness of the Model -CASH/TA-CL
— — — — CA/CL
-WC/SF

171
 0.200-

0.175-

0.150-
LU
:1
0.125-
(7.1 PE
LJ- -

fa- N.100

0.075

0.050-

'- 0.025
1972 1974 1976' 197 g. 1980' 1982' 1984' 172 1974 1976' 1978' 1981 1982. 1984
YEAR YEAR

,,„
0.25-
3.0

2.. 5
0.20-

/
•• n•

0.5 -
0.05-
1974 1976 1973 1980 1982. 1984
—YE
1972. 1974- 1976' 1978 1980' 1982' 19841
YEAR

AL.BR.IGHT & WILSON LTD VALUE

- - - - - - -+11/SALES
— -NI/SF
-NI/TA-SF
— —CASH/SF
Figure 5.3.22 Testing the Effectiveness of the Model -CASH/TA--CL
— — CR/CL
-WC/SF
CL/ TA

172
 0.200

0.175

0 150

'6E1
- '0.125
FE
V \ \\
'60.100
‘--K)
\j
0.075- \\.

0.050 /

0.025-
972 1974 1976 1978 1980 1982 1984
YEAR 972 1974 1976 1978 1980 1982 1984
YEAR

0.250
1.8
I

0.225-
1.6
0.200-
I
I I 1
I/11
1.4
2,0.175 II \II
_t
FE1.2
E2
!=.0.150-
C)
co
0,_
Ii \\ co
ml1125

(r,
m
It tI 1.\
c..) _
t
0.100 III ir

0.6-
Ii
0.075- ) \ 11
,
, I/
/ j

9 0 .4- -•

t 0.2- \,/
---•,..._.../...,"
0.025
972 1974 1976' 197d 198d 1982 1984 97 1974 1976' 1978' 198d 1982' 1984
YEAR YEAR

BARROW HEPBURN GROUP PLC

Y VALUE
-NI/SALES
-NI/SF
-NI/TA-SF
--------CASH/SF
Figure 5.3.23 Testing the Effectiveness of the Model -CASH/TA--CL
cripa
-WC/SF

173

F-


0.5
, ,
,/ \
0.45 i ' .-____J. 1
I
i
I
0.40 ./ 1
›.-
0,35 f
7' 1
i
.IEd
FCE 0.30 /i \I

20.25 -- I
/ \

/ / I
4
0.20
/

7--- .---/ \ ,
/ .
.. --

1972 1974 1976 1978 1980 1982 1984 1.972 1974 1976 1978 1980 1982 1984
YEAR YEAR

0.9
1\
0.8 / \
/ 1 /'' \
/

/ I
0.6
D I
r- I
(.710.5

en' 0.4
Li

0.3
fj 972! 1974 1976,...----1478. 1980 1982' 19E14'
0.2
\J
•
0.1 0-.50-
1972:. 1974 1976' 1978' 1980 1982 1984
YEAR

PLEASURAN4 PLC Y 'VALUE

-NI/SALES
--NI/SF
-NI/TA-SF
—CASH/SF
Figure 5.3.24 Testing the Effectiveness of the Model -CASH/TA-CL
-WC/SF
—CL!TA

174
 0.1

97 1974 1976 74-4... 1980 198

YEAR
97 1974 1976 197 1980 198
/Th\)
e-. 1

0 -.4

0-. 5

1.4
0.06-

1.2 \
0.05 N
_ j 1.0 ,.__. /— --
6 m
1-- \ /— — N
N\s)
.L7). 0.04

i\ I eff 0.8
p
m
F., 0.6
\J

'60.03
ji C)
- 0.4

0.02-
\ 0.2

0. 01- / 972 19 1976 197e- --4380 182

s, EA
0 -.2
1972 1974 1976 1978' 1.980' 1982
YEAR

BRITISH RAILWAYS BOARD

Y VALUE
-NI/SALES
-NI/SF
-NI/TA-SF
Figure 5.3.25 ----CASH/g
Testing the Effectiveness of the Model -CASH/TA-CL
— — CA/CL
41C/SF

175
 1 .6-
0.20-
1 .4-

1.2-

1 . 0-

0.8

0.6

0.4
0.05 1
0.2 /

972' 1974' 1 76' 1.978' 1988 1.982 1.98.4

YEAR 372 1974 1 . 978 1980 1982. 1984'
0-.2 YEAR

0.12 1.50

I\ - - '
•
•••.-

0.10
I`, I I. Lou-
I! V\1
n0.08 ()\ I \ \ e.... 0351

L71-
i
It
i t %
iIi
i
\ (-) CM
0.50-
1"0.06 Z

/r\ .E. 0.25

Gul cz,

0.04 ()\ ) 972' 1974' 1976 1978 198d 1982'. 1984'

YEAR
0-..25
0.02 -_!-/\j
j/
0-.50-

1972. 1974' 1978 1978' 1980' i.se 18841

YEAR

ANCHOR CHEMICAL GROUP PLC

Y UFLUE
-NI/SALES
-NI/SF
t'11/TA-SF
--CASH/SF
Figure 5.3.26 Testing the Effectiveness of the Model -CASH/TA--CL
- ----CA/CL
-WC/SF
CL/TA

176


0.250
3. - /e\
0.225- I
I
I I
3.0 0.200- I

0.175-

!]0.150-

2'0.125-
u_

E0.100-

1.5 0.075

0.0511
1.0
0.025- ./

1974 1976 1978 1980 1982 1984 1974 1976 1978' 1980 198 1984
YEAR YEAR

I\
0.07 I
,' —\ I' 1 \
2.0 1
\ I \ 1
0.06 / \
/ 1
\ - / \ \ ...... 1 ‘.....„-\
k

z
o 1

r-o.o5

c,
2
C-),
= / / \
Ili
//11/1
: I\ i

0.03
i

0.02 / 74r
1978 1980
\

1982 1984
0.8-

0.6-

1974 1976' 1978 198d 1982 1984

YEAR YEAR

BAKER PERKINS HOLDINGS PLC

Y VALUE
-NI/SALES
------NI/SF
-NI/TA-SF
--------CASH/SF
Figure 5.3.27 Testing the Effectiveness of the Model -CASH/TR-CL
CR/CL
-WC/SF

177


3 .0- 0.4

2.5

2.0 0.3

1.5

_
F.5 0.5

9 2 13 1 6 1978 1986' 1982 1984

YEAR
72 1374 1976 1978 1980 1982 1984
YEAR
- 1.0

0-.1
- 1.5

0.10
/
0.09 t‘
i /
0.08 \/
1.4-

z
Q
0.07
1
1r
r
\ \ _r _

0.06
;I 1 i a-
cc
ii
CL 0.05
=
U)
11 \\
C2
60.8
(LE, 0.04
\ n

0.03 \i 0.6

0.02 0.4
\\
0.01
‘ 0.2 z
1972 1974 1976 1978 1980 1982 1984 972 1974 1976 1978 1980 1982 1984
YEAR YEAR

VALUE
FORD MOTOR CO. LTD.
-NI/SALES
--NI/SF
-NI/TA-SF
---CASH/SF
Figure 5.3.28 Testing the Effectiveness of the Model -CASH/TA-CL
-----CA/CL
-61C/SF

178
 3.5 0.20

0.18

3.0 0.16-

0.14

r1-0.08

0.06
1.5
0.04

0.02- -
1 01
1972. 197.4.- 1976 1978 1980 1982 1984 1972 1974 1976 1978' 1980' 1982" 1_984'
YEAR YEAR

0.02.00
1.75"
0.0175 \
/ 1.50 \ /
i
0.0157 1.25-
Z '\i cc
.90.0125 1.00-
I— cL
....,/ \ liV i" \ :\ CC
U7

20.0100-
ii 0.75-

(-1 \ ' \ /111 0.50-

' 0.0075- U \\
0.5

i1 V
0.0050 I 11 (--- \,
I il 972 1974 1376 1978 1980 1982 1984
YEAR
0.0025-

1974 1976 1978' 1980' 1982' 1984'

\ 0-.25

0-.50
YEAR

ADAM & GIBBON PLC Y UALUE

- - - - - -N1fSFILES
— -NI/SF
-NI/TA-SF
— —CASH/SF
Figure 5.3.29 Testing the Effectiveness of the Model -CASH/TA-CL
— CR/CL
-WC/SF
CL/TA

179


0.30-

0.25-

..---

2
1\ /
/ \ /

1 % /

0.05- n /
1 .- ...
1972 1974- 1976' 1978' 1.986 1982 . 1.9E14 972 197+ 1976 1978' 1900 1982 1984
YEAR YEAR

0.14 2..5 I
\
\

0.12-
24 \
/.•
0. n /
8"_
m n
(--'1.
m
(I-)
1
0 ix
50.06- C)
I
1.0 ,--..
0.04-

0 .02
\
,-, y/ ' - /
/.,...--- ---t-. ,
7
-
fi 1 \
0.5
n
n
n

, -N,
1972 1974' 1978 1978 1980' 1982 1.984 1972'. 1974 1976 1978 1980 1982 1984
YEAR YEAR

ARRITAGE SHANKS GROUP LTD Y VALUE

- - - - - - -NI/SALES
-N1/SF
-NI/TA-SF
CASH/SF
Figure 5.3.30 Testing the Effectiveness of the Model
-CASH/TA-CL
CA/CL
-WC/SF

180

F-
 5.0- 0.30-

4.5
0.25
4.0-

\
,I' 1
1
k

1
0.10-

0.05-

1974 1976 1978 1980 1982. 1.984 197.4: 1976' 1978' 198d. 1982 1924'
YEAR YEAR

i
3.5- ip.. \ / \
/ k / i / ---. .....
1\ / 1 C n
i \
0.02T 3.0.- n / N • . -..
...
\ i \

1
F.0.02C 2.. 5

0_
(T)0.015
1
CC

0. 0 10 1.5-

1 .0-
0.005
--
0 .5-
1974' 1976 1978' 19El8' 1982 1984' 1974" 1976' 1978' 1380' 1982". 1984'
YEAR YEAR

ATKINS BROTHERS PLC

Y VALUE
-NI/SALES
— -N1 /SF
-NI/TA-SF
— —CASH/SF
Figure 5.3.31 Testing the Effectiveness of the MOdel - -CASH/TA-CL
CA/CL
-WC/SF

181


0.15

1.50

0.1.0

1.25

1. 00 >_ 0..05
17-

972 1974 1976 1978

YEAR
nu -1-'3
°- 0.50
0-.05
0.25

0-.10
972 1974 1976 1978 1980 1984
YEAR
0-.25
0-.15

0.250-
2.0
0.225-

0.200-
1.5
60.175-
I--
'&10.150-
C)
-
a_
-
Ei0.5
12 1

Lt
II \
0.100-
%
i
0.075- I/

— / \71; •
0.050- 972 1974 1.976 1978 1980' 1982' ,38\4,
N;.--'• " YEAR
0.025-'52
1972 1974 1974 1974 1980 1982 1984
YEAR

DUNLOP HOLDINGS PLC

Y VALUE
-NI/SALES
-NI/SF
-NI/TA-SF
Figure 5.3.32 -------CASH/SF
Testing the Effectiveness of the Model -CASH/TA-CL
CA/CL
-WC/SF

182
 4.0- 0.200

0.175
3.5-

015T
t;:;3.0
630.125 Ai1\ //r—\ \
I1
0. 100
1k
\ _I/ -. /
i j/
0.075
_
...\ \ I
1.5- / ..- n f
0.050 \\ \.__--/ /
/ ‘
\t
\ r
0.025 .
--
1972 1974 1976 197d 198d 1982 1984 1972 1974 1976 1978 1980 1982 1984
YEAR YEAR

\
'•••n

0.25

0.20

_
R0.15

CT,

0.10-

0.05
0.4-

1972 1974 1976' 1978 1981i 1982' 1984 197 1974 1976 1978 1980 1982 1984
YEAR YEAR

BARNO INDUSTRIES PLC

Y VALUE
-NI/SALES
-NI/SF
-NI/TA--SF
-------CRSH/SF
Figure 5.3.33 Testing the Effectiveness of the Model -CASH/TA--CL
CA/CL
-WC/SF

183
 0.14
1.6
0.12 \J
1 .4- rN.,/
0.10 \

t±j1.2- 0.08
cc
:7. 0.06 - -S.

A- 0.04
0. 8- 2/r\\
0.02
0 .6-
972 1974 1976 1978 19 982 1984
0 .4- YEAR
0-.02

1972 1974 197d 1978' 198d 1982 1984

YEAR

0.10 1.8-
;\ / \ / \\
0.09 / \
1.6- / \ ,
\ /
0.08
-- /
\ /
1.4-
=0. 07 \.1
1 cc

I
t,10.M cc

;0.05 /f.\\
I
_
0.04 0.8
t
0.03
0. 6
V--
0.02
0 . "Th
0.01 1976 1978
1972 1974 1 . 980 1982 1984 1972' 1974 1976 1978' 1980 1982 1984
YEAR YEAR

BBA GROUP PLC Y VALUE

-NI/SALES
------NI/SF
411/TA-SF
-------CASH/SF
Figure 5.3.34 Testing the Effectiveness of the Model -CASH/TA--CL
CA/CL
-WC/SF

1 84
 0.30-

0.25'

>-0.M

0.10

- _

0.05

1974 1976 1978 1980 1982 1984 1974 1976 1978 1980 1982 1984
YEAR YEAR

0.1 1.0 /..- —

0.14 1 0.8

0.12 0.6

n=0.10
61

dt 0.08
1
83
Li
0.06 \\ 1974 1976 1978 1980 '1982 13 ?4
YEAR
0-.2
0.04 ie.-
0-.4
0.02

0-,6
1974 1976 1978 1980 1982 1984
YEAR

BRTLEYS OF YORKSHIRE PLC

Y VALUE
-NI/SALES
-NI/SF
-NJ/TA--SF
-----CASH/SF
Figure 5.3.35 Testing the Effectiveness of the Model -CASH/TA-CL
CA/CL
-WC/SF

185

F-
 1.75'

0.75'

0.50'

0.25"

972: 1974' 1976: 1978' 1980 1982: 1984

YEAR 1.972 1974 1976 1978 1980 1982 1984
YEAR

0.09 \./""\
1..6 /I
0.08

0.07

g30.05
CL

0.03

0.02"

0.01
rA
197 1974' 1976: 1978' 1980 1982 1984 1974" 1976' 1978 1980 1982 1984
YEAR YEAR

BEMROSE CORPORATION PLC

Y VALUE
-NI/SALES
-NI/SF
-NI/TA-SF
-------CASH/SF
Figure 5.3.36 Testing the Effectiveness of the Model -CASH/TA-CL
CA/CL
-WC/SF

186


4.0 0 1

--
3.5
0.10
3.0
0.05 s'‘
2.5

2.0 972 1974 1976 1978 1980 1982 194

YEAR
1.5
0-.05
1.0
0-.10
0.5

972 1974 1976 1978 1980 1982 198 0-.15

YEAR

0.18' ,
/ \
A / \
/ \
0.16- t - - ----\ 1 \ / \
I 1.8 \ / \\,./ \
0.14- \., \

P0.12'
I\ FE 1 .6

u '
D i II \ % ES
=. 0 10 2 1-4
=
cn
LJ
/,\ 1 \' 01
I k 1.2`
0.00- i \ Ili \;
\

0.06
/
1
\ N
'' iI \\
1/ V \II V\ Hi-
---\ i •-•
0-047 ------. \. 0.8 •

1972: 1974 1976 1978 1980 19E2 1984 197i 1974" 1976 1.978 1980' 1982' 1984
YEAR YEAR

BESTOBELL PLC Y OLLIE

-----NI/SALES
•- -NI/SF
-NI (TA-SF
--CRSH/SF
Figure 5.3.37 Testing the Effectiveness of the Model -CASH/TA-CL
CR/CL
-WC/SF

187


0.30

2.0
0.25

1.5
,-. 0.20
1=1
,
m
m
o 1 . 0 F-

LL
DI 0.15
Lálj_
IT

0.5
0.10

1972 1973 1974 19/5 1976 19/7 1978 19/

YEAR 0.05

1972 1973 1974 1975 1976 1977 1918 1979

YEAR

0.09 - -

0.08 /
I 1
ii\I
2.0
0.07

z
cp

F.r.
0.06
i
ii
/
f/

7'..\
'6;0.05
(7)
a_ ill
/ \
ai 0.04

//
ct

03
0. I 7. \

0.02
/ / A / 1972 1973 1974 1975 1976 1977 1978 1379
0.01 //

1972 1973 1974 1915 1976 1.977 1978 1.979 0- .5-

YEAR

BROCKS GROUP OF CO LTD `t VALUE

- - USRLES
- - -N

441/SF
-NI/TA-SF
— —CRSH/SF
Figure 5.3.38 Testing the Effectiveness of the Model -CASH/TA-CL
— — — — CA/CL
-WC/SF
CUTR

188


3.5 0.15-

0.05'

1.97 -1974: 1976 -1978

YEAR

1972 1974- 1976 1978 N o— AT

YEAR

0.18-

0.16'
\

‘‘. I \
c\ r

• / ——

30. II \---i \\
it/

1972 1974 1976 1978 1980

YEAR
0.02
19721 .197‘. 1976 1978 1980 (3-.5-
YEAR

STONE PLRTT INDUSTRIES PLC

Y VALUE
-NI/SALES
-NI/SF
-NI/TA--SF
— —CASH/SF
Figure 5.3.39 Testing the Effectiveness of the Model -CASH/TA-CL
— — CA/CL
-WC/SF
CL/TA

189


3.5 0.3

3.0
0.2
2.5

cu 2.0
E 1.5

1972 1974 1976 1978 1980

YEAR
0.5

0-.1
1972 1974 1976 1978 1980
YEAR
0-.5
0-.2

0.06-
2.0-

0.05- 1.8- /
i
_r 1 . 6 - /
CC
E, O. 04-
/\
1— :*:) 1.4
\
cn
C)
10.03-/ g 1.2
Ln
ct
r‘`,\ 1 '-'
cc
(_) i r ' ‘-j
f

0.02/
0.8

0.6
0.01-

0.4 ,
197i 1974 1976' 1976' 1980' 1972 1974 1.976' 1978' 1986'
YEAR YEAR

BRITISH AIRWAYS
- - - - -
Y VALUE
NJ/SALES
-NI/TA-SF
—. —CASH/SF
Figure 5.3.40 Testing the Effectiveness of the Model -CASH/TA-CL
CA/CL
--11JC/SF

19 0
 3. 0.25r
3.0
0.20
2. b

1.0

0.5 0..05
nn
n
1972 1974 1976 978 1980 n -
YEAR 1972' 1974
0-. 5 - 1976'-
194
YEAR
-1.0 0- . 05-

0.061

r-N\ \
,.....„ ...... n ....n
•n• ....n.

/
\
%
e-
\ .--..
/
\

‘
\%
If
\
IS
LJ
2
LO
(ctT) 0..03 1 ii
IC
n
n ..............

