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 LIST OF TABLES LIST OF FIGURES CHAPTER 1: INTRODUCTION 1.1 DEFINITION OF PRIMARY DATA 1.2 DEFINITION OF RATIOS 1.3 THE MANAGEMENT'S TOOLS 1.4 MEASUREMENT OF PERFORMANCE AND CORPORATE ACCOUNTING 1.5 DEFINITION OF TREND 1.6 BANKRUPTCY AND LIQUIDATION 1.7 OUTLINE OF RESEARCH 1.8 CONCLUSION CHAPTER 2: HISTORICAL BACKGROUND OF FINANCIAL ANALYSIS 2.1 CORPORATE FINANCIAL STATEMENTS
2.2 FINANCIAL ANALYSIS DEVELOPMENT

V VIII X

3 4 5

6 7 8 9 11

13 14

2.3 ADDED VALUE AS A PERFORMANCE MEASUREMENT 16 2.4 SECURITY ANALYSIS 2.5 RATIO CLASSIFICATION 2.6 INDUSTRIAL AVERAGE ANALYSIS 2.7 DISCRIMINANT ANALYSIS 2.8 FINANCIAL RATIOS IDENTIFICATION 2.9 SOME LIMITATIONS OF THE RATIO ANALYSIS 2.10 CONCLUSION 27 31 34 38 44 48 50

V

CHAPTER 3: BASIC TOOLS OF PERFORMANCE MEASUREMENT 3.1 CAUSES OF FAILURE 3.2 DETECTION OF FAILURE BY RATIOS 3.3 PROFITABILITY 3.4 MEASURING THE PROFITABILITY 3.5 BEHAVIOURAL EQUATIONS 3.6 PROFIT VS PROFITABILITY 3.7 RISK VS PROFITABILITY 3.8 RESTRAINTS IN PROFITABILITY ANALYSIS 3.9 PROFITABILITY RATIOS 3.10 MANAGERIAL PERFORMANCE 3.11 MANAGEMENT VS RISKINESS OF LOAN 3.12 MANAGERIAL PERFORMANCE RATIOS 3.13 OPTIMUM AMOUNT OF CASH 3.14 LEVERAGE ANALYSIS 3.15 SOLVENCY RATIOS 3.16 CONCLUSION CHAPTER 4: METHODOLOGY OF FACTOR ANALYSIS 4.1 EXTAT LIMITATION 4.2 FACTOR ANALYSIS 4.3 CORRELATION COEFFICIENTS 4.4 THE MODEL OF FACTOR ANALYSIS 4.5 FACTOR EXTRACTION 4.6 FACTOR ROTATION 4.7 THE KAISER VARIMAX METHOD 97 102 104 111 117 120 124 54 55 56 60 63 65 66 69 71 73 75 76 79 89 92 94

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 5.2 BUILDING COMPOSITE FACTOR SCORES FROM THE FACTOR-SCORE COEFFICIENT MATRIX 5.3 TESTING THE EFFECTIVENESS OF THE MODEL 5.4 CONCLUSION CHAPTER 6: PERFORMANCE CLASSIFICATION AND COMPARISON 6.1 CLASSIFICATION OF THE PERFORMANCES 6.2 FAILURE PREDICTION STUDIES 6.3 COMPARISON OF THE MODEL WITH SIMILAR MODELS AND STUDIES 6.4 CONCLUSION CHAPTER 7: PERFORMANCE STABILISATION 7.1 PERFORMANCE STABILISATION 7.2 PERFORMANCE IMPROVEMENT 7.3 A GRAPHICAL ILLUSTRATION OF IDEAL PERFORMANCE 7.4 CONCLUSION CHAPTER 8: CONCLUSIONS AND RECOMMENDATIONS 8.1 SUMMARY OF THE MAIN CONCLUSIONS 8.2 RECOMMENDATION FOR FURTHER STUDY DYNAMIC ASPECT OF RATIOS APPENDICES 1) GEOMETRIC PRESENTATION OF THE FACTOR MODEL 309 2) FACTOR ROTATION 3) FACTOR EXTRACTION BY THE CENTROID METHOD COMPUTER PROGRAMS LIST OF REFERENCES 319 323 330 345 305 302 244 299 232 238 224 230 211 218 141 145 209 137

VII

LIST OF TABLES Page No. CHAPTER 2 2.3.1 Comparison of Return on Capital for four Imaginary Companies 2.3.2 Manpower Productivity and Capital Productivity 2.3.3 Primary Production Data from Payroll 2.3.4 Elementary Production Ratios 2.5.1 Ratio Classification 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 59 22 23 25 32 19

3.3.2 Submodels of Profitability

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 91 92

3.14.1 Company's Financial Structure 3.14.2 Company's Financial Structure CHAPTER 4

4.3.1 Ratios with Volatile Standard Deviations 108 4.3.2 Ratios with the Highest Correlation Coefficient 4.7.1 Varimax rotation of two (x,y) factors 110 127

VIII

4.7.2 Ratios with the Highest Varimax Rotated Factors after Rotation with Kaiser Normalisation 129 131 134

4.7.3 Transforming the Table 4.7.2

4.8.1 Scale of Ratio-Factor Correlation CHAPTER 5 5.1.1 Factor Score Coefficients

140

5.3.1 Classification of Companies Performance 146 5.3.2 Effectiveness of the Model 5.3.3 Overall Effectiveness of the Model CHAPTER 6 6.1.1 Applying the New Classification to the Sample Companies 6.2.1 The Altman's Predictive Accuracy 215 223 205 208

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 6.3.3 A Comparison of Cash Position Ratios with differing Levels of Overall Company's Financial Performance 6.3.4 The Classification Accuracy of some Financial Performance Models CHAPTER 7 7.1.1 Comparison of Ideal Path with its Actual Path 236 228 227 226

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 3.13.2 The Miller Model of Optimal Amount of Cash CHAPTER 5 5.3.1 Testing the Effectiveness of Model on General Electric Co. 5.3.2 5.3.3 5.3.4 5.3.5 5.3.6 5.3.7 5.3.8 5.3.9 5.3.10 5.3.11 5.3.12 5.3.13 5.3.14 5.3.15 5.3.16 5.3.17 5.3.18 " 5.3.19 5.3.20 5.3.21
tt
ft

82

86

151 Coalite Group 152 153 154 155 156

n

n "

" " " " "

n

n "

Allied Textile Co Plc British Home Store Plc

"

" Bell(Arthur) & Sons Plc " Wellcome Fundation

" Benford Concrete Machinery Plc 157
11

"
"

Beecham Group Plc Marks & Spencer

158 159 160 161 162 163 164 165 166 167 168 169 170 171

"

If

II

" Pearsons
▪ "

Racal Electronics BPB Industries Plc

N

"

" Allied Colloids Plc " Ash & Lacy Plc " Boots Co Plc (THE) " British Gas Corporation " Anglia Television Group Plc " Goodyear Tyre & Rubber Co " " " Babcock International Plc " APV Holdings Plc
"

Ault & Wiborg Group Plc

X

5.3.22 " 5.3.23 ' 5.3.24 " 5.3.25 • 5.3.26 • 5.3.27 ° 5.3.28 " 5.3.29 ' 5.3.30 ° 5.3.31 ° 5.3.32 ° 5.3.33 • 5.3.34 ° 5•3.35 ° 5.3.36 •
5 .3.37 '

"

"

• Albright & Wilson Ltd
"

172 173 174 175 176 177 178 179
180

Barrow Hepburn Group Plc

A

• Pleasurama Plc
" British Railways Board

" • °

" •

• Anchor Chemical Group Plc ° Baker Perkins Holdings Plc ° Ford Motor Co Ltd ° Adams & Gibbon Plc ° Armitage Shanks Group Ltd
N

'
/I

"
If

11

Atkins Brothers Plc

181
182

° Dunlop Holdings Plc
"


X

Barno Industries Plc

183 184 185
186

° BBA Group Plc ° Batleys of Yorkshire Plc
n

II

Bemrose Corporation Plc

° Bestobell Plc

187
188 189

5.3.38 • 5.3.39 • 5.3.40 • 5.3.41 • 5.3.42 ° 5.3•43 • 5.3.44 • 5.3.45 • 5.3.46 • 5.3.47 ' 5.3.48 • 5.3.49 " 5.3.50 °

Brocks Group of Co Ltd

II

° Stone Platt Industries Plc • British Airways
"

• • •

190 191 192 193 194 195
196 197 198

Viners Blackman & Conrad

II

'

° Amalgamated Industrials • Blackwood, Morton & Sons
" Pickles (William) & Co
'

• •

. °

Burrell & Co.


le


U

° Cawdaw Industrial HLDGS • Airfix Industries ° Oxley Printing Group ° Lesney Products & Co.

" •

" •

199
200

XI

5.3.51

It "

Richards & Wallington Ind.

201 202 203

5.3.52

II

" Norvic Securities

5.3.53 " CHAPTER 6

ft

" Austin (F.)(Leyton)

6.1.1 Classification of Performing area CHAPTER 7 7.2.1 Trajectories of Failing Company Performance

214

238

7.3.1 A Graphical Illustration of Ideal Performance of General Electric Co 7.3.2 " 7.3.3 7.3.4 7.3.5 7.3.6 7.3.7 7.3.8 7.3.9 7.3.10 7.3.11 7.3.12 " 7.3.13 7.3.14 7.3.15 7.3.16 7.3.17 7.3.18 " 7.3.19 7.3.20
ft

247 248 249 250 251 252

" Coalite Group •
ft ft

"

" Allied Textile Co Plc
"

British Home Stores Bell(Arthur) & Sons Plc Wellcome Fundation

"

n

n "

n

n "

"

ft h "

Benford Concrete Machinery Plc 253 254 255 256 257 258 259 260 261 262 263 264 265 266

ft "
ft

Beecham Group Plc
"

Marks & Spencer Pearsons Racal Electronics BPB Industries plc

ft"

ft "

ff

"

" Allied Colloids Plc " Ash & Lacy Plc

• " Boots Co Plc (THE)
British Gas Corporation Anglia Television Group Plc

ft"

ft"

• • •

" Goodyear Tyre & Rubber Co " Babcock International Plc " APV Holdings Plc
XII

7.3.21 " 7.3.22 7.3.23 7.3.24 7.3.25 7.3.26 " 7.3.27 7.3.28 " 7.3.29 7.3.30 7.3.31 7.3.32 7.3.33 " 7.3.34 " 7.3.35 " 7.3.36 7.3.37 " 7.3.38 7.3.39 ° 7.3.40 7.3.41 7.3.42 7.3.43 " 7.3.44 " 7.3.45 " 7.3.46 7.3.47 " 7.3.48 7.3.49 " . .
'I
II II

" Ault & Wiborg Group Plc " Albright & Wilson Ltd
n

267 268 269 270 271 272 273 274 275 276 277 278 279 280 281 282 283 284 285 286 287 288 289 290 291 292 293 294 295

Barrow Hepburn Group Plc

. .

. .

" Pleasurama Plc " British Railways Board " Anchor Chemical Group Plc

n

n

"

Baker Perkins Holdings Plc

. . .

. . . .

" Ford Motor Co Ltd " Adams & Gibbon Plc " Armitage Shanks Group Ltd " Atkins Brothers Plc " Dunlop Holdings Plc
"

.
if

.
N

Barno Industries Plc

.
u

.
n

" BBA Group Plc
"

Batleys of Yorkshite Plc

. .
a

" Bemrose Corporation Plc " Bestobell Plc
"

.
n

Brocks Group of Co Ltd Stone Platt Industries Plc

. .

" British Airways " Viners
"

Blackman & Conrad Amalgamated Industrials Blackwood, Morton & Sons

N

II

"

n

of "

. . “ . "

. . .
N

" Burrell & Co " Cawdaw Industrial HLDGS " Airfix Industries
"

Oxley Printing Group

"

" Lesney Products & Co

XIII

7.3.50 " “ “ " Richards & Wallington Ind 7.3.51 " 7.3.52 "
n “ "

296 297 298

Norvic Securities Austin(F.)(Leyton)

.

II

"

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 considerations, other

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. accurate, 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. and These data must be up to date and contain useful financial

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 interpretation. and

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. action on what they reveal. This allows management to take

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. managerial However, when there are proper

tools, management can make valid appraisals

quickly. They can make decisions with the greatest confidence and objectivity. areas fruitfully. They can also spend time on other vital

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 Entire sections of Graham and

of Graham and Dodd (1934).

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 quadratic factor analysis and

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, 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. it can be

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 companies. four imaginary

18

TABLE 2.3.1: An Example of Comparisons of Return on Capital for four Imaginary Companies

COMPANY (

000s)

Al

D

SALES PURCHASES

I I

1000 400

I I

1000 400

I I

1000 400

I I

1000 400

ADDED VALUE WAGES, etc DEPRECIATION INTEREST ON LOANS

600 450 100

600 450 75

600 450 75 25

600 425 75 25

PROFIT CAPITAL LOANS

50 500

75 525

50 325 200

75 325 200

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. investors but of governments. It must take account not just of customers, suppliers and

employees,

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 (ADDED VALUE PER EMPLOYEE)

CAPITAL PRODUCTIVITY (ADDED VALUE PER UNIT OF CAPITAL) RISING
I

STATIC

1

FALLING

1

1 1

RISING STATIC FALLING

EXCELLENT GOOD POOR

I
I

GOOD STATIC BAD

I

POOR BAD VERY BAD
1

1

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 1

Pounds code

1 1

Hours code

1 1

total gross paid payroll total clocked payroll direct labour: on standard: earned on standard: clock off standard: clock Total direct labour Indirect labour: downtime: miscellaneous waits for equipment repairs for tool repairs excess direct labour: Jig and die trouble Equipment trouble Material trouble other: Tool and fixture making Setup Maintenance and repairs Salvage, re-work, re-process Service Supervision Factory engineering Factory clerical Total indirect labour

1
2

24 25

3

26 27

4 5

28 29

6 7 8 9 10 11 12 13 14 15 16 17 18 19 20

30 31 32 33 34 35 36 37 38 39 40 41 42 43 44

23

Direct labour subsidy (lost) Direct incentive premium (gained) indirect incentive premium

21 22 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

1 I I I I

gross productivity net productivity ; 1

26/27 (27-45+46)/27 27/29 (27-45+46)129 (27-45+46)125 45/46

U U

3 I 4 I 5 I
6

work standards coverage performance index improvement index worker standards consistency indirect support indirect support cost indirect usage indirect usage cost subsidy excess cost down-time cost excess direct labour cost tool and fixture cost setup index setup cost maintenance and repair index maintenance and repair

I I I

U U U D

II I I I 7 I
8

441(29+46) 20/5 44/24 20/1 45/27 (6+7+8+9+10+11+15+21)/5 (6+7+8)/5 (9+10+11)/5 12/5 37/29 13/5 38/29

I I

D D D D D D D D D D D D

9 I

1 10 I 11 I
1 12 I

I 13
1 14

I 15 1 16 I I 17
1 18 I

I 1 19

I

14/5

D

Icost

1 20 I

service index

40/29

D

25

21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39 40 41 42 43 44 45 46 47 48

service cost supervisory ratio supervisory production factory engineering cost factory clerical cost support index support cost incentive support incentive cost setup effectiveness maintenance effectiveness productivity planning direct usage cost direct usage index variable indirect variable indirect-direct premium avoidable cost avoidable content machinery-labour economy production, indirect service-payroll index direct-productive index productivity yield index indirect yield index net payroll productivity gross payroll productivity service-wait index indirect payroll

11/5 41/25 41/29 18/5 19/5 (40+41+42+43)/29 (16+17+18+19)15 (46-45+47)/29 (21+22+23)/5 37/26 38/26 22/6 5/1 29+46/24 6+7+8+9+10+11+13+14+15/20 6+7+8+9+10+11+13+14+15/5 22/(14+15) (14+15)/5 (7 10+14)/5 (44/24)(29/20) 40/24 (29+46)/(44+45) (27-45+46)/24 (27-45+46)/44 (29-45+46)/24 (29-45+46)/25 (6+16)/5 (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 category. Ratio 10- payout ratio=common dividends/net profit for common shares toward those issues not in the "growth-stock"

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 dividend) charges + preferred

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 2.0 > R > 1.5 1.5 > R > 1.0 R - 1.0 1.0 > R R < 0.5 0.5

overliquidity optimal liquidity under liquidity marginal liquidity payment difficulties danger of bankruptcy

excellent very good good sufficient deficient
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 The 125 types of business

on their financial statements.

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 The

2.6.1. The complete data give the fourteen ratios.

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 Implements & Machinery (74)

LR MR SR

3.78 2.27 1.52

.0715 .0412 .0323

.2144 .1459 .083

.3682 .2068 .1495

5.27 3.21 2.34

8.13 4.6 2.98

1 1

25 39 52

1 1

1

1

Airplane parts & Accessories (59)

LR MR SR

2.4 1.81 1.42

.0812 .0525 .031

.2778 .1811 .119

.4496 .3221 .1776

4.46 3.43 2.72

8.27 5.29 4.2

1 1

34 46 61

1 1

1

1

Automobile Parts & (84) Accessories

LR MR SR

3.77 2.58 2.03

.0675 .0459 .0332

.1889 .146 .0865

.3211 .2032 .1409

3.89 2.99 2.19

6.54 I 4.63 I 3.23 I

35 42 51

1 1

1

Bedsprings & Mattresses (49)

LR MR SR

3.6 2.33 1.87

.0269 .0206 .008

.1153 .0646 .0271

.1503 .1095 .0511

5.85 3.48 2.61

8.52 5.79 I 4.34 I

30 42 55

1 1

1

Breweries (27)

LR MR SR

3.34 2.59 1.88

.0648 .0475 .0128

.1515 .1038 .0255

.6372 .3427 .0823

3.23 2.49 1.72

11.34 8.51 5.13

I 1

8 16 24

1 1

1

1

Chemicals, Agricultural (33)

LR MR SR

2.98 1.73 1.33

.0387 .0202 .0095

.1178 .0758 .0156

.4491 .1773 .028

5.11 3.46 1.98

13.41 6.72 4.15

1 1

32 55 87

1 1

1

1

36

Chemicals, Industrial (60)

7.05 1 39 1 ILR I 2.77 1. 0815 1.1 6 07 1.5001 I 3.09 MR I 2.28 p.0553 J.1245 1. 303 2 I 1.95 I 5.03 1 50 1 ISR I 1.51 J.0393 1. 090 3 1.1795 I 1.52 I 3.39 1 59 1

Contractors, LR Building (188) MR construction SR

2.06 .0314 .1904 .3304 12.51 20.41 1 1.49 .0138 .1239 .1638 8.09 11.52 1 1.27 .0074 .0620 .0914 4.32 5.79 1

b 1 b 1 b 1

continues of Table 2.6.1

LB

NS

FA --TNW

CD

TD

In

CD 1 FD 1 --- 1 --- 1 In 1 NWC I

NR

In

TNW

TNW

NWC

Agricultural Implements & Machinery (74)

LR MR SR

6.1 3.9 3.1

.215 .335

.225 .493

.475 .713 .800 1.049 1.496 1.614

.446 1 .178 1 .720 1 .370 1 .984 1 .509 1

.636 1.153

Airplane parts & Accessories (59)

LR MR I SR

8.6 .279 5.9 I .484 3.9 .755 1

1 1 .738 I .879 1 .141 1 11.034 I 1.00 1 .475 1 1 1.125 11.791 1.547 1.419 .558 1 .432 1 .580 .615 11.035 1

LR 8.0 Automobile .257 .235 .473 .778 Parts & (84) 5.3 .396 .380 MR Accessories SR 4.2 .555 .634

.605 .862

.585 1 .146 1 .797 1 .416 1 1.137 1 .599 1

1.169 1.005

Bedsprings & Mattresses (49)

LR MR SR

11.7 8.2 5.5

.156 .281 .493

.229 .459 .763

.487 .728

.548 .768

.556 1 .036 1 .936 1 .266 1 1.548 1 .521 1

1.339 1.145

Breweries

1 1 1 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)

+
Chemicals, Agricultural (33)

1 II
1SR LR MR SR

11.4

1 I

.819

1 I

.341

1 I

.975

1 I

.877 11.949

1

762

1 +

I
.621 1.066 1.605 .895 1.229 2.373

10.4 6.6 5.0

.295 .536 .712

.336 .731 1.23

.584 1.11 1.659

1 1 1

.241 .479 .752

1 1 1

Chemicals, Industrial (60)

LR MR SR

10.1 6.9 5.5

.426 .688 .889

.201 .300 .500

.318 .589 1.06

.652 .847 1.001

.761 .985

1 1

.440 .942

1 1 1

1.287 11.524

Constructors, Building (188) Construction

LR MR SR

b b b

.095 .222 .421

.617 1.38 2.398

1.194 1.884 3.180

b b b

1 1 1

.119 .274 .834

1 1 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 Smith used

analysis in the area of financial analysis.

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 discriminant analysis. using

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. 2. 3. 4. 5. FUNDS FLOW(GROSS TRADING PROFIT)/TOTAL ASSETS FUNDS FLOW/NET WORTH FUNDS FLOW/TOTAL LIABILITIES FUNDS FLOW/CURRENT LIABILITIES FUNDS FLOW/NET TRADING CAPITAL(EQUITY+TOTAL LIABILITIES-CASH) 6. FUNDS FLOW/NET CAPITAL EMPLOYED(EQUITY+LONG TERM LIABILITIES) 7. 8. 9. 10. 11. 12. 13. EBIT/TOTAL ASSETS EBIT/NET WORTH(EQUITY) EBIT/TOTAL LIABILITIES EBIT/CURRENT LIABILITIES EBIT/NET TRADING CAPITAL EBIT/NET CAPITAL EMPLOYED CASH FLOW(RETAINED PROFITS - EXCEPTIONAL ITEMS + DEPRECIATION)/TOTAL ASSETS 14. 15. 16. 17. 18. 19. 20. 21. 22. CASH FLOW/NET WORTH CASH FLOW/TOTAL LIABILITIES CASH FLOW/CURRENT LIABILITIES CASH FLOW/NET TRADING CAPITAL CASH FLOW/NET CAPITAL EMPLOYED TOTAL LIABILITIES/NET WORTH log (FIXED ASSETS/NET WORTH) FIXED ASSETS/NET CAPITAL EMPLOYED TOTAL LIABILITIES/CURRENT ASSETS

42

23. 24. 25. 26.

CURRENT LIABILITIES/TOTAL ASSETS TOTAL LIABILITIES/TOTAL ASSETS TOTAL LIABILITIES/NET CAPITAL EMPLOYED DEBT/EQUITY

27.
28. 29. 30. 31.

log

(QUICK ASSETS/CURRENT LIABILITIES)

(CURRENT ASSETS/CURRENT LIABILITIES) (QUICK ASSETS/TOTAL ASSETS) (CURRENT ASSETS/TOTAL ASSETS) (WORKING CAPITAL/TOTAL ASSETS)

32. 33.
34. 35.

log log

(QUICK ASSETS/NET WORTH) (CURRENT ASSETS/NET WORTH)

WORKING CAPITAL/NET WORTH (QUICK ASSETS/TOTAL LIABILITIES)

36. 37.
38.

log log

(QUICK ASSETS/NET CAPITAL EMPLOYED) (CURRENT ASSETS/NET CAPITAL EMPLOYED)

WORKING CAPITAL/NET CAPITAL EMPLOYED

39.

log

(INVENTORY/WORKING CAPITAL + SHORT TERM

LOANS - CASH)

40.
41. 42. 43.

log

(SALES/WC+SHORT TERM LOANS-CASH)

SALES/AVERAGE INVENTORY DAYS DEBTORS DAYS CREDITORS

44.

log

(READY ASSETS(CASH+7 DAYS DEBTORS)/CURRENT

LIABILITIES 45. log (READY ASSETS/TOTAL ASSETS)

46. 47.
48.

log log

(READY ASSETS/NET WORTH) (READY ASSETS/TOTAL LIABILITIES)

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 stockouts.

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. has been some other There

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 FIXED CAPITAL' 'INVESTMENT' 'CHARGE RATEI
I I I I I

'LABOR' 'MATERIALS' 'VARIABLE (OVERHEAD
I I I I I

PLUS

I

I

TIMES

I

PLUS

I

PLUS

I

I

FIXED COSTS

I

(VARIABLE
I

I

I

I

COSTS

I

PLUS
I I

TOTAL

I

I

NET SALES
I

I I I

I

TOTAL COST

I

I

I I

I I

I I

I I

'INVESTMENT
I

DIVIDED INTO

MINUS

IPRETAX 'PROFIT

I

I

INCOME TAXES

I

I

MINUS

I

NET

I

(PROFIT ' DIVIDED INTO

I

CAPITAL TURNOVER RATE

I

'PROFIT 'MARGIN

I

I

I

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-ING COST 0 PRODUCED) = DIRECT MANUFACTURING COST (DMC) DMC + FIXED OVERHEAD + CAPITAL CHARGES = TOTAL MANUFACTURING COSTS

DEPRECIABLE INVESTMENT(BUILDINGS AND EQUIPMENT)+ A 3) INVESTMENT EXPENSES & AMORTISED INVESTMENT(ENGINEERING, R & D,I 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 where P Profits (1-T)(rA-iL)

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

P/E

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

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 relationship. Thus i= dL/E is rewritten as i= dL/E + u random error term in the behavioural

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. different concepts. measure of profit. Profit and profitability are the

Accounting principles determine

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 Risk level Interest !Management (2) (2) 1 Risk
(2)

Total return
(2)

Typical return (2)

1 1

1

1) very low 2) below average 3) average 4) above average 5) high

8-10 8-10 8-10 8-10 8-10

0-1 1-2 1-2 1-2 1-2

1-3 2-6 6-10 12-20 20-40

9-14 11-18 15-22 21-32 29-52

11 15 18 25 41

1 1

I 1

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 Antitrust Product safety Hiring Pollution control and so on ---

POLICY DECISIONS Line of business size of firm type of equipment use of debt Liquidity position and so on Risk Value of Firm

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 Recently, some financial

accompanying the use of ratios.

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 1 R 2 R 3 R 4

NPAT/SALES NPAT/TOTAL ASSETS NPAT/NET WORTH(SHAREHOLDERS' FUND) NPAT/WORKING CAPITAL

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 = EBIT/NET WORTH(SF) R 13 R = EBIT/(TOTAL LIABILITIES - CURRENT LIABILITIES) 14 R = (EBIT + DEPRECIATION)/NET WORTH(SF) 15 = (EBIT + DEPRE.)/(TOTAL LIABILITIES - CURRENT LIABILITIES) R 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 33

(DEPRECIATION+TOTAL INTEREST+TOTAL TAX)/(TOTAL CAPITAL)

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 b) Competitive weakness C) Heavy operating expenditure d) Inadequate control of debtors e) Excessive fixed assets f) Inadequate inventory control g) Poor geographical location h) Others 44 percent 24 percent 9 percent 8 percent 4 percent 4 percent 2 percent 4 percent

Argenti (1976) identified five characteristics of bad management: 1) One-man rule (not by any means necessarily a oneman 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 debtequity 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 34 R

SALES/INVENTORY

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 COMMON STOCK (BOOK VALUE) /COMMON STOCK (MARKET VALUE) R 56

77

R ... COMMON STOCK/NET WORTH 57 R = FIXED ASSETS/NET WORTH 58 R = FIXED ASSETS/DEBT 59 ... FIXED ASSETS/TOTAL ASSETS R 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 1 where P 1 P 2

+ cP /i 2

the expected number of unit periods of cash stock the expected number of unit periods of cash shortage

Figure 3.13.1 can help to determine the expected number of unit periods of cash stock. Figure 3.13.1

A

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)

2 * 3,/ 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 0

x

_ . 1_ 2z

..0

.4
C.)

m as

h -

PI H • rl 0 1::)

z

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 balance(inventory) + sales - purchases

opening

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 j j

-ItCX j=1 j j

subject to i-1 -

<B- A j-1 j
i-1

(i = 1,2,3,....,n)

j = 1 j Y j=1 j

-X <A 3=0 j

(i = 1,2,3,....,n)

X ,Y > 0 j j

(j - 1,2,3 ..... ,n)

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
j=1 j

) minus previous purchases (

X ). j=1 j

87

for example if i = 2 X <B-A+Y +Y - X 1 1 2 2 (buying constraints)

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 3 <A+X+X-Y1 2 1 Y 2 (selling constraints)

M - the initial cash balance 0 M - the minimum cash balance permissible and write i-1 7-- PY<Mj=1 j j 0

CXj=1 j j

M

(i = 1,2,3,....,n)

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

period

i-1 (=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 33 <M-M+PY+PY -CX -CX 11 0 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 j=1 j-g j-g

-P Y j=1 j-r j-r

<M -M 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
1 I 1 PERCENT OF AFTER TAX(a) 'TOTAL CAPITAL I COST (Z)

I
I

I 1 +

WEIGHTED COST (Z)

SHORT TERM DEBT LONG TERM DEBT SHAREHOLDERS' EQUITY
+ 1 1 +

5.0 15.0 80.0

6.0 8.0 10.0

0.30 1.20 8.0
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 LONG TERM DEBT SHAREHOLDERS' EQUITY

10
30 60

6.0 8.0 10.0

.60 2.4 6.0

1 1

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 - WORKING CAPITAL/CASH FLOW R 101 = WORKING CAPITAL/SALES R 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 = TOTAL LIABILITIES/NET WORTH R 109

93

R 110 R 111 R 112 R 113 R 114 R 115 R 116 R 117 R 118 R 119 R 120 R 121 R 122 R 123 R 124 R 125 R

= TOTAL LIABILITIES/CURRENT ASSETS = NET WORTH/FIXED ASSETS = NET WORTH/TOTAL LIABILITIES = EBIT/INTEREST = EBIT/FIXED CHARGES NO CREDIT INTERVAL = ANNUAL FUNDS FLOW/CURRENT LIABILITIES = REDUCED SALES INTERVAL - REDUCED OPERATIONS INTERVAL DEBITORS/CAPITAL FUNDS = LONG TERM LIABILITIES/(STOCK+SURPLUS-INTANGIBLE ASSETS) = DEPRECIATION/TOTAL ASSETS = CREDITS/NET WORTH = BASIC DEFENSIVE INTERVAL = MARKET VALUE OF EQUITY/TOTAL LIABILITIES - MARKET VALUE OF EQUITY/LONG TERM LIABILITIES

= (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 = 1 R = 2 R = 3 R = 4 R = 5 R = 6 R = 7 R = 8 R = 9 R 10 R 11

NI/SALES NI/TA NI/SF NI/(CA-CL) NI/(TA-SF) NI/CA NI/FA NI/(PD+CD) NI/(TA-CL) = (NI-PD)/0C (PBT+TI)/TA

98

R 12 R 13 R 14 R 15 R 16 R

= (PBT+TI)/SALES = (PBT+TI)/SF = (PBT+TI)/(TL-CL) = (PBT+TI+DEPRE)/SF = (PBT+TI+DEPRE)/(TL-CL) = 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 = SALES/(TA-SF) R 26 - (PD+CD)/NI R 28 R - (PD+CD)/(NI+DEPRE+EI) 29 R - CD/SF 30 = (DEPRE+TI+TT)/(P5+0C+DC) R 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 = (TA-SF)/(CA-CL) R 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

= (NI+DEPRE+EI)/(TA-SF) 94 R = (NI+DEPRE+EI)/CL 95 = (CA-CL)/INVENT R 98 = (CA-CL)/FA R 99 = (CA-CL)/TA R 100 (CA-CL)/(NI+DEPRE+EI) R 101 = (CA-CL)/SALES R 102 = (CA-CL)/SF R 103 = CL/(TA-SF) R 104 = CL/(CA-INVENT) R 105 = CL/SF R 106 R = CL/CA 107 R = (TA-SF)/TA 108 (TA-SF)/SF R 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 R

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 it Where

x /Sx i it

x
it

= X it

- X i

(i=1,2,3,...,n, t=1,2,3 ....

. ,T)

-Tx
i t=1 it

IT

Sx =

= \//k1 (X 1 t=1 it

-

2 /T 2 X ) /T = \/ x /T t=1 it i

The ratios, normalised satisfy therefore the conditions: T _ Z =Z IT ===x /TSx =(Z=X -TX )/TSx =(TR -TX )/TSx =0 i i i i t=1 it i i t=1 it t=1 it 2 S z T 2 Z /T i t=1 it 2 2 2 /TS x = S x IS x = 1 i t=1 it T 2

=Z:x

(i=1,2,3,..,n)

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 observations, divided by the number of

normalised observations.

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

C--2

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

=Z:

If now, the product of the matrices of the normalised observations of the ratios under examination is determined, we get:

Z,....,Z 11 n1

Z=Z Z

Z

t=1 it it

t=1 it nt

Z,....,Z 1T nT

:=Z Z t=i nt it

,...., --Z

Z ti nt nt

106

ITr
1

, 11

,Tr

I

1r
1

, 11

,r

1

1n1

.

1

1= T 1

1Tr I nl

„Tr 1 1r , nnl

ml

1n1 I= TR ,r 1 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

+

II11971 'RATIOS
R4 R8 R10 R20 R22 R23 R24 R28 R33 R34 R35 R42 R47 R48 R54 R64 R76 R99 R101 R105 R106 R109 R113 3.7 293 3 4.1 5.3 67 23 404 3.7 49 12 8 29 13 356 .41 .7 1.7 3.5 17 1.3 1.6 385

1

1

1

1

1

1

1

1

1

1

1

1 1 +

172 173 174 175 176 177 178 179 180 181 182 183 184 185

+

4.3 148 9.4 2.8 53 3.8 3.4 134 66 12

5.8 3.1 6.3 1.9 10 96 5.3 6.1 23 62 5 12 283 13

2.1 5.413.81.861 88 65 142 126 1 22 13 115 1.581 5.512.612.11 5.515.712.71 116157 193
1

2.5 2.8 3.8 3.1 6.6 4.7 3.5 11 4.7 79 139 64 14 .9 18 3.2 3

3.9 3.3 2.7 2.9 3.1 4.2 26 5 4.1 3.9 3.9 5.1 26 48 63 159 65

4.5 4.7 5.6 249 44 13 10 50 9

378 46 10

9.1 8.5 8.4 8.7 12 2

25 112 15•71 .761.8911.51 12 110 1.751 16 154 16.31 24 123 121
1

.67 1.7 .45 11

.61 .29 1.3 100 3.3 4 34 25 5.2 12 17 34 16 33

3.1 3.9 4.7 3.8 4.2 24 55 20 58 13 31 28 27 22 30 19 51 26

7.9 8.1 11 15 56 16 25 14 18

170 47 43 17

6.1 120 39 27 14 81 12

5.3 20 27 17

5.3 17 23 51

8.8 21 124 111 22 48 124 129

1

109 25 13 15

1

9.3 3.2 3.6 4.4 5.5 6.5133 11.61

.68 .66 .98 .43 10 .91 .7 3.6 .46 33

.55 .28 1.2 100 3.2 1.9 .711.8411.21 .83 .3 1.3 1.5 3.8 2.1 .781.8911.61

.58 .51 .71 .43 12 1.2 18 37 2

1.1 1.4 3.3 1.6 6.2 8.2 1.415.41.551

1.2 1.9 1.8 1.5 1.7 1.6 1.8 1.8 8.3 48 158 11.31 33 14 7.5 5.9 34 215 73 22 9.8 67 11 15 58 29 18 19 15 125 18.51 61 119 127
1

5.6 16 37 84

.97 22 1.3 23

1.9 1.4 1.9 1.5 .94 3.9 1.3 1.6 10 2.5 1.6 2.2 1.8 1.3 10 1.6 1.9 10

1.711.41.731 1.912.11 1
1

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 R1 11971 339 .79 I .62 I .78 .98 .92 I .67 .76 I .67 1 1 1 R1 11972 j 607 II .71 I .14 I .26 I .94 I .33 I .54 I .47 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 +
R1 R1 R1 R1 R1 R1 R1 R1 R1 R1 R1 R1 R1 11973 I 562 III 11974 I 561 I .68 .49 I .96 I .93 I .46 I .62 I .52 1

.79 I .56 I .90 I .91 I .62 I .72 I .58 1 .65 .92 .88 J .69 .75 I .64 1

11975 I544I .75 I .73

11976 I 541 I .77 I .71 I .69 11977 I 574

.94 I .85 I .71 I .72 I .65 1 .59 I .72 I .70 1 .62 1

.66 I .65 I .56 I .94 J .87

11978 I 548 I .67 I .66 I •57 I .91 11979 11980 11981 I

.89 I .60 I .63

517 I .72 I .28 I .65 I .92 I .91 I .64 I .72 I .69 1 490 .82 I .79 I .77 I .93 .87 I

I .74

.71 1

I .79 I .76 I .74 I .93 I .90 I .74 I .70 I .68 1
.81 .81 I .76 I .92 .88 I .66 I .66 .64 1 .65 1

11982 I 496

11983 I 509 I .72

.75 I .67 I .93 I .89 I .69 I .67

11984 I493I .77 I .80 I .70 I .91 11985 I 142 I .65 .93

.89 I .71 I .65 I .60 1 .68 1

.54 I .91 I .89 J .62 I .80

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 - (DEPRE+TI+TT)/(PS+0C+DC) R 33 R = INVENT/CA 46 R - CL/TA 50 = (TL+PS)/TA R 51 R - OC/SF 57 R - FA/SF 58 = FA/(TA-SF) R 59 -. CASH/CA R 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 = (CA-CL)/(NI+DEPRE+EI) R 101 - (CA-CL)/SF R 103 - CL/(CA-INVENT) R 105 = DEPRE/TA R 121

4.4 THE MODEL OF FACTOR ANALYSIS

Factor analysis is based specifically on intercorrelations. 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 ....

i

. ,n)

simultaneously.

b) Specific factors. S (i=1,2,3,

i

,n) factors

which influence only one ratio at a time.

C) Error

factors. e (1=1,2,3,

i

,n) factors to

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

i

n) at

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 it

+aF +....+aF +bS+C e = aF il it i2 2t im mt i it i it

(5)

112

(i = 1,2,3, where a ij

,n), (t = 1,2,3,

,T)

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

corresponding to the three separate categories of factors. The factor f , S and e can be regarded as the new, theoretical

i

i
mutually satisfy the

ratios. There are assumed to be normalised and independent of each other so that they must conditions:

T
j 2 s f j t=1 T

f it

/T = 0

2 f /T = 1 jt

a

t=1

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

i b=
2 Ss

=s /T = 0 t=1 it 2 T =s /T = 1 t=1 it i

Ss s i

=
t=1

(s

)/T = 0 s it i't

e IT = 0 E(e ) = t=1 it i T 2 e IT = 1 Var(e ) = t=1 it i

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

113

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

Sf e (f e )/T = 0 t=1 jt it i i Ss e ii :•(s e )/T = 0 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 + t=1 ii it i2 2t im mt i it i t=1 it it

2 T 2 2 T 2 2 m2 T2 C e ) ) =a (==f /T) + b ( --S /T) + c (==e /T) + i t=1 it i t=1 it j=1 ij t=1 jt i it m m a a (Z:f f /T) + 2b Z:a (==f s /T) 2Z: i j=1 ij t=1 jt it j-1 j 1 =1 ij ij' t=1 it j't + 2c Z:a (Z:f e /T) + 2b c (17. e e /T) = i i t=1 it it i j=1 ij t=1 jt it 2 2 +b +c i i j=1 ij m2 (i=1,2,3 ,....,n)

so that 2 Sz 2 2 2 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 common variance or communality. 2 b) b is the part of the total variance, which shows no the

association with the variance of other ratios,

this part

belonging to the specific factor is the specific variance uniqueness.

or

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. working model of factor analysis expressed observation is therefore: Z -a f +a f+ it il it i2 2t + a f im mt

The practical in normalised

(i1,2,3,. ..,n)

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

In matrix notation this is Z = AF or in detail
IZ I 11 1 , ,Z 1

1TI 1

la 11

„a

(I

f

,

,f

I

iml „a

I 11

iTI
1

1=1 1

11

12 , nl
1

,

Z

la nTI nl
1

lif , nmll ml

If

1

mT1

Where Z = The matrix of the normalised ratios Z (i=1,..,n, t=1,..,T) it A = The matrix of factor loadings a ij F = The matrix of factors f with elements f (j=1,..,m,t=1,..,T) (i=1,.. ,n, j=1,..,m)

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 .32 .64 .56 .48 .28 .56 .49 .42 .24 .48 .42 .36 = .41 .81x[.4 .8 .7 .6] •71 .61 A

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 m2 that is

il

where m is the number of common factors. All the data 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 a represent the sum of i=1 ik

number of ratios. If

squares of

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 1 1 1 n1 called the residual matrix after extraction of factor 1 the first residual matrix. or

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 1 values which are substantially different from zero.

have same

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 These factors

represent the final factor solution, however.