Li
9 O. 5'
r\
0.02
11‘. //
197
„,.// 1974 1976 1971i 1980
YEAR
0.01
0-.. 5
197 1974 1976 1978' 1980
YEAR

VINERS Y VALUE
-NI/SALES
- -NI/SF
-NI/TA-SF
Figure 5.3.41 Testing the Effectiveness of the Model -CASH/TA-CL
CA/CL
-11.1C/SF
--CUM

191

F-
 0.20
uu r=
LJ
z --I 0.15
mcc
E'

E
tr 0.10
oL 22
1972 1974 19 1978 1980°-
YEAR 0.05
- - --
1972 1974 1976 874--
, / 1980
Y EAR
0 -.05

0.20
1.6
/
0.18 /
1.4 / I
0.16 / I
1.2-

0.14 _

;720.12 \I
'6;
R- 0.10
lt
u/
50.08

0.0G 0.4

0.04
0.2
k
0.02
197 1976 1978' 1980'
1972 1974 1976 1978 1980 YEAR
YEAR

BLACKNAN & CONRAD -Y

VALUE
-NI/SALES
-NI/SF
-NI/TA-SF
--------CASH/SF
Figure 5.3.42 Testing the Effectiveness of the Model -CASH/TA-CL
CA/CL
-WC/SF

192


0.1

0.10

0.05 •••.
YEAR
1973 1974 1975 1976 1977 197 10
0,5
itnrs /1
197.
--J
;30-.05 ii
g
m F--

Et-, 0-.5 L o—. Lo I

R
-L.0 CL 0 -'. 15 I

0-.20 I
-1.5
0-.25

0-.30

1.75
0.10 0 1.50
N,

1\ 1.25
...•••••

o_oe''
i \ e 1.00
.
;::: , I ' \ 1
'..jo..136 0.75
0_
--
, --,
t
u, 11( \\ /
ct II
'. 04 1\
0.
11 0.25 -. ,.../
'11 \
il
1972 1973 194 1975' 1976 1977 1976 19.1i
0.02" II YEAR
0-.25

/‘,...._./
3
1972 197 ' 1974 1975 1976 197f 134 1.34
0-.50
YEAR

AP1ALGAMATED INDUSTRIALS Y VALUE

-NI/SALES
-NI/SF
-NI/TR-SF
--------CRSH/SF
Figure 5.3.43 Testing the Effectiveness of the Model -CASH/TA-CL
— — — — —CR/CL
-WC/SF
-------CL/TA

193


0.20
2.0

0.15
1.5

0.10
1 .0
e:
n 0.05
I0.5
LT: 1973 1974 1 1976 1977
YEAR
'980

1973 1974 1975 1976 1977 19 1979 1 80

YEAR 0-.05

0-.5
0-.10

0-.15

0.0200

0.0175'

0.0150- 1.

I‘
20.0125
c-
ZTri

20.0100\ //(\

u-)
cc \ g
(-10.0075-

0.0050'
1973 1974 19/5 19/6 19/7 19/8 1979 1980
0.0025- kt: YEAR

1973 1974 1975 1976 1977 1978 1979 1980 0-.5-

YEAR

BLACKWOOD, PlORTON 8, SONS

- - —
Y VALUE
NI/SALES
----- -NI/SF
-NI/TA-SF
CASH/SF
Figure 5.3.44 Testing the Effectiveness of the Model - CASH/TA-CL
— CR /CL
- 111C/SF
CL/TA

19 4
 0.25

0_

1972 1973 1974 1975 1976 1977 1i 1919

YEAR 1972 1973 19i+ 1915 196 12TT 19 J979
IERR
0-.05
.\\:
‘

0-.10

0.040

0.035

A
0.030

6 i \
8a_ 0.025

±0.020
to ili \
L,
' -_ii \
0.015
:
i
i
0.010
\ 972 19(3 1974 1975 19/6 1977 1918 1919
YEAR
0.0(6
1972. 1974 1974 1975 1974 197i 1978 ' 1974 0-.5
YEAR

BURRELL 8, CO.
Y VALU
-NI/SALES
------NIISF
- Nian-sF
----- --CASH/SF
Figure 3.3.46 Testing the Effectiveness of the Model - CASH/TA-a

- WC/SF

195
 \
\

0.05 _ _ _ YEAR
197 19-
74 ". -1-976 19-7 198

0 - . 05
a

1972 1974 1976 1978 990 0-.15

YEAR
0-.20

0-.25

0.14

0.12

0.'
10'

..t°
r=
E0.08

\2i0.6

±: 0.04'

1972T 1976
0.02 1978 1980
YEAR

1972 1974 -1976' 1978 1.980
YEAR

PICKLES (WILLIAM & CO. Y VALUE

----- - NI/SALES
-NI/SF
-NI/TA-SF
--------CASN/SF
Figure 5.3.45 Testing the Effectiveness of the Model -CASH/TA-CL
CA/CL
-WC/SF
CL/TA

196


0.1

0.10

0.05

0-.15

0-.20

0-.25

0-.30

0.02.00
1. (5- \

0.0175- 1.50-

0.015(1 i\ 1.25-
I'

It

( ,-. \ "4 i .00'

20.0125- 7 \ % !---,

ul ES 0. 75-
20.0100 ,,.
0. 50 -....--"---- -
7=
U/

'0.0075-
11I '\\ '
, \I -\ _ _ __,,/
\
I. I 0. 25 ' .

0.0050- 197,1 197d 1978 1980

YEAR
0
-.25-
0.0025- .------..
-----.... -..._.---
- )1( 0-. 50-
- 1976 1978.. 1980.
YEAR

CAWDAW INDUSTRIAL HLDGS Y VALUE

------- -NI/SALES
-NI/SF
-NI/TA-SF
CASH/SF
Figure 5.3.47 Testing the Effectiveness of the Model -CASH/TA-CL
—•--•--CR/CL
-WC/SF
CL/TA

197
 O. 2

0.1

1973 1974 1975 1976 1977 197 197\9 198

1973 1974 1975 1976 1977 1978 1979 980 50-.1

YEAR

0.2

0.14

0.12

1.
0.10

-.0.08

(-c2 0.06
n
0.04
11111.1 1
1973 1.974 1975 1976 1977 1978 1979 1980
YEAR
0.02
0-. 5-
(
1973' 1974 1975' 1976. 1977 1978' 1974 1980)
YEAR

RIRFIX INDUSTRIES
- -
Y VALUE
- - - -N I /SALES
-NI/SF
-NI/TA-SF
— —CASH/SF
Figure 5.3.48 Testing the Effectiveness of the Model -CASH/TA-CL
— — — CR/CL
-WC/SF
CL/TA

198


0.030 L.50-

1.25
0.025'
1 .00'

E0.020' 0.75'
ii
i=7 ii ii
cz) 0.50"
=0.015
=
Ln

I.
Ir\\ I
0.010' 1972 1974 JO 1979
/
0.005-

1972' 1974 1979 1379 1986

YEAR

OXLEY PRINTING GROUP

V VALUE
-NI/SALES
-NI/SF
-NI/TA-SF
-------CASH/SF
Figure 5.3.49 Testing the Effectiveness of the Model -CASH/TA-CL
— CA/CL
-IC/SF
CL/TA

199


1974 L976 1978 1.980

YEAR

\
0.225-
/ \

.-- \ / \
0.200- / \
/
-
3 6' / \ / \
0.175 / \ / \
ccs 2.5`I
— 1 I \
o
r= 0.150
F--
\ . i \
.... ___) \
174 cct
ID
-0.125
L5
ct .
'0.100-

O. 075'' _
0.5
0.050-
19JEL.- • 1980'
0.025- YEAR
• 1974' 1976 1978 1980'
YEAR

LESNEY PRODUCTS & CO. 4 VALUE

- - -N I /S ALES
• -NI/SF
-NI/TA-SF
— —CASH/SF
Figure 5.3.50 Testing the Effectiveness of the Model -CASH/TA-CL
CA/CL
-WC/SF
CL/TA

200


O. _

197 1974 1976 197 98

0-.

0-.4-

2.0
r---------- \
0.030 -
\
/ 1.5
--_--/ /
\
0.025- \
I
\
..j LO
z . \ cE \
I
p0.020- .L-.-- \
\ \ t
I S 0.5 \
o _------
a..
LT, 0_015' 1- n .--!
Ct
I-3 C\ / ‘ \--/..-. \ \ 5) 1972 1 978 _ 1 BO
74 ---- YE94
19---- 16 _ _No
i \
0.010
0-.5
•
0.005"/
xi -1.0

1974 • 1976' 1978' 1980

YEAR

RICHARDS & WF1LLINGTON INDUSTRIE

7- - - -
URLIJE
- -N1/511115
NI/SF
-NI/TR-SF
— —CASH/SF
Figure 5.3.51 Testing the Effectiveness of the Model -CASH/TA-CL
—CA/CL
-1.dC/SF
CL/TA

201


YEAR

1972 1974 1976 1978 1980

YEAR

.—\
0.30- /— \
/ \ 2.5 \ /
\,/
N-

0.25
/// /.\ \ —l
ca
2.0

i /7 \
\
F---

';
a
..

c_)
1.5

i /
/ \ % 1_0
,T)0.15
Li
\\ %
0.10-
I
\k
1972: 1974! • 1976 1978. 188d
0.05 YEAR

- 0-.5
1972 1974 1976 137E1 198O
YEAR

NORVIC SECURITIES Y VALUE

-NI/SF
NI/TA-SF
CASH/SF
Figure 5.3.52 Testing the Effectiveness of the Model CASH/TR-EL
CR/CL
-WC/SF
CL/TA

202
 /-\
0.1
— — 19-7 —i'80

0 - .1
r.
j.-1 10-.2
i CIS
cc
LL, -2 t 0-.3
1.
m
`12_3

0-.. 5

0-.6

0-.7

2.0
0.12'

0.10'

z.
p0.08-

J: 0.06
uo
Li

0. 04 /— —
, •
19761374! • 1978' 19e0'
0.02' YEAR

0-.5-
• 1974i- 1976' is7d /980'
YEAR

AUSTIN(F.)(LEYTON) Y VALUE
-NI/SALES
-NI/SF
-NI/TA--SF
--CRSH/SF
Figure 5.3.53 Testing the Effectiveness of the Model -CASH/TA--CL
----CR/CL
-WC/SF
--CUM

203
5.3.4 OVERALL EFFECTIVENESS OF THE MODEL

To evaluate overall effectiveness of the model for all 53

companies we can look at the general trends of their four

graphs such as performance (Y-value), profitability, cash

position and working capital for each company and over the

time which were presented by Figure 5.3.1 to 5.3.53. If the

general trend over time is improving it is called 'up', if it

is constant over time it is called 'static' and if it is

declining then it is called 'down'. This demonstration for

all the companies is shown in Table 5.3.2, by considering that

P - profitability

CP = cash position

WC = working capital

AOP = actual overall performance

204


Table 5.3.2 Effectiveness of the Model

I I
Figures P CP WC I AOP IY-valuelModel Effectiveness'
+

5.3.1 I up I up Ist atic I up up very good

5.3.2 Istatic I up I up I up up very good

5.3.3 I up down up up I up I good

5•3•4 'static up down 'static up bad

5.3.5 I up I up I up I up up excellent

5.3.6 'static I up I up I up I up very good

5.3.7 I down up I up 'static 'static I bad

5.3.8 'static I up I up I up I up j very good

5.3.9 I down down I down I down I down excellent

5.3.10 I up I up I up I up I up excellent

5.3.11 I down down 'static I down I down very good

5.3.12 I up down 'static 'static I up I bad

5.3.13 'static I down 'static 'static 'static I very good

5.3.14 I up 'static I up I up I up I very good

5.3.15 down down 'static I down 1 down very good

5.3.16 up I down I down I down I up I very bad

5.3.17 down down 1 down I down I down I excellent

5.3.18 down down I up 'static I up I very bad

5.3.19 I up I up I up I up 1 up I excellent

5.3.20 down I up 'static 'static 'static I good

5.3.21 I down up I up I up I up I good

5.3.22 down I down I down I down I down I excellent

5.3.23 'static up 1 up 1 up 1 up very good

5.3.24 I up I up I up I up I up I excellent

205
 5.3.25 I up up I up I up I up excellen

5.3.26 'static up 'static 'static 'static very good

5.3.27 down down down down down excellent

5.3.28 up up up I up up excellent

5.3.29 down down down down down excellent

5.3.30 down down down down down excellent

5.3.31 down down down down down excellent

5.3.32 down up down down down good

5.3.33 down down down down down excellent

5.3.34 down down 'static down down very good

5.3.35 I
1
down down 'static I
1
down I down very good

5.3.36 'static down 'static 'static 'static very good

5.3.37 down down

do I down
do down down excellent

5.3.38 down down I down down do

down excellent

5.3.39 down down 'static down down very good

5.3.40 down 'static I up Istatic down bad

5.3.41 down down down down down excellent

5.3.42 down down down down down excellent

5.3.43 down down down down down excellent

exc

5.3.44 down down Istatic down down very good

5.3.45 down down down down down excellent

5.3.46 down I down down down down excellent

5.3.47 down 'static down down down very good

5.3.48 down I down down

do down down excellent

5.3.49 down 'static down

do down down very good

5.3.50 down I down down down down excellent

5.3.51 down I
1
down down down down excellent

5.3.52 down I
1
down down down down excellent

5.3.53 down I down down down down excellent

+

206
 For classifying the effectiveness of the model the

following computations can be done, by this assumption that

the model has almost got 33% of profitability, 33% of cash

position and 33% of working capital.

1) if P + CP wc U = Y-value

then 33% 33% 33% 99% 11

So when the effectiveness is about 99% it is called 'excellent'

2) if P CP 1-t- + WC (static) = Y-value II

then 33% 33Z + 22% = 88%

When the effectiveness is about 88% it is called 'very good'.

3) if P CP + WC = Y-value

or P + CP (static) + WC (static) = Y-value

or P I+ CP + WC (static) = Y-value (static)

then 33% 11 332 J1 11% = 77% J1

or 33% 22% + 22% = 77% 11

When the effectiveness is 77% it is called 'good'.

4) if P + CP If WC (static) = Y-value

or P CP + WC = Y-value (static)

then 33% + 11% II 22% = 66%

or 22% + 22% + 22% = 66%

207
When the effectiveness is around 66% it is called 'bad'.

5) if P + CP li wc 11 Y-value

then 33% + 11% + 11% if = 55Z fl

When the effectiveness is 55% it is called 'very bad'.

Overall effectiveness of the model is shown in Table 5.3.3.

Table 5.3.3 Overall Effectiveness of the Model

Effectiveness (1) No (2) I' (1)x(2)

excellent 26 99% 25.75 1

very good 17 88% 14.96 1
good 4 77% 3.08 1
bad 4 66% 2.64 1
very bad 2 55% 1.10

total 53 47.52 1

If we divide 47.52 to 53 then we have 90%, which means that

the overall effectiveness of the model is 90% or its accuracy

to measure the companies' performance is about 90%.

208
5.4 CONCLUSION

In this chapter a financial model has been described which

was developed to measure companies' financial performance.

This model was applied to a sample of 53 companies. About 83

percent of failed companies and 100 percent of going concerns

were classified correctly. Of the 15 failed companies 13 have

gone into receivership and the other 2 were in serious

financial difficulties. At this stage it appears that the

model might be effective in measuring the companies'

performances.

A second aspect of the model is that it explains 30 percent

of profitability, 37 percent of working capital and 31 percent

of liquidity, which means that it almost explains the same

variance of the three main factors of the companies'

performance.

Finally by plotting the output from the model against time

for each company separately and comparing its trend with

companies' actual profitability, cash position and working

capital trends (pages 151-203), it is possible to demonstrate

the model's effectiveness in measuring the company's financial

performance. The main result of this visual analysis is that

the overall effectiveness of the model in identifying the

companies' strengths and weaknesses is about 90 percent.

209
 CHAPTER 6

PERFORMANCE CLASSIFICATION AND COMPARISON

210
CHAPTER 6 : PERFORMANCE CLASSIFICATION AND COMPARISON

Measurements are taken to obtain either definitive

statements or information for the purpose of comparison. In

the analysis of financial data the comparative aspect is

foremost and it is the direction of trends that is important

in most cases. Consequently a standard of performance can not

be established in an absolute sense and in practically all the

measurements taken the previous year's results are used for

comparison.

6.1 CLASSIFICATION OF THE PERFORMANCES

The next step after testing the model is to use it to

classify companies. If we consider the model as the following

equation:

Y =a +aR +aR+ +a R
0 11 22 10 10

and compute the Y-value for each company and each year

separately then we have for company A:

213.
 • =b
1971 1

• =b
1972 2

• = b
1973 3

• =b
1985 n

Where n is the number of years, and b is the Y-value at the

end of each year. To compute the mean value of all Y-values

we need to divide the total value of 'Y' by the number of years

for each company.

mean = m = (b + b + b + +b )/n
1 2 3

where m is the mean of Y-values. This mean value shows the

average performance of the company over the years, or how

effectively they were doing in the past. This mean value can

be used as a base for analysing and evaluating each year's

activity. It can be said that each Y-value above the mean

value is classified as the good and well performing an fur

all the Y-value's below the mean are classified as the poor

and bad performing companies.

So if we assume D as deviation of each year performance

from the mean or simply:

D = b -m

Then we can classify the company's performance into three

212
different categories such as:

1)

if D>0

and b >0

That such companies are classified as the well performing

companies.

2)
if D<0

and b >0

Such companies are classified as the fair performing companies

3)
if D<0

and b <0

Such companies are classified as the poor performing companies

By applying the above classification to our 53 sample

companies we have:

well performing companies 20

fair performing companies 15

poor performing companies 18

To identify cut-off lines to distinguish areas which specify

the above three categories, we can compute Z:b /m for each

j=1 nj

group separately where m is the number of companies in each

group and b is the terminal 'Y-value' for each company. Then

20
well performing=Z:b /20=66.486/20=3.3243
j = 1 nj

213
 fair performing4
15
--b
/15=28.4912/15=1.899
j=1 nj

poor performing =t=b

18
/18=-38.5746/18=-2.143
j=1 nj

And the cut-off lines are calculated as follows:

a) cut-off line between first and second

group=(3.3443+1.899)/2=2.6

b) cut-off line between second and third

group=(1.899-2.143)/2=-.244

So by the above calculations we can specify the cut-off

lines as follows:

If Y>2.6 well performing companies

If 2.6>Y>-.244 fair performing companies

If Y<-.244 poor performing companies

The above classifications can be shown as

well performing area

2.6

fair performing area

-.244

poor performing area

Figure 6.1.1 Classification of performing area

By applying the above classification criterion to the

sample companies which have been presented in Chapter 5 we

have:

214
 Table 6.1.1 Applying the new classification to the sample

companies

CLASSIFICATION NO OF CO FAILED GOING 1

WELL 16 0 16 1

FAIR 21 21 1

POOR 16 15 1 1

As we can see from the above table 100% of the well

performing companies are truly classified and 94% of the poor

companies have gone into receivership and the other 6% are in

serious difficulty. 100% of those classified as fair

performing companies are going concerns. Therefore, the model

can classify 98 percent of the whole sample companies

correctly.

The companies comprising the three classes are:

a) WELL PERFORMING COMPANIES

1) General Electric Co.

2) Coalite Group

3) Allied Textile Companies plc

4) British Home Stores plc

5) Bell (arthur) & Sons plc

6) Wellcome Fundation

7) Benford Concrete Machinery plc

8) Beecham Group plc

9) Marks & Spencer

215
 10) Pearsons

11) Racal Electronics

12) BPB Industries plc

13) Allied Colloids plc

14) Ash & Lacy plc

15) Boots Co plc (The)

16) British Gas Corporation

b) FAIR PERFORMING COMPANIES

17) Anglia Television Group plc

18) Goodyear Tyre & Rubber Co (GB) Ltd.

19) Babcock International plc

20) APV Holdings plc

21) Ault & Viborg Group plc

22) Albright & Wilson Ltd.

23) Barrow Hepburn Group plc

24) Pleasurama plc

25) British Railways Board

26) Anchor Chemical Group plc

27) Baker Perkins Holdings plc

28) Ford Motor Co Ltd.

29) Adams & Gibbon plc

30) Armitage Shanks Group Ltd.

31) Atkins Brothers (hosiery) plc

32) Dunlop Holdings plc

33) Barno Industries plc

34) BBA Group plc

35) Batleys of Yorkshire plc

36) Bemrose Corporation plc

37) Bestobell plc

216
C) POOR PERFORMING COMPANIES

38) Brocks Group of Companies Ltd. (Receiver

appointed 3rd March 1981)

39) Stone Platt Industries plc (Receiver appointed

18th March 1982)

40) British Airways (On 12th March 1986, because of

difficulties on renewal of the UK/US Air Service

Agreement and other political reasons the

Government decided to privatise British Airways.

On 30th september 1986, British Helicopter

Ltd.(BAHL) was sold.)

41) Viners (Receiver appointed 16th November 1982)

42) Blackman & Conrad (Voluntary Liquidation 11th

February 1981)

43) Amalgamated Industrials (Compulsory liquidation

6th November 1981)

44) Blackwood, Morton & (HLDGS) (Receiver appointed

15th November 1981)

45) Pickles (William) & Co. (Receiver appointed

16th June 1982)

46) Burrell & Co. (Receiver appointed 4th August

1980)

47) Cawdaw Industrial HLDGS (Receiver appointed 22nd

February 1982)

48) Airfix Industries (Receiver appointed 29th

January 1981)

49) Oxley Printing Group (Receiver appointed 17th

August 1981)

217
 50) Lesney Products & co. (Receiver appointed 11th

June 1982)

51) Richards & Wallington Industries (Receiver

appointed 15th July 1981)

52) Norvic Securities (Receiver appointed 15th July

1981)

53) Austin (F.)(Leyton) (Receiver appointed 31th

July 1982)

Or testing the model's effectiveness is classifying

companies it might be enlightening to compare its

effectiveness with those of other models that exist for this

purpose which is the subject of the following discussions.

6.2 FAILURE PREDICTION STUDIES

Business failures can be attributed to circumstances or

conditions that were known prior to make any major financial

commitments and could be easily identified. For some reason

whether enthusiasm or ignorance, management simply failed to

recognise the importance or existence of these failures.

The prediction of failure was stimulated in the USA by the

high rate of business failures during the Depression of the

1930s. Between 1930 and 1942, five studies were undertaken,

by Fitzpatrick (1932), Smith (1930), Smith and Winakor (1935),

Ramser and Foster (1931), and Merwin (1942). These studies

gave a good indication of the data which appeared to be

relevant to the prediction of failure. Some data were shown

to indicate serious weaknesses in a company several years in

218
advance of failure. The idea was that, for example if current

assets more than current liabilities, this was a sign of

strength. The lower the current assets, the greater the

weakness. The extremes could readily be identified, and a

cut-off point or range could be established from predictive

experience. Most of the data was in the form of ratios, and

those which appeared to be useful predictors were:

1) Current ratio=current assets/current liabilities

(two studies)

2) Acid test ratio=(current assets-inventories)/

current liabilities (two studies)

3) Net Worth to Fixed assets=(total assets-total

liabilities)/ Fixed assets (five studies)

4) Working capital to total assets=(current assets-

current liabilities)/total assets (four studies)

5) Net profit to net worth=Net profit/net worth

(three studies)

6) Net worth to total liabilities-(total assets-

total liabilities)/ total liabilities

The first two measuring the company's ability to meet

short-term liabilities. The others measuring the overall,

long and short term position of the company. The ratio

analysis has been considered as a tool in assessing current

and expected company performance, in relation to investment

decisions as well as more specially in relation to the

prediction of failure.

The next major study was by Tamari (1964) on Israeli data,

who found that six ratios in particular were good predictors

219
of failure, in some cases up to five year ahead, and all cases

in the year prior to failure:

1) current ratio, as above

6) net worth to total liabilities, as above

7) (sales+change in inventory)/inventory

8) sales/(current assets-current liabilities)

9) profit trend(fitting a trend line to profit

figures over the recent past)

10) sales/debtors

Tamari observed that a large proportion of the successful

companies in his sample had at least one weak ratio, some had

two and even three. He concluded that the analyst can not

rely on one ratio alone in measuring the degree of risk

associated with a company.

Beaver (1966) found that the best predictor of failure was

the hitherto untested longer-term ratio:

11) cash flow/total debt

12) net profit/total assets

13) total liabilities/total assets

Beaver tested the ability of financial ratios to predict

failure. He found that not only the financial ratios of

failed firms differ significantly from non failed firms, but

they deteriorated considerably during the five years prior to

failure. He also found that the mean of total debt over total

assets of the failed firms was 0.79, whereas that of the non

failed companies was 0.37. He should that the low ratio of

net profit over total assets is one of the three major

220
characteristics of the company failure.

Horrigan (1968) showed that in the 1930s, the first attempt

were made to test the utility of ratios by examining how

effective they were in predicting business failure.

Altman (1968) attempted to 'assess the analytical quality

of ratio analysis - a set of financial ratios was combined in

a discriminant analysis approach to the problem of corporate

bankruptcy prediction, by the use of multiple discriminant

analysis. Discriminant analysis aims at distinguishing

between two or more distinct populations on the basis of some

characteristics of their members, and the classification of

individual companies into one or other of the classifications,

in this case 'failing' and 'non-failing'.

Altman, like Beaver, selected a sample (thirty-three) of

solvent companies to 'pair' with (thirty-three) failed

companies. From twenty-two ratios, he selected five that

appeared to be most effective in predicting failure, and these

ratios were used to discriminate between failed and solvent

companies, using data from one to five years before failure.

The predictive ability of his'five-ratio' model declined in

proportion to the number of years prior to failure but was

able to predict fairly accurately up to two years ahead.

221
 Altman assigned weights to each of his ratios, as below:

weights

(4) working capital/total assets 0.012

(14) Retained earning/total assets 0.014

(15) EBIT/total assets 0.033

(16) Market value of equity/book value of long-term

debt 0.006

(17) sales/total assets 0.999

These ratios were drawn together, with the weights assigned

to each of them to give an overall score, often called the Z

factor:

Z=(4)W +(14)W +(15)W +(16)W +(17)W

4 14 15 16 17

According to Altman, a minimum Z score of 1.8 is necessary

to avoid failure, but only with a Z score of 3.0 or more is

the company fairly safe.

222
Table 6.2.1 The Predictive Accuracy

Altman's predictive accuracy

+

within one year 95%

within two year 75%

within three years 48%

within four or five years 30%

Taffler (1977) has used a model to predict failure among UK

companies which has the following characteristics:

Z=C +(PBT/AVCL)C +(CA/TL)C +(CL/TA)C +(No Credit interval)C

0 1 2 3 4

Where C is a constant which measures half the distance between

0

the Z score of the failed and solvent companies, C ,....,C are

1 4

the weights, (PBT/AVCL) is the ratio of profits before taxes to

average current liabilities and

'No credits' interval=(cash and market securities-current

liabilities)/projected daily operating expenditure

The weights C to C contributed 0.53, 0.13, 0.18 and 0.16,

1 4

respectively, to the models operation. The failed/insolvent

cut-off point was found to be Z = -1.95.

Betts (1984) developed two models for identifying those

companies which are in danger of financial failure, using

published accounting data and multiple discriminant analysis.

223
 On the basis of these studies, it appears that financial

ratios can be used as predictors of various events, and it is

likely that ratio analysis will become more useful in future.

6.3 COMPARISON OF THE MODEL WITH SIMILAR MODELS AND STUDIES

Although some studies have been undertaken to measure the

overall financial performance of companies, the main problem

with these studies is the proprietorial nature of the models,

which makes comparison of performances of different models

difficult. However, there are some similarities of the

present study with others which is presented in this section.

According to the previous studies such as Wall & Dunning

(1928), Tamari ( 1964), Smith (1965), Lev (1974), Altman

(1977), Hoshino (1982) and Taffler ( 1982), the current ratio

is a good indicator of company's success and failure. Tamari

also found from data of manufacturing companies in Israel in

1968 that 70 percent of failed companies had a current ratio

less than 1.0 whereas only 27 percent of non failed companies

had similar values.

In this study, it was found that the current ratio is

significantly related the company's financial performance. As

described in Table 6.3.1, 88 percent of well performing

companies had a current ratio in excess of the optimum

liquidity ratio which is 1.5 according to Richard (1964). 75

percent of poor performing companies had a current ratio less

than 1.5 which is called under liquidity and they all had

payment difficulties.

224
 Table 6.3.1 A comparison of current ratios with differing

levels of company overall financial performance.

liquidity over optimal under payment

ratio liquidity liquidity liquidity difficulties I

R = CA/CL R>2.0 2.0>R>1.5 1.5>R>1.0 R<1.0

Well performing 57% 31% 6% 6%

Fair performing 5% 48% 382 9%

Poor performing OZ 25% 372 38%

The variation in the current ratios overtime for particular

companies are depicted in the lower right graphs of Figures

5.3.1 to 5.3.53.

There are also nine studies which found that business

failure is usually linked with low or declining profitability.

The studies were those of Beaver (1966), Altman (1968), Haslem

and Langbrake (1971), Schoeffler (1974), Tamari (1977),

Taffler (1977), Bass (1978), Belhoul (1983) and Betts (1984).

As indicated in Table 6.3.2 the present study showed that

about 81 percent of well performing companies had excellent

and good profitability whereas 100 percent of poor performing

companies had low and deficient profitability with about 94

percent of them have already gone into receivership.

225
 Table 6.3.2 A comparison of profitability ratios with

differing levels of company overall financial performance

+ +
1 1 1 1

1
1 excellent 1 good 1 deficient I danger of 1

IR — NI/SFlprofitability 'profitability 'profitability I failure 1

R>0.15 I 0.15>R>0.10 I 0.10>R>0.0 I R<0.0

well 50% 31% 19% OZ

fair 19% 19% 57% 5%

poor OZ OZ 19% 81%

Another good indicator of business success or failure was

found to be company's cash position. This view is shared by

Beaver (1966), Blum (1969), Gonedes (1971), Deakin (1972),

Martin & Scott (1974), Pinches (1975), Mao (1976) and Belhoul

(1983).

Table 6.3.3 presents information on the cash position of

companies for varying levels of overall financial performance.

The variation of this ratio over time is shown at the lower

left of Figures 5.3.1 - 5.3.53 for various companies. In

summary nearly 56 percent of well performing companies had a

considerable margin of cash in hand to make immediate payments

whereas 100 percent of poor performing companies had problems

meeting immediate payments.

 Table 6.3.3 The comparison of cash position ratios with

differing levels of company overall financial performance

+ +

1
'cash position lexcellent Ivery good good I bad very bad 1

1 R =. cash/SF I R>0.15 .15>R>.10 .10>R>.05 .05>R>.01 I R<.01 1

1
+ +

well 44% 6% 6% 25% 19% 1

fair 5% 5Z 33% 33% 24% 1

poor OZ OZ OZ 44% 56% 1

+ +

The models output is also depicted in the top left corner

of Figures 5.3.1- 5.3.53. This output can be simultaneously

compared with the three main indicators of company financial

performance, ie. profitability, working capital and cash

position, for the 53 companies analysed.

By the above analysis it was found that the effectiveness

and accuracy of the model to measure companies' financial

performance whose data were used to construct the model is

about 91 percent which dropped to 88 percent when it was

applied to companies whose data was not used in the model's

construction. However, the overall effectiveness of the model

is about 90 percent which can be compared with some of the

other model's and studies accuracy regardless of their

specific purposes or different techniques or criterions used

for their construction. Some of these studies are summarised

in Table 6.3.4 as follow.

 Table 6.3.4 The Classification Accuracy of Some Financial

Performance Models

1 authors year area of study 'classification 1

1 accuracy 2'

1 Walter 11959 financial characteristics 80

1 Smith 11965 common stock analysis 72

1 Altman 11968 failure prediction 75

1 Haslem & 1

1 Longbrake 11971 bank performance analysis 86.5

1 Frank & 1

1 Weigandt 11971 debt characteristics analysis 90

1 Klekowsky 1

1 & Petty 11973 share price analysis 86

1 Blum (1974 business failure analysis 81.7

1 White 11975 shares analysis 84

1 Schick & 1

1 Verbrugge 11975 'financial characteristics analysis 77

1 Taffler 11977 company failure analysis 98.5

'Gillingham 11980 profitability analysis 94.4

1 Betts & 1

1 Belhoul 11982 company failure analysis 97

1 Belhoul 11983 high performing companies 85

1 Betts 11984 failure prediction analysis 90

Finally the classification accuracy of this model is

compared with that of Betts' (1984) first model. Although,

228
Betts' model was designed for the restricted purpose of

identifying financially failing companies within a set of

going concerns, it was thought that such a comparison may be

useful, because the present model ought among other things be

able to identify failing companies.

The model was applied to 15 out of 23 failed companies that

Betts (1984) used in his study and it was able to classify

them as failed companies. It was then applied to another 6

companies which Betts defined as well known financially

healthy companies and again they were classified correctly.

•
These companies are Allied Colloids Group Plc, Anglia

Television, Coalite Group, General Electric Co, Pleasurama Ltd

and Racal Electronics.

229
6.4 CONCLUSION

In this chapter the model was used to classify companies.

The average performance of the company over the years was used

as a base for analysing and evaluating each year's activity.

The cut-off line between well and fair performing companies

found to be Y = 2.6, and between fair and poor performing

companies was computed to be Y = -.244. These criteria were

applied to the sample 53 companies. 100 percent of well

performing companies and 94 percent of poor performing

companies were correctly classified.

At the end of this chapter the similarities between the

present model and other models were discussed in detail.

The main result of above comparison is that we have almost

used the same indicators of business success or failure as

others used in their models and studies. By comparing the

model's output with these main indicators of company's

financial performance, it reveals that the accuracy of the

model in measuring company's financial performance whose data

were used to construct the model is about 91 percent which

dropped to 88 percent when it was applied to companies whose

data was not used in the model's construction.

230
 CHAPTER 7

PERFORMANCE STABILISATION

231
CHAPTER 7 : PERFORMANCE STABILISATION

The goals of performance stabilisation are not simply to

eliminate fluctuations in performance variables, but to force

variables to follow 'ideal' paths. For example a 5% profit

margin even if it is constant over time, is not acceptable.

Thus the goals of stabilisation might include reaching (and

then maintaining) a high rate of profitability, a high rate of

working capital and a low rate of leverage. Eliminating

fluctuations in the company performance is therefore a

secondary objective that becomes desirable only after the

performance has reached a 'healthy' steady state.

In other words, we would like variables such as current

assets, current liabilities, net income and cash as closely as

possible to follow a nominal or 'ideal' path throughout the

performance period.

7.1 PERFORMANCE STABILISATION

The structural model of stabilisation consists of four

equations which are extracted from five different factors.

The factors themselves are extracted by factor analysis

available on SPSSX at University of Bradford. The variables

are R1 to R10 the main 10 variables of Y-model and the number

of cases are 7420 (530 companies multiply by 14 years of

activity for each company). By applying the above package to

our variables we can construct the following equations:

232
 F = .60132ZR + .4056ZR
1 2 7

F = .49905ZR + .50836ZR
2 5 8

F = .53485ZR + .4632ZR
3 1 3

F = 1.07767ZR
4 9

F = .82264ZR + .15715ZR
5 6 10

Where the Z is the normalised value of ratios and is equal

to

Z = (variable - mean)/standard deviation

By replacing the actual variables in the above equation we

have

F = 1.1R + .34R - .276

1 2 7

F = 5.1R + 4.54R - .594

2 5 8

F = 9.96R + 3.83R - .826

3 1 3

F = 7.627R - 2.887
4 9

F = 1.04R + 1.23R - 2.19

5 6 10

And by substituting the real variables with the ratios we have

F = 1.1NI/SF + .34(CA-CL)/SF - .276

1

F = 5.1CASH/CA + 4.54CASH/(TA-CL) - .594

2

F = 9.96NI/SALES + 3.83NI/(TA-SF) - .826

3

233
 F = 7.627CL/TA - 2.887
4

F = 1.04CA/CL + 1.23(CA-INVENT)/TA
5

In Chapter 6 it was seen that well performing companies had

D?,0

and b - 140

Which means that for well performing companies the b score

in year n should be greater than or equal to M the mean value

of bn scores. So to get an ideal value we can write

b =M

or b =riff +mF +mF +mF +mF = M

n 1 2 3 4 5

where mF is equal to the mean value of the factor 1

1

On the other hand the mean values of factors are equal to

zero and their standard deviation is equal to one, which means

that

M 0

or simply

1.1NI/SF + .34(CA-CL)/SF .276 = 0

5.1CASH/CA + 4.54CASH/(TA-CL) - .594 = 0

9.96N1/SALES + 3.83NI/(TA-SF) - .826 - 0

7.627CL/TA - 2.887 = 0

1.04CA/CL + 1.23(CA-INVENT)/TA = 0

234
 Finally the ideal values for four important and

controllable variables such as CA, CL, CASH and NI are

calculated as follows:

ideal CA = OCA = .55TA + .31INVENT

ideal CL = OCL = .378TA

ideal CASH = OCASH = .37TACA/(3.2TA + 4.5CA)

ideal NI = ONI = .826SALES(TA-SF)/(9.96TA-

9.96SF+3.83SALES)

In this chapter the ideal path based on the above equations

together with its associated actual path which is based on

historical data are presented in graphical form. This is done

so as to make it possible to easily observe the general form

and characteristics of the ideal solution. We can consider

the positive direction (+) for each actual value above or

better than the ideal value and negative direction (-) for

each value below the ideal value (except for CL). By doing

the above classifications for all the cases which are the

whole set of sample companies the results can be shown in the

following tables.

235
Table 7.1.1 Comparison of Ideal Path with its Actual Path

COMPANY WORKING NET I CASH

CAPITAL I INCOME

General Electric Co + + +
Coalite Group + + +

Allied Textile Companies plc + +

British Home Stores plc + + +

Bell (Arthur) & Sons plc + + +

Wellcome Fundation + +

Benford Concrete Machinery plc + _

Beecham Group plc + + +

Marks &Spencer + + +

Pearsons + + +

Racal Electronics + + +

BPB Industries plc + + _

Allied Colloids plc + +

Ash & Lacy plc + + +

Boots Company plc (THE) + +

British Gas Corporation + +

Anglia Television Group plc +

Goodyear Tyre & Rubber Co (GB) Ltd. + -

Babcock International plc - +

APV Holdings plc - +

Ault & Wiborg Group plc + +

Albright & Wilson Ltd. + +

Barrow Hepburn Group plc - +

236


Pleasurama plc + +

British Railways Board + -

Anchor Chemical Group plc - + +

Baker Perkins Holdings plc -

Ford Motor Co. - -

Adams & Gibbon plc

Armitage Shanks Group Ltd. +

Atkins Brothers (hosiery) plc + _

Dunlop Holdings plc - - +

Barno Industries plc - -

BBA Group plc +

Batleys of Yorkshire plc -

Bemrose Corporation plc -

Bestobell plc

Brocks Group of Companies Ltd.