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 11 a

a 12 a sin a cos a
1 I= I

V

v 11 12 v 21 22 v 31 32 v 41 V 42

'cos a 21 22 xl a a 1-sin a 31 32 a a 41 42 A

V V 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
1

xlcos a -sin al isin a cos al

=

11 01
10 11

-sin a cos a

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. involved. This means that different constructs are

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 intermediatesized 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:

V =

m 2 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 x x

y
11

X 'cos a-sin al x I 1= 'sin a cos al

y
22

y
33

x n

y
n V1 A

Y ii X Y 22 X Y 33 . . X Y n n 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. in V1 are known. The values in V2 are not. The values 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 ) 2 22 2 22 2 6::[(x - y ) - ( 2xY) ]} - {[:— ( x - y )]

( 2xy)]/n

2 [(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 .531

.562 .344

.0182 .1636 .2939 .8267

.6497 .3653

.0003 .0268

.4221 .1334 .3362 .5483

.0118 .0598 -.1704 -.2509

-.4218 -.1066 -.2498 -.4251

1 1

.687 -.422 .765 -.484

-.5798 .0864 -.7405 .1232

1

1

67 1.8 26 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 25 2 / for 4a. The angle 'a' is 6 20'. With a negative a denominator, the angle of rotation will be (45 - a) or 38 41/ 0 which is rounded(39) numerator and denominator negative, the transformation matrix is as follows: .578 .56201 .531 .34401 1.7771 .62931 1= l x 1 .687 -.4221 1-.629 .77711 .765 -.4841 .10 .80 .20 .60 .80 .10 .90 .11
0 ,

Where Cos 39 = .7771 and Sin 39 = .6293

0

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
I

174

175

176

177 178

179

180

181 182 183

184

185

1

I

I

I

I

I

I

I

I

I

I

R1 R2 R5 R7 R26 R29 R30 R33 R46 R50 R51 R57 R58 R59 R73 R75 R77 R80 R82 R83 R84 R87 R98

I I

.84 .76

.641.481.7 1.811.751.851.741.851.911.831.781•721•921•951 .771-.91.841-.91-.61-.81-.71.991-.91-.91-.71.711.791.791 1.7 1.511.8 1.811.861.731.781.811.881.851•931•881•681.691

I

.7 .76 .9 •79 .47
1

.431.711.431.601.601.321.291.341.351.591.3 1.791.881.651 .811.841.831.8 1.851.741.831.831.831.841.861.681.761-.71 1.691.611.921.551

I

J I

I.99L 6 1.651.981•771.711.831.081.311.8 .651.881.8

1•431.5 1.731.731.351.461.411.791.451.361.821

.741-.31.341.331.611.481.461.081.121.121.081.131.171.771 1-.91-.81-.81.7 1-.81-.81-.71.711-.61-.61.8 1.861.781.8 1.841.891.9 1.8 1-.81-.91

-.9 .84 -.3 -.5 -.6
- .8

1

1.941.741.891.911.811•871.831•971 1-.21-.21 1.351-.61

1

1-.31-.21-.21-.21-.21-.21.111.141-.21-.21-.11.1 1-•31•9 1-.21.731.821.791.681-.91.811.881.741.5

1

1

1-.61.971-.91-.71.811•561.591-.81.721.771.951-.61.861-.71 1-.71-.81-.7I--51-.81--71--71-.61-.51-.81-.71-.51-.61-.81 1.791.881.881.891.891.851.851.851.821.851.851.871.861.941 1.331.791-.41-.41-•41-.41•441.451

I

1

.52

1

.41 1.371•351-.31-.41-.51.3 .17 .79 -.6 .66 .71 .93 .35

1

1.241-.11-.11-.11.111.191-.3 .131.091-.11.171.051.211.291 1.821.871.951-.81.721.7 1•761.8 1.651.6 1.721.551.931.831 1.721.641.431.461•591

1

1

1-.71-.71-.71.811-.71-.61-.51-.51.6

1

1.841.991.571.571.511.631.671.831.831.551.971.891.881.771 1.721.8 1.791-.71.761.821.871-.81.871.861.

1

71-

.8 1

.7

1.691

1

1.881.831.9 1.281.3

1.891.861.821.821.851.831.821.8 2 1

.89 1

.9

1.91(

1

1.281.661.321.311.351-.31.331.321.221-.71.281.651

129

1

R101 R103 R105 R121

1

.74 1.971.471.041.941-.71.441.6 1.231.251.8 1.741.351.

1.411

1

1

.83 1.791-.91.651.7 1.711.831.831.981.761.811-.91.761.931.881 -.6 1-.51.6 1-.61.761-.51-.51-.41.621-.41-.51.651.481-.51-.61 -.3 1-.31-.51-.31-.41-.41.251-.41-.41-.41-.31-.31-.41.511-.41
1 1 1 1 1 1 1 I 1 1 1 1

1

1

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

+
1 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
I I

+
R1 R2 R5 R7 1 1 I 11111111 1 BIC BIA BIC FICIBIC I B ID BIC AIA BIC AIBIAID I C IC I B IC EIBIBIB CIFIDID BIB BIB CIB FIF CIB BIB FIF BIB BIA EIF B B C B F CIAIA CIBB BICC BIAD D CC

I C IF

R26ICIB

PAl DID III C I B FIFI B R30 R33 R46 I BID I AIB F1C A FIF FIE I CIC I FIF I F FID FIF FIF CID CIA F F F

D lAPE FIFB FIFC BA

BBB

CIBIBIC

DIBIB

R50 I B I BBB lBIAIAIA R51 F FFF FIFIFIF

AIBIB I BA F FIF FF

R57 I E IFAFICIBBIDABBCEFD R58 R59 R73 R75 R77 R80 R82 R83 R84 R87 R98 R101 I I I I D B E F F DABICIBEIDBCCADBC D B CIE1B C DIE E DID EDD

I B I ABIBIA F F F F FIFIE FIFIF

B I BIB I B I BIB I B I BA F F FIB FIFIF F F FIF FIF

FIFIFIFIF

BIB I B IIICI CI C1BID IDI C I E IAIB DIC D C A F C C CIBIC E EIEID CID FIFD

IB I AIEIEIE I DIDIBIB I EIA I AIAB IC BIBICIC BIBIBIBIBICIBICC

I BIBIBIBIBIBIAIAA IAI BIAIA1B IF IA FIFIDIF FIFIAIC FIFIFIFIFIFICIFD FIDIFIFIBICIFIFIF

131

I

R103 R105

1

B D F

IBIAIDICI

C

IBI

B

I

A

I

C

I

B

I

A

I

C

1

1A1

1

I

IEIDIDICIEIFIFIDIFIEID1F1E1E1 IFIFIFIFIFIFIFIFIFIFIFIFIEIF1
1 1 1 1 1 1 1 1 1 1 1 1 +

I 1 +

R121

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 .63 .55 .45 .32

50 40 30 20 10

EXCELLENT VERY GOOD GOOD FAIR 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:

4112 +1)2+ Zf =b2 22i 33i 1 li i where

b n ni

Zf is a standard score of factor f for subject i

Z ii 2 2i

is a standard score of ratio 1 for subject i

is a standard score of ratio 2 for subject i

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
To obtain the bi weights for this

criterion variable.

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 1

+br +br + 313 212

+ b r =r n ln if +br =r n 2n 2f + b r =r n 3n 3f +b =r n nf (5.1.2)

br +b+br+ 121 323 2 br +br +b + 131 232 3 br +br +br+ 1 n1 2n2 3n3

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:

b

-1 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.
I I I I 1 I I I I I 1

-1R
1

Fl

1

F2

1

F3

1F4
I

F5

1

F6

1

F7

1

F8

1F9

F10

1

Fll

1

-V
I I I I I I I

1R1 1R2 1R5

.04411.12011.04851.44811-.0481.04391-.0671-.1811.09491-.0941-.0591 -.0831.08971-.3771.30961-.0211.11021-.0351.00521.03711.66511-.0131 .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. case a vector of factor f is calculated: f = Fz (5.2.3) For each data

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 7 26 29 1 2 5 1 - .003z - 1.12z .0048z + .0048z + .0653z - .02z 51 57 46 50 33 30 .012z 58 .022z 82 .07z 103 - .009z 105 - .172z 83 - .011z 121 - .016z 59 - .015z 73 + .0953z 84 + .001z 75 + .0142z 87 -.000z 77 + .01145z 80

+.0019z - .003z 98 101

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 f 2 f 3 f 4

= - 1.11449z 57 = .61235z 84 = .568742 83 = .44807z 1 + .512z 5

142

f 5 f 6 f 7 f 8 f 9 f 10

= .54025z 73 = .49844z 50 = .38124z 46 = .51104z 26 = -.17859z 7 = .66508z 2 .03017z 75 - .31409z 11 29

+ .49215z 87

+ .54781z 80

+ .19001z 103

+ .18855z 59 + .67259z 58 + .10307z 33 + .30982z 101

+ .36611z 82 + .10113z 30 - .124z 51

+ .15803z 105 + .22604z 121

+ .17812z 98
+

- .0144z 77

f

By adding all the above equations together we will have: f 1 +f+f+f+f+f+f+f+f+f +f= 4 5 6 8 11 7 9 10 3 2 + .66508z 1 .10113z 30 .672602 58 .36611z 82 .19z 103 + .15803z + .56874z 83 +.10307z 33 + .18855z 59 2 + .512z 5 - .17859z 7 + .51104z 26 + .31409z 29 +

.44807z

+.38124z + .49844z - .12400z - 1.1145z + 57 46 50 51
+ + .5403z + .0302z - .0144z + .5478z 80 73 75 77 + + .6124z + .49215z + .17812z - .3098z 101 98 87 84

+ .56874z 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) 26 7 5 /1.7032 + .31409(R - .1534)15.8897 + .38124(R - .4517)/.1749 + 47 29 .49844(R - .3785)1.1413 + .67259(R - .7736)/.7898 + .18855(R 59 58 50 .7355).6126+.54025(R -.0631)/.0978+.54781(R - 1.7276)/.7931 + 80 73 .3661(R - .4456)/.2759+.56874(R - 1.5767)/6.2481+ .61235(R 83 82 84 .319)/.1273+.19(R -.468)/1.1866+.30982(R -3.412)/28.862- 1.1145 101 103 (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) 98 105 75 .0755 + .10307(R 33 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 50 46 51 57 58 59 5.524R +.4R 73 75 -.0006R +.691R +1.327R +.091R +4.81R + 77 80 82 83 84 - 1.4741)/7.2896 - .124(R 51 - 1.0119)/.0239

+.072R +10.23R -1.989 4.394R +.0394R +.011R +.16R 98 101 103 87 105 121 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

CLASSIFICATION

1 1

FAILED
I I

I
1
+

NO OF 1 COMPANIES
1

GOING

1
1
+

RECEIVERSHIP
I

1 OTHERS
I

I

1 1
I

1

FAILED GOING

I

18
35

1 1

13 o

2 0

31 35 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 2) working capital 3) liquidity 30% 37% 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 (Yvalue) 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 0.175 0.150 E4.5 4.0 3.5 3.0 1974 1976' 197EI 198d YEAR 1982r 1984' 0.100 /' 0.075 0.050 19741976 1978 1980 YEAR 1982 1984

6.0 5.5

0.401
1

2.0

N.

0.35

0.30

// n\

\\ /
0.1

//.
4

1.5

\\

(_) z: cc

1.0
•-••••

_-

0.5

1974' 0.10 1974 '. 1976 1978' 1980' 1982' YEAR 1984'

19b

1978' 1980 YEAR

1982t.

1984'

GENERAL ELECTRIC CO
Figure 5.3.1 Testing the Effectiveness of the Model

Y VALUE --NI/SFILES -NI/SF -NI/TA-SF --CASH/SF -CASH/TA-CL CA/CL -{i1C/SF CL/TA

151

0.40
6-

0.35 0.30*L-• 0.25 j
1/4 1/4 1/4

tz

ilf\f

\

2 0.10 0.051974 1976 1978 1980 YEAR 1982: 1984' 1974' 1976 1978 1980 YEAR

\-)

\/\

1982 1984

0.2

0.20 2.0 // F-T 'E 1.5

I

'-' 1 . 0 /

0.5 0.05 1974 1974 1976 1978 1380 YEAR 1982 1984
---NI/SF -NI/TA-SF CRSH/SF Y VALUE

1.976

1.978 1980 YEAR

1.982

1984

COALITE GROUP
Figure 5.3.2 Testing the Effectiveness of the Model

CRSH/TA-CL ------CF1/CL
WC/SF

CL/TA

152

4.5 w

V,-

0.06

0.04 1.0 , 1972.

1974

1976 '

1978' YEAR

1980

1982. 1984

1972

197.4 . 1976

1978 YEAR

1980

1982

1984

0.1 0.14 0.12 0.10
01-11 0..

3.5 3. 2.T

0.

cc

1.5 1.0 0.5

r0.08 tr) cc 0.06 0.04

972. 1972. 197.4 1976 1978 YEAR 1980 1982 198.4

1.974

1976 1978 __YEAR

1980

1982

1984

ALLIED TEXTILE CO PLC
Figure

5.3.3 Testing the Effectiveness of the Model

VALUE -NI/SALES -NI/SF -NI/TA-SF -------CASH/SF -CASH/TA -CL ----CA/CL -WC/SF CL/TA

Y

153

7. Q 6.5 6.0 0.40

0.35"
./ •

0.30 0.25a. 0.200.15

1.0 13-- 4.5
4

7-\\

,--\

.0-

0. 3.0
0.

10-

051974' 1976 1978' 1980' 1982' 1984' YEAR

1974

1976' 1978 1980 YEAR

1982

1984

0.5 ./
2.5" 0.4-

\
/I
/ / ILi
1.5

\

E
tr10.30.2

I

/

I I \\ Jj
11 1974 1976

//"/

°
1.0 0.5
S. S.

0.1-

1976' 1980. 1982 YEAR

1984'

1574

1976

1978. 1980 YEAR

1.982

1984

BRITISH HOME STORES PLC

Figure 5.3.4 Testing the Effectiveness of the Model

VALUE NI/SALES -NI/SF -NI/TA-SF — —CASH/SF -CASH/TA-CL — — CA/CL -WC/SF - - - - - -

154

0.30

fN, i, \

6

,f
\‘‘
%

0.25 5

I

I \-/' "i ,
I

, ,i) , 0.z,, , , c. ,- , , 0.15 /......_..,
o / \
0.10 \ .

i n\
A !

1

\\L/

/

----/\ \

2 0.05 ii 1972 1974 1976 197d YEAR \

, ,,,.. s„,„,‘ / 1978 YEAR 1980

, , • _. _ ,. . „. _, , , ,
198 1984

mid 19E4 1984' 1972: 1974' 1976

0.18 0.16 0.14 g0.12

4.54.0 3.5 3.0
cm „

(I) 0.08
L_1

0.06 0.04 0.02 1972 1974 1976 1978 YEAR 1980 1982 1984 1.0 • 1972 1974- 1976 197d YEAR 198d Figure 5.3 . 5 Testing the Effectiveness of the Model 1982: 1984'

BELL (ARTHUR) & SONS PLC

Y VALUE -NI/SALES -N1/SF -N1/TR-SF -CASH/TA-ft CA/CL -112/SF

155

0.14'

0.12-

In

r
AJ/

‘‘:
/ ,--, 1 \,
I

v\
...
s- n t \

\

.

n ...

i 0_04'

".

n
\

\,1

1972 1974 1976

1978 YEAR

1980 1982 1984

1972.- 1974 1976 1978 YEAR

1980

19821 1984

0.200" 0.175' m0.150" '417) o_ nt
&10 .125-

E 0.100
0.075 0.050 0 025 972 1974 1976 1976 YEAR 19ed 1982
196.4'

9
0.5

972

1.974-

1976

1978 YEAR

1980

19821 1984
V_

WELLCOME FUNDAT I ON
Figure 5.3.6 Testing the Effectiveness of the Model

Y VALUE -NI/SALES -NI/SF -NI/TA-SF -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 1972 1974 1976' 1978' 198d 1982 1984 YEAR 0.05 97 1974 1976k 1978' 1980 YEAR 1982 1984

0.00f1 0.007

/ tr\
/ / /-‘
\J /

\,/

0.006 20.005
co

20.004'
in cc

'O.003 0.002-

1972 1974 1976 1978 1980 1982 1984 YEAR

1974 1976' 1978' 198d YEAR

1982 1984

BENFORD CONCRETE MACHINERY PLC
Figure

5.3.7 Testing the Effectiveness of the Model

Y VALUE -NI/SALES -NI/SF -NI /TR-SF --------CASH/SF -CASH/TA-CL --- - -CA/CL -IC/SF

157

5.5'"

0.250F 0.225 ' / )(\\ 20.200F.----„, j:\

5.0

-..7 '-] 14. 0 i 1:

E 0.1503.0 0.125'

/
0.075-

5.

1974

1976

1976 1980 YEAR

1982: 1984

1974

197d

1978' 198d YEAR

1982

1984

2.50/-- -'--

0.2500.2250.20T

N

/

/ / \

-N

/

/

/

.

\
\_-

/

\

0.175(20.150 D A 25
0.1.00

0.075 O. 75-1 0.050 1974 1976' 1978' 198d YEAR
1382'

1984'

0.50 7-`----"Y 197d 1974

1978' 198d YEAR

1982' 1984

BEECHAM GROUP PLC
Figure 5.3.8 Testing the Effectiveness of the Model

- - -

VALUE -N I /SFILES -NI/SF -NI/TA-SF ----CASH/g -CASH/TA-CL -----CA/CL -1./JC/SF

158

0.356.0 0.36 5.5 5_0
t.L1

\

0.25

g4.5

:k 30.20

60_4.0 a-0.15 3.5 3_0 2.5 1974 1976 1978 1980 1982 1984 YEAR 0.10
_

0.05 1974

1976' 1978' 1986 YEAR

1982

1984'

(LT

1.0 0.8
er. -j
• _

- 0.6
Li
CD

LE)

FL; 0.4
ct

0.2

0.2

0.1 0-,2 1974.- 1976' 1978' 1980' 1982' YEAR 1984'

197A

197G -1 43 1-9811----1-9E-1•984,' YEAR

MARKS & SPENCER
Figure
5.3.9

Y

Testing the Effectiveness of

the

Model

VALUE NI/SALES -NI/SF -NUTA-SF CASH/SF -CASWITFCL -111C/SF -CUM

159

0.18'

0. 18'
0.14 n DO12 -.-\ t .

lr
i , " n \I\

0Z

/\

/ /
t

\ 7 \/ j/I

E
2.0

-1'1On0..10
008 . 0.06'

\\ \
\ ' %1

i

‘V/ k

//-

t

/

1.5 0.04972. 1974. 1976' 1978' 1980' 1982' 1984 YEAR

/

\ . --

\

/

/

1972 1974' 1976

1978' 198d 1982 19E4 YEAR

2.000.200 f'

\ i t.-,.

1.
N

.-

0.175

1 A1, 50 - ......
1 1 ii 1 --1 1.25' cc \ 'cc 1.00 / 7.17 -,\ ,,./1 t.. % ,......

t

.....- ,.

6 0.150

I

0. 100 0.075

/ .I / .,: %...-- . 1 ..- J /

IL) 1 cc

0.75' 0.50'
0.25"

'9

0.050 0.025 19 12.-
0-.25-

972

1974' 1976

1978' 1980k 1982 YEAR

1984'

1974

1976

197B YEAR

1980

1982.

1 .984

PEARSONS
Figure 5.3.10 Testing the Effectiveness of the Model

Y

VALUE - NI/SALES -NI/SF -NI/TA-SF CASH/SF


-CF1SH/TR-CL
CA/CL -111C/SF

--CUTR

160

7

0.4

0.35 0.30 :EE 0.25 cl
Lj

_ 1974:

197e

1978' 198d Y.EAR

1982:

1984: 1.974

1976

1978 1.980 YEAR

1982

1984

/

0. 25-

0. 20:-

11\
I-...' 0Ct

2 .0-

\

V
1.0

cn
CC

LJ

0.10 0.5 0.051974 19 -4 1979. 1979 i980: 1982': 1984' YEAR
0-. 5

_
1979 1978:

1980: 1982:

1984

RACAL ELECTRONICS
Figure

5.3.11 Testing

the Effectiveness of the Model

1 VALUE -NI/SALES — -NI /SF -NI/IA-SF —CASH/SF - 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 c -0.15

2.0 0.10 1.5 0.05 1974 19767, 197d- 1980' YEAR 198 1984' 1974
• • • _

/

1976' 1978' 1980' 1982' YEAR r

1984'

0.200-

1.8 0.1750.150.90.125 If
Ro.100\\ /

/
\_,--

n "

'0.075 0.8 0.050 0.02.5 1974 1976' 1978' 1980' 1982' 1984' YEAR 1974 1976 1978 1980 YEAR 1982 1984

BPB INDUSTRIES PLC
Figure 5.3.12 Testing the Effectiveness of the Model

Y VALUE -NI/SALES ------NI/SF -NI/TA-SF -------CASH/SF -CASH/TA-CL CA/CL -WC/SF

162

5.0 4,5 tA.1 4.0 I3.5'
'at' 3.0

\

\

0.1 1_5 1974 1976' 1978 1980 YEAR 1982 1984

\

0"

---_-- -'

/ ,---

/

/

, ---

\

,

.