Stone Platt Industries plc -

British Steel Corporation -

British Airways

Viners

Blackman & Conrad

Amalgamated Industrials - -

Blackwood,Morton & Sons - -

Pickles (William) & Co -

Burrell & Co. - -

Cawdaw Industrial HLDGS

Airfix Industries -

Oxley Printing Group

Lesney Products & Co. - -

Richards & wallington Industries

237

1
Norvic Securities 1 1
-
1 1

1
Austin (F.)(Leyton) 1
-
1 1
-
1

As the above table shows, in well performing companies 100%

of working capital, 88% of the net income and 63% of the cash

are above ideal values and in poor performing companies,

100% of working capital, 100% of the net income and 100% of

cash are below their ideal paths. It means that all the

companies that have gone into financial difficulties and

receiverships were suffering from insufficient working

capital, lack of profit and shortage of cash and the majority

of well performing companies are doing very well in the above

three important dimensions.

7.1 PERFORMANCE IMPROVEMENT

From the quantitative model of the characterics of the

failing company, Argenti suggested what he called three

possible trajectories of failing company performance, which

are illustrated below:

Exce lent E
a) a)
o 0
O 0
0 Good dG
E m
o 0
4-1 Poor clAp
;-I
a)
k
a)
fa4 1:14

Fai F
-----..,,

Time . s
Time
. "- )1,-
Time Time
Type 1 Type 2 Type 3 Type 4

238
 Type (1) failure should be preventable at the

planning stage. The company never performs satisfactorily,

and should probably never have been established.

Type (2) failure exhibits 'mercurial'

characteristics, with very high growth rates and other

performance measures, until some point at which the company

over-reaches itself and collapses equally dramatically. One-

man rule is, according to Argenti, a major feature of such

companies, and the prevention of collapse should take the form

of a moderating influence, preferably from inside the company

otherwise from the company's bankers and advisers.

Type (3) companies are probably typical of the long-

established business which has not 'moved with the times' and

has not recruited enough professional management from outside

the company. The dashed lines indicate what might happen if

the company were rescued by a management change or other

factor and in case of the non-failed company what might happen

if things start to go wrong.

Argenti's study is interesting because it relates a largely

qualitative approach of management alongside he quantitative

and statistical research studies, in an attempt to identify

common themes in the behaviour of failing companies.

In our case we can not do anything about the poor companies

because they have already failed to meet a certain level in

their activities, but we are able to keep the fair and well

performing companies at a good level or as close as possible

to their ideal paths to improve their further activities.

This can be effective when the other environmental factors are

239
Table 7.2.1 Performance Improvement Recommendations

COMPANY 1VARIABLESIFROM 19851 TO 1986

(O00) (E, 000)

Allied Textile Companies plc Cash I

1093
I
1695
British Home Stores plc CA I
116981 1219393.3

Bell (Arthur) & Sons plc CA 156976 1169387.3

Wellcome Fundation CA I
466500
I
489621

NI 31600 I
37121.4

Benford Concrete Machinery plc NI I

474 I
584

Cash I
116 I
856.3

Beecham Group plc CA I

1247800
I
1356095

Marks & Spencer CA 456600 I

1097287

Pearsons CA I
471434
I
511465

BPB CA I
215500
I
284238

Cash 3900 I
15253

Allied Colloids plc Cash 915 3092.3

CA 48089 I
53810.1

Ash & Lacy plc CA I

15149 I
15904.2

Boots Co plc (THE) CA I

674000 767872

Cash I
9000 43307.1

British Gas Corporation CA J

2735500 110193209

Cash I
30300 261667

Anglia Television Group plc NI 1868 2310

Cash I
448 I
1458.8

Goodyear Tyre & Rubber Co Ltd. NI I

1097 7208.1

Cash 1 593 5308.3

241
 Babcock International plc CL I
349000 1 26 54

NI j 24800 1 50803.4

APV Holdings plc CL I

119606 1104406.6

NI I
3890 1 17486.6

Ault & Wiborg Group plc NI I

816 1 3329.8

Albright & Wilson Ltd. CA I

197827 1225330.1

Cash I
6517 12876.5

Barrow Hepburn Group plc CL I

11221 9333.2

NI I
992 I
1642.9

Pleasurama plc CA I
15424
I
67990.6

British Railways Board CA I

859300
I
1139238

NI 97300 1124287.2

Cash I
27100
I
61619

Anchor Chemical Group plc CL I

6213 I
4547

Baker Perkins Holdings plc CL I

84139
I
61614.4

NI I
7999 I
10497.4

Cash I
3984
I
6713.2

Ford Motor Co. CL I

1297000 1223208

NI I
45000 1179715.6

Cash 117000 1128949.1

Adams & Gibbon plc CA I

6682 I
6906.1

CL 4617 I
3917.6

NI 413 I
808.3

Cash I
2 I
405

Armitage Shanks Group Ltd. CA I

45644 I
59128.1

CL I
36837 I
35482.5

Cash 16 1
3134.4

Atkins Brothers (Hosiery) plc CA I

4914 5307.6

NI I 169 I 467.6

242
 Cash 43 3 .4

Dunlop Holdings plc CL 808 396.1

NI 0 81.6

Barno Industries plc CL 7838 5079.6

NI 439 994.8

Cash 142 545.6

BBA Group plc CA 70644 77872.8

NI 1217 7548.5

Cash 1101 4445.2

Batleys of Yorkshire plc CA 18674 20150.8

CL 19087 10528.4

NI 1260 3336.4

Cash 2 1111.4

+
7.3 A GRAPHICAL ILLUSTRATION OF IDEAL PERFORMANCE

As stated in pages 232-235, there are four ideal equations

for four important and controllable financial variables such

as current assets, current liabilities, cash and net income.

In the following pages, the graphs for all the companies

are listed according to their classifications such as well,

fair, and poor performing companies. All the ideal paths are

indicated by '0' at the beginning of the variables, for

example OCA stands for ideal current assets which is plotted

against CA or actual current assets. If CA is greater than

OCA it is favourable but if it is lower than OCA it is not

favourable. For example, this kind of evaluation can be done

for three different classified companies as follows:

WELL PERFORMING COMPANIES

These companies are shown from Figure 7.3.1 to 7.3.16. If

we take a look at the General Electric Co (Figure 7.3.1) on

the top left hand side current assets is plotted with its

ideal path, on the top right hand side is the current

liabilities with its ideal path, on the bottom left hand side

is net income with its ideal path and on the bottom right hand

side is cash with its associated ideal path. As it can be

seen the current assets and current liabilities are better

than their ideal paths, which means that the working capital

of the company is at a good and satisfactory level. Company's

net income and its cash are both well above their ideal paths.

244
This evaluation shows that the General Electric Co is doing

very well in working capital, net income and cash, and the

overall performance is improving.

FAIR PERFORMING COMPANIES

These companies are illustrated from Figure 7.3.17 to

7.3.37. By looking at the Anglia Television Group plc (Figure

7.3.17) we can see that its current assets and current

liabilities are nearly the same as their ideal paths and its

net income and cash have gone under their ideal paths. This

means that the working capital is almost ideal and static,

while the net income and cash are both declining but they are

still above the safety level and overall performance is not

bad.

POOR PERFORMING COMPANIES

Poor performing companies are shown from Figure 7.3.38 to

7.3.53 and we choose the Burrell & Co as an example. This

company's current assets and current liabilities are worse

than their associated ideal values and its net income and cash

are also far below and worse than their ideal paths. This

means that this company's working capital, its net income and

its cash are declining sharply and the company is in danger of

failure and bankruptcy. In fact as indicated in 5.3.3 a

receiver was appointed for this company on 4th August 1980.

245
 The difference between cash graph in Figures 7.3.1 to

7.3.53 and cash position graph of Figures 5.3.1 to 5.3.53 is

that the first one shows the total cash held by each company

at the end of each year and second one is equal to the ratio

of cash over shareholders fund and the ratio of cash over

total assets minus current liabilities. This is also

indicated in legend at the bottom right hand side of each

graphs.

246


4.0E6
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3.0E6 LLI / ?'"1
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ui ///
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E //'
cc / /'
,/
u
2.0E6

,. /
/
LI:10.8E6-
a-
(--) 0 . 6 E G-
/
1 . 5E6- .
0.4E6-
1.0E6
0.2E6-

1974 1976 1918 1980 1982 1984 1974 1976 1978 198d 1982 1984'
YEAR YEAR

1.2E6
4.0E5

1.0E6
3.5E5

3.0E5
(75
W 2.5E5- (.--- Ln
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0.5E5 / _____ ---•------
1974 1976 1978 1980 1982 1984 1974 1976 1978 198d 1982 1984'
YEAR YEAR

GEACJ
GENERAL ELECTRIC CO -CL
—
Figure 7.3.1 A Graphical Illustration of Ideal Performanc -NI
•- — OCASH
-CASH

247
 1.8E5
80000-
1.6E5
70000-
1.4E5
Ln
1u. 60000
E1.2E5-
Ln
1.0E5
Lu
z'
40000-
0.8E5 Li
L_)
0.6E5 a 30000-
0.4E5- 20000-

-
0.2E5- 10000--

1974 1976 1978 1980 1982' 1984' 1974 13 S 1378 1980 1982 1984'
YEAR YEAR

30000-
18000

16000 25000-

14000'
20009-
12000'
Li
— 10000- (cf, 15090
I--

/7
Li 7-
8000-
10000
6000-

4000'

2000'

1974 1976 1978 1980 1982 1984 1974 1976 1978 1980 1982 1984
YEAR YEAR

COALITE GROUP COME cn
-ocn
Figure 7.3.2 A Graphical Illustration of Ideal Performance
-CL
— —ON!
-N
OCF1SH
-CASH

248


35000- 14000-

30000
12000
u-)
Li
U,
25000
Lc:2
("-x -',c. ;1• 10000-

/
\I
La=.I 20000
a-.
I_TJ 8000
Li

15000-
Li 7;"\
6000-

10000-
4000-

1972 1974 1976 1978 1980 1982 1984 1972 1974 1976 1978' 1980 1982 1984'
YEAR YEAR

2500 2250 i
t \ i \
2250 2000
I /...\
..
r
: 1
2000 1750- 1 s \

1 I

Li
1750 ,.. 1
1 1500-
I

\ /
/

1500 I. \ \/ ...," LTec

C 1250- I
K\ :I
,'", Li \I
v / , ......-
' I i
1-Z-I 1250 000
1-

1000 750

•50 500-

500 250

1972 1974 1976 1978 1980 1982 1984 972 1974 1976 1978 1980 1982 1984
YEAR YEAR

ALLIED TEXTILE CO. PLC CA

OCR
—
—
Figure 7.3.3 A Graphical Illustration of Ideal Performance
— — °CASH
--CASH

21+9
 200000-
1.2E5-
175000-
E.11.0E5
V2150000-

PIET
125000 !-21

=
100000- tri'i 0 . 6E5
cr.
Li
75000-
0.4E5

50000-
0.2E5
25000-
1974 1976' 1978 1980 1982 1984 1974 1976 1978 1980' 1982' 1984'
YEAR YEAR

I/ 70000
35000-
/
t
60000
30000-

50000
u, 25000
Ei
Li
FA 40000-
—20000- I Li
Ui
30000
15000-

20000
10000-

10000-
5000-
1974 1976' 1978' 1980' 1982' 1984' 1974 1976 1978 1980 1982' 1984'
YEAR YEAR
•

BRITISH HOW STORES CA

-OCR
-CL
—
Figure 7.3.4 A Graphical Illustration of Ideal Performance - -NI
— — — OCFISH
-CASH

250
 1 ,6E5- 90000

1,4E5- 80000-

1-13 70000-
1,2E5-
LU
---160000-
1,0E5- 22.

0. 8E5
50000- ,

/
\1
Li cc 4 0000-
(X
Lij

0.8E5-
Li rr---\
30000-
J
0,4E5- 20000-

10000-_
I
1972 1974 1976 1978 1980 1982 1984 19744 9841
1972 1 1976 1978 1980 1982
YEAR YEAR

20000
25000-
17500

15000 20000-

(512500
,15
1 : 15000-
Li
g 10000
I

7500 10000-

5000
5000-

2500 —
972 1974 1976 1978 1980 1982 1984 1972 1974 1376 1978 1980 1982 1984
YEAR YEAR

BELL (ARTHUR) & SONS PLC -OCA

—
— —0N1
Figure 7.3.5 A Graphical Illustration of Ideal Performance -NI
— NASH
-CASH

251


3.0E5-
4.5E5

4.0E5 2.5E5
tr)
LU
,3.5E5 _
LU
_
2.0E5
tcf-'. 3.0E5 'Er3
cr.

1 . 5E5-
u.;
cc

2.0E5 LU
er 1 . 0E5-
1.5E5
/
1.0E5
0.5E5._

1972 1974 1976 1978 1980 1982 1984 1972 1974 1976 1978 1980 1982 1984
YEAR YEAR

1.0E5
35000 0.9E5

30000 -
/1
/ 0.8E5

0.7E5
Lu 25000- ,,,i.'---J
E i 0.6E5-
U i I 2:
• _ .
_... 7t.._
Lt.)

20000- E9 0.5E5
z
/ //'./' 0.4E5
15000-
V 0.3E5
10000- 4
0.2E5 -
_

0.1E5
5000

1972 1974 1976 1978 1980 1982 1984 1972 1974 1976 1918 1980 1982 1984
YEAR YEAR

WE.LLCOPIE FUNDAT ION CA

-OCR
-CL
— ---ON I
Figure 7.3.6 A Graphical Illustration of Ideal Performance --NI
— — — °DISH
-CASH

252


16000- 8000-

14000-
" 7000
tri
Li
E 12000- ;726000-

cc
5000-
'2 /0000-
cr.
LEV 400C
Booci

3000-
6000-

2000
4000-
97i 1974 ' 1976' 1978 ' 1980 ' 1982 ' 1984' 1972 1974 ' 1976 ' 1978' 1980 1982 1984
YEAR YEAR

1800-

/60C

1400
/
//
/

\ •
\
\
•
I
1\
.1
%
900

800

700-
\... I.
LIJ
600
E, 1200-
tT) 500
1-- 1000
400
,/
800-
300

600 200

400 100 /
972 1974' 1976' 1978' 1980 1982 19841 1972 1974 1976 1978 1980 1982 1984
YEAR YEAR

BENFORD CONCRETE MACHINERY PLC CA

-OCR
-GEL
— -CL
— I
Nigure 7.3.7 A Graphical Illustration of Ideal . Performance -NI
— KASH
-CASH

2 3

F-
 8E5-
I .2E6
7E5-

1.0E6
c.n 6E5
LI;

ucE) 0.8E6 f c'D 5E5

'i

'lt 4E5
6 0.6E6 /

Li
3E5-
///
0.4E6
2E5- Ji

0.2E6
1E5--
1974 1976 1978 1980 1982 1984 1974 19761- 1978 1980 1982 1984'
YEAR YEAR

2.5E5
1.6E5

1.4E5
2.0E5
1.2E5
w
CD

Z' 1.0E5 / LT 1.5E5

II / cr

0.8E5
1.0E5
0.6E5

0.4E5 0.5E5

0.2E5 -
'-
1974 1976 1978 1980 1982 1984 1974 1976 1978 1980 1982 1984
YEAR YEAR

BEECHAM GROUP PLC CA

-ocn
-CL
Figure 7.3.8 A Graphical Illustration of Ideal Performance —
—ON]
-NI
— — — — OCASH
-CASH

254
 7E5
1.0E6
6E5

o . 8E6
r".". 5E5
(.1) -
MU)

I- O. 6E6 4E5
LU
ix
cr

LU
IT-. 3E5
0.4E6 LU

2E5
0.2E6
1E5
1974 1976 1978 1980 1982 1984 1974' 197E: 1978 198d 1982 1984'
YEAR YEAR

1.8E5 80000

1.6E5 70000

1.4E5 / 60000

614.1.2E5
LU 50000
U)
cr
Lu
1.0E5-
40000
rt
0.8E5 ••n

V 30000
0.6E5-
///
20000
0.4E5-
10000-
0.2E5
1974 1976 1978 1980 1982' 1984 1974' 1976' 1978' 198d 1982' 1984'
YEAR YEAR

MARKS & SPENCER CA

-OCR
— --CL
—ONI
Figure 7.3.9 A Graphical Illustration of Ideal Performance -NI
– °CASH
-CASH

255
 5.0E5
3.0E5-
4.5E5

4.0E5 v) 2.5E5-

if
E- 3.5E5
21
2.0E5 r
3.0E5 cr.

115: 2.5E5 ti! 1.5E5-

I.-.) f'
2.0E5
-
1.5E5 1.0E5-
,///'
1.0E5
0.5E5-/
0.5E5 97i
1974' 1976' 1978' 1980' 1982' 1984 972' 1974 1976 1978 1980 1982 1984
YEAR YEAR

60000
90000-

80000-
50000
'7000T

u, 40000- 60000-

g!.450000-
L)
ICzi] 30000-
40000

30000-
20000-
20000-

10000- 10000-

1972 1974 1976 1978 1980 1982 1984' 1972' 1974' 19761 1978 1980 1982 1984'
YEAR YEAR

CA
PEA RSONS -OCA
— -CL
— —ON!
Figure 7.3.10 A Graphical Illustration of Ideal Performance -N1
— — (KASH
- --CASH

256
 8E5 4.5E5

7E5 4.0E5
I
3.5E5
6E5
cr,

LU .t; 3.0E5
a-.
Fi 2.5E5
..J
I.T.J 4E5
LT, 2.0E5
cr.
3E5
(-) 1.5E5
2E5
1.0E5

1E5 0.5E5

1974 1976 1978 1980 1982 1984 1974 1976 1918 1980 1982 1984
YEAR YEAR

80000
70000-

'70000
60000-
60000 1

LU 50000-
650000
/ 40000-
.,
LU 40000
30000- I.
30000
20000-
20000

10000-
10000
-
1974 1976 1978 1980 1982 1984 1974' 1976' 1978' 198d 1982 1984'
YEAR YEAR

RACAL ELECTRONICS CA
-OCR
— --CL
— --ON1
Figure 7.3.11 A Graphical Illustration of Ideal Performance -NI
— — OCASH
-CASH

257
 1 .8E5-

2.5E5 EGET

1.4E5

E. 1 . 2E5
1.0E5
E, 1.5E5

1.0E5 0. bE5
/-
-
0.4E5
0.5E5
0.E5 ,
1974 1976' 1978 1980 1982 1984' 1974 19761- 1978 19801 19821 1984 -
YEAR YEAR

\
18000
50000
1600C1 1'
./

14000-
40000 i

12000 I

F.; 30000 Eil0000 .

8000- ../
0'.
t I

\I
20000 6000-

4000
j
10000-
2000--
-
1974 1976 1978' 1980 1982' 1984' 1974 1976 1978 1980 1.982 1984
YEAR YEAR

BPB INDUSTRIES PLC Fl

- - -

— --ON I
Figure 7.3.12 A Graphical Illustration of Ideal Performance -NI
°CASH
-CASH

258


50000- 30000-
III

u., 25000-
40000 u..1
r
f—
in
Lu / I=•
.•.,
/
Ln
ul .i:73! 20000-
cc 30000 cc
:11
LL.I
.

cc Li
Z 15000-
R cl-.
— 20000- a
10000- ,j'
10000
5000-

1974 1976 1978 1980 1982 1984 1974 1979 1979 198d 1982 1984'
YEAR YEAR

3000.
12000-

2500.
10000-

2000
It' BOOT
LU a:
cc
ir)
(--) 1500
LT; 6000-
\

4000- 1 0 00-
I ,r •
,
If
2000- 500-
ii

1974 1976 1979 1980 1982 1984 1974 1976 1979 198d 1982 1984
YEAR YEAR

ALAFY CA
—ocn
ALLIED COLLOIDS PLC
--CL
--ONI
Figure 7.3.13 A Graphical Illustration of Ideal Performance • -NI
— OCASH
-CASH

259


16000

9000-

14000
8000-

12000
Ui
Lr)
m10000 •••
226000-
.:1
LU

E 6000 =
:It 5000-

'4000-
6000
3000

4000
2000-
1972 1974 1976 1978 1980 1982 1984 1972 1974 1916' 197d 198d 1982' 1984'
YEAR YEAR

2250 900-
/- --

2000
800- / -
/
. .- /
700
1750
6U.1 00 -
/ tr\
51500 1 %
Li m _ / t
"(2500 i t
Li /
L:1250
400-
1000 /
/ ,-
1 \
300 - / I 1
I,•\ t t
./ ri-\
750 I
200-'
1 i
1
I
500 100-
%
! \
-1!
1 ,
1972
1972 1974 1976 1978 1980 1982 1984 19741- 1916 1978 1980 1982 1984'
YEAR YEAR

CA
ASH & LAP( PLC -OCA
-0CL
— -CL
— 1
Figure 7.3.14 A Graphical Illustration of Ideal Performance -N1
- - OCRSH
-CASH

260


4.5E5

7E5-
4.0E5

6E5- 3.5E5

`C-nij 5E
5- 3.0E5
In
= CO
cr
:12.5E5
- 4E
5. I-
/ uJ
Li
cig 2.0E5
3E5 Li

1.5E5
2E5-
1.0E5
1E5-
1974' 976' 1978' 1980 1982 1984 1974' 1976' 1978' 1986' 1982' 1984'
YEAR YEAR

II
1.0E5 i i
1.0E5-
/ 0.9E5
0.9E5- / I \
/ I
0.8E5 / I
0.8E5- ,/ 1

L.Li O. 7E5-
tp I
1- --...../-
0.7E5
/
//-.-
1

La I 7.: 0 . 6E5
.va2.
.F-. 0 . 6E5- 1
I-. It Li 0. 5E5 1
/ / 1
0.5E5
,/''' ..." f n

0.4E5 I
0.4E5- /,/ ---' --- r
• ''' .......„../ 0.3E5
0.3E5- /
0.2E5 ,...- 1

,'''
0.2E5 .---- .--- --

0.1E5 -- -
...„-- k
1974 1976 1978 1980 1982 1984 1974 1976 1978 1980 1982 1984
YEAR YEAR

BONS CO PLC (THE) CA

-OCA
— -CL
— —ON I
Figure 7.3.15 A Graphical Illustration of Ideal Performance I
— — — °CASH
-CASH

261
 1.0E7- 7E6

0.9E7-
6E6
0.8E7-
(cf, 5E6
(MO. 7E7-

0.6E7- cio 4E6

E 0.5E7- 1--
a: _ 5 3E6
0.4E7 a:

O. 3E7- 2E6

0.2E7-
_ -
1E6
0.1E7-
1974 1976' 1976 1980' 1982' 1984' 1974 19(6 1978 1980 1982 1984
YEAR YEAR

0E4

0E4

0E4
I

1-Z' 0E4

0E4

19 6 1978 1980 1982 198:14

YEAR T - 1

1974 19761 1978 1980 1982 19841

YEAR

-OCR
BRITISH Gm CORPORATION
— - - EL
— — -ON I
Figure 7.3.16 A Graphical Illustration of Ideal Performance
— — °CASH
-CASH

262
 16000-
22500

20000 14000 /
/7

17500 ,7
tr, 12000
1..0

r-: 7
L1115000
10000-
m
cr. /
/
5: 12500 :11
l- 8000-
w If
Lc110000 Ex
cr //
a6000 --..../
7500
4000
5000

2000
2500
1972 1974 1976 1978 1980 1982 1984 1972 1974 1976' 1973 198d 1982 1984
YEAR YEAR

3000
3500

2500
3000-
n
2500- 2000
LJJ

•
2000 w
cr

\
/ //V
n ,
(-31500

1500
,
,,
, ///' " // 1000
t \
1000 i I,,

/- 500-
500 ........„.. ___ -----

197 1974 1976 1978 1980' 1982 1984 1972 1974 1976 1978 1980 1982 1984
\ERR YEAR

ANGLIA TELEVISION GROUP PLC ANAB I CA

-OCR
—
—ON1
Figure 7.3.17 A Graphical Illustration of Ideal Performance -NI
- — OCFISH
-CASH

263
 60000-
90000-

55000
80000-
50000-
.-
Li
45000
tc̀ilL 70000-

-7:140000

cg 35000-

50000- 30000-

25000- I
40000-
20000 -
197 1974' 1976' 1978' 1980' 1982' 1972 19741 19161— 19781 1980 1982
YEAR YEAR

5000
5000

YEAR 4000-
1.93 _ 1978 19.93814___
1.1-; . I
1
1
o I
Li 1
,
z
.--. I I LcT.3000-
I 1
• _
-5000

2000-
-
-10000

1000-

-15000
-•
1972 1974 1976 1378 1980 19872r—
YEAR

GOODYEAR TYRE & RUBBER CO. -KR

-CL
—0N1
Figure 7.3.18 A Graphical Illustration of Ideal Performance
- OCASH
-CASH

264
 •

5.0E5- 3.5E5

4.5E5-
3.0E5-
4.0E5-

IT 3.5E5- • -
2.5E5
w

cc 3.0E5- •
n2.0E5-
(g. 2.5E5
1.5E5
2.0E5-

1.5E5 1.0E5

1.0E5- ,
--r
1972
1974 1976 1978
0.5E5 —
1980 1982 1984 1972 194 1916' —19 (81--1 -9-807- 198i - 19E141
YEAR YEAR

50000- /
45000- /-
.../,
50000-
40000-
,-- —/
7

/ •
sz _
35000- 40000-
LL.,

30000 _./
Lt :
Li- 25000- le— ,.,- 5 in
30000-

20000-
/f\
. / \, 1

15000 //F
,
1
/
20000
.r ,
10000
/ i 10000
1

5000
1972
---- 1974 197
.—
—
.--..--/ ---,
1978 1980 1982 1984 1972 1974 1976 1978 1980' 1982 1984
YEAR YEAR

BABCOCK INFERNATIONHL PLC -OCA

— —ON!
Figure 7.3.19 A Graphical Illustration of Ideal Performance -NI
— KASH
-CASH

265


1.2E5-

200000

175000
1.0E5- /
LU

u-' 150000
tLU 0.8E5-
In

C17.
, 125000
cr.
7:1

1
2 0 . 6E5-

S' 100000
C
(X

75000 0.4E5

50000
0.2E5-
25000
1972 1974 1976 1978 I
1980 1982 1984 1972
1 1974 1976
980' 19(8 1982' 1984'
YEAR YEAR

18000 20000-
/
16000 18000- 'I/
/
14000 / 16000-
/
/
14000- i
u., 12000-
,,,'
r"-- - -- - --'
9
c=
u N., , • - \ \ =, 12000 /
,-. 10000 - 1/ c.n i /
cc
L
-- L' 10000
/ f \
.--- ,1-
f ''''/
8000-
/I 8000
/
6000-
1 1 6000 /1 ' \\ _ _ _I
4000- 4000-
..-
-- ."
2000-
1972 1974 1978 1978 1980 1982 19841 1972 1974 1976 1978 1980
YEAR 1982 1984
YEAR

APV HOLDINGS PLC CFI

-0CF1
— • -CL
—ON1
Figure 7.3.20 A Graphical Illustration of Ideal Performance - -N I
- -- -- -- • -
°CASH
-CASH

266
 30000

27500 22500-

25000 20000-
(r)
LLI
in 22500
;217500-
7-n
in, 20000
cr.
1—
E, 17500
II
a 15000 c
(z

(-) 000ci
12500

10000 7500-

7500 5000-
•
1972 1974 1976 1978 1980 1982 1984 1972 1974 1976 191E1' 1980 198 2-i 1984'
YEAR YEAR

It
3500 2000-

3000
;
\ 1750- ./

I II 1500-
2500
Li.:
1250-
Li

-2000 u'
m 1
; Li
H-
LL 1000-
,/
1500 •750-

500- r
1000

250 n
500 ,
1972 1974 1976' 1978' 1980 1982' 1984' 1972- 1974 1976 1978 1980 1982 1984'
YEAR YEAR

AULT & WIBORG GROUP PLC CA

-OCA
-CL
—ON 1
Fig ure 7.3.21 A Graphical Illustration of Ideal Performance -NI
• - - OCIISH
-CASH

267


225000-

200000-
1.2E5
175000-
Ln.

V! 150000-
1777.1.0E5
i
..11 . f /
`n
Ln
/
cc 125000- .C7 ,

LL.1
:721 0.8E5 /
1-. /
E=g 100000- =
u..1 ,.

E i
/
75000 0.6E5
/

50000- ...-/
r •
0.4E5
25000

972 1974 1976 1978 1988 1982 1384' 1972 1974 1976 1918 1980 1.982 1984
YEAR YEAR

40000
22500

35000-
20000
t
t
17500 1
i: 30000
C.-- i

LEI. 15000 u, 25008

-\ / i
t_) 7:
2::
t
12500 1
1 5 20000
1 !
t
10000-
1 15000

7500 1
I
/
I 10000
1
5000- t
t j
5000

1972 1974 1976 1378 1980 1982 1984 1972' 1974 1976 1978 1988 1982 198-4T
YEAR YEAR

ALBRIGHT 8, WILSON LTD FA

-0CF1
• — • -CL
-- ---ON!
Figure 7.3.22 A Graphical Illustration of Ideal Performance -N1

OEFISH
-CASH

268


35000 r\
30000'
32500

30000
tri 25000-
CO 27500
u
T25000
520000
E 22500
:D

(-) 20000 c

17500
a )5000- it \
1

, /--
\
15000 \
10000 t'
12500 ‘.*\\./-\
1972 1974 1976 1978 1980 1982 1984 1972 1974 1976- 19(8 198-0( 1982 1984'
YEAR YEAR

r.
fl
4500- / \ 2500- ;1
' 1
/ t
4000- 2250- ._
i \
/ \ /
3500 2000- /
/ 1
L.L.;
B 3000
.
1 I .-.
E 1500
1750
/
/
/
/\
\
1

Li 2500- 7 \ .__.... / 1 :Th

/'
z
1250 1 ''
2000/ \ // 1 I

1500 -
I
i - -,
I ,,i\

„.. . .n1_ 7 ____./

/
1000-
750
/ "s.... i...r......,-, \ 1
i
1
1000- .V'''.
1

% , v
',.//'-' n 500 7 \..../ .
%
• / %v

7
1972 , --- 1
. 19761- 1978
1914 1980 1982 19841 19(2 19(4 19 (6 1v9E 116R - 19801— 1982 1984
YEAR

BARROW HEPBURN GROUP PLC CA

ocn
•- --OCL
CL
— —ONI
Figure 7.3.23 A Graphical Illustration of Ideal Performance - °CASH
-CASH

269
 / 45000
60000-
1 40000

50000 ,3 000-
5
Ui

t; 30000
ce.1,2) 40000- Ec;
a-.
cl; 25000
..J
SLC. 30000
E
cL
20000

20000- Li 15000
/
10000 /
10000-
5000 -
1972 1974 1976 1978 1980 1982' 1984' 1972 1974 1976 1978 1980 1982 1984
YEAR YEAR

14000 7000
//I\
12000- 6000

10000 / 5000-
/ I
uJ / \
,1 r I
F--. 8000
8 ,,,, 4000. t../
in
cr.
1-- U
/ /
L-1 6000 3000
/
/
4000 / 2000.
/ ,/
,-- -} /
2000 .... ,/ 1000. /
.._ ..../ ..---
_ --------- .... .__ .- -- --' '
_ __
1972 1974 1976 1978 1980 1982 1984 1972 1974 1976 1y90178R 1980
YEAR 1982 1984

PLEASURAMA PLC PL ABU CR
UCF1
• -CL
— —ON!
Figure 7.3.24 A Graphical Illustration of Ideal Performance NI
— °CASH
-CASH

270
 1.4E6
9E51

1.2E6- 8E5

1.0E6
tt..;
tn

12-0.8E6
Ui
Q:.

=
(-3

0.6E6

3E5-
0.4E6-

2E5-
0.2E6-
1972 1974 1976 1978 1980 1982 19 (2 1974 1916 19(8 198d 1982
YEAR YEAR

•
60000
1
1.0E5

50000-
0.5E5-

Li 40000
Li

•-•
972 1974 1976 / 1978 IpicIU 19821
YEAR W
CC
Li

Li 30000
n
0. • .5E 5- :‘.

20000 ,-***
•-•"'

-1.0E5-
I j
10000
/
-1.5E5-
1972 1974 1976 1978 1980 1982
YEAR.

BRITISH RAILWAYS BOARD -OCA

CA
• -CL
—UN!
Figure 7.3.25 A Graphical Illustration of Ideal Performance -NI
— KASH
-CASH

271

4
 6000

(..r)
cc
5000
7:
11.1
CC:

Li 4000
-

2000

972 1974' 1976' 1978' 1980' 1982' 1984 972 1974 1976' 1918' 1980' 1982' 1984
YEAR YEAR

500
800
450-
700
400-
600 .1
,-- ; 350-
tiv....„-
w. 500
/‘; 1 300
•=•

-.400
, 1
t
1
,
u-)
cc
1I Li
250

j\
11
/ I
,
300- /
/\
/ 1
200 . ' —\ ; t I
1
if
! i
1 ; ;
100 \

972 1974 1976 197E1 1980 1982 1984

YEAR 1972 1974 ' 1976 1918 1980 1982' 1984
YEAR

ANCHOR CHEMICAL GROUP PLC In

EICF1
—
— --ON!
Figure 7.3.26 A Graphical Illustration of Ideal Performance • -NI
- ocnsH
-CASH

272
 1.1E5 80000

1.0E5
70000

0.9E5
;:60000"
"1-n
(. 0.8E5

'20.7E5
nalooT

E 0.6E5
0.5E5
30000
0.4E5
20000
0.2E5

19 ./4 1976 1918 1980
1982 1984 1914' 1916 1918 1980 1982 1984
YEAR YEAR

10000

6000

//
8000
/// 5000
./

6000
/ _4000

-
4000 3000

2000
2000

1000"
1914' 1916' 1918 19801 1982 1984 1914 1916'T 1918 1980 1982 1984
YEAR YEAR

BAKER PERKINS HOLDINGS PLC CII

-CL
—
Figure 7.3.27 A Graphical Illustration of Ideal Performance NI
- — — ocnsH
-CASH

273


.2.0E6- 1.4E6

. 1.8E6-
1.2E6
1.6E6- Li
172.

uJ *f_l 1.
1 . 4E6-
cc an
1.2E6- :71
Li 0.8E6 /1'
z:
Lu
1.0E6- a,

O. 8E6-1
a 0.6E6-
0.6E6- 0. 4E6

0.4E6-

1972 1974 1976 1978 1980 1982 1984 972 1974 1976 19(8 1980 1982 1984'
YEAR YEAR

5E4
1 .8E5-

0E4 1 . 6E5-
\
11
5E4 1.4E5-
I \%
Li 1. 2E5- A/
I

e2,11.0E5-

J/' /7- \ 0.8E5-

: ,
0E4 \ 0.6E5-
%

\ 5E4 0.4E5-

0.2E5
(2 1974 1976 1978 1980 1982 1984
YEAR 1972 1974 1916 1980T 1982 19841
YEAR

cn
FORD MOTOR CO. LTD. -0 CA
- - -0CL
-CL
—ON!
Figure 7.3.28 A Graphical Illustration of Ideal Performance -N1
— °CASH
-cnsn

274
 • 00 0 5000

4500-
6000
4000
Ui

r: 5000 -J
3500-
Cr7
/
Cr)

E 3000-
/ /---, \s/
--J
E4000
_
2500
Li

3000 2000

1500
2000
1 00 0
1972 1974 1976' 1978' 198d 1982' 1984 1972 1974 1976 1978 1980' 1982' 1984
YEAR YEAR

800 /r 400

700-

600 /
r \ \ / 350

300

250
:..;'. 500-
Lu // f\II\ in
w
/ i E 200
I
z ,."
/
400
1 150 /
1
/
300 100
/(-----\

I. 50
200
--i

J 1 l'\\._,l

1972 1974 1976 1978 1980 1982 1984 1972 1974 1976 1978 1980 1982 1984
YEAR YEAR

AnAms a GIBBON C71

OCA

—
— •—ON I
Figure 7.3.29 A Graphical Illustration of Ideal Performance -NI
- -- • - • - °CASH
-CASH

27 5


35000-

30000-

E 25000-
;FO
:c

"615000

10000

5000
9-.? 1974 197d 1978' 1980' 1982' 198'14 1972 1974 1976 1978 1980 1982 1984
YEAR YEAR

8000
3000
7000-
2500
/-**-
6000

. ,
I
/
2000 / ' r\
A

It n / , mg.'. / --- -- / 1
Ili; 4000- t 1 1
i
I I

I
/ u 1500 /
/

I
i
s 1
I
I
/ /
7 s \
3000- 1000
/ \ t /
. r I .....\ n'. ''.
2000 //-* ..4""."-.. I li
.,,....,G, 500 1 I
I ,
,

1000.1
1972 1974 1976 1978 1980' 1982k 198:41 1972 1974 1976 1978 1980 1982 1984
YEAR Y YEAR .