\

.

\

\

/

/,

/

1974. 1976' 1978 1980 YEAR

1982:

1984'

,\
/ /
a.0 /
_,L.5' ," ----. .....
ES ,9

/ ,--... / /

\ 1 /

/

\ \

\

/

FIm

L:

z

1.0

--\
115-

'
1974 1976 1978 1980' 1982' 1984 YEAR

'..\

1974 1976

1978 1980 YEAR

1982 1984

0-.5

ALLIED COLLOIDS PLC
Figure 5.3.13 Testing the Effectiveness of the Model

Y VALUE -NI/SALES 411/SF -NI/TA-SF -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 YEAR

1982

1984

19721 1974'

1976'

1978' YEAR

1988' 19821 1984'

0.05'

2_75
I\
2.50-

f\
1
1

I 1
I 1 \ V 1

\
\

0.04L
2.25-

E. /
i)\ cm z. / 1.50 1.25 1.00 0.75' 9721 1974 1976 . 1978: YEAR
c i=i m

a.4. 2_00-

, •175' / \

I
/ \_„..•
..
/ \ .. ._

0..01

t

0.509721

1974' 1976

1978' 1980' 198211984' YEAR Y VALUE -NI/SALES --NI/SF -NI/TA-SF ---CASH/SF -CASH/TR-n_ CA/CL -WC/SF

ASH

& LACY PLC

Figure 5.3.14 Testing the Effectiveness of the Model

164

0.35
t

6.0

I

0.30
5.5 5.0 4-5 0.20 6`
SE

(
=0.25 (\

0.15

0.10

/

0.05 1974 1976 1978 1980 YEAR 1982 1984 1974 1976 1978 1980 YEAR 1982 1984

/ '.- ---..N.

,,
1.6-

/

\ \

\

/ \ /

/----

0.60.4 1974 1976 1980 1978 YEAR 1982 1984 1971 1976

N. 1978' 1980' 1982' 1984' YEAR Y VALVE -NI/SALES - --111/SF -N I /TFE-SF ---CASH/SF -CRSH/TR-CL CA/CL -111C/SF

BOOTS CO PLC (THE)
Figure 5.3.15 Testing the Effectiveness of the Model

165

0.6

0.4

/ - -KW"
74 197 „ 978

/-\ .--\\

• '1980

0 -.4

76

1978

1980 YEAR

1982

1984 0-.6

0.05-

5 0.04-

i-

_ 6 _. La,... cL.
0.02 /

5)
\J 0.01

l \ / I z 1 , , , , , ,

ii, (/ \\
\ f_ _,

, ... ....
1974 1976

,

1978

198d YEAR

1982' 1984

1974

1976' 197d

1980' 1982 YEAR

1984

BRITISH GAS CORPORATION
Figure 5.3.16 Testing the Effectiveness of the Model

Y VALUE - ------ -NI/SALES NI/SF -NI/TA-SF CASH/SF -CASH/TA-CL -WC/SF

166

0.50

8-

0.450.40


0.35

0.30 1E0.25 -0.20
0.15

0.10
0.05 1972 1974 1976 1978 YEAR 1980 1982 1984 1972 1974

-

//-\
1980 1982! 1984

1976

1.878 YEAR

0.4 0.40

2.5

/-•

-

0.30 E0.25
0.m
0.15 0.10 972! 0.05 1972 1974 1976 1978 YEAR 1980 1982 1.984
- - - URLUE
___

1974

1976! 19?8 YEAR

1980

1982

1984

ANGLIR TELEVISION GROUP PLC
Figure
5.3.17

Testing the Effectiveness of the Model

-NI/SRLES -NI/SF -NI/TA--SF IRSH/SF -CRSH/TR-CL CA/CL -MC/SF CL/TA

167

0.1 97 YEAR 1978

1981

198

0 , .....„ , •

r 0- . 1

-

'

1

\ s- - - I ‘\\,

11 7

! ,.
0-.3 0-.4

\,._i L__/

\I
\J

I

0-.5

0.050
I'

2.25-

0.0450.040•

I

/
2.001 1

I , \ I I l\,

0.035c% E0.030cn o 0... _ 0.025
cut'

7
li
/I \\

1 II
i

Li0.020-

0.0,5-
0.010-
0.005" -.1.

!I_

_I

L\
_ 198d

0.75-

\\ '.-.-

972

1974

1976

1978 YEAR

, r. - 0.501982' 1.972

1974

1976 1978 198d YEAR

'

'

1982'

GOODYEAR TYRE & RUBBER CO.
Figure 5.3.18 Testing the Effectiveness of the Model

Y VALUE ----- .- NI/SALES -N1/SF -NI/TA-SF -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 YEAR 198( 1982' 1984 197 1974 1976' 1978' 198d YEAR 19E2 1984

0.160.14

1.4

N \

\
/ ' \. /

_

__ N

z

1.2

= co

60.M 0.0 6
0.04

/ z
972' 1974 1976

/

-1978' 198d YEAR

7
0.4

198

1984

1972' 1974

1976' 1978 YEAR

1980' 1982'

1984

BABCOCK INTERNATIONAL PLC
Figure

5.3.19 Testing

the Effectiveness of the Model

VALUE -NI/SALES -NI/SF -NI/TB-SF -------CRSH/SF -CASH/TA-CL CA/CL -WC/SF

169

1972 1974 1976

1.918 YEAR

1980

1982 1984

972 1974 1976 1978 YEAR

1980 1982 1984

0.12-

2.0-` /

NJ

0.04-

972

1974

19/6

1978 YEAR

1980

1982

1984

1972

1974

1976

1978 YEAR

1980

1982:

1984' Y VALUE -NI/SALES -NI/TA--SF

APV HOLDINGS PLC
Figure 5.3.20 Testing the Effectiveness of the Model

-CRSH/TR-CL ClitCL -WC/SF CL/TA

17 0

2.5

0.2000.175 >_ 0.150

2.0

iTa.1250.1000.0750.50.050 0.0251972 1974 197d 1978 YEAR 198 • 1982. 198.4 972. 197.4 1976 19714 YEAR 1980 1982. 198.4

0.07

0.061.6-

0.05z-:
in 0.04 Li

A / --

/ \._ _ /

/
I I

!

\

\

3 0.03
0.020.8 0.60.010.41972 1974 1976 197d YEAR 1980 1982. 1984' 1972 1974' 1976 1978' 198d YEAR 1982' 198.4

, ----", / \
X %

I

AULT & WIBORG GROUP PLC
Figure 5.3.21 Testing the Effectiveness of the Model

Y VALUE -NI/SALES -N1/SF -NI/TA-SF — —CASH/SF -CASH/TA-CL — — — — CA/CL -WC/SF

171

0.2000.1750.150LU

:1

0.125(7.1 LJ-

PE
-

fa-

N.100
0.075 0.050'1972 1974 1976' 197 g. 1980' 1982' 1984' YEAR 0.025 172 1974 1976' 1978' 1981 YEAR ,,„ 1982. 1984

0.25-

3.0 2.. 5

0.20-

/
•• n•

0.5 0.051974 1972. 1974- 1976' 1978 YEAR 1980' 1982' 19841 1973 1976 —YE 1980 1982.

1984

AL.BR.IGHT & WILSON LTD
Figure 5.3.22 Testing the Effectiveness of the Model

VALUE - - - - - - -+11/SALES — -NI/SF -NI/TA-SF — —CASH/SF -CASH/TA--CL CR/CL — — -WC/SF CL/ TA

172

0.200 0.175 0 150 '6E1 '0.125 FE

V \

\\
‘--K) \j

'60.100

0.0750.050 0.025972 1974 1976 1978 YEAR 1980 1982 1984 972 1974 1976 1978 YEAR 1980
/

\\.

1982 1984

0.250
I

1.8 1.6
I

0.2250.2002,0.175 E2
!=.0.150-

I
I I/11 II \II

1.4

1

_t
FE1.2 co 1.\
ir

0,_

C)
co

ml1125 (r,

m

It

Ii \\ tI
III

c..)

_

0.100 0.075-

t
0.6Ii

, I/
---•,..._.../...,"

,

) / j

\ 11

t

9

0 .4- -•

0.2- \,/ 97 1974 1976' 1978' 198d YEAR 1982' 1984

0.025 972 1974 1976' 197d 198d 1982 YEAR 1984

BARROW HEPBURN GROUP PLC
Figure

5.3.23 Testing the Effectiveness of the Model

Y VALUE -NI/SALES -NI/SF -NI/TA-SF --------CASH/SF -CASH/TA--CL

cripa

-WC/SF

173

F-

0.5 0.45
i

i

,

,
' .-____J.

,/ \
1 I I

0.40 ›.0,35 .IEd F E 0.30 C 20.25 / 0.20

./ i /i

7' f

1 1

\I
-- I / \

/

I
4

/

7--- .---/

.. --

/

\ , .

1972 1974

1976

1978 YEAR

1980

1982 1984

1.972

1974

1976

1978 YEAR

1980

1982

1984

0.9 0.8

1\
/ /
/ / I I I

\ 1 /'' \

0.6 D r(.710.5 en' 0.4
Li

0.3 0.2 0.1 1972:. 1974

fj

972!

1974

1976,...----1478.

1980

1982'

19E14'

\J 0-.501976' 1978' 1980 YEAR 1982 1984 Y 'VALUE -NI/SALES --NI/SF -NI/TA-SF —CASH/SF -CASH/TA-CL

PLEASURAN4 PLC
Figure 5.3.24 Testing the Effectiveness of the Model

-WC/SF —CL!TA

174

0.1

97 97 1974 1976 YEAR 197 1980 198

1974

1976 74-4... 1980

198

/Th\) e-. 1

0 -.4
0-. 5

0.06-

1.4 1.2 \

0.05

6
7). .L 0.04

_ j 1.0
m 1--

N

,.__. /— -\ /— — N N\s) \J

i\
ji

I
\ / s,

eff 0.8 p

m F., 0.6

'60.03

C) -

0.4 0.2 972
0 -.2

0.02-

0. 011972 1974 1976 1978' YEAR

19

1976

197e- --4380 EA

182

1.980' 1982

BRITISH RAILWAYS BOARD
Figure

5.3.25

Testing the Effectiveness of the Model —

Y VALUE -NI/SALES -NI/SF -NI/TA-SF ----CASH/g -CASH/TA-CL — CA/CL 41C/SF

175

1

.6.40.20-

1

1.21 . 0-

0.8 0.6 0.4 0.05 0.2 972' 1974' 1 76' 1.978' YEAR 0-.2 1988 1.982 1.98.4 372 1974 1 . 978 YEAR 1980 1982. 1984'
/

1

0.12 I\ 0.10

1.50 - -
'
•••.-

I`, I I!
()\ I \
i

V\1

%

I.

Lou0351 0.50-

n0.08
L71-

It i t

iIi
i

\ e ....
CM Z

\ (-)

1"0.06
Gul

/r\
()\ )

.E. 0.25 cz, 972' 1974' 1976 0-..25 1978 YEAR 198d 1982'. 1984'

0.04

j 0.02 -_!-/\j /
0-.50-

1972. 1974' 1978

1978' 1980' YEAR

i.se

18841 Y UFLUE -NI/SALES -NI/SF t'11/TA-SF --CASH/SF -CASH/TA--CL - ----CA/CL -WC/SF CL/TA

ANCHOR CHEMICAL GROUP PLC
Figure 5.3.26 Testing the Effectiveness of the Model

176

0.250

3. 0.2253.0 0.2000.175!]0.1502'0.125u_ I
I

/e\
I I I

E0.100-

1.5

0.075 0.0511

1.0 0.0251974 1976 1978 1980 YEAR 1982 1984 1974
./

1976

1978' 1980 YEAR

198

1984

0.07 ,' 0.06
z / 1

I\

2.0

—\ \
\ - /

I' I \
\

I 1 \ 1 1

\ ...... 1

/

\ k

‘.....„-\

o

1

r-o.o5

0.03

0.02

c, / / \ = C-), i /
2
Il i :

I\

i

//1 1/1

0.80.61974 1976' 1978 198d 1982 YEAR 1984

\

74r

1978 1980 YEAR

1982

1984

BAKER PERKINS HOLDINGS PLC
Figure

5.3.27 Testing the Effectiveness of the Model

Y VALUE -NI/SALES ------NI/SF -NI/TA-SF --------CASH/SF -CASH/TR-CL CR/CL -WC/SF

177

3 .02.5 2.0 1.5

0.4

0.3

_

F 0.5 .5 9 2 13 1 6 1978 YEAR 1986' 1982 1984 72 - 1.0 - 1.5 0-.1 1374 1976 1978 YEAR 1980 1982 1984

0.10 / 0.09 0.08 0.07 z Q 0.06 1r r t‘ i \/ /

1

\

\
\ n \i

1.4_r acc _

ii
CL 0.05 = U) (LE, 0.04 0.03 0.02 0.01 1972

;I 1 i 11 \\

C2 60.8 0.6 0.4 0.2 1976 1978 YEAR 1980 1982 1984

\\ ‘ 1974

z
972 1974 1976 1978 YEAR 1980 1982 1984 VALUE -NI/SALES --NI/SF -NI/TA-SF ---CASH/SF -CASH/TA-CL -----CA/CL -61C/SF

FORD MOTOR CO. LTD.
Figure 5.3.28 Testing the Effectiveness of the Model

178

3.5

0.20 0.18

3.0

0.160.14

r1-0.08 0.06 1.5 0.04 1 01 1972. 0.02197.4.- 1976 1978 YEAR 1980 1982 1984 1974 1976

1978' 1980' 1982" 1_984' YEAR

1972

0.02.00 1.75" 0.0175
/ i

\
\ /

1.50 1.25-

0.0157
Z

.90.0125
I— U7

'\i
....,/

cc

1.000.750.50-

20.0100(-1 ' 0.0075-

\ liV i" \ \ ' \

:\ ii /111 U \\

cL

CC

0.0050
0.00251974 1976 1978' YEAR

iV 1
I 11 I il

(--- \,

0.5 972 1974 1376 1978 YEAR 1980 1982 1984

1980' 1982' 1984'

\

0-.25 0-.50

ADAM & GIBBON PLC
Figure 5.3.29 Testing the Effectiveness of the Model

Y UALUE - - - - - -N1fSFILES — -NI/SF -NI/TA-SF — —CASH/SF -CASH/TA-CL — CR/CL -WC/SF CL/TA

179

0.30-

0.25-

..--2
/
1

\
%

/

1\

/

0.05- 1 1972 1974- 1976' 1978' 1.986 YEAR 1982 . 1.9E14 972

n .... 1976

/

/ 1982 1984

197+

1978' 1900 YEAR

0.14

2..5

I

\

\

0.12-

24

\
/.•
n /

0.
8"_ m (--'1. m (I-) 50.06-

n

1

I

0.04 /.,...--- ---t-. ,

0 .02

\

,-, y/ ' - /
7
fi 1 \ 0.5 1978 YEAR

0

ix

C) 1.0 ,--..
n n n

1972

1974' 1978

-N, , 1980' 1982 1.984

1972'.

1974

1976

1978 YEAR

1980

1982

1984

ARRITAGE SHANKS GROUP LTD
Figure 5.3.30 Testing the Effectiveness of the Model

Y VALUE - - - - - - -NI/SALES -N1/SF -NI/TA-SF CASH/SF -CASH/TA-CL CA/CL -WC/SF

180

F-

5.04.5

0.30-

0.25 4.0-

,I'
\
0.10-

1 1

k

1

0.05-

1974

1976

1978 1980 YEAR

1982.

1.984

197.4:

1976'

1978' 198d. YEAR

1982

1924'

3.5- ip.. \ /
k / /

/ 1\

i

\
i

1 n / ...

C n

/ ---. .....

0.02T

3.0.-

N
\ i

i •

\

. -..
\ 1

F.0.02C
0_

2.. 5

(T)0.015
CC

1

0.

0 10

1.5-

0.005

1

.0-

-0

.51974" 1976' 1978' 1380' YEAR 1982". 1984'

1974' 1976

1978' 19El8' YEAR

1982

1984'

ATKINS BROTHERS PLC
Figure

5.3.31

Testing the Effectiveness of the MOdel

Y VALUE -NI/SALES — -N1 /SF -NI/TA-SF — —CASH/SF - -CASH/TA-CL CA/CL -WC/SF

181

0.15 1.50
0.1.0

1.25 00 >_ 0..05
17-

1.

972 °- 0.50 0-.05 0.25 0-.10

1974

1976

1978 YEAR

nu -1-'3

972 0-.25

1974

1976

1978 YEAR

1980

1984

0-.15

0.2502.0 0.2250.2001.5 60.175I-'&10.150C)

1
II \

a_

-

Ei0.5 12
Lt

0.100-
i

%

0.075-

I/

0.050N;.--'• "

/ \71;

972

1974

1.976

1978 YEAR

1980' 1982' ,38\4 ,

0.025-'52 1972 1974 1974 1974 1980 YEAR 1982 1984

DUNLOP HOLDINGS PLC
Figure

5.3.32

Testing the Effectiveness of the Model

Y VALUE -NI/SALES -NI/SF -NI/TA-SF -------CASH/SF -CASH/TA-CL CA/CL -WC/SF

182

4.03.5t;:;3.0

0.200 0.175 015T 630.125
0. 100 \ _I/ -.

Ai1\

//r—\ \ I1 1k

i

0.075 1.50.050 0.025 1972 1974 1976 197d 198d 1982 1984 YEAR / ..- n \\

j/

/
\ I

f

_ ...\

/ ‘ \t \ r . 1976 1978 YEAR 1980

\.__--/ /

1972 1974

-1982 1984

0.25

\

'•••n

0.20

_ R0.15 CT,

0.10-

0.05 0.41972 1974 1976' 1978 YEAR 1981i 1982' 1984 197 1974 1976 1978 YEAR 1980 1982 1984

BARNO INDUSTRIES PLC
Figure
5.3.33

Testing the Effectiveness of the Model

Y VALUE -NI/SALES -NI/SF -NI/TA--SF -------CRSH/SF -CASH/TA--CL CA/CL -WC/SF

183

0.14 1.6
1 .4-

0.12 0.10 0.08 cc :7. 0.06 A- 0.04 0.02 \

\J
rN.,/

t±j1.2-

-S.