ARMITAGE SHANKS GROUP LTD CA

-OCA
-CL
— —ONI
Figure 7.3.30 A Graphical Illustration of Ideal Performance -N1
— — OCF1SH
-CASH

276
 3000-
5000

4500 2500-

3000

2500
1000

2000
500 I
1974 1976 1978 1980 1982 1984 1974 1976 198 1986 1 -9821 1984T
YEAR YEAR

450 300-

400 250 / - •

350
L.L.1
200-
E:

g. 300 a.:

1-, 150"
Ui
250
‘
tf
100
200 I \
\

150 50-

100
1974' 1976 1978 1980' 1982' 1984' 1974' 1976' 1978' 1980' 1982 1984
YEAR YEAR

ATKINS BROTHERS PLC -

-OCR

-CL
— —ON I
Figure 7.3.31 A Graphical Illustration of Ideal Performance -NI
- OCRSH
-CASH

277

F-
 7E5

Li
Ln
5E5
w
in _
5E5
2;
6E5-
,- 1 \
y'
m
4E5
,4E5
.,
1-.
,r t1
ill
or.
a 3E5 cc
3E5 , --- -)
1
%
2E5- t
/ i
til
1E5

1912 1974 1976' 1978 1980 1982 1984 1972 197; 1976r 19ig
F r---18811 —1982' -1984
YEAR YEAR

8E4- 80000
,
70000-
6E4-

60000-
w 4E4 7
E \ 50000
u
21:

•-• •- 340000-

n 30000-
972 1974 1976' 1978 iseo' 1982' 1921
YEAR
20000
-2E4
, 10000-
I.
-4E4 1972 1974 19761- 1978. 1980 1982 1.984
YEAR

DUNLOP HOLDI\ GS PLC -OCA

- --OCL
Cl
—ONI
Figure 7.3.32 A Graphical Illustration of Ideal Performance -- • - •- NI
- ocnsH
cnsH

278


9000

7000
8000

7000 En 6000
1.1/

.n LU

// f
4000 LU
3000

3000
2000-
2000
1 .
1972 1974 1976 1978 1980 1982 1984j °°°1972 1974 1976 1978 1980 1982 1984
YEAR YEAR

1000-
1200-
11
900

I 100C
800-

700 / 114( 800

,

Llj O /iii
Goo cr,
I LU
II r
600
tj-. 500 721

400 //' 400

/ r
300
200- / k \
200 ./ /
.
1972 1974 1976 1978 1980 1982 1984' 1972 1974 1976 1378 1980 1982 1984'
YEAR YEAR

BARNO INDUSTRIES PLC CA

OCR
-CL
— —OWL
Figure 7.3.33 A Graphical Illustration of Ideal Performance -NI
— • - OCASH
-CASH

279

H-


/ 45000

70000 40000

60000 Li) 35000

IL7.1
Ln
(efE' 50000 '&130000
cc
Li
640000 ra,

Li _
20000
30000

15000
20000

1972 1974 1976 1978 1980 1982 1984 1-9-772r 19761 — 19—?8T —190 1982 1984)
YEAR YEAR

4500-
7000
4000-
6000
3500-
5000-
...
1 3000-
4000 1 /
e i
Li
z
-------;" I
`1_:3Pc 2500 i /
— 3000
,..
, 1
1-- 1 II.
L1.1
z /
2000
.7<
\
2,3ors
1
.1 ' \
, A,
I i \.•/\
i5o0-
1000 1
,
i ...

1000
..,. ; •
,
.- \ j
,‘ . .-,
___ __ . \ ,, 1
972 1914 1976 1978 198 1982 1984 ---.._
YEAR
-1000 t f

n. 500 /
1974' 197 1976 1978 1980 1982 1984'
YEAR

-CA
BBA GROUP PLC -ocn

— -CL
— —ONI
Figure 7.3.34 A Graphical Illustration of Ideal Performance - -NI
—•— ocnsn
CASH

280
 •

20000 if 18000

17500 16000

E 14000-
15000
J '11!
2112000-
ccri 12500
`j /
:110000-
10000
8000
• 7500
u 6000-
5000
4000-

2500 2000

1974 1976 1978 1980 1982 1984' 1974 1976 1S8 1980 1982 1984
YEAR YEAR

1200

3000
1000

2500
800

0 2000
1500

400
1000
II
200
500

1974 1976 1978 1980' 1982' 1984 1974 1976 1978 1980 1982 1984
YEAR YEAR

BATLEYS OF YORKSHIRE PLC CFI

-0CF1

-CL
— —ON I
Figure 7.3.35 A Graphical Illustration of Ideal Performance -NI
— — — • - °CASH
- CASH

281


18000
25000

16000
22500 s's

u-)20000 14000

Ls) It
In - 12000-
cr. 17500 ER

LcS15000-
, /1 I
LLI
CY
a-.
12500- (-) 8000-

10000 6000"

7500-
4000
1972 1974 1976 197d 1980' 1982 1984 972 1974 1976 1978 1980 1982 1984
YEAR YEAR

1600
2500/1 t
1 140C
"-•••

A /
2000 ? /I 1 1200-

1000-
C) I 1 t I ,
/ = 17
1500 1 En
— I 1 A
/ 5 80C
I—
z
w/. ;
1000 1 \ 60 0
/ 7. \) k \.]
I

1
I 40C/ / // Ill
7
, t 1 ' I
500 t 1 f

t .-. !
200- z-
\./ 1
\ //'I \n
1972 1974' 1976 1978' 1980 1982 19841 1972 1974 1976 1978 1980 1982 19-8-4
YEAR YEAR

BEMROSE CORPORATION PLC CA

-CL
—
Figure 7.3.36 A Graphical Illustration of Ideal Performance -N1
•— — ()CASH
-CASH

282


70000-
45000-

60000- Lu
tn 4000C

3500C
/
50000
cr.
/ FE: 30000
.
(SA 40000-
c, 25000
1-0

20000 -
30000-
'
15000 ,
20000
10000
972 1974 1976 1978 1988 1982' 1984 972 1974 1976' 1978 1980 1982
YEAR 1984
YEAR

6000 8000

7000
4000
6000-

g 2000
m 500C
cn
CE

•972 1974' 1976 400C

1978 1980 1982' 1914i
YEAR

- 2000-
3000
\
2000
- 4000-
1000
1972 1974 1976 1978' 1988 1982' 1984'
YEAR

BESTOBELL PLC CA
-OCR
----
• — -CL

—0N1
Figure 7.3.37 A Graphical Illustration of Ideal Performance -NI
— OCASH
-CASH

283
 8000- I 5000

, 1
4500- ,
7000 ,
, ,
LU
. , 7-\ I
4000- , \
6000 I/ \ , '-' \ ,
- \ ,I/
___/ i
cc cc 3500 \...
:71
(,, \
E 5000 I-.
Ixa-.=i 3000
_
E

Li
4000- i
/
(-) 2500- / II \ /
3000 2000 ;

1500-(
2000-
1972 1973 1974 1975 1976 1977 1978 1979 1972 1973 1974 197 1976 1977' 1978' 19791
YEAR YEAR

800
I \ 400-

1 n 350-
700 I
%

I 300-
600- I:
w
Ii

LU
500-

400 /
\
%
s,

n
In
cc
'200-
250-

150-
ln

r/
/ \\

,
\ N\
300 \ A 100
j

200- 50

1972 1973' 1974 1975 1976 197/ 1978 1979 1972 197:3 1974' 1975 1978 1977' 1978 1915
YEAR YEAR

BROCKS GROUP OF CO. LTD 0CA

CA
—L
— --ON I
Figure 7.3.38 A Graphical Illustration of Ideal Performance -NI
• - • - ocnsH
-CASH

284


1 .3E5-

1.2E5-
70000-
//
1.1E5-
\
co 1.0E5- glmooT
"n...-..• •
(1/-.)) O. 9E5-
cr. 50000 / t' / .. ... -- .. ...'- •
..J
0.8E5
Hx
cr

Li (3..7E5- gr
e 40000
Li
0.6E5-
30000-
0.5E5-

0.4E5 20000

1972 1974 1976 1978 1980' 1972 • 1974 • 1976" • 1978 • 1980'
YEAR YEAR

/N 16000
10000 I`
8000 14000-

6000 1 12000-
...:-..; ' t
w 4000 i
E.-. -,/.
2. 1 10000-
C/
L.)
2000 LT/
CC
I- - \ ' 8000-
Li
„
1972' . 1974' • 1976' • 1978' It 1980'
YEAR 1
6000-
-2000 i
/
-4000 4000- •
./

-6000 2000
• ,
1972' • 1974'. 1976 • 1978 • 1980'
YEAR

STONE PLATT INDUSTRIES PLC -OCA

CA
— -CL
— I
Figure 7.3.39 A Graphical Illustration of Ideal. Performance -NI
— — OCASH
-CASH

285

F-


1.6E5
90000-

1.4E5- 80000
Ui

n7000C
cr.
_ //
1— 60000
LIJ
0'.

a 50000- , ' 1/7 \* \ j/

0.8E5
- _ .... .., 7

0.6E5
30000-
1972 1974 1976 1978 1980 1972. '1974 1978 1978 1980
YEAR YEAR

20000 9000

15000 8000-

10000 I
i 7000
/ i I
t-LI 5000
c)
Li a, GOOC t
(.17 ,
r
972 1974 1976 1978 1980 1 m
YEAR I 5000 .. • i' •-. j
-5000 r

\ 4000
-10000 .... '

3000
-15000

-20000 2000

1972 1974' 197E; 1978 1980'

YEAR

BRITISH AIRWAYS -OCA

CA
— --CL
— --ON1
Figure 7.3.40 A Graphical Illustration of Ideal Performance -Ni
— KASH
-CASH

286
 5000-

U7

4000-
Cr:
11nIl

2000-

1000 •
1972 1974 1976 1978 1980 1972 1974 1976 1978 ned
YEAR YEAR

450-
500
400- .,/

400-
350-

300 , • //'
300-

g.! 200/ }/ n
ic2 250

100
200-

1972' 1974' 1976' 1979 1980 150

YEAR
-100- 100-

-200- 50
• I

1972' 1974' 1976 1978' 19807

YEAR

VINERS OCA
CA

— • ft
— ---owl
Figure 7.3.41 A Graphical Illustration of Ideal Performance -N I
-- • - NASH

287


5000 /
/ ,- , • \\
3500
4500
I \
Lu
cn 3000-
cr: 4000-
;L:
:=;
rN / , ,
1 N-- /; '
(n
u'
3500-

u 3000-
2000
ci
200
1500
2000

1972' 1974 1976' 1978' 1980 1972 1974 1976 1976 1980
YEAR YEAR

500
250

400
200
300 (
Fi
200

I OT

1972 1974 1976 \lr 198d

YEAR

-10T
1972 1974 1916' 1978' 1980
YEAR

BLACKMAN & CONRAD -OC11

— --ON I
Figure 7.3.42 A Graphical Illustration of Ideal Performance -NI
— -- • - — acnsH
-CASH

288
 12000
11000
11000
10000-
10000
9000
9000
U.J
U/ 8000
8000
7000-
L.
cL .J

a'.
7000
6000
6000
5000
5000
4000
4000
3000
3000
1972 1973 1974 1975 1976 1977 1918 1979 1972 1973 1974 1975 1976 1977 1978 1979
YEAR YEAR

800 /
600

w 400

— 200-
1
LU-

172 1973 1974 1975 1976 1977 1978 1919

YEAR
-200

-400

1972 1973 1974 1915 1976 1977 1978 1979

YEAR

AMAL1AP1ATED INDUSTRIALS -OCA

CA
----
— ----ON!
Figure 7.3.43 A Graphical Illustration of Ideal Performance -NI
— °CASH
-CASH

289


14000

13000
7000

6500-
(\ //1/
12000 /
/ . tn
(.1-) 6000
L now , , _ ,1
u-) 1
tr) /
cc 135500
S.
10000
uJ 1—
E5000
a 9000 `x
ce

a
4500-
8000

7000 4000

1973 1974 1975 1976 1977 1978 1979 1980 1973 1974 1975 1976 197? 1978 1979 1980
YEAR YEAR

1000
700
750
/
600
500
500 ../
LL.1 250-

1974 1974 151976 1977 1n978 1/979 980 (-c2 400

YEAR
-250 300

-500-
200-
-750-
100-
-1000-
I•
1974 1975
1973' „ 1976 19T? 1978 1979 1980
YEAR

BLACKWOOD,FlORTON & SONS -OCA

CA
— -CL
— —ONI
Figure 7.3.44 A Graphical Illustration of Ideal Performance -NI
— — OCFISH
-CASH

290

•

7/- 5000"

6000 4500-

4000-
Li.t
u)
5000
E-J 3500-

cE
0
300
."

4000
2500-
6 _
(-) 2000
3000

1500-,

2000 loaf
1972 1973 1974 1975 1976 1977 1978 1979 1972 1973 1974 1975 1976 1977 1978 1979
YEAR YEAR

‘\ ------ 350-
l'
400 n
n
. \ ..._./ ; 300-
/ 1 / \
200 ,/ t
t 250-
L.).1 \ I
C) ‘
L., m
z
..... FE) 200-
I-- 1972 1973 1974 1975 1976 1977 197k 1979 L)
w YEAR
z
‘
t 150-
,
-200 t
(-\\
100- \
'-\\ \

-400 50-
t
1972' 1973 1974 1975 1976 1977 1978 1979
YEAR

BURRELL & CO. -OCR

CA

—
—
Figure 7.3.45 A Graphical Illustration of Ideal Performance -NI
OCRSH
- -CASH

291
 6000-
4500
5500
4000
5000
Lr) 1._- 3500
11-; I \
117, 4500 // 1 '.... \
..--". I 1
-------
/ \
FE;
nE 4000 -J 3000- ...',
1- ........... - - ...
Z
3500- Ieti 2500-
a
rx
..."/ /
3000-
2000-

2500-7
1500-

2000
1974 1976 1978' - 1980' 1974 197E 1978 1980'
YEAR YEAR

600
\
350-
400
300-

200
YERP 250-
U_1 1974, 7 1978, 1980,
CZ11

LT) 200-
=
Li
- - /
L.1-200
150

-400
100-
1

-600
50

-800
1974 1916 197E1 1980'
YEAR

CAWDAW INDUSTRIAL HLDGS -OCR

CR
- --CL
— —ON!
Figure 7.3.46 A Graphical Illustration of Ideal. Performance -NI
-- °CASH
-CASH

292


30000 30000

25000 25000

U)
n
I-.
in
r.Fc; 20000
Vr). 20000 m

LT; I -
ai
m z:
= W15000-
u 15000 a-.
La

10000
10000

5000
1973 1974 1975 1976 1977 1978 1979 1980 1973 1974 1975 1576 1971 1978 1974 1980
YEAR YEAR

3000
1800-

2000- 1600
.:
/
1000
-
1400- /I
\,
1200- / 1 ,
,

- 1006
1974 1974 1975 1976 1977
YEAR
a:
U.) 1000
E

800

600- 1
l
1
(\
I

.A,--
,

/./
.
/
I
I
\
I
I
I

!---- I I
400 I \
I
- 2000-
200
,
1974 1974 1975 1975 19T/ 1978 1974 1.980
YEAR

AIRFIX INDUSTRIES -OCA

CA
—
—ON]
Figure 7.3.47 A Graphical Illustration of Ideal Performance -141
OCASH
-CASH

293
 12000 11000

10000
10000
9000
LU
8000
)j 8000
L11
7000

LU
cc - - 6000
Z
a- 6000
c LU

5000-
Li

4000-
4000
3000" ,

2000- //,

1972 1974 1976 137Ei EgeG csd {Te4 (Re6' csee' ?see'
YEAR YEAR

,
-
700 /
1000 /
• ••••"--.°

500 600
YEAR
197 13 19 1978 198
500
LU
E.

Li 500
6-.41

-
W
=--1000

-1500

-2000

-2500

1972 1974 1976 1978 1980

YEAR

OXLEY PRINTING GROUP -OCR

CA
— --CL
— --ONI
Figure 7.3.48 A Graphical Illustration of Ideal Performance - --NI
— °CASH
-CASH

29L1.


70000
40000
60000
35000-
LU
11) 50000 r- 30000-
LU
II I
cr. 'Er; -
E- 40000 cc 25000
.-J
cuj
cr. L.T., 20000
u 30000 =11."

Lj 15000-

20000
10000-
-
10000 5000
1974 1976 1978 1980 1974 1976 1978 1980
YEAR YEAR

4000 6000

2000 - YEAR
--11374--- 1976 197 19 5000-
!
! \1
-2000 4000 tI
a-:
v)
/ / I -
/.....' \ \
- 4000 LI I
\

- 6000
3000
\ \/ A

- 8000 2000- , 1
\\.."

...• .-•••
I1

/
% \
. \ t
..."
..."
-10000 \,. /

1000
,
-12000
1974 1976 1978 1980
YEAR

LESNEY PRODUCTS & CO.

-OCR
cn
-OCL
— -CL
— —ON1
Figure 7.3.49 A Graphical Illustration of Ideal Performance
OCFISH
-CASH

295
 .„/•••n\

30000-
30000-

25000-
f-1-125000-

_
ES. 20000
I
1-1-;
cg 15000-
15000-

10000- ,
10000- "

•
1972' 1974' 1976' 1978 1980 1972 1974' 1976 1978'
YEAR YEAR

1400- /

YEAR
1200- IN /
197 1974 1976
1000

IT:
(ff. 800
Li
/

600
,
400 n
n

200
- -

•
1972 • 1974' 1916' • 1978' 1980
YEAR

RICHARDS & WALLINGTON INDUSTRIES -OCR

CFI
• -0CL
— -CL
— ---ON1
Figure 7.3.50 A Graphical Illustration of Ideal Performance --N1
- - KASH
-CASH

296
 8009
5000

7000 4500

4000
6000 tr)
LL.1
cri
F-

in' 5000 _

`n
cr. 3000
a-.
o--.

4000 2500
cr'
or.
2000
3000
1500-

2000
1000-

1000
• ,
1972 1974 1976 1978 1980 1972' 1974' 1976 1978' 1980'
YEAR YEAR

1400
500-
/f

YEAB..--
1200
1972, • 19- •---711376, , 1978, ., 1980,

1000-

(-1 -500 800

IFn111
cr:

600
- 1000-
400

- 1500-
200

1972 1974 1976 • 1978 1980

YEAR

NORVIC SECURITIES ocn

CFI

—
-- —ON!
Figure 7.3.51 A Graphical Illustration of Ideal Performance -NI
-- • - ocnsH
-CASH

297
 3000
3500
2150

:300O 250d

cr.
w
FE, 2250-
Ele. 2500
:5'2'2000- ,
cr.
Ci
1750-
2000

1500-

1500 1250-'7/
• 1974' 1976' 197E1 198d • 1974 1976 1978
• 1980
YEAR YEAR

250 250-
1
1974,
/I-

200 I\
-250 / I/
n

I 1, \ : t
-500 1
I
= 150 I
V)
-750 cc
U ./. i\ 1

! I \
1
-1000 I 1
1001 1

V
-1250
1 \

n
-1500 50; n

-1750

1974 1976 1978 1980
YEAR

AUSTIN (F.)(LEYTON)
—
Figure 7.3.52 A Graphical Ellustration of Ideal Performance — —ON!
-NI
OCFISH
-CASH

298
7.4 CONCLUSION

Factor analysis has been used to construct the ideal

equations as presented in this chapter. There are four

equations that can be used to calculate ideal values of

current assets, current liabilities, cash and net income for

each company separately and at the end of each year.

By applying these equations to the sample of companies, it

is found that in well performing companies about 84 percent of

performance variables are above their ideal values and 100

percent of these variables are below the ideal values in the

poor performing companies. This means that all the companies

that have had financial difficulties and have gone into

receivership were suffering from insufficient working capital

(managerial performance), lack of profit ( profitability) and

shortage of cash (liquidity), and the majority of well

performing companies are doing very well in the above three

important financial dimensions. This will also confirm the

earlier conclusion that the present model has almost explained

the same variance of three significant performance factors;

profitability, managerial performance and liquidity.

299
 These equations could be also used to improve future

financial performance, and guide managers to provide better

plans. In the Marks & Spencer case (page 240), based on its

past performance and comparison of its actual performance with

associated ideal values, it is possible to detect that current

assets should have been increased in 1985 from their present

value of 456 million pounds. A more appropriate level would

be over 1 billion pounds.

300
 CHAPTER 8

CONCLUSIONS AND RECOMMENDATIONS

301
CHAPTER 8 : CONCLUSIONS AND RECOMMENDATIONS

8.1 MAIN CONCLUSIONS

The main conclusions of the present study can be summarised

as below

1) The knowledge of financial ratios and its use as

a measuring tool provides the means of

controlling the success and stability of a

business.

2) A single ratio can not reflect every aspect of a

company's performance and sets of ratios are

proposed to allow a better evaluation of the

financial performance of company.