0. 80 .6-

2/r\\
972 1974 1976 1978 YEAR 19 982 1984

0 .40-.02 1972 0.10 0.09 1.60.08 1.4=0. 07 I t,10.M ;0.05 0.04 0.03 0.02 0.01 1972 1974 1976 1978 YEAR 1 . 980
V-

1974 197d 1978' 198d 1982 YEAR

1984

;\

1.8-

/
/ / -- \ \.1 / /

\
\ \ \ , /

/

\\

1

cc

cc

/f.\\

I
_

t

0.8

0. 6 0 . "Th
1982 1984 1972' 1974 1976 1978' 1980 YEAR 1982 1984

BBA GROUP PLC
Figure

5.3.34 Testing the Effectiveness of the Model

Y VALUE -NI/SALES ------NI/SF 411/TA-SF -------CASH/SF -CASH/TA--CL CA/CL -WC/SF

1 84

0.30-

0.25'

>-0.M

n

0.10 0.05

_

1974 1976

1980 1978 YEAR

1982 1984

1974

1976

1978

1980 YEAR

1982

1984

0.1 0.14 1 0.12 n =0.10
61

1.0 0.8 0.6

/..-

dt 0.08
1

Li

83

0.06 \\ 0.04 0.02 0-.2 0-.4 0-,6 1974 1976 1978 1980 1982 1984 YEAR

1974

1976

1978 1980 '1982 YEAR

13 ?4

ie.-

BRTLEYS OF YORKSHIRE PLC

Figure 5.3.35 Testing the Effectiveness of the Model

Y VALUE -NI/SALES -NI/SF -NJ/TA--SF -----CASH/SF -CASH/TA-CL CA/CL -WC/SF

185

F-

1.75'

0.75'
0.50'

0.25" 972: 1974' 1976: 1978' 1980 YEAR 1982: 1984

1.972

1974 1976

1978 YEAR

1980

1982

1984

0.09 1..6 0.08 0.07

\./""\
/I

g30.05
CL

0.03 0.02"
0.01

rA
1974' 1976: 1978' 1980 YEAR 1982 1984 1980 1974" 1976' 1978 YEAR 1982 1984

197

BEMROSE CORPORATION PLC
Figure 5.3.36 Testing the Effectiveness of the Model

Y VALUE -NI/SALES -NI/SF -NI/TA-SF -------CASH/SF -CASH/TA-CL CA/CL -WC/SF

186

4.0 3.5 3.0 2.5 2.0 1.5 1.0 0.5 972 1974 1976 1978 YEAR 1980 1982 198

0 1 --

0.10 0.05 972 1974 1976 0-.05 0-.10 0-.15 1978 YEAR 1980 1982 s'‘ 194

0.18' 0.16 I 0.14- P0.12' D u ' =.10 0 cn LJ = 0.00- i 1 / 0.06 I A t 1.8 FE 1 .6 ES 2 1-4 01 1.2` - - ----\ \ / \., 1 \ \ / \,. / / /

, / \ \ \ \ \ \

I\
i II \ % /,\ k \ \ ---\
''

1 \'
Ili \; \

N

1/

V \II
------. 1978 YEAR 1980

iI

\\
V\
\. Hi0.8 197i
•-• •

0-047 1972: 1974 1976

i 19E2

1984

1974" 1976

1.978 YEAR

1980' 1982' 1984 Y OLLIE -----NI/SALES •- -NI/SF -NI (TA-SF --CRSH/SF -CASH/TA-CL CR/CL -WC/SF

BESTOBELL PLC
Figure

5.3.37 Testing the Effectiveness of the Model

187

0.30 2.0 0.25 1.5 ,-. 0.20
1=1 ,

o
Lálj_

m m
1 . 0

F-

LL DI

0.15

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 0.07
z
cp

- /
1 I ii\I

2.0

0.06

F.r.

ii

i

/

f/ 7'..\

'6;0.05
(7)
a_ ill

ai 0.04
ct

03 0. 0.02 0.01

I

// / /
//

/

\

7.

\

A

/
0- .5-

1972 1973 1974 1975 1976 1977 1978 1379

1972 1973 1974 1915 1976 1.977 1978 1.979 YEAR

BROCKS GROUP OF CO LTD
Figure

-

`t VALUE

5.3.38 Testing the Effectiveness of the Model

USRLES 441/SF -NI/TA-SF — —CRSH/SF -CASH/TA-CL — — — — CA/CL -WC/SF CUTR
-N

188

3.5

0.15-

0.05'

1.97

-1974:

1976 YEAR

-1978

1972

1974-

1976 YEAR

1978

N

o— AT

0.180.16' \ ‘‘.
c\ I \

r • /

——

30.

II \---i

\\
1972 1974 1976 YEAR 1978 1980

it/

0.02 19721 .197‘. 1976 YEAR 1978 1980 (3-.5

Y VALUE

STONE PLRTT INDUSTRIES PLC
Figure

5.3.39 Testing the Effectiveness of the Model

-NI/SALES -NI/SF -NI/TA--SF — —CASH/SF -CASH/TA-CL — — CA/CL -WC/SF CL/TA

189

3.5 3.0 2.5

0.3

0.2

cu 2.0
E 1.5 1972 0.5 1972 0-.5 0-.2 1974 1976 YEAR 1978 1980
0-.1

1974

1976 YEAR

1978

1980

0.062.00.051.8_r 1 . 6

/ i
/

-

E, O. 04 1— cn \ /\

CC

:*:)

1.4 1.2

C)

10.03-/
Ln ct (_) i

r‘`,\ 1
r ' ‘-j f

g
'-' cc

0.02/

0.8 0.01- 197i 1974 1976' YEAR 1976' 1980' 0.6 0.4 , 1972

1974

1.976' YEAR

1978'

1986' Y VALUE NJ/SALES

BRITISH AIRWAYS
Figure 5.3.40 Testing the Effectiveness of the Model

- - - - -

-NI/TA-SF —. —CASH/SF -CASH/TA-CL CA/CL --11JC/SF

19 0

3.
3.0 2. b

0.25r

0.20

1.0 0.5 1972 0-. 5 -1.0 0- . 051974 1976 YEAR 978 1980 1972' 1974 - 1976' YEAR 0..05 nn

n

n

194

0.061

r-N\
/ \ %

\

,.....„ ...... n ....n •n• ....n.

/
Li

\

(ct) 0..03 T
0.02

\% 1

e\ .--..

If

\

IS LJ
2

LO
n n ..............

ii

r\
11‘. // „,.// 0.01 197 1974

9 O. 5'
197 1974 1976 YEAR 1971i 1980

IC

0-.. 5 1976 YEAR 1978'
1980

VINERS
Figure

Y VALUE -NI/SALES - -NI/SF -NI/TA-SF -CASH/TA-CL CA/CL -11.1C/SF --CUM

5.3.41 Testing

the Effectiveness of the Model

191

F-

0.20 uu
LJ

z

r=
--I
mcc

0.15

E'
E oL

tr 0.10
22

1972

1974

19 YEAR

1978

1980°0.05 - - -1972
0

1974

1976 Y EAR

874-- , /

1980

-.05

0.20 0.18

1.6
1.4

/ / / / I I
_

0.16
1.2-

0.14 ;720.12 \I '6; R 0.10 u/
lt

50.08 0.0G 0.04 k 0.02 197 1972 1974 1976 YEAR 1978 1980 1976 YEAR 1978' 1980' 0.4 0.2

BLACKNAN & CONRAD

-Y

Figure 5.3.42 Testing the Effectiveness of the Model

VALUE -NI/SALES -NI/SF -NI/TA-SF --------CASH/SF -CASH/TA-CL CA/CL -WC/SF

192

0.1
0.10

0.05 0,5 197.
g

YEAR 1973 1974 1975 1976 1977 197 10
•••.

itnrs
--J

/1 ;30-.05 ii
F--

m

, Et- 0-.5 -L.0 -1.5

L o—. Lo I

R
CL 0

-'. 15 I

0-.20 I 0-.25 0-.30

1.75

0.10
o_oe''

0 1\
i \ I ' \ 1

N,

1.50 1.25 e 1.00 0.75
-...•••••

. ;::: , '..jo..136
0_

t u, ct

11( \\ II
0.

/ 0.25 -. ,.../

,

--,

'. 04

11

1\ '11 il

\
1976

0.02"

II

1972 1973 194 1975' 1976 1977 YEAR 0-.25 0-.50

19.1i

1972 197 ' 1974 1975 1976 197f 134 1.34 YEAR

/‘,...._./ 3

AP1ALGAMATED INDUSTRIALS
Figure 5.3.43 Testing the Effectiveness of the Model

Y VALUE -NI/SALES -NI/SF -NI/TR-SF
--------CRSH/SF -CASH/TA-CL — — — — —CR/CL -WC/SF

-------CL/TA

193

2.0

0.20 0.15

1.5
0.10
1

.0

e: n

0.05

I0.5

LT:
1973 1974 1975 1976 1977 19 YEAR 0-.5 1979 1 80 0-.05 0-.10 0-.15

1973 1974 1

1976 1977 YEAR

'980

0.0200 0.0175' 0.0150I‘ 20.0125 cZTri 20.0100\ //(\

1.

u-)

cc (-10.00750.0050' 0.0025-

\

g

kt:

1973 1974 19/5 19/6 19/7 19/8 1979 1980 YEAR
0-.5-

1973 1974 1975 1976 1977 1978 1979 1980 YEAR

BLACKWOOD, PlORTON 8, SONS
Figure 5.3.44 Testing the Effectiveness of the Model

Y

VALUE

- - —

NI/SALES ----- -NI/SF -NI/TA-SF CASH/SF - CASH/TA-CL — CR /CL - 111C/SF CL/TA

19 4

0.25

0_

1972 1973 1974 1975 1976 1977 1i 1919 YEAR 0-.05
0-.10

1972 1973 19i+ 1915 196 12TT 19 J979
IERR .\\: ‘

0.040 0.035 0.030 0.025 A

6 8_ a
to L, '

i \
ili
-_ii i :

±0.020
0.015

\
\

i

0.010

\
0-.5

972 19(3 1974 1975 19/6 1977 1918 1919
YEAR

0.0(6 1972. 1974 1974 1975 1974 197i 1978 ' 1974 YEAR

BURRELL 8, CO.
Figure 3.3.46 Testing the Effectiveness of the Model

Y VALU -NI/SALES ------NIISF
- Nian-sF ----- --CASH/SF - CASH/TA-a - WC/SF

195

\

\

0.05 197

_ _ _ 19- ". 74

YEAR -1-976

19-7

198

a

0 - . 05

1972

1974

1976 YEAR

1978

990 0-.15 0-.20 0-.25

0.14 0.12

0.' 10'

r= .. t° E0.08
\2i0.6

±:

0.04' 1972T 0.02 -1976' YEAR 1978 1.980 1972 1974 1976 YEAR 1978 1980

PICKLES (WILLIAM & CO.
Figure

5.3.45 Testing the Effectiveness of the Model

Y VALUE ----- - NI/SALES -NI/SF -NI/TA-SF --------CASN/SF -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 0.01750.015(1 20.0125ul 20.0100
7= U/

1. (51.50-

\

i\
I' It 7 % !---,

1.25-

( ,-. \ "4 i .00' \
ES

0. 750. 50 -....--"---- -
0. 25 ' 197,1 0 -.25- 197d YEAR 1978

'0.00750.00500.0025- 1976 YEAR 1978..

I. I

,

11I '\\ \I '

-\ _ _ __,,/

,,.
\ 1980 .

.------..

)1(
1980.

0-. 50-

-----.... -..._.---

CAWDAW INDUSTRIAL HLDGS
Figure

5.3.47 Testing

the Effectiveness of the Model

Y VALUE ------- -NI/SALES -NI/SF -NI/TA-SF CASH/SF -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 YEAR

50-.1
0.2

0.14 0.12 1. 0.10 -.0.08 (- 0.06 c2 n 0.04 0.02 0-. 5( 1973' 1974 1975' 1976. 1977 1978' 1974 1980) YEAR
11111.1 1 1973 1.974 1975 1976 1977 1978 1979 1980 YEAR

RIRFIX INDUSTRIES
Figure 5.3.48 Testing the Effectiveness of the Model

- -

Y VALUE - - - -N I /SALES -NI/SF -NI/TA-SF — —CASH/SF -CASH/TA-CL — — — CR/CL -WC/SF CL/TA

198

0.030

L.501.25

0.025'
1 .00'

E0.020' i=7 cz) =0.015 = Ln

ii

ii ii

0.75' 0.50"

Ir\\ 0.010'
I.

I

/
1972' 1974 1979 YEAR 1379 1986

1972

1974

JO

1979

0.005-

OXLEY PRINTING GROUP
Figure

5.3.49

Testing the Effectiveness of the Model

V VALUE -NI/SALES -NI/SF -NI/TA-SF -------CASH/SF -CASH/TA-CL — CA/CL -IC/SF CL/TA

199

4

1974

L976 YEAR

1978

1.980

0.2250.2003 6'

\ / \

-

/
/

.-- \ /

\
\

/
/

/

/

\ \

\

0.175 o r= 0.150 174 ID -0.125
ct .
'0.100F--

—s cc 2.5`I

1
\
.... ___)

.

i

I

\

\

\

\

cct L5

O. 075'' 0.5 0.0500.025• 1974' 1976 YEAR 1978 1980'

_

19JEL.- • YEAR

1980'

LESNEY PRODUCTS & CO.
Figure

4

5.3.50 Testing the Effectiveness of the Model

VALUE - - -N I /S ALES -NI/SF • -NI/TA-SF — —CASH/SF -CASH/TA-CL CA/CL -WC/SF CL/TA

200

O. 197

_ 1974 1976 197 98

0-.

0-.4-

0.030 -

r----------

2.0

\ --_--/
\ /

/
0.025- z o a..
L , 0_015' T Ct
I-3

1.5 \
\ \ ..j LO

\ \ \

I
I

.

cE

p0.020-

.L-. --
S 0.5 .--!

\
\

t

I
1- n

_-----1972 74 19---- ---- YE94 16

\

C\

/ ‘ \--/..-. \ \
i

5) 0-.5

1 978 _ 1 BO _ _No

0.010 • 0.005"/

\ xi -1.0

1974

• 1976' 1978' YEAR

1980 7- - - URLIJE - -N1/511115 NI/SF -NI/TR-SF — —CASH/SF -CASH/TA-CL —CA/CL -1.dC/SF CL/TA

RICHARDS & WF1LLINGTON INDUSTRIE
Figure

5.3.51 Testing

the Effectiveness of the Model

201

YEAR

1972

1974

1976 YEAR

1978

1980

.—\

0.300.25

/ \
/// /.\

/— \ 2.5 \ / \,/ N-

\
\

2.0
—l ca F--'; .. a

i
,T)0.15
Li

/7

\ \ %

1.5 1_0

c_)

/

\\ 0.10I \k 0.05 - 137E1

%

i /
1972: 0-.5
198O

1974!

• 1976 YEAR

1978.

188d

1972

1974

1976 YEAR

NORVIC SECURITIES
Figure

Y VALUE -NI/SF NI/TA-SF CASH/SF CASH/TR-EL CR/CL -WC/SF
CL/TA

5.3.52 Testing the Effectiveness of the Model

202

0.1

/-\ — — 19-7 —i'80

j.-1 i LL, -2 `12_3

0 - .1 r. 10-.2 CIS cc t 0-.3 1. m

0-.. 5 0-.6 0-.7

0.12'

2.0

0.10' z.

p0.08J: 0.06
0.

uo Li

04

/— —
, •

1374! 1976

0.02'

YEAR

1978'

19e0'

• 1974i-

1976'

YEAR

is7d

/980'

0-.5-

AUSTIN(F.)(LEYTON)
Figure 5.3.53 Testing the Effectiveness of the Model

Y VALUE -NI/SALES -NI/SF -NI/TA--SF --CRSH/SF -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 5.3.2 Istatic I up 5.3.3
I

Ist atic I up I up I up up up

up up I up up up I up I

very good very good good bad excellent very good bad very good excellent excellent very good I bad very good very good very good I very bad excellent very bad excellent good good excellent very good I excellent

up

down up I up

5•3•4 'static 5.3.5
I

down 'static I up I up I up I
up I I

up

up up

5.3.6 'static I up 5.3.7
I

down

up

'static 'static I
I up I I I I up I I I I

5.3.8 'static I up 5.3.9
I

j

down

down I down I up I up

down up down

down up down up

5.3.10 I up 5.3.11
I

down

down 'static

5.3.12 I up 5.3.13 'static 5.3.14 5.3.15 5.3.16 5.3.17 5.3.18
I I

down 'static 'static

down 'static 'static 'static I
I

up down up down down

'static

up

I I I I

up down down down

I 1 I I I

up down up

I

down 'static I down down down I up
I I 1 I

down down up

down I up I I

'static
I up

5.3.19 I up 5.3.20 down

I up

1 up

up up

'static 'static 'static I
I I

5.3.21 I down 5.3.22

up down up

I I

up down up

I up I

I

down I down up
I up

down I up

5.3.23 'static 5.3.24
I up

1

1

1

I up

I up

I up

205

5.3.25 5.3.26 5.3.27 5.3.28 5.3.29 5.3.30 5.3.31 5.3.32 5.3.33 5.3.34 5.3.35 5.3.36 5.3.37 5.3.38 5.3.39 5.3.40 5.3.41 5.3.42 5.3.43 5.3.44 5.3.45 5.3.46 5.3.47 5.3.48 5.3.49 5.3.50 5.3.51 5.3.52 5.3.53 +

I

up

up up down up down down down up down down down down down do down down

I

up

I

up

I

up

excellen very good excellent excellent excellent excellent excellent good excellent very good very good very good excellent excellent very good bad excellent excellent excellent exc very good excellent excellent very good excellent very good excellent excellent excellent excellent

'static down up down down down down down down I down 1 'static down down down down down down down down down down down down down down down down down
I

'static 'static 'static down up down down down down down 'static I down
up

down
up

down down down down down down
I

down down down down down down down

'static I down 1

'static 'static 'static
I

do down down

down down down Istatic down down down down down down down down down down down down down

down do down down down down down down down down down down down down down down down down

I

'static up down down down Istatic down down down down do down do down down down down

'static I down down down down down down

'static
I

down

'static
I

down

I down 1 I down 1
I

down

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 =
33% 33%

Y-value

then 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
+ 11% + 11%

then 33%

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 very good good bad very bad

26 17 4 4 2

99% 88% 77% 66% 55%

25.75 14.96 3.08 2.64 1.10

1 1 1 1

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 In

statements or information for the purpose of comparison.

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+ 0 11 22

+a R 10 10

and compute the Y-value for each company and each year separately then we have for company A:

213.

• 1971 • 1972 • 1973

=b 1 =b 2 = b 3

• 1985

=b 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 + 1 3 2 +b )/n

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 fair performing companies poor performing companies 20 15 18

To identify cut-off lines to distinguish areas which specify

the above three categories, we can compute Z:b /m j=1 nj group separately where m is the number of companies

for each

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

15 /15=28.4912/15=1.899 fair performing4 j=1 nj

--b
18

poor performing

=t=b

/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 group=(3.3443+1.899)/2=2.6 b) cut-off line between second and third group=(1.899-2.143)/2=-.244 second

So by the above calculations we can specify the cut-off lines as follows: If Y>2.6 If 2.6>Y>-.244 If Y<-.244 well performing companies fair performing companies 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 FAIR POOR

16 21 16

0

16 21 1

1 1

15

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 correctly. companies

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 assetscurrent liabilities)/total assets (four studies) 5) Net profit to net worth=Net profit/net worth (three studies) 6) Net worth to total liabilities-(total assetstotal liabilities)/ total liabilities

The first two measuring the company's ability to meet short-term liabilities. The others measuring the overall, The ratio

long and short term position of the company.

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 companies. (thirty-three) failed

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 (14) Retained earning/total assets (15) EBIT/total assets (16) debt (17) sales/total assets 0.012 0.014 0.033

Market value of equity/book value of long-term 0.006 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 16 15 17 14

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 within two year within three years within four or five years 95% 75% 48% 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. cut-off point was found to be Z = -1.95. The failed/insolvent

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 ratio R = CA/CL

over liquidity R>2.0

optimal liquidity 2.0>R>1.5

under liquidity 1.5>R>1.0

payment difficulties R<1.0

I

Well performing Fair performing Poor performing

57% 5% OZ

31% 48% 25%

6% 382 372

6% 9% 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

1 1

deficient I good excellent IR — NI/SFlprofitability 'profitability 'profitability I R>0.15 I 0.15>R>0.10 I 0.10>R>0.0 I

danger of failure R<0.0

1 1

well fair poor

50% 19% OZ

31% 19% OZ

19% 57% 19%

OZ 5% 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 1 R =. cash/SF I R>0.15 .15>R>.10
1 +

good bad very bad I .10>R>.05 .05>R>.01 I R<.01

1 1

+

well fair poor +

44% 5% OZ

6% 5Z

6% 33% OZ

25% 33% 44%

19% 24% 56%

1 1

OZ

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
1

year

area of study

'classification accuracy 2'

1

1 1

Walter Smith Altman

11959 11965 11968
& 1

financial characteristics common stock analysis failure prediction

80 72 75

1

1

Haslem

1

Longbrake 11971 Frank
& 1

bank performance analysis

86.5

1

1

Weigandt 11971 Klekowsky
1

debt characteristics analysis

90

1

1

& Petty 11973 Blum White (1974 11975
& 1

share price analysis

86 81.7 84

1

business failure analysis
shares analysis

1

1

Schick

1

Verbrugge 11975 'financial characteristics analysis Taffler 11977 company failure analysis profitability analysis

77 98.5 94.4

1

'Gillingham 11980
1

Betts

&

1

1

Belhoul 11982 Belhoul 11983 Betts 11984

company failure analysis high performing companies failure prediction analysis

97 85 90

1

1

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. model's By comparing the

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 1 F 2 F 3 F 4 F 5

= .60132ZR 2 = .49905ZR 5 = .53485ZR 1 = 1.07767ZR 9 = .82264ZR 6

+ .4056ZR 7 + .50836ZR 8 + .4632ZR 3

+ .15715ZR 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 F 2 F 3 F 4 F 5

= 1.1R 2 = 5.1R 5 = 9.96R 1 = 7.627R

+ .34R 7 + 4.54R 8 + 3.83R

- .276

- .594

- .826 3

- 2.887 9

= 1.04R 6

+ 1.23R 10

- 2.19

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

b

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

NET WORKING CAPITAL I INCOME

I

CASH

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

Austin (F.)(Leyton)
- 1 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 a)
E

E

o
O 0
o

0
Good
m 0

a)

0

dG
clAp

4-1 Poor
;-I
a) fa4

k

a) 1:14

Fai -----..,, Time Type 1

F . s Time Type 2 Type

. "Time 3

Time Type

)1,-

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 characteristics, (2) failure exhibits 'mercurial'

with very high growth rates and other

performance measures, until some point at which the company over-reaches itself and collapses equally dramatically. Oneman 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 longestablished 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 (O00)

19851

TO 1986 (E, 000)

Allied Textile Companies plc British Home Stores plc Bell (Arthur) & Sons plc Wellcome Fundation

Cash CA CA CA NI

I

1093

I

116981 156976
466500

1695 1219393.3
I

1169387.3
I

I

489621 37121.4 584 856.3 1356095 1097287 511465 284238 15253 3092.3

31600
I

I

Benford Concrete Machinery plc

NI Cash

474 116
1247800

I

I

I

Beecham Group plc Marks & Spencer Pearsons BPB

CA CA CA CA Cash

I

I

456600
I 471434

I

I

I

215500

I

3900 915 48089
I

I

Allied Colloids plc

Cash CA

I

53810.1 15904.2 767872 43307.1

Ash & Lacy plc Boots Co plc (THE)

CA CA Cash

15149 674000 9000

I

I

I

British Gas Corporation

CA Cash

J

2735500 110193209 30300 1868 261667 2310
I

I

Anglia Television Group plc

NI Cash
I

448 1097 593

1458.8 7208.1 5308.3

Goodyear Tyre & Rubber Co Ltd.

NI Cash

I

1

241

Babcock International plc

CL NI

I

349000 24800 119606 3890 816 197827 6517 11221 992
15424

1

26

54

j
I

1

50803.4

APV Holdings plc

CL NI

1104406.6
1

I

17486.6 3329.8

Ault & Wiborg Group plc Albright & Wilson Ltd.

NI CA Cash

I

1

I

1225330.1 12876.5 9333.2
I

I

Barrow Hepburn Group plc

CL NI

I

I

1642.9 67990.6 1139238

Pleasurama plc British Railways Board

CA CA NI Cash

I

I

I

859300

I

97300
I 27100

1124287.2
I

61619 4547 61614.4 10497.4 6713.2 1223208

Anchor Chemical Group plc Baker Perkins Holdings plc

CL CL NI Cash

I

6213
84139

I

I

I

I

7999
3984

I

I

I

Ford Motor Co.

CL NI Cash

I

1297000 45000 117000

I

1179715.6 1128949.1
I

Adams & Gibbon plc

CA CL NI Cash

I

6682 4617 413

6906.1 3917.6 808.3 405 59128.1 35482.5 3134.4 5307.6

I

I

I

2 45644 36837 16

I

Armitage Shanks Group Ltd.

CA CL Cash

I

I

I

I

1

Atkins Brothers (Hosiery) plc

CA NI

I

4914 169
I

I

467.6

242

Cash Dunlop Holdings plc CL NI Barno Industries plc CL NI Cash BBA Group plc CA NI Cash Batleys of Yorkshire plc CA CL NI Cash

43 808 0 7838 439 142 70644 1217 1101 18674 19087 1260 2

3

.4

396.1 81.6 5079.6 994.8 545.6 77872.8 7548.5 4445.2 20150.8 10528.4 3336.4 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 1.8E63.5EEi 3.0E6 H LL ui T. 2.5E6 / 1.6E6- /-- - - in 1 . 4E6- LLI :1.2E6 ::j. 1.0E6/ / //'
/

/1 / ?'"1

/ '

///

E cc

1--

u

2.0E6 1 . 5E6- 1.0E6 1974 1976 1918 1980 YEAR .

/

,. /

LI:10.8E6a(--) 0 . 6 E G0.4E60.2E61982 1984 1974

/
1976

/ /' ,/

1978 198d YEAR

1982

1984'

1.2E6 4.0E5 3.5E5 3.0E5 (75 W 2.5E5Lu

1.0E6

i ;

(.--Z‘..

Ln

5 0.6E6

2.0E5 1.5E51.0E5 0.5E5 1974 1976

/

!

/
0.4E6

0 .2E6 7- • - - 'N....." / 1978 1980 YEAR 1982 1984 / _____ ---•-----1976 1978 1974 198d YEAR

.- --

- ---

1982

1984'

GEACJ
GENERAL ELECTRIC CO

-CL —
-NI •- — OCASH -CASH

Figure 7.3.1 A Graphical Illustration of Ideal Performanc

247

1.8E5 800001.6E5 700001.4E5 Ln 1u. 60000

E1.2E5Ln

1.0E5 Lu z' L_) 0.8E5 0.6E5 0.4E50.2E51974 1976 1978 1980 YEAR 1982' 1984'
Li

40000-

a 300002000010000--

1974 13 S 1378 1980 YEAR 1982 1984'

3000018000 16000 14000' 2000912000'
Li

25000-

— 10000I-Li 800060004000' 2000' 1974 1976

(cf, 15090

/7

710000

1978 1980 YEAR

1982

1984

1974

1976

1980 1978 YEAR

1982

1984 cn -ocn

COALITE GROUP COME Figure 7.3.2 A Graphical Illustration of Ideal Performance

-CL — —ON! -N OCF1SH -CASH

248

3500014000-

30000 u-) Li
U,

12000

25000 c L:2
a L=.I
a-. Li

("-x -c. ;1• 10000',

20000
I_TJ

/
8000
Li

\I

15000-

7;"\
60004000-

100001972 1974 1976 1978 YEAR 1980 1982 1984 1972 1974 1976 1978' 1980 YEAR 1982 1984'

2500
t \

2250 2000

i i \ .. /...\

2250 I 2000 1750 1500
,'",

r

17501500I

:

1

1
1

s

\

I /
/

Li

,..

1

1

T I. \ \/ ...," L C 1250- ec

Li

I

\

1-Z-I 1250 1000 •50 500 1972 1974 1976 1978 YEAR 1980 1982 1984

000 1-

v / , ......'

\ I K :

\I

I

i

750 500250 972 1974 1976 1978 YEAR 1980 1982 1984 CA OCR — —

ALLIED TEXTILE CO. PLC
Figure 7.3.3
A

Graphical Illustration of Ideal Performance

— — °CASH --CASH

21+9

200000175000-

1.2E5-

E.11.0E5 V2150000125000 10000075000500000.2E5 250001974 1976' 1978 1980 YEAR 1982 1984 1974 1976 1978 1980' 1982' 1984' YEAR PIET
!-21

tri'i 0 . 6E5
cr.
Li

=

0.4E5

I/

70000 60000

35000t 30000-

/

50000 u, 25000
Ei
Li
FA 40000-

—20000Ui

I

Li

30000 1500020000
10000-

1000050001974 1976' 1978' 1980' 1982' 1984' YEAR

1974

1976

1978 1980 YEAR

1982' 1984' CA -OCR — -CL

BRITISH HOW STORES
Figure
7.3.4

A Graphical Illustration of Ideal Performance

- -NI — — — OCFISH -CASH

250

1 ,6E51,4E51,2E5LU
1-13

90000 8000070000-

---1600001,0E50. 8E5
22.

50000Li 0.8E50,4E5cc 4 0000(X Lij

,

Li

300002000010000-_

rr---\ J
I

\1

/

1972

1974

1976

1978 YEAR

1980

1982

1984

1974 1982 1972 19841 4 1976 1978 1980 YEAR

20000 2500017500 15000 (512500
, 5 11:

20000-

Li
I 10000 g

15000-

7500 5000 2500 972 1974 1976 1978 YEAR 1980 1982 1984

10000-

5000— 1972 1974 1376 1978 YEAR 1980 1982 1984

BELL (ARTHUR) & SONS PLC
Figure
7.3.5

-OCA — — —0N1 -NI — NASH -CASH

A Graphical Illustration of Ideal Performance

251

3.0E54.5E5 4.0E5
tr)

2.5E5
LU
_

,3.5E5
LU

tf-'. 3.0E5 c

_
'Er3 cr.

2.0E5

1 . 5E5u.; cc

2.0E5 er

LU 1 . 0E5-

1.5E5
1.0E5 1972 1974 1976 1978 YEAR 1980 1982 1984

/

0.5E5._ 1972 1974 1976 1978 YEAR 1980 1982 1984

1.0E5 35000 30000 Lu

/1

/

0.9E5 0.8E5 0.7E5
2:

E U
z

25000- ,,,i.'---J 20000- 1500010000- 5000 1972 1974 1976 1978 YEAR 1980 1982 1984 4 • _
_... 7t._ .

.

i I

i

0.6E5-

Lt.)

E9 0.5E5

/ //'./'
V

0.4E5 0.3E5 0.2E5
_

0.1E5 1972 1974 1976 1918 YEAR 1980 1982 1984 CA -OCR -CL — ---ON I --NI — — °DISH -CASH

WE.LLCOPIE FUNDAT ION
Figure
7.3.6

A Graphical Illustration of Ideal Performance —

252

1600014000"

80007000 tri Li ;7260005000L 400C
EV

E 12000cc

'2 /0000cr.

Booci

6000400097i 1974 ' 1976' 1978 ' YEAR 1980 ' 1982 ' 1984'

30002000 1972 1974 ' 1976 ' 1978' YEAR 1980 1982 1984

1800/

/60C
/

//

\

900 800
• \ \ • I \... 1\ .1 %

700600 tT) 500

1400
LIJ

I.

E, 12001-- 1000

400 800600 400 972 1974' 1976' 1978' 1980 YEAR 1982 19841 300 200 100 1972 1974

,/

/
1976 1978 YEAR 1980 1982 1984

BENFORD CONCRETE MACHINERY PLC
Nigure 7.3.7 A Graphical Illustration of Ideal . Performance

CA -OCR -GEL — -CL — I -NI — KASH -CASH

2 3

F-

8E5-

I .2E6 7E51.0E6
c.n LI;

6E5 'i'D 5E5 fc

uE 0.8E6 c)

6 0.6E6
0.4E6

'lt 4E5
Li

/

3E5///

2E50.2E6 1974 1976 1978 1980 YEAR 1982 1984 1E5-1974

Ji

19761- 1978 1980 YEAR

1982

1984'

1.6E5 1.4E5

2.5E5

2.0E5

w
CD

1.2E5

Z' 1.0E5
0.8E5

II

/ LT 1.5E5
/ cr

1.0E5 0.6E5 0.4E5 0.2E5 1974 1976 1978 1980 YEAR 1982 1984 1974 1976 0.5E5 '1978 1980 YEAR

1982

1984 CA

BEECHAM GROUP PLC
Figure

-ocn

7.3.8 A

Graphical Illustration of Ideal Performance

-CL —ON] -NI — — — — OCASH -CASH —

254

7E5 1.0E6 6E5

o . 8E6
(.1)
MU) I-

r".". 5E5 4E5

O. 6E6

LU
ix cr
LU

IT-. 3E5 0.4E6
LU

2E5 0.2E6 1E5 1974 1976 1978 1980 YEAR 1982 1984 1974' 197E: 1978 198d YEAR 1982 1984'

1.8E5 1.6E5 1.4E5 614.1.2E5
LU

80000 70000

/
U) cr

60000 50000 40000

1.0E5Lu 0.8E5 V 0.6E50.4E50.2E5 1974 1976 1980 1978 YEAR 1982' 1984

rt
••n

30000 20000 100001974' 1976' 1978' 198d YEAR 1982' 1984' CA -OCR — --CL —ONI -NI – °CASH -CASH

///

MARKS & SPENCER
Figure 7.3.9 A Graphical Illustration of Ideal Performance

255

5.0E5 4.5E5 4.0E5
E- 3.5E5
v)

3.0E5-

2.5E5if

21 cr.

2.0E5

r

3.0E5 11: 2.5E5 5 I.-.) 2.0E5 1.5E5 ,///' 1.0E5

i t!

1.5E5f' 1.0E5-

0.5E5-/ 0.5E5 97i 1974' 1976' 1978' 1980' 1982' 1984 YEAR 972' 1974 1976 1978 YEAR 1980 1982 1984

60000

9000080000-

50000 '7000T u, 4000060000-

ICi] 30000z
20000-

g!.450000L)
40000 3000020000-

100001972 1974 1976 1978 YEAR 1980 1982 1984'

100001972' 1974' 19761 1978 YEAR 1980 1982 1984' CA -OCA — -CL — —ON! -N1 (KASH — — - --CASH

PEA RSONS

Figure 7.3.10 A Graphical Illustration of Ideal Performance

256

8E5 7E5 6E5
cr,

4.5E5 4.0E5 I 3.5E5 .t; 3.0E5
Fi

LU a-.

I.T.J

4E5 3E5 2E5 1E5 1974 1976 1978 1980 YEAR 1982 1984

..J
LT,
cr. (-)

2.5E5 2.0E5 1.5E5 1.0E5 0.5E5 1974 1976 1918 1980 YEAR 1982 1984

80000 '70000

7000060000-

60000
LU

1

50000/

650000
LU

40000 30000 20000 10000 1974 1976 1978 1980 YEAR

.,

40000300002000010000I.

1982 1984

1974' 1976' 1978' 198d YEAR

1982

1984' CA -OCR

RACAL ELECTRONICS
Figure 7.3.11 A Graphical Illustration of Ideal Performance

— --CL — --ON1 -NI OCASH — — -CASH

257

1 .8E5-

2.5E5

EGET

1.4E5

E. 1 . 2E5
E, 1.5E5

1.0E5

1.0E5 0.5E5

/0. bE5 0.4E5 0.E5 1974 1976' 1978 1980 YEAR 1982 1984' 1974 , 19761- 1978 19801 YEAR 19821 1984 -

\ 50000

18000 1600C1
1' ./ i
I

40000

1400012000

F.; 30000

Eil0000

.
0'. ../ t I

800020000
6000-

4000 100001974 1976 1978' 1980 YEAR 1982' 1984' 1974 2000--

j
1976 1978 1980 YEAR

\I

1.982

1984 Fl
- - -

BPB INDUSTRIES PLC
Figure 7.3.12 A Graphical Illustration of Ideal Performance

--ON I -NI °CASH -CASH

258

50000-

30000III

40000 f— in Lu ul Ln cc 30000
LL.I .

/

/

r

u., 25000u..1 I=• .•., .i:73! 20000cc :11 Li 15000Z cl-.

cc R — 20000-

a

10000-

,j'

10000

50001974 1976 1980 1978 YEAR 1982 1984 1974 1979 198d 1979 YEAR 1982 1984'

3000. 120002500. 100002000 a: ir) cc (--) 1500

It' BOOT
LU

LT; 6000-

\
40001 0 00-

2000

500-

ii
1974 1976

, If

I

,r •

1974

1976

1979 1980 YEAR

1982

1984

1979 198d YEAR

1982

1984 CA
—ocn

ALAFY
ALLIED COLLOIDS PLC

--CL --ONI Figure 7.3.13 A Graphical Illustration of Ideal Performance

-NI — OCASH -CASH

259

16000

900014000 800012000
Ui

Lr) m10000
LU

•••

226000.:1
:It

E 6000

=

5000-

'40006000 3000 4000 20001972 1974 1976 1978 YEAR 1980 1982 1984 1972 1974 1916' 197d YEAR 198d 1982' 1984'

2250 2000 1750
U.1 600 51500 Li

900800- / 700
m _ "(2500 Li / /

-

/

. .- /

/

/- --

tr\ 1 % t i t

L:1250 400- 1000 300
I,•\ /

/

,1
I t

-
./
200-'

/

\

1 t

750 500

ri-\
1

i
1
% !

I

I

100-

\
1984'

-1!

1972 1974 1976 1978 1972 1980 1982 1984 YEAR

19741-

1916

1978 YEAR

1 , 1980 1982

ASH & LAP( PLC

Figure 7.3.14 A Graphical Illustration of Ideal Performance

CA -OCA -0CL — -CL — 1 -N1 - - OCRSH -CASH

260

4.5E5 7E56E5- 5`Cn 5E ij In = - 4E 5.
/ Li

4.0E5 3.5E5 3.0E5 CO cr
I-

:12.5E5 cig 2.0E5

uJ
Li

3E5
2E5-

1.5E5 1.0E5 1E51974' 976' 1978' 1980 YEAR 1982 1984 1974' 1976' 1978' 1986' YEAR
A II

1982' 1984'

1.0E50.9E5- / 0.8E5- ,/ L.Li O. 7E5- tp La .F-. 0 . 6E5I-. 0.5E5 ,/''' 0.4E5- • ''' .......„../ /,/ ---' --I /

1.0E5

i i I \ I I / 1 1 / /
f n

/ 0.9E5 0.8E5

1-

--...../-

0.7E5
7.: .va2. 0 . 6E5 / Li 0. 5E5 0.4E5 0.3E5

//-.-
1 1 1

I It

..."

r

I

0.3E5-
0.2E5 ...„-1974 1976 ,'''

/

0.2E5
.---- .--- --

,...- -- 1974 1976

1

0.1E5 1978 1980 YEAR 1982 1984

k 1978 1980 YEAR

1982

1984 CA -OCA

BONS CO PLC (THE)
Figure 7.3.15 A Graphical Illustration of Ideal Performance

— -CL — —ON I I — — — °CASH -CASH

261

1.0E70.9E70.8E7(MO. 7E70.6E7(cf,

7E6 6E6 5E6

cio 4E6 1-5

E 0.5E7a: 0.4E7
_

a:

3E6 2E6

O. 3E70.2E7_ -

1E6 1980' 1982' 1984' YEAR 1974 19(6 1978 1980 YEAR 1982 1984

0.1E71974 1976' 1976

0E4

0E4

0E4 I Z' 1- 0E4

0E4

19 6

1978

1980 YEAR

1982

198:1 4
T 1

1974

19761 1978

1980 YEAR

1982

19841 -OCR

BRITISH Gm CORPORATION
Figure 7.3.16 A Graphical Illustration of Ideal Performance
— —

— - - EL — — -ON I °CASH -CASH

262

22500 20000 17500 L1115000

1600014000 tr, 12000
1..0

/
/7

,7 7

r-: m cr. 10000-

5: 12500
Lc110000

:11 l- 8000w Ex cr a6000 4000

/ /
If

7500 5000 2500 1972 1974 1976 1978 YEAR 1980 1982 1984 2000 1972 1974 1976' 1973 YEAR

// --.../ .

198d

1982

1984

3000 3500 30002500LJJ

2500

n

2000

2000
\

n

/ //V
,

w cr (-31500

1500 1000 500 197 i

, t \

,, I,,

, ///' "

//

1000

/........„.. ___ -----

500-

1974

1976

1978 \ERR

1980' 1982

1984

1972

1974

1976

1978 YEAR

1980

1982 CA -OCR

1984

ANGLIA TELEVISION GROUP PLC

ANAB I
-

Figure

7.3.17 A

Graphical Illustration of Ideal Performance

— —ON1 -NI — OCFISH -CASH

263

90000-

6000055000

80000.Li t`l 70000ciL

5000045000

-7:140000 c 35000g 50000300002500040000197 1974' 1976' 1978' 1980' 1982' YEAR 20000 1972 19741 19161— 19781 1980 YEAR 1982

I

5000 5000 YEAR 1.93 _ 1978 1.1-;
o Li
z .--.

19.93814___ .
1
I

40001

I I I , I 1

1

LcT.3000_ 2000-

-5000
-10000 1000-15000

1972

-• 1974

1976

1378 YEAR

1980

1987r— 2
-KR

GOODYEAR TYRE & RUBBER CO.