3) Three dimensions represented by profitability,

managerial and liquidity ratios jointly measure

nearly every aspect of a company's financial

performance. They can and do serve as tools for

detecting irregularities in managerial behaviour

and company performances. They also provide a

meaningful and quantitative representation of the

results of decisions and the effects of external

conditions.

302
4) The techniques available in the past were wholly

inadequate for proper analysis, and there is a

need for constructing a firm conceptual basis for

financial analysis; particularly, the

desirability of a shift from univariate to

multivariate financial analysis.

5) An important result of the past studies was that

there is a significant degree of correlation

between different ratios and one of the best

techniques which can be used to study the

correlation between the ratios is factor analysis

which enable management to choose the most

significant and reliable ratios.

6) The model developed using factor analysis

together with regression analysis to measure

companies' financial performance with the

following significant characteristics:

6.1) It explains nearly 30 percent of

profitability, 37 percent of working capital

and 33 percent of liquidity, which means that

it almost explains the same percentage of

variance of the three main indicators of the

companies financial performance.

6.2) Its overall effectiveness in identifying

companies strengths and weaknesses is about 90

percent.

6.3) It can correctly classify 100 percent of well

performing companies and 94 percent of poor

performing companies.

303
 6.4) Its accuracy to measure companies' financial

performance whose data were used to construct

the model is about 91 percent which dropped to

88 percent when it was applied to companies

whose data was not used in the model's

construction.

7) The Ideal models which were constructed using

factor analysis for calculating ideal values of

current assets, current liabilities, cash and net

income, when applied to a sample companies, it

was found that in well performing companies about

84 percent of performance variables are better

than their associated ideal values, whereas 100

percent of these variables are worse than their

ideal values in poor performing companies.

8) These models could also be used to improve the

future financial performance, and guide managers

to provide better plans for their company.

Finally it appears that the model is able to measure and

summarise past performance and assist in ide tifying future

targets of financial performance. That is, it can be a useful

tool for financial planning and control.

304
8.2 RECOMMENDATION FOR FURTHER RESEARCH: DYNAMIC ASPECT OF RATIO

Saint Augustine says that we always are in the present.

The present has several dimensions, however: the present of

the past, the present of the present, the present of the

future. Thus, at any time our actions at every single instant

depend not only on our current state but on our memory of the

past and anticipation of the future. However, while there is

little that can be done to affect the past, there is still

time to influence the future by present actions. To do so, it

is essential that we relate the past and the future i,e,

construct a model of 'temporal change'. When a model of

temporal change is used for the purposes of selecting a

desired future sequence of states, this is called 'planning'.

Thus our ability to plan is strictly a function of our ability

to reconstruct the process of temporal change as a function of

discretionary acts. As it has been stated the main purpose of

this section is to seek a greater understanding of how the

special characters of time and change influence our ability to

construct dynamic financial models and how su h models have

improved our ability to cope with and manage time and change.

The management of time and change is, however, a very complex

task, requiring that we understand how and why change occurs

over time. To do this it is necessary that we first

understand the dynamic behaviour of financial ratios. Once

their behaviour over time is understood there may be a

possibility of controlling them to some extent.

305
 It would appear that fruitful research could be carried out

into how financial ratios vary over time and into the extent

that the company can control future values of these ratios.

In this way it might be possible to control future company's

financial performance to a limited degree. Of course

companies are exposed to considerable influences outside of

their control and therefore the extent to which future

performance can be endogenously controlled will be limited.

The major objective of analysing dynamic financial ratios

is to predict future values of the ratios. The general

approach to such predictions is to search for dynamic patterns

in the historic behavior of the ratios; knowledge of such

patterns can then be used in the prediction process. This

approach to the prediction of ratios rests on the assumption

that the underlying process generating the ratios is stable

over time, that is, the process continues to operate as it did

in the past. Dynamic patterns in the behaviour of ratios can

be determined by various statistical techniques, such as

plotting the data on scatter diagrams, serial correlation

analysis, and various transformations of the original data.

The best prediction model to be used depends on the

statistical nature of the process generating the ratios.

However, most processes in business and finance are very

complex and, in many cases not even well understood because of

the large number of factors and the complex interactions

involved.

306
 For example, a firm's net income is usually effected by

1) Economy-Wide factors such as interest rate and

price-level fluctuations.

2) Industrial factors such as a change in demand for

the industry's product.

3) Firm's factors such as firm size and quality of

management.

Consequently the financial analyst would be interested in a

set of techniques and methods which enable him to study and

explain the crucial effects of these factors in order to

improve the behaviour of the financial ratios.

307
APPENDICES

308
APPENDIX 1: GEOMETRIC PRESENTATION OF THE FACTOR MODEL

To understand the basis of factor analysis which is a

complex statistical technique, Comrey(1973) find it helpful to

employ an additional medium of representation of factor model.

In the geometric representation of factor model, a data

variable may be represented as a vector in a space of as many

dimensions as there are common factors(Fig.A11). In this

case, the length of the vector is h, the square root of h, the

communality. It is also possible to represent the data

variables in spaces of higher order, adding also a dimension

for each specific and error factor. If all of these factors

are included, h rises to 1.0 for each data variable and so

does the vector length.

Figure All
Y(Rotated factorII)
1.0

P (.19.8)

P (.2 6)

•4 (.59.4)(Centroid point)

P
3 (. P8 ' (.1)9 1)
4 ' X(Rotated
i° factor n I)
.0

As an illustration, Fig.All represents four data variables

as vectors in a two dimensional space. A vector is a line

extending from the origin to some point in space. The

coordinates of the end points of the vector are given. There

are two coordinates for each point because the vector are

represented in two dimensions.

309
 By the Pythagorean theorem, the length of each vector in

Fig.All is given by the square root of the sum of squares of

its coordinates:

2 2
h = +(.8) = \/.01+.64 = \/7-E- = . 806
1

2 2
h = \/(.2) +(.6) \0 .04+.36 = V770T .632
2

2 2
h = \/(.8) +(.1) \/74-T7E— = V7i3- . 806
3

2 2
h = \/(.9) +(.1) \i
v .81+.01 = V782— .906
4

For more than two dimensions, vector length is given by

2 2 2 2
h=\/a +a +a + +a
1 2 3

Where the a values are the coordinates of the vector with

3.

respect to the m reference axes or dimensions For more than

three dimensions of course, it is impossible to visualise the

results.

310
 The scalar product of two vectors may be defined as follows:

a
21
a
22
[a a a ...a ] x a = [c] (Al2)
11 12 13 lm 23

a
2m

Where c=a a +a a +....+a a is a constant. The values a

11 21 12 22 lm 2m 11

a , a ,...,a represent the coordinates of first vector, and

12 13 lm

the values a , a , a ,...,a are the coordinates for the

21 22 23 2m

second vector. Thus, the scalar products of all possible pairs

of four test vectors in Fig.All are given as follows:

311
 Pair Row Column Scalar product

1,2 (.1 .8) x 1.21 =(.1x.2) + (.8x.6) =(.02+.48) =.50

I

.61

1,3 (.1 .8) x 1. 8 1 =(.1x.8) + (.8x.1) =(.08+.08) =.16

I

.11

1,4 (.1 .8) x 1.91 = (.1x.9) + (.8x.1) =(.08+.09) =.22

I

.11

2,3 (.2 .6) x 1 .8 1 =(.2x.8) + (.6x.1) =(.16+.06) =.24

I

.11

2,4 (.2 .6) x 1.91 =(.2x.9) + (.6x.1) =(.18+.06) =.24

I

.11

3,4 (.8 .1) x 1.91 =(.8x.9) + (.1x.1) =(.72+.01) =.73

Lets L represent the cosine of the angle between vector i and

ij

coordinate axis j. The value L is called the direction cosine

ij

of vector i with respect to coordinate (factor) axis j. If a

ij

is the coordinate of data vector i with respect to factor axis

j, and h is the length of vector i, then

L = a /h , L = a /h , ...,L = a /h
11 11 1 12 12 1 lm lm 1

or

a = hL ,a = hL , ....,a =hL
11 11]. 12 112 lm 1 lm

and

a = hL ,a = hL , ....,a =hL
21 221 22 122 2m 1 2m

Substituting these values in Eq. (Al2) gives the following

312
representation of the scalar product of two vectors:

h L
jjl

[h L h L .... h L ] x h L = [c]
iii i i2 urn j i2

h L
jiff'
or

hhL L +hhL L + ...+hhL L -c

i j il jl i j i2 j2 i j im jm

and

h h [L L + L L + ...+ L L ] = c (A13)
i j il jl i2 j2 im jm

A theorem from analytic geometry that will not be proved

here states that the inner product of the direction cosines

for two vectors equals the cosine of the angle between the

vectors. Thus Eq. (A13) becomes

h h cos v =c (A14)
ii ij

The scalar product between vectors i and j is also equal to the

correlation between them. The proof proceeds from

r =aa +aa + ....+ a

ij il j1 i2 j2 im jm

Dividing both sides of this equation by h and h gives

J

r /h h =a /h .a /h + a /h .a /h +...+a /h .a /h
ij i j il i jl j i2 i j2 j im i jm j

=LL +LL + ...+LL = cos v

il jl i2 j2 im jm ij

Or

r = h h cos v (A14)
ij i j ij

313
 The application of the law of cosine will show that the

scalar products computed all pairs of vectors in the series of

above equations are the same as the results of multiplying the

length of two vectors by the cosine of the angle between them

as on the right hand side of Eq. (A14). For two of the

vectors, P1 and P2, for example the law of cosines states that

2 2 2
h h cos v = 1/2(h +h -c )
12 12 1 2

Where c is the distance between the vector end points and is

given by

2 2
c = \//(X -X ) + (Y -Y )
12 12

Where (X ,Y ) and (X ,Y ) are the coordinates for P and P

11 22 1 2

respectively, in Fig. All. For the first two vectors

2 2
c = \//(.1 -.2) + (.8-.6) = \/.o1+.04 = \/7(7)3

Then, h h cos v = 1/2(.65 +.40 -.05) =.50. This value is the

12 12

same as that obtained for the scalar product of vector 1 and 2.

Using the squared lengths of the vectors and scalar

products for all non-identical pairs of vectors in Fig. All,

the correlation matrix with communalities, as shown in Table

A15, is obtained for the four data variables.

314
Table A15 : A Centroid Factor Analysis

1 2 3 4 I II

1 (.65) .50 .16 .17 1 .578-.562 1 2 3 4

2 .50 (.40) .22 .24 2 .531-.344 I .578 .531 .687 .765

3 .16 .22 (.65) .73 = 3 .687 .422 II -.562 -.344 .422 .484

4 .17 .24 .73 (.82) 4 .765 .484 A'

R A

In Table A15, R is the correlation matrix; A is a factor

matrix, or a matrix of extracted factors derived from R; and

A is the transpose of A.

The values in parentheses along the main diagonal of R are the

communalities h obtained by squaring the vector lengths h .

ii i

The off-diagonal elements of R are the correlations r among

ii

the fictitious data variables, derived as scalar products of

the vectors in Fig. All.

Figure Al2

n
Cent oid vector

315
 If the X and Y coordinates for the four vectors in Fig.

All are averaged, the average X coordinate would be .5 and the

average Y coordinate would be .4. These two coordinates

locate the centroid point Pc(.5, .4). Centroid factor

analysis derives the factor loadings by obtaining the

perpendicular projections of the test vectors onto a line

extending from the origin through the centroid point Pc as in

Fig. All. The perpendicular projection of vector 1 on the

centroid vector is shown as line OA in Fig. Al2. Then

Cos v =OA/OP =a /h
lc 1 1 1

Where a is the factor loading, or projection of vector 1 on

1

the centroid vector. Using these equalities, the expression for

the factor loading a becomes

1

a = h Cos v
1 1 lc

Cosine v here is the cosine of the angle between 1 and the

lc

centroid vector. The scalar product between vector 1 and the

centroid vector is:

(.1 .8) x 1.51 = (.1 x .5) + (.8 x .4) = .37 = h h Cos v

II 1 c lc
1.41

.37 = h (h Cos v ) = h a
c 1 lc c 1

a = .37/h
1 c

2 2
h = j(.5) + (.4) = .6403
C

a = .37/.6403 = .578
1

316
Performing this operation for the other three vectors in Fig.

All gives a = . 531, a = . 687, and a = . 765

2 3 4

The contribution of factor I to the R matrix is removed by the

equation R = R - A A i . R , the matrix of residuals after the

1 11 1

extraction of factor I, is reproduced exactly by the product of

the second factor times its transpose. Or

(.65) .50 .16 .17 .578

.50 (.40) .22 .24 .531

.16 .22 (.65) .73 _ .687 x [.578 .531 .687 .765]

.17 .24 .73 (.82) .765

R A At
1 1

(.65) .50 .16 .17 .334 .307 .397 .442

.50 (.40) .22 .24 .307 .282 .365 .402

=

.16 .22 (.65) .73 .397 .365 .472 .526

.17 .24 .73 (.82) .442 .406 .526 .585

R A Al
11

(.316) .193 -.237 -.272 -.5621

I
.193 (.118) -.145 -.166 -.3441
=
I
-.237 -.145 (.179) .204 .4221x [-.562 -.344 .422 .484]
I
-.272 -.166 .204 (.234) .4841

R A Ai
1 2 2

In matrix terms, R - A A i = O. Since R is reproduced exactly

1 22 1

by the second factor multiplied by its transpose, no more than

two factors are necessary to account for the original R matrix.

317
 The sum of the original communality values is

.65 + .40 + .65 + .82 = 2.52

The sum of squares of the first factor loadings 1.6737,

plus the sum of squares of the second factor loadings, .8463

also equals 2.52 showing that all of the common factor

variance was extracted. The first factor was approximately

twice as large as the second factor since 1.6737 is roughly

twice as much as .8462.

318
APPENDIX 2: FACTOR ROTATION

Factor analysis in general and factor extraction methods in

particular do not provide a unique solution to the matrix

equation R = An'. One of the reasons is that the R matrix is

only approximately reproduced in practice and experimenters

may differ on how closely they feel they must approximate R.

This will lead to their using different numbers of factors.

Also, different methods of determining A may give slightly

different results. An even more important reason for lack of

unique solutions, however, is the fact that even for A

matrices of the same number of factors, there are infinitely

many different A matrices which will reproduce the R matrix

equally well.

a a V V
11 12 11 12
a a I Cos v Sin vi V V
21 22 xi 1= 21 22
a a I-Sin v Cos vi V V
31 32 31 32
a a V V
41 42 41 42

A A V

AA= V

If R = AA' then R = VV / since if we transpose the product A

A as

(A 6) = V / or A IN = V/

VV I = A A A'A'

but " Ai , is

319
1 Cos v Sin vi 'Cos v -Sin v1 11 01
1 1 x 1 1 = 1 1
1-Sin v Cos 111 'Sin v Cos v1 10 11

A Ai I

since multiplying by an identity matrix does not alter the

matrix, that is AIA 1 = AA'

The angle between the centroid axis and the Y axis in Fig.

All may be obtained as follows : The Y-axis vector terminus

has coordinates (0,1). The scalar product with the centroid

is given by

h h Cos v = (0 1) x 1•51 = ( 0x.5) + (lx.4) = .4 e

y c yc 1 1
1.41

Cos v = .4/h h = .4/(1.0 x .6403) = .625

y c

0 ,
Hence v = 51 19 and the Sin v is .781. The angle of the

centroid axis with the X axis in Fig. All is 90 - 511 19' or

I
384' 41 .

To obtain a configuration of points corresponding to those

in Figure All using the coordinates of the data points from

the matrix of factor loadings A in Table A15, it is necessary

to reverse the direction of factor II in matrix A. This is

done by changing the signs of all the loadings in factor II,

matrix A, Table A15. Any factor may be reversed in direction

in this manner at any stage in the factor analytic process

without affecting the property that AA 4 reproduces the matrix

R.

320
 If the signs on the loadings for factor II in Table A15 are

reversed in this manner, the coordinates for the four data

vector with respect to the centroid axes become P1(.578,

:562), P2(.531, .344), P3(.687, -.322) and P4(.765, -.484).

Plotting these data points with respect to centroid factor

axes I and II yields Fig. A13. Only the end points of the

data vectors are plotted here. This is a more useful practice

than drawing in the full vector from the origin to each data-

vector end point.

Rotation of factor I away from factor II by an angle of 38

41 will bring it into coincidence with the old X axis (see

Fig. A13). At the same time, rotation of factor II an

equivalent amount toward factor I into coincidence with the

old Y axis. The matrix operations in Table Al2 show how this

rotation is carried out, transforming the coordinates with

respect to centroid axes (after reversing axis II) into the

coordinates with respect to the original X and Y coordinate

axes, respectively.

Fig. A13 Rotation from centroids to original coordinate axes

II

P ( . 531 e 344 )
• 2 '

.6 .8 1.0
38-1 Lfit
P (.687,-.422)
- 3
• P4(.765,-.484)
x 321
Table A16 : Rotation of the Centroid Axis

Unrotated factor1 Transformation 1 Rotated factor

1 1

I II I(X) II(Y)

.578 .562 1 .1 .8

.531 .344 1 .781 .6251 2 .2 .6

x 1
1=

.687 -.422 1-.625 .7811 3 .8 .1

.765 -.484 4 .9 .1

A A V

322
APPENDIX 3: FACTOR EXTRACTION BY THE CENTROID METHOD

The centroid method of factor extraction (Thurstone, 1947;

Fruchter, 1954) is probably the best known of all methods of

factor extraction. The centroid method has the advantage of

being easily conceptualized in terms of the geometric model of

factor analysis.

In Fig. All the centroid point was located by averaging

all the data- vector X coordinates to get the X coordinate of

the centroid point and all the data-vector Y coordinates to

get the Y coordinate of the centroid point. If there had been

more than two dimensions involved, the third, fourth, and

other coordinates would have been averaged to get the

remaining coordinates of the centroid point. Imagine a new

set of coordinate axes at right angles to one another placed

in such a way that one of the axes goes through the centroid

point, as Fig. A13. Suppose that the coordinates of the data

vectors with respect to these new coordinate axes are known

(actually they are the centroid loadings given in Table Al2.

With these new coordinates, it would be possible to recompute

the coordinates of the centroid point with respect to the new

coordinate axes. Since one of the axes, say the first one,

goes right through the centroid point, however, the

coordinates of the centroid point with respect to the new axes

will be

323
 in
— E a ,0,0, 0 (1)
n i=1 il

That is, since the centroid point falls on the first

coordinate axis, its coordinates with respect to all axes will

be zero. In Fig. A13 there are only two factors, hence only

two coordinates. Therefore, the coordinates of the centroid

point can be found by averaging the loadings with respect to

the new axes, the first of which goes through the centroid

point. These loadings are given in Table Al2. Thus,

averaging the coordinates in the first column gives 1/

4(.578+.531+.687+.765)=.64 as the first coordinate of the

centroid point. The second coordinate of the centroid point

is the average of the second column of the A matrix in Table

A16, that is, 1/4(.562+.344 — .422—.484) =0, which is in

accordance with Eq.(1). To use Eq.(1) for deriving an

expression for the centroid loadings, Eq.(2) serves as a

starting point:

r =a +a a + +a a (2)
ij il i2 j2 im jm

Summing both sides of Eq.(2) over i gives

E.
n n n n
r = a 1:a + a Ea + ....+ a /:: a

(3)
i=1 ij jl 1 = 1 il J2 1 = 1 12 jm i = 1 im

Summing both sides of Eq.(3) over j gives

n n
EE
n n n
r = Ea Ea + a La + ... +
n

j=1 i=1 ij j=1 jl i=1 il J=1 j2 i=1 12

n n
La E
a (4)
j=1 Jm i=1 im

324
But

Z: a = a (5)
j=1 jk i=1 ik

Since both terms in Eq. (5) are merely the sum of the entries

in the kth column of the A matrix of factor loadings.