-CL —0N1 OCASH -CASH

Figure 7.3.18 A Graphical Illustration of Ideal Performance
-

264

5.0E54.5E5-

3.5E5

3.0E54.0E5IT w

3.5E5-

2.5E5 • -

cc 3.0E5( . 2.5E5 g

n2.0E51.5E5

2.0E51.5E5 1.0E5- , 1972 1.0E5

--r 1974 1976 1978
YEAR 1980

1982

1984

0.5E5 — 1972

194

1916' —19 (81-- --807- 198i - 19E141 19 YEAR

500004500040000/-

/ .../,
5000040000-

LL.,

Li-

sz _
30000 2500020000-

35000_./

/ /f\ / . //
\,
F

,--

7 —/

le—

,.,- 5
in
1 , 1

Lt : 30000-

15000 10000 5000

/ i ---1972 1974

/
1982 1984

20000

1
10000

.r ,
---, 1984

.—
.-- — ..--/ 1974 1972 1976 1978 YEAR 1980' 1982

197

1978 YEAR

1980

BABCOCK INFERNATIONHL PLC
Figure 7.3.19 A Graphical Illustration of Ideal Performance

-OCA — —ON! -NI — KASH -CASH

265

1.2E5200000 1.0E5175000
LU

/

-' tLU 150000 u
In

0.8E5cr.

C17.
,

125000 7:1

1 S' 100000

2

0 . 6E5-

C (X

75000 50000

0.4E5

0.2E525000 1972 1974 1976 1978 YEAR 1980 1982 1984 I 1972 1974 1976 19(8 1980' 1982' YEAR 20000/ 16000 / 14000 u., 120009 c=

1984'

18000

18000- 'I/ / 1600014000- i i f / .--- ,1- '''' / 1 6000 4000200019841 1972 /1 ' \\ _ _ _I /

,,,'

r"-- - -- - --'

/

u ,-. 10000 - L -- 8000-

1/ / f

N., , • - \ \ =, 12000 c.n cc L' 10000
\

/
/

/I
600040001 ..-- ." 1974 1978 1978 YEAR 1980 1982

8000

1972

1974

1976

1978 YEAR

1980

1982

1984 CFI -0CF1

APV HOLDINGS PLC
Figure 7.3.20 A Graphical Illustration of Ideal Performance
- --

— • -CL —ON1 - -N I -- -- • °CASH -CASH

266

30000 27500 25000 in 22500
n i, cr. 1—
(r) LLI

2250020000;2175007-n

20000

E, 17500

a 15000
12500 10000 7500 1972 1974 1976 1978 YEAR 1980 1982 1984

c (z (-) 000ci

II

750050001972 1974

• 1976 191E1' 1980 YEAR

198 2i 1984' -

3500

It

2000-

3000

I II
;
Li

;

\

175015001250u' m

./

Li.:
Li

2500

-2000 HLL 1500

1
1000•750500- r 250 n 1972- 1974 1976 1978 YEAR 1980 1982 1984' CA -OCA -CL —ON 1 -NI • - - OCIISH -CASH ,/

1000

500 , 1972

1974

1976'

1978' 1980 YEAR

1982' 1984'

AULT & WIBORG GROUP PLC
Fig ure 7.3.21 A Graphical Illustration of Ideal Performance

267

225000200000175000Ln.

1.2E5

V! 150000`n Ln

1777.1.0E5
. f / /
,

i

..11

cc
LL.1

125000-

.C7

:721 0.8E5
1-. = u..1 ,.

/ / i

Eg 100000=
75000 50000-

E

0.6E5
/ ...-/

/

0.4E5 25000 972 1974 1976 1978 YEAR 1988 1982 1384' 1972

r •

1974

1976

1918 YEAR

1980

1.982

1984

40000 22500 20000
t t

35000i: C.--

17500 L I. 15000 E
t_) 2::
-\

1

i

30000 u, 25008

/ t 1 1 t

i

7:

12500 100007500 5000-

1
!

5 20000
15000

1
1 I 1 t t j

I
/ 1982 1984

10000 5000 1972' 1974 1976 1978 YEAR 1988 1982 198-4T FA -0CF1
• — • -CL -- ---ON! -N1

1972

1974

1976

1378 YEAR

1980

ALBRIGHT

8,

WILSON LTD

Figure 7.3.22 A Graphical Illustration of Ideal Performance

OEFISH -CASH

268

35000 32500 30000
CO

r\ 30000'

27500

tr 25000i

u

T25000
E
:D (-)

22500 20000 17500 15000

520000
c

a )5000, /-10000 t'

it \
\ \

1

12500 1972 1974 1976 1978 YEAR 1980 1982 1984 1972 1974

‘.*\\./-\ 1976- 19(8 YEAR 198-0( 1982 1984'

r.
fl

4500- 4000- 3500
L.L.;

/ \ i \ 1

2500- 2250- 2000- /
/ / /

;1 ' 1 / t ._
/ \ /

B 3000

.

1

/

I
\ \

Li 2500- 7 /' z

E 1500
1250 //

.-.

1

1750 .__.... /

/\ \

1

2000/ 1500 1000- .V'''.

I ,,i\
„.. . .n1_ 7 ____./
%v

i - -, I
% %

1000/
,

750 500 7 19(2 \..../ . 19(4

/
19 (6

1

I " i ,-, \ 1 s.... ...r......
i
1

1

:Th ''

',.//'-' n

v

1

• /

1972

7

. 1914 19761- 1978 YEAR

1980

1982

19841

, --- 1 1v9 116 - 19801— 1982 1984 E R
CA
ocn •- --OCL CL — —ONI

BARROW HEPBURN GROUP PLC

Figure 7.3.23 A Graphical Illustration of Ideal Performance

- °CASH -CASH

269

/ 45000 6000050000 ce.12) 40000,
a-.

1
Ui

40000 ,3 0005 t; 30000 Ec; cl; ..J 25000

SL . 30000 C 2000010000-

E 20000 cL
Li 15000 10000 5000 1972 1974 1976 1978 YEAR 1980 1982' 1984' 1972 1974 1976 1978 YEAR 1980 1982 1984 / /

14000

7000
//I\

12000- 6000 10000
/
uJ

/

5000I

8 8000 F--.
1--

,1

,,,, 4000.
in cr.

r

/

\

I

t../

U

L-1 6000 4000 2000 .._ ..../ 1972 _ 1974 1976 1978 YEAR 1980 PLEASURAMA PLC ,-- -}
....

/ / / / ,/

3000

/

/

2000. /

,/ /

1000. _ __ 1974 1976 .... .__ .- -- --' ' 1y9 78 01 R 1980 ..---

--------- 1982 1984 1972

1982 CR UCF1

1984

PL ABU

Figure 7.3.24 A Graphical Illustration of Ideal Performance

• -CL — —ON! NI — °CASH -CASH

270

1.4E6 9E51 1.2E68E5

1.0E6 tt..; tn 12-0.8E6
Ui

Q:.
= (-3

0.6E6

0.4E6-

3E52E5-

0.2E61972 1974 1976 1978 YEAR 1980 1982 19 (2 1974 1916 19(8 YEAR 198d 1982

60000

1

1.0E5 500000.5E5Li
Li •-•

40000 972 1974 1976
/

1978 YEAR

IpicIU

19821
Li W CC

Li
n

30000 0. • .5E
5:‘.

20000
•-•"'

,-***

-1.0E5I

j

10000 -1.5E51972 1974
/

1976

1978 YEAR.

1980

1982

BRITISH RAILWAYS BOARD
• Figure 7.3.25 A Graphical Illustration of Ideal Performance —

-OCA CA -CL —UN! -NI
KASH

-CASH

271

4

6000

(..r)

cc 5000
7: 11.1 CC:

Li

4000 2000

972

1974' 1976' 1978' 1980' 1982' 1984 YEAR 500 450-

972

1974

1976'

1918' 1980' 1982' 1984 YEAR

800 700

400600
,-tiv....„w . •=• .1 ;

350300 u-) cc Li 250

500

-.400
/

,
11 I / /
. ' —\ if ! ; \ ;

/‘; 1 1 1 t , ,

300200 100 972

j\

1I
/\
t 1 i I ;

1

1

1974

1976

197E1 YEAR

1980

1982 1984

1972

1974 ' 1976

1918 YEAR

1980

1982' 1984 In EICF1 — — --ON! • -NI - ocnsH -CASH

ANCHOR CHEMICAL GROUP PLC
Figure 7.3.26 A Graphical Illustration of Ideal Performance

272

1.1E5 1.0E5 0.9E5

80000

70000

;:60000" "1-n 0.8E5 (. '20.7E5

nalooT

E 0.6E5
0.5E5 30000 0.4E5 20000 0.2E5 19 ./4 1976 1918 1980 YEAR 1982 1984 1914' 1916 1918 1980 YEAR 1982 1984

10000 6000 8000 /// // 5000
./

6000

/

_4000 -

4000

3000

2000 2000

1000" 1914' 1916' 1918 19801 1982 YEAR 1984 1914 1916'T 1918 1980 YEAR 1982 1984

BAKER PERKINS HOLDINGS PLC
— Figure 7.3.27 A Graphical Illustration of Ideal Performance - — —

CII
-CL NI
ocnsH

-CASH

273

.2.0E6. 1.8E61.6E6uJ cc

1.4E6

1.2E6
Li
172. f_l *

1 . 4E6-

1.

Li

1.2E61.0E6O. 8E6-1 0.6E60.4E61972 1974 1976 1978 YEAR 1980 1982 1984

an :71 0.8E6 z: Lu
a,

/1'

a 0.6E60. 4E6

972

1974

1976

19(8 YEAR

1980

1982

1984'

5E4
1 .8E5-

0E4
5E4

\ I \%

1 . 6E5-

11
1.4E51. 2E5e2,11.0E5J/' Li

A/
I

: 0E4 \ 5E4 (2

,

/7- \ \
%

0.8E50.6E5 0.4E50.2E5

1974

1976

1978 YEAR

1980

1982

1984 1972 1974 1916 YEAR 1980T 1982 19841 cn
-0 CA - - -0CL

FORD MOTOR CO. LTD.

-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
Cr7 -J

3500E

Cr) --J

30002500
_

/ /---, \s/

/

E4000

Li

3000

2000

1500

2000
1 00 0

1972

1974

1976' 1978' 198d YEAR

1982' 1984

1972

1974

1976

1978 YEAR

1980' 1982' 1984

800

/r

400 350 300 250

700r 600 / //

\ \ /
f\II\ I / i 1 1

:' Lu 500w.. ; .

in E 200 ,." 150 100 /

z
400

/ /

300
--i

/(-----\

200 1972

J
1974

I. 1976 1978 YEAR

1 l'\\._,l
1980 1982 1984

50 1972 1974 1976 1978 YEAR 1980 1982 1984 C71
OCA — — •—ON I

AnAms a GIBBON
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 4 1978' 1980' 1982' 198'1 YEAR 1972 1974 1976 1978 YEAR 1980 1982 1984

8000 3000 70002500 6000 / 2000 /-**-

Ili; 400030002000 //-* 1000.1 1972 ..4""."-.. .,,....,G,
,

i

n It / t 1 1
I I I

. ,

I

/
/

, m'. g.

/ --- -- / 1
/

/ '

r\
A 1 I

u 1500 7 s \ 1000 I 500 .....\ I 1
I ,

/
/ /

s
I

i

I

/

\ . r

t

n'. ''.
I li

1974

1976

1978 YEAR

41 1980' 1982k 198: 1972

1974

1976

1978 Y YEAR

1980 .

1982

1984

ARMITAGE SHANKS GROUP LTD
Figure 7.3.30 A Graphical Illustration of Ideal Performance

CA
-OCA -CL — —ONI -N1 — OCF1SH -CASH

276

30005000 4500 2500-

3000 2500 2000 1974 1976 1978 1980 YEAR 1982 1984 500 1974

1000

1976

I 198 1986 YEAR

9821 1 - 1984T

450 400 350
L.L.1 E:

300-

250

/

-

200300 250 200 150 100 1974' 1976 1978 1980' 1982' 1984' YEAR 1974' 1976' 1978' 1980' 1982 YEAR 1984 100
I

g .

a.: 150"

1-,
Ui

tf


\ \

50-

ATKINS BROTHERS PLC
Figure 7.3.31 A Graphical Illustration of Ideal Performance

-OCR -CL — —ON -NI - OCRSH -CASH

I

277

F-

7E5 6E5wn _ i 5E5
2;

Li

Ln y' m

5E5 4E5

,- 1
\

or.

a 3E5

,4E5 ., 1-. 3E5 cc 2E5- 1E5 1912 1974 1976' 1978 YEAR 1980 1982

,r
, --- -) /

t1 ill 1
%

t
i

til

1984

1972

197;

1976r 19igr---18811 —1982' -1984 F YEAR

8E4-

80000 , 7000060000-

6E4-

w 4E4 7
E
u
21:

\ 50000 •n
340000-

•-•

3000020000

972

1974

1976' 1978 YEAR

iseo'

1982' 1921

-2E4 , -4E4 I. 1972 1974 19761- 1978. 1980 YEAR 1982 1.984 10000-

DUNLOP HOLDI\ GS PLC
Figure 7.3.32 A Graphical Illustration of Ideal Performance

-OCA - --OCL Cl —ONI -- • - •- NI - ocnsH
cnsH

278

9000 8000 7000
1.1/

7000 En 6000

.n
4000 3000

LU

LU

3000 2000-

//

f

2000 1972 1974 1976 1978 YEAR 1980 1982 1984j 1 . °°°1972 1974 1976 1978 YEAR 1980 1982 1984

10001200900 800 700 Llj O
I 11

100C , 800 cr,
LU

/ 114(
/iii I
II

Goo
tj . 500 400 300 200 . 1972 1974 1976

600

r

721 //' / r 200- /
k

400

./
1978 YEAR 1980 1982 1984' 1972 1974 1976

/
1378 YEAR 1980

\
1982 1984' CA OCR -CL — —OWL -NI • - OCASH — -CASH

BARNO INDUSTRIES PLC
Figure
7.3.33 A

Graphical Illustration of Ideal Performance

279

H-

/ 45000 70000

40000
Li) 35000

60000 IL7.1 Ln (efE' 50000 Li 640000

'&130000 cc

ra,

Li

_

20000 30000 15000 20000 1972 1974 1976 1978 YEAR 1980 1982 1984 2r 1-9-77 — 19761 — 19 ?8T —190 1982 1984) YEAR

45007000 40006000 350050001

4000
Li
z

1
e i
I

3000- `1: ,.. _ 3Pc 2500 i , 1 1 I I. / /

...

/

— 1-L1.1

3000 2000 1000 972
.7<

-------;"

z

\

2,3ors .1 ' \
i ... 1982
f

1 I 1 1914 1976 1978 YEAR

,

i5o0-
1000

,A , , ; • ..,.
.- \ j

,‘

198

1984

___ __ .

. .-,

\ ---.._

,,

1

i \.•/\

t -1000 500 / n. 1974' 197

1976

1978 YEAR

1980

1982

1984' -CA
-ocn

BBA GROUP PLC
Figure

7.3.34 A Graphical Illustration of Ideal Performance

— -CL — —ONI -NI - ocnsn —•— CASH

280

20000 17500 15000 r `j cci 12500 10000
/

if

18000 16000

J

E 14000'11!

2112000-

:1100008000 • 7500 5000 2500 1974 1976 1978 1980 YEAR 1982 1984' u 600040002000 1974 1976 1S8 1980 YEAR 1982 1984

1200 3000 1000 2500 800

0 2000
1500 400 1000
II

200

500 1974 1976 1978 1980' 1982' 1984 YEAR 1974 1976 1980 1978 YEAR 1982 1984

BATLEYS OF YORKSHIRE PLC
Figure 7.3.35 A Graphical Illustration of Ideal Performance
— — — —

CFI
-0CF1 -CL —ON I

-NI

• - °CASH - CASH

281

18000 25000 22500 u-)20000 Ls) In cr. 17500 LcS15000LLI CY

16000
s's

14000
It
ER

12000-
, /1

I

1250010000 75001972 1974 1976 197d YEAR 1980' 1982 1984

a-. (-) 80006000" 4000 972 1974 1976 1978 YEAR 1980 1982 1984

1600 2500/ 1
A / /1 I

t
1

140C
"-•••

2000

?

12001000-

C)

1500 / 1000 7 t , 500
t
t

/

I

I

1 1

=

t I ,

I—

1

En
5

17
80C A

z . w/ / 7. \)
1 k \.]

;

\
I

60 0 40C/ / // Il l
f

1 '
1

1 I I

\./ 1972 1974' 1976 1978' 1980 YEAR 1982

200- z\ 19841 1972

.-.

!

//'I

1

\n
1978 YEAR 1980 1982 19-8-4 CA — •— -CL -N1 — ()CASH -CASH

1974

1976

BEMROSE CORPORATION PLC
Figure
7.3.36

A Graphical Illustration of Ideal Performance

282

70000- 4500060000-
Lu tn

4000C 3500C

/
' ,

cr.

50000 .
/ FE:

30000

(SA 40000-

1-0 25000 c, 20000 15000

30000-

20000 972 10000 1974 1976 1978 YEAR 1988 1982' 1984 972 1974 1976' 1978 YEAR 1980 1982 1984

6000

8000 7000

4000 6000g 2000 m 500C
cn
CE

•972

1974' 1976

1978 YEAR

1980

1982' 1914i

400C 3000

- 20002000 - 40001000 1972 1974 1976 1978' 1988 YEAR

\

1982' 1984' CA -OCR ---• — -CL —0N1 -NI — OCASH -CASH

BESTOBELL PLC
Figure 7.3.37 A Graphical Illustration of Ideal Performance

283

80007000

I

5000 ,

4500LU

,

1

,

40006000
cc
E

. (,,

,

, 7-\

,

,

I
\ \ \ \...

5000 40003000 20001972 1973 1974 1975 1976 1977 1978 1979 YEAR i /

cc 3500 :71

_

I/

\ , '-' \

/ ,I/ ___ i

,

I-.
E

Li

Ixi 3000 a-. =
2000

(-) 2500-

/ II
;

\

/

1500-( 1972 1973 1974 197 1976 1977' 1978' 19791 YEAR

800
1

I

\
n

400350%

700
I

I

300-

w
Ii LU

600- I: 500400 300 200/

\

% s, n
cc
In

250'200-

ln r/

/

\\

\

N\
\ j

, A

150100 50

1972 1973' 1974 1975 1976 197/ 1978 1979 YEAR

1972 197:3 1974' 1975 1978 1977' 1978 1915 YEAR 0CA CA —L — --ON I -NI ocnsH • - • - -CASH

BROCKS GROUP OF CO. LTD

Figure

7.3.38

A Graphical Illustration of Ideal Performance

284

1 .3E51.2E5700001.1E5co 1.0E5(1-) /. )

//

\
O. 9E5-

glmooT
"n...-..• • /
t'

cr.

50000 0.8E5
..J

/ .. ... -- .. ...'- •

Hx cr

Li (3..7E50.6E5-

ge r

40000

Li

300000.5E50.4E5 1972 1974 1976 YEAR 1978 1980' 20000 1972 • 1974 • 1976" • 1978 YEAR • 1980'

10000 8000 6000 w 4000
L.)

/N

16000

I`

140001 ...:-..;
-,/. 2.

12000t
i
1
10000-

'

E.-. C/

2000
I- Li \

LT/

CC '

8000„ 600040002000
• ,

1972' -2000 -4000 -6000

. 1974'

1976' YEAR

1978'

It 1 i

1980'

/

./

1972' • 1974'. 1976 YEAR

• 1978

• 1980' -OCA CA

STONE PLATT INDUSTRIES PLC
Figure

7.3.39 A Graphical Illustration of Ideal. Performance

— -CL — I -NI — OCASH -CASH

285

F-

1.6E5 900001.4E5Ui

80000

n7000C
cr.
_

//

1— 60000
LIJ
0'.

a 500000.8E5 0.6E5 1972 1974 1976 YEAR 1978 1980
_

, ' 1/7 \* \ j/ .... .., 7

30000-

1974 1972. '

1978 YEAR

1978

1980

20000 15000 10000
i

9000 80007000 a, GOOC (.17 m 5000
\

I / i
r .. ,

t-LI 5000 c) Li 972 -5000 -10000 -15000 -20000 1974 1976 YEAR 1978 1980 1 I r

I
t

• i' •- j .

4000 3000 2000

.... '

1972

1974'

197E; YEAR

1978

1980' -OCA CA — --CL — --ON1 -Ni — KASH -CASH

BRITISH AIRWAYS
Figure 7.3.40 A Graphical Illustration of Ideal Performance

286

5000U7

4000Cr:
11nIl

-

2000-

1000

1972 1974

1972

1974

1976 YEAR

1978

1980

1976

1978

ned

YEAR

450500 400400350300
,

.,/

//' 300-

g.!

200/ }/ 100

n

c i 2 250
200-

1972' 1974'
-100-

1976' YEAR

1979

1980

150
100-

-200-

50

I

1972' 1974'

1976 1978' YEAR

19807

VINERS
Figure 7.3.41 A Graphical Illustration of Ideal Performance

OCA CA — • ft — ---owl -N I -- • - NASH

287

5000 3500 4500
Lu cn

3000-

cr: 4000-

;L:
:=;

(n u'

3500u 3000200 1500 2000 1980 1972 2000 ci

rN / , , 1 N-- /; '

/ / ,- , • \\
I \
1976 1980

1972' 1974

1976' YEAR

1978'

1974

1976 YEAR

500 400

250

200 300 Fi 200 I OT (

1972

1974

1976 YEAR

\lr

198d

-10T
1972 1974 1916' YEAR 1978' 1980 -OC11

BLACKMAN & CONRAD
Figure 7.3.42 A Graphical Illustration of Ideal Performance

— --ON I -NI — -- • - — acnsH -CASH

288

12000 11000 11000 1000010000 9000 9000
U.J U/

8000 8000 7000-

L. .J cL a'.

7000 6000 6000 5000 4000 3000 1972 1973 1974 1975 1976 1977 1918 1979 YEAR 5000 4000 3000 1972 1973 1974 1975 1976 1977 1978 1979 YEAR

800 600 w 400 — 200LU-

/

1

172 1973 1974 1975 1976 1977 1978 1919 YEAR -200 -400 1972 1973 1974 1915 1976 1977 1978 1979 YEAR

AMAL1AP1ATED INDUSTRIALS
Figure 7.3.43 A Graphical Illustration of Ideal Performance

-OCA CA ---— ----ON! -NI °CASH -CASH

289

14000 13000

7000 6500-

(\
_ ,1

/ /1/
/

12000

L now u-)
tr)
cc

(.1-)

/

/

.

tn

6000

,
1
S.

,
135500 1— E5000
`x ce

uJ

10000

a 9000
8000 7000 1973 1974 1975 1976 1977 YEAR 1978 1979 1980

a

4500-

4000

1973

1974 1975 1976 197? 1978 1979 1980 YEAR

1000 750

700 600

/
../

500 LL.1 2501974 1974 -250 -500200-750-10001001974 „ 1973' 1975 1976 19T? 1978 1979 1980 YEAR
I•

500 c2 (- 400 300

151976 1977 YEAR

1n978 1/979

980

BLACKWOOD,FlORTON & SONS
Figure

-OCA CA — -CL — —ONI -NI OCFISH — — -CASH

7.3.44 A

Graphical Illustration of Ideal Performance

290

7/- 5000" 6000 450040005000
cE
0." 300

Li.t u)

E -J

3500-

4000

6
3000
(-)

2500_

2000 1500-,

2000 1972 1973 1974 1975 1976 1977 1978 1979 YEAR

loaf
1972 1973 1974 1975 1976 1977 1978 1979 YEAR

l' 400 .
/ \

‘\
n n

------

350-

..._./ ; 1 / \ t t

300-

200
L.).1

,/ \ I

250‘
m
FE) 200L)

C) L.,
I--

z .....

1972

1973

1974

w
z

1975 1976 1977 197k 1979 YEAR

t

150,
t

-200

100'-\\ -400
t

(-\\

\

\

501972' 1973 1974 1975 1976 1977 1978 1979 YEAR

BURRELL & CO.
— — Figure 7.3.45 A Graphical Illustration of Ideal Performance

-OCR CA

-NI OCRSH - -CASH

291

60004500 5500 4000 5000 Lr) 117, 4500 nE 4000 350030002500-7
1500-

1.11-; 3500 _ ..--". FE; -J 30001Z Ieti 2500rx -------

I \ // 1 '.... \
I 1

/ ...',

\

........... - - ...

a

..."/
2000-

/

2000 1974 1976 YEAR 600
\

1978'

- 1980'

1974

197E YEAR

1978

1980'

350300-

400 200 YERP
U_1 CZ11

1974,

250-

7

1978,

1980,
LT) 200-

- L.1-200 -400

Li

=

/
150

1001

-600
50

-800 1974

1916
YEAR

197E1

1980' -OCR CR - --CL — —ON! -NI -- °CASH -CASH

CAWDAW INDUSTRIAL HLDGS
Figure 7.3.46 A Graphical Illustration of Ideal. Performance

292

30000

30000

25000
U) n I-.
in

25000

Vr). 20000
LT;

r.Fc; 20000

m I -

ai m

= u 15000

z: W15000a-. La

10000 10000 5000 1973 1974 1975 1976 1977 1978 1979 1980 YEAR 3000 180020001200a: U.) 1000 1974 1974 1975 1976 1977 YEAR - 1006
E

1973 1974 1975 1576 1971 1978 1974 1980 YEAR

1600 1400-

.: /I / (\
l
1 I / I

/

1000

\
, , ,

1 I

800 600400
1 !----

,
/./

.

\

I I I

.A,-I I I

I

\

- 2000200 , 1974 1974 1975 1975 19T/ 1978 1974 1.980 YEAR -OCA CA — —ON] -141 OCASH -CASH

AIRFIX INDUSTRIES
Figure
7.3.47

A Graphical Illustration of Ideal Performance

293

12000

11000 10000

10000
LU

9000 8000 7000 - - 6000 Z LU 5000Li

)j 8000 L11
LU cc c a- 6000

40004000 3000"
, 2000- //,

1972

1974

1976 YEAR

137Ei

EgeG

csd

{Te4

(Re6' YEAR

csee'

?see'

, 1000
• ••••"--.°

700 / 600 197 13 YEAR 19 1978 198 500

/

500

LU E.

6-.41

Li 500
-

W

=--1000 -1500 -2000 -2500 1972 1974 1976 YEAR
1978 1980

OXLEY PRINTING GROUP
Figure 7.3.48 A Graphical Illustration of Ideal Performance

-OCR CA — --CL — --ONI - --NI °CASH -CASH

29L1.

70000 40000 60000 3500011) LU LU

50000

r- 30000II I

cr.
E-

40000

'Er; cc 25000
.-J

cuj cr. u 30000

L.T., 20000
=11."

Lj 1500020000 1000010000 1974 1976 YEAR 1978 1980 5000 1974 1976 YEAR 1978 1980

4000 2000 - -11374--- YEAR 1976 197 19

6000

5000! !

-2000 - 4000 - 6000 - 8000 -10000 -12000

a-: v)
LI

4000

\1

/
I

tI

/ I -

/.....' \ \
\

3000
\ \\.." 1

\/
I1

A

2000-

.

,

...• .-•••
..." ..."

/
\ \,. / t

%

\

1000 1974

,
1976 YEAR 1978

1980 -OCR cn -OCL — -CL — —ON1 OCFISH -CASH

LESNEY PRODUCTS & CO.
Figure 7.3.49 A Graphical Illustration of Ideal Performance

295

.„/•••n\

3000030000-

25000f-1-125000-

_

ES.

20000
I

15000-

1-1-; c g 15000-

1000010000•

, "

1972' 1974'

1976' YEAR

1978

1980

1972

1974'

1976 YEAR

1978'

140012001000
(ff. Li
IT:

/

197

1974

YEAR 1976

IN

/

800
/

600

,
400 200
- n n

1972

• 1974' 1916' YEAR

• 1978' 1980 -OCR CFI • -0CL — -CL — ---ON1 --N1 - - KASH -CASH

RICHARDS & WALLINGTON INDUSTRIES
Figure 7.3.50 A Graphical Illustration of Ideal Performance

296

8009 7000 6000 cri
`n cr. o--. Fin' 5000

5000 4500 4000 tr)
LL.1 _

a-. 4000

3000 2500 2000
1500-

cr' or. 3000 2000

1000-

1000 1972 1974 1976 YEAR 1978 1980 1972' 1974'
• ,

1976 YEAR

1978'

1980'

1400 500YEAB..-1972, • 19- •---711376, , 1978, ., 1980,

/f

1200 1000800
cr:

(-1 -500
IFn111

600 - 1000400 - 1500200

1972

1974

1976 YEAR

1978

1980
ocn CFI

NORVIC SECURITIES
Figure 7.3.51 A Graphical Illustration of Ideal Performance

— -- —ON! -NI -- • - ocnsH
-CASH

297

3000 3500 2150 :300O cr. w
Ele. 2500

250d FE, 2250:5'2'2000cr.

,

Ci

2000

17501500-

1500 • 1974' 1976' 197E1 YEAR 198d

1250-'7/

• 1974

1976 YEAR

1978

1980

250 1974,

2501 /I-

-250 -500
=

200
n

I\
/ I/

I

1,

\ :

t
1 I

150
!

I
./.

-750 -1000 -1250 -1500 -1750

V)

cc U 1001

i\

1

I I V

\
1 1 1

1 50;

\

n
n

1974

1976 YEAR

1978

1980

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 a

controlling the success and stability of 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 to

desirability of a shift from univariate 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) management. Firm's factors such as firm size and quality of

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)
(.59.4)(Centroid point) P

•4

8 3 (. P ' (.1) 1) 4 ' 9 X(Rotated i°
.0

factor n I)

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 h 1 = +(.8)

2 = \/.01+.64 = \/7-E- = . 806

h 2

2 2 = \/(.2) +(.6)

\0 .04+.36

=

V770T

.632

h 3

2 2 = \/(.8) +(.1)

\/74-T7E— =

V7i3-

. 806

h 4

2 2 = \/(.9) +(.1)

\i .81+.01 v

= V782— .906

For more than two dimensions, vector length is given by

2 h=\/a 1

2 2

2 +a 3

2

+a +a +

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 11 a 12 a 13 ...a lm a 2m Where c=a a +a a +....+a a is a constant. The values a 11 21 12 22 lm 2m 11 represent the coordinates of first vector, and lm for the ] x a 23 = [c] (Al2)

a 12

, a 13

,...,a

the values a , a , a ,...,a are the coordinates 23 21 22 2m

second vector. Thus, the scalar products of all possible pairs of four test vectors in Fig.All are given as follows:

311

Pair 1,2

Row (.1 .8)

Column

Scalar product

x 1.21 =(.1x.2) + (.8x.6) =(.02+.48) =.50
I

.61 1,3 (.1 .8) x
1. 8 1 I .11

=(.1x.8) + (.8x.1) =(.08+.08) =.16

1,4

(.1 .8)

x 1.91
I .11

= (.1x.9)

+ (.8x.1) =(.08+.09) =.22

2,3

(.2 .6)

x

1

.8 1 I .11

=(.2x.8) + (.6x.1) =(.16+.06) =.24

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 11 or a 11 and a 21
= =

= a /h , L = a /h , ...,L = a /h 11 1 12 12 1 lm 1 lm

hL ,a 11]. 12

=

hL , ....,a =hL lm 112 1 lm

hL ,a 221 22

=

hL , ....,a =hL 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 urn iii i i2 h L j i2 = [c]

h L jiff' or hhL L +hhL L + i j il jl i j i2 j2 and h h [L L + L L + ...+ L L ] = c i j il jl i2 j2 im jm (A13) ...+hhL L -c i j 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 ii ij

(A14)

The scalar product between vectors i and j is also equal to the correlation between them. The proof proceeds from r ij + ....+ a =aa +aa im jm il j1 i2 j2

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 im i jm j ij i j il i jl j i2 i j2 j = cos v + ...+LL =LL +LL il jl i2 j2 im jm ij

Or
r ij = h h cos v i j ij (A14)

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 (X c = \// -X ) + (Y -Y ) 12 12 Where (X ,Y ) and (X ,Y ) are the coordinates for P and P 11 1 2 22 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 1 2 3 4

2

3 .16

4 .17 .24

I

II 1 I .578 2 3 4

(.65) .50

1 .578-.562 2 .531-.344

.50 (.40) .22 .16 .17

.531 .687 .765

.22 (.65) .73 .24 .73 (.82)
R

= 3 .687 .422 II -.562 -.344 .422 .484

4 .765 .484 A

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 ii the fictitious data variables, derived as scalar products of the vectors in Fig. All. among

Figure Al2

Cent oid vector

n

x

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. locate These two coordinates Centroid factor

the centroid point Pc(.5, .4).

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 1 1 1 lc Where a is the factor loading, or projection of 1 vector 1 on

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 1 c lc II 1.41 .37 = h (h Cos v ) = h a c 1 1 lc c a = .37/h 1 c

h
C

2 2 (.5) + (.4) = j

= .6403

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 .24

.578 .531 x [.578 .531 .687 .765]

.50 (.40) .22 .16 .17 .22 (.65) .24
R

.73 _ .687 .765
A 1

.73 (.82)

At 1

(.65) .50
=

.16

.17 .24 .73

.334 .307 .397 .442 .307 .282 .365 .402 .397 .365 .472 .526 .442 .406 .526 .585
A Al 11

.50 (.40) .22 .16 .17 .22 (.65) .24
R

.73 (.82)

(.316) .193

-.237 -.272

.193 (.118) -.145 -.166
=

-.237 -.145 -.272 -.166
R

(.179) .204 .204 (.234)

-.5621 I -.3441 I .4221x [-.562 -.344 .422 .484] I .4841
A Ai

1
1 22

2 1

2

In matrix terms, R - A A i = O. Since R is reproduced exactly

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 11 a 21 a 31 a 41 A

a 12 a 22 a 32 a 42 A
I

V 11 Cos v Sin vi V 21 V 31 V 41

V 12 V 22 V 32 V 42 V

xi 1= I-Sin v Cos vi

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 11 01 'Cos v -Sin v1 1 x 1 1 1 = 1 1 1-Sin v Cos 111 10 11 'Sin v Cos v1

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 y c yc 1 1 1.41 Cos v = .4/h h = .4/(1.0 x .6403) = .625 y c

e

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

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

I

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 datavector 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

n

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

1

Rotated factor

1

I .578 .531

II .562 .344 x
1 1

I(X) II(Y) 1 .781 .6251
1=

.1 .2 .8 .9 V

.8 .6 .1 .1

2 3 4

.687 -.422 .765 -.484 A

1-.625 .7811

A

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, however, the

goes right through the centroid point,

coordinates of the centroid point with respect to the new axes will be

323

in — a ,0,0, n i=1 il

E

0

(1)

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 accordance with Eq.(1). in

To use Eq.(1) for deriving an

expression for the centroid loadings, Eq.(2) serves as a starting point:

r =a +a a + i2 j2 il

ij

+a a im jm

(2)

Summing both sides of Eq.(2) over i gives n n n a + ....+ a /:: a a + a r = a jm i = 1 im J2 1 = 1 12 jl 1 = 1 il i=1 ij n

E.

1:

E

(3)

Summing both sides of Eq.(3) over j gives n n n n n n r = Ea Ea + a La + ... + a (4) j=1 i=1 ij j=1 jl i=1 il J=1 j2 i=1 12 j=1 Jm i=1 im

EE

n n

La E

324

But

Z:

a a = j=1 jk i=1 ik

(5)

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 n 2 2 a ) + a ) +( r j=1 1-1 ij i-1 ii i-1 i2

=(Z:

E:

n a ) +( i=1 im

Z.:

2 (6)

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 a i=1 ) 2 (7)

r j=1 i=1 ij

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

a Cr = a i -1 ij j1 i=1

(8)

Taking the square root of both sides of Eq.(7) and substituting in Eq. (8) gives n n Er j=1 i=1 ij

= a i = 1 ij Solving for a gives jl j1

\

(9)

r 1=1 ij a jl =

(10)

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. 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. (10) calls for the

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 t a i

1 (.65) .50 .16 .17 1.48 .578

2 .50 (.40) .22 .24 1.36 .531

3 .16 .22 (.65) .73 1.76 .687

4 .17 .24 .73 (.82) 1.96 .765

T =

E
\J 1/\/Y—

r = 6.56 2.56125 = . 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 Sum 0

1 (.316) .193 -.237 -.272 .000 -.316

2 .193 (.118) -.145 -.166 .000 -.118

3 -.237 -.145 (.179) .204 .000 -.178

4 -.272 -.166 .204 (.234) .000 -.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 Sums without communalities

1 (.316) -.193 .237 .272 .316

2 -.193 (.118) -.145 -.166 -.504

3 .237 -.145 (.179) .204 .296

4 .272 -.166 .204 (.234) .310

Reflected 1st Factor Residuals and 2nd Factor Calculations

1 2 3 4 t a

1 (.316) .193 .237 .272 1.018 .562

2 .193 (.118) .145 .166 .622 .343

3 .237 .145 (.179) .204 .764 .422

4 .272 .166 .204 (.234) .877 .484

T = 3.281

VT = 1.81135 1A117= .55207

1

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 R56 R57 R58

0 RE/TA 0 CASH/CA 0 SF/TA 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 Data List Factor Analysis 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 OPTIONS STATISTICS

VARIABLES=R1 TO R65 7,10,11 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 Yvalue 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

LIST OF REFERENCES

344

LIST OF REFERENCES

1)

Afifi A.

A.

and Azen S. P., (1979), "Statistical

Analysis", Academic Press Inc. New York, London.

2) Altman E. I. (1968), "Financial Ratios Discriminant Analysis and the Prediction of Corporation 4, pp

Bankruptcy", Journal of Finance Vol 23, No. 550-612.

3)

Altman E. I. (1969), "Corporate Bankruptcy Potential, Stock- holder Returns, and Share Valuation" Journal of Finance Vol 24 pp 887-900.

4)

Altman

E.

I.

(1971), "Corporate Bankruptcy in

America", Heath and Lexington.

5) Altman E. I., Haldemann R. G. "Zeta

and Narayaman (1977)

analysis : A New Method of Identifying

Bankruptcy Risk of Corporation" Journal of Banking and Finance Forthcoming, vol 1, pp 20-62.

6) Anderson T. W. (1958) "An Introduction to Multivariate Statistical Analysis" Wiley.

7) Anderson T. W. (1956) "Statistical inference in Factor Analysis" Math. Statistic vol 5, pp 111-150.

8

Anthony R.

N.

(1960) "The Trouble with Profit

Maximisation" Harvard Business Review Vol 38 pp 126134.

345

9)

Archer S. H. (1966) "A Model for the Determination of Firm Cash Balance" Journal of Financial and Quantitative Analysis Vol 1 pp 1-11.

10) Argenti J. (1976) "Corporate Collapse : the causes and symptoms" London, McGraw-Hill

11)

Argenti J. (1983) "Predicting Corporate Failure" Institute of Chartered Accountants in England and Wales, London

12)

Ball R. J. (1968), "The Use of Value Added in Measuring Efficiency", Business Ratios, Summer, pp 33-45.

13) Bargh E. E., (1972), "Factor Analytical Comparisons of Company Performance", Southern Journal of Business, Vol 7, No. 3 pp 28-39.

14)

Barnea A. and Dennis E. L. (1973), "Evaluating the Forecasts of a Security Analyst" Financial Management Vol 2, pp 38-45.

15)

Bartlett M. S. (1937) "The effect of standardisation on an approximation in factor analysis" Biometrika vol 38 pp 337-344.

16)

Bartlett M. S. (1938) "Methods of estimating mental Factors" Nature, Land. vol 141 pp 609-610.

17) Bass F. M. (1978) "Firm Effects and Industry Effects on the Analysis of Market Structure and Profitability" Journal of Marketing Research, vol

346

15, pp 1-16.

18)

Beaver W. H. (1966) "Financial Ratios as Predictors of Failure" Empirical Research in Accounting, Selected Studies.

19)

Beaver W. H. (1967) "Financial Ratios as Predictors of Failure" Journal of Accounting Research, vol 5, pp 70-112

20)

Beer M., Dawson R. & Kauanagh M. J. (1978) "A Performance Management System" Personnel Psychology vol 31 pp 505-535.

21)

Belhoul D. (1983), "An Evaluation of Financial Performance of Companies", Vol 1 University of Bradford.

22)

Benston G. J. (1966), "Multiple Regression Analysis of Cost Behaviour" Accounting Review October pp 657672.

23)

Berkwitt G.

J. (1971) "The Big new move to Measure

Managers" Dun's Review Sept. pp 61-6 .

24) Berkwitt G. J. (1968), "The Model Way to Corporate Success"

25)

Betts J. & Belhoul D. (1982) "The identification of companies in danger of failure using discriminant analysis" University of Bradford.

26)

Betts J.

(1984) "The Identification of Companies at

347

Risk of Financial Failure : Two Models" University of Bradford

27)

Bierman H.

(1960) "Measuring Financial Liquidity"

Accounting Review