Substituting (5) in (4), therefore, gives

2 n 2 n 2

r =(Z:
a ) +( a ) + E: Z.:
+( a ) (6)
j=1 1-1 ij i-1 ii i-1 i2 i=1 im

By Eq. (1), however, all the sums on the right-hand side of Eq

(6) are zero except the first. Eq. (6) reduces, therefore, to

n n ii 2

r a ) (7)
j=1 i=1 ij i=1

Also by Eq. (1) the sums of loadings for the second and

subsequent factors are zero, since the second and subsequent

coordinates of the centroid point derived from these sums are

zero, making Eq. (3) reduce to

Cr = a a (8)
i -1 ij j1 i=1

Taking the square root of both sides of Eq.(7) and substituting

in Eq. (8) gives

n n

= a \ Er (9)
i = 1 ij j1 j=1 i=1 ij

Solving for a gives

jl

r
1=1 ij

a = (10)
jl
n n
r
j=1 1=1 ij

325
 Eq. (10) gives the formula for a centroid loading for

variable j on factor 1. To get the centroid factor loading

for data variable 1, for example, Eq. (10) calls for the

following steps:

1) Add up the entries in the first column of the

correlation matrix, including the diagonal cell.

2) Divide this number by square root of the sum of

all the entries in the entire correlation matrix,

including the diagonal cells.

For the second data variable, compute the sum of the

entries in the second column of the correlation matrix and

divide by the same square root term as for first data

variable. Continue this for all columns of the R matrix.

Thus, the computation steps involve computing the sums of the

columns of the R matrix, adding these column sums to get the

sum of all entries, taking the square root, and dividing this

square root into each column sum.

Applying these steps to the four-variable correlation

matrix in Table All gives the results in Table A17. The

contribution of factor 1 must be removed.

Table A17: Correlation Matrix

1 2 3 4
1 (.65) .50 .16 .17
2 .50 (.40) .22 .24
3 .16 .22 (.65) .73 T = E r = 6.56
4 .17 .24 .73 (.82)
t 1.48 1.36 1.76 1.96 \J 2.56125
a .578 .531 .687 .765
i 1/\/Y— = . 3904

326
 From the correlation matrix by the operation R-AlA q , as

shown before. The results of this operation give the matrix

R1, the matrix of first factor residuals shown in Table A18.

Note that in Table A18 the columns in each case add up to

zero, within the limits of rounding error. As a check, the

rows should be added also, to make sure that the row totals

equal the column totals as required for a symmetric matrix.

Table A18: First Factor Residuals

1 2 3 4
1 (.316) .193 -.237 -.272
2 .193 (.118) -.145 -.166
3 -.237 -.145 (.179) .204
4 -.272 -.166 .204 (.234)
Sum .000 .000 .000 .000
0 -.316 -.118 -.178 -.234

It was established in Eq. (1) that the sum of the loadings

on the second and subsequent centroid factors is zero, which

provides the basis for a check on the computations of the

first factor residuals used above. Since the sums of the

columns are zero, however, it is clearly impossible to apply

the steps used for computing the first centroid factor to the

matrix of residuals given in Table A18. It is necessary first

to carry out a process of reflecting the residuals to get rid

of as many negative signs as possible in the matrix of first

factor residuals.

327
First Factor Residuals after Reflecting Variable 1

1 2 3 4
1 (.316) -.193 .237 .272
2 -.193 (.118) -.145 -.166
3 .237 -.145 (.179) .204
4 .272 -.166 .204 (.234)
Sums without
communalities .316 -.504 .296 .310

Reflected 1st Factor Residuals and 2nd Factor Calculations

1 2 3 4
1 (.316) .193 .237 .272
2 .193 (.118) .145 .166
3 .237 .145 (.179) .204
4 .272 .166 .204 (.234) T = 3.281
t 1.018 .622 .764 .877
a .562 .343 .422 .484 VT = 1.81135
1
1A117= .55207

328
COMPUTER PROGRAMS

329
COMPUTER PROGRAMS

C This program reads 23 financial data from EXSTAT tape

for all the British companies which have 14 years

available data.

Data

88 C2 B29

C31 C105 C114 C157 C115 C158 C49 C111 C91 C122 C43

C34 C57 C47 C48 C52 C50 C42 C123 C124 C151 C132 C106

End

Select

(B9 EQ EX AND B29 EQ 14)

END

C This program reads the above data and indicates

companies which have missing values.

Program MISSVAL

Dimension X(23), KX(23)

Character 35 company

Integer date, NY

Open (1, file = 'datal', status='old')

DO 10 I = 1, 23

10 KX(1) = 0

20 Read (1„ END=99) Company, date, NY, (X(I), 1=1,

23)

DO 30 I = 1, 23

30 If (X(I).GT.9999999999.0) KX(I)=KX(I)+1

DO 40 K= 1, NY-1

330
 Read (1, ) Company, date, NY, (X(I), I = 1, 23)

DO 50 I=1, 23

50 If (X(I).GT.9999999999.0) KX(I)=KX(I)+1

40 Continue

GO TO 20

99 Write ( , ) (KX(I), I = 1, 23)

STOP

END

C This program eliminates the missing values from the

extracted financial data.

Program ELMISVA

Dimension X(23)

Character 35 Company

Integer Date, NY

Open (1, file='datal', status='old')

30 Read (1„ END = 99) Company, date, NY, (X(I), I=1,

23)

DO 20 I = 1, 23

20 IF (X(I).GT.9999999999.0) GO TO 60

Write (2, 200) Company, date, NY, (X(I), I=1, 23)

200 Format (A35, 1X, 14, 1X, 12/14(5F15.0/))

60 Continue

DO 40 K = 1, NY-1

Read (1, ) Company, date, NY, (X(I), I=1, 23)

DO 50 I = 1, 23

50 IF (X(I).GT.9999999999.0) GO TO 80

40 Write (2, 200) Company, date, NY, (X(I), I=1, 23)

80 Continue

331
 GO TO 30

99 STOP

END

C This program calculates ratios for all the cases based

on year by year activities from the original

financial data.

Program RATIOS

Character Company 35

Integer date, NY

Real Invent, NI

Open (1, File = 'tape2', status='old')

Rewind 1

Rewind 2

Rewind 3

Rewind 4

Rewind 5

Rewind 6

Rewind 7

Rewind 8

Rewind 9

Rewind 10

Rewind 11

Rewind 12

Rewind 13

Rewind 14

Rewind 15

Rewind 16

Rewind 17

332
10 Read (1, 200, END =99) Company, date, NY, Sales,

Invent, CA, CL, TA, TL, RE, Cash, FA, PS, NI, PBT,

TI, PD, CD, Depre, El, TT, OC, DC, Credits, SF,

Debts

R1 - NI/TA

R2 = NI/SF

R3 = NI/CA

R4 = NI/(TA-SF)

R5 = NI/SALES

R6 = NI/FA

R7 = (PBT+TI)/TA

R8 - (PBT+TI)/SALES

R9 = (PBT+TI)/SF

R10 = (PBT+DEPRE)/SF

R11 = SALES/TA

R12 = SALES/SF

R13 = SALES/CA

R14 - SALES/(TA-SF)

R15 = NI/(TA-CL)

R16 = (PD+CD)/(NI+DEPRE+EI)

R17 = (DEPRE+TI+TT)/(PS+0C+DC)

R18 = TI/SF

R19 = TI/(PBT+TI)

R20 = CD/NI

R21 = CA/CL

R22 = CL/SF

R23 = (CA-CL)/TA

R24 = CA/TA

R25 = CA/SALES

333
R26 = CA/SF

R27 = (CA-CL)/FA

R28 = (CA-CL)/SALES

R29 = (CA-INVENT)/CL

R30 = (CA-INVENT)/SALES

R31 = (CA-INVENT)/TA

R32 = (RE+DEPRE+EI)/(TA-CL)

R33 = DEBTS/SF

R34 = CASH/TA

R35 = CASH/SALES

R36 = CASH/CL

R37 = CREDITS/SF

R38 = TL/SF

R39 = SF/FA

R40 = (NI+DEPRE+EI)/(TA-SF)

R41 = (NI+DEPRE+EI)/CL

R42 = (NI+DEPRE+EI)/SALES

R43 = (NI+DEPRE+EI)/SF

R44 = (NI+DEPRE+EI)/TA

R45 = INVENT/SALES

R46 = INVENT/CA

R47 = INVENT/TA

R48 = INVENT/CL

R49 = INVENT/(TA-CL)

R50 = CL/CA

R51 = CL/TA

R52 = TL/CA

R53 = RE/SF

R54 = (CA-CL)/SF

334
R55 0 RE/TA

R56 0 CASH/CA

R57 0 SF/TA

R58 0 FA/SF
R59 = FA/TA

R60 = RE/NI

R61 (TL+PS)/TA

R62 = SF/(TA-SF)

R63 = CL/(TA-SF)

R64 = FA/(TA-CL)

R65 = OC/SF

IF (DATE.EQ.1971) IC = 1

IF (DATE.EQ.1972) IC = 2

IF (DATE.EQ.1973) IC = 3

IF (DATE.EQ.1974) IC = 4

IF (DATE.EQ.1975) IC = 5

IF (DATE.EQ.1976) IC = 6

IF (DATE.EQ.1977) IC = 7

IF (DATE.EQ.1978) IC = 8

IF (DATE.EQ.1979) IC = 9

IF (DATE.EQ.1980) IC = 10

IF (DATE.EQ.1981) IC = 11

IF (DATE.EQ.1982) IC = 12

IF (DATE.EQ.1983) IC = 13

IF (DATE.EQ.1984) IC = 14

IF (DATE.EQ.1985) IC = 15

WRITE (IC, 100) COMPANY DATE R1 R2 R3 R4 R5 R6 R7 R8

R9 R10 R11 R12 R13 R14 R15 R16 R17 R18 R19 R20 R21

R22 R23 R24 R25 R26 R27 R28 R29 R30 R31 R32 R33 R34

335
R35 R36 R37 R38 R39 R40 R41 R42 R43 R44 R45 R46 R47

R48 R49 R50 R51 R52 R53 R54 R55 R56 R57 R58 R59 R60

R61 R62 R63 R64 R65

N = NY

DO 20 I = 1, N-1

Read (1, 200, END=99) Company, date, NY, Sales,

Invent, CA, CL, TA, TL, RE, Cash, FA, PS, NI, PBT,

TI, PD, CD, Depre, El, TT, OC, DC, Credits, SF,

Debts

R1 = NI/TA

R2 = NI/SF

R3 = NI/CA

R4 = NI/(TA-SF)

R5 = NI/SALES

R6 = NI/FA

R7 = (PBT+TI)/TA

R8 = (PBT+TI)/SALES

R9 = (PBT+TI)/SF

R10 = (PBT+DEPRE)/SF

Rll = SALES/TA

R12 = SALES/SF

R13 = SALES/CA

R14 = SALES/(TA-SF)

R15 = NIRTA-CL)

R16 = (PD+CD)/(NI+DEPRE+EI)

R17 = (DEPRE+TI+TT)/(PS+0C+DC)

R18 = TI/SF

R19 = TI/(PBT+TI)

R20 = CD/NI

336
 R21 = CA/CL

R22 = CL/SF

R23 = (CA-CL)/TA

R24 = CA/TA

R25 = CA/SALES

R26 = CA/SF

R27 = (CA-CL)/FA

R28 = (CA-CL)/SALES

R29 = (CA-INVENT)/CL

R30 = (CA-INVENT)/SALES

R31 = (CA-INVENT)/TA

R32 = (RE+DEPRE+EI)/(TA-CL)

R33 = DEBTS/SF

R34 = CASH/TA

R35 = CASH/SALES

R36 = CASH/CL

R37 = CREDITS/SF

R38 = TL/SF

R39 = SF/FA

R40 = (NI+DEPRE+EI)/(TA-SF)

R41 = (NI+DEPRE+EI)/CL

R42 = (NI+DEPRE+EI)/SALES

R43 = (NI+DEPRE+EI)/SF

R44 = (NI+DEPRE+EI)/TA

R45 = INVENT/SALES

R46 = INVENT/CA

R47 = INVENT/TA

R48 = INVENT/CL

R49 = INVENT/(TA-CL)

337
R50 = CL/CA

R51 ... CL/TA

R52 = TL/CA

R53 = RE/SF

R54 = (CA-CL)/SF

R55 = RE/TA

R56 = CASH/CA

R57 = SF/TA

R58 = FA/SF

R59 = FA/TA

R60 = RE/NI

R61 = (TL+PS)/TA

R62 = SF/(TA-SF)

R63 = CL/(TA-SF)

R64 = FA/(TA-CL)

R65 = OC/SF

IF (DATE.EQ.1971) IC = 1

IF (DATE.EQ.1972) IC = 2

IF (DATE.EQ.1973) IC = 3

IF (DATE.EQ.1974) IC = 4

IF (DATE.EQ.1975) IC = 5

IF (DATE.EQ.1976) IC = 6

IF (DATE.EQ.1977) IC = 7

IF (DATE.EQ.1978) IC = 8

IF (DATE.EQ.1979) IC = 9

IF (DATE.EQ.1980) IC = 10

IF (DATE.EQ.1981) IC = 11

IF (DATE.EQ.1982) IC = 12

IF (DATE.EQ.1983) IC = 13

338
 IF (DATE.EQ.1984) IC = 14

IF (DATE.EQ.1985) IC = 15

20 WRITE (IC, 100) COMPANY DATE R1 R2 R3 R4 R5 R6 R7 R8

R9 R10 R11 R12 R13 R14 R15 R16 R17 R18 R19 R20 R21

R22 R23 R24 R25 R26 R27 R28 R29 R30 R31 R32 R33 R34

R35 R36 R37 R38 R39 R40 R41 R42 R43 R44 R45 R46 R47

R48 R49 R50 R51 R52 R53 R54 R55 R56 R57 R58 R59 R60

R61 R62 R63 R64 R65

GO TO 10

100 FORMAT (A35, 2X, I4/9(8(F9.4,1X)/))

200 FORMAT (A35, 1X, 14, 1X, 12/14(5F15.0/))

99 STOP

END

C This SPSS package reads the above ratios and analyse

them by Factor Analysis technique.

Run Name Factor Analysis

Data List Fixed (10)/

1 company 1-8 (A), year 38-41/

2 R1 TO R8 1-80/

3 R9 TO R16 1-80/

4 R17 TO R24 1-80/

5 R25 TO R32 1-80/

6 R33 TO R40 1-80/

7 R41 TO R48 1-80/

8 R49 TO R56 1-80/

9 R57 TO R64 1-80/

10 R65 1-10

N OF CASES UNKNOWN

339
 FACTOR VARIABLES=R1 TO R65

OPTIONS 7,10,11

STATISTICS 1,2,4,5,6,7

This SPSSX package reads the selected ratios and

COMPUTE the Y-value for each company.

TITLE COMPANL

FILE HANDLE TAPE21

DATA LIST FILE = TAPE21 FIXED (3) /1 COMPANY 1-8 (A),

YEAR 13-16/

2 R1 TO R8 1-80/

3 R9 TO R10 1-20

COMPUTE Y = 8.344R1 + 1.218R2 + 4.235R3 + .3R4 +

5.524R5 + .691R6 + .16R7 + 4.394R8 - 2.969R9 +

4.81R10 - 1.989

FILE HANDLE KOBRA

PRINT OUTFILE = KOBRA/ COMPANY, Y (A8,F9.4)

EXECUTE

FINISH

C This program reads the KOBRA file and recode it company

by company.

program recode

character 10 comp, compl

integer year, c

open (3, file='kobra')

open (4, file='farhood')

compl = 'A. C. Cars'

c= 0

5 read (3, 10, end=999) comp, year, Y

340
 If (compl.NE.comp) then

compl = comp

c = c+1

end if

write (4, 20) comp, year, Y, c

Go to 5

999 close (3)

close (4)

stop

10 format (A10, 14, 1X, F8.3)

20 format (A10, 14, 1X, F8.3, 1X, 13)

end

C This SPSSX package reads the Farhood file and plots Y-

value against years.

FILE HANDLE FARHOOD

DATA LIST FILE = FARHOOD/COMPANY 1-10 (A), YEAR 11-15,

Y 16-23, C 24-27

SORT CASES BY C

SPLIT FILE BY C

PLOT TITLE = 'PLOT YEAR AND RATIOS'

/VERTICAL =

/HORIZONTAL = YEAR

EXECUTE

FINISH

C This Fortran program reads the provided data and plots

four different groups of data on four different

scales in one page by the SIMPLE PLOT.

PROGRAM PLOT14

341
DIMENSION XARR(14), YlARR(14), Y2ARR(14), Y3ARR(14),

Y4ARR(14), Y5ARR(14), Y6ARR(14), Y7ARR(14),

Y8ARR(14)

REWIND 1

OPEN (UNIT=1,FILE='KOBRA')

READ (1, ) (XARR(I), YlARR(I), Y2ARR(I), Y3ARR(I),

Y4ARR(I), Y5ARR(I), Y6ARR(I), Y7ARR(I), Y8ARR(I),

I = 1, 14)

CALL PAGE (20.0, 29.7)

CALL PICSIZ (8.0, 8.0)

CALL MARGIN (1.0)

CALL GROUP (2, 2)

CALL SCALES (1972.0, 1985.0, 1, 28.0, 45.0, 1)

CALL AXES7 ('YEAR', 'CURRENT ASSETS')

CALL BRKN CV (XARR, YlARR, 14, 6)

CALL BRKN CV (XARR, Y2ARR, 14, 0)

CALL SCALES (1972.0, 1985.0, 1, 67.0, 78.0, 1)

CALL AXES7 ('YEAR', 'CURRENT LIABILITIES')

CALL BRKN CV (XARR, Y3ARR, 14, -1)

CALL BRKN CV (XARR, Y4ARR, 14, -6)

CALL SCALES (1972.0, 1985.0, 1, 56.0, 9 .0, 1)

CALL AXES7 ('YEAR', 'NET INCOME')

CALL BRKN CV (XARR, Y5ARR, 14, -5)

CALL BRKN CV (XARR, Y6ARR, 14, 5)

CALL SCALES (1972.0, 1985.0, 1, 238.0, 458.0, 1)

CALL AXES7 ('YEAR', 'CASH')

CALL BRKN CV (XARR, Y7ARR, 14, -2)

CALL BRKN CV (XARR, Y8ARR, 14, 4)

CALL TITLE7 ('L', 'C', 'COMPANY'S NAME')

342
CALL SET KY ('L', 'R', 8, 6)

CALL LINE K7 (0, 'CA')

CALL LINE K7 (6, 'OCA')

CALL LINE K7 (-6, 'CL')

CALL LINE K7 (-1, 'OCL')

CALL LINE K7 (5, 'NI')

CALL LINE K7 (-5, 'ONI')

CALL LINE K7 (4, 'CASH')

CALL LINE K7 (-2, 'OCASH')

CALL ENDPLT

STOP

END

343
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344
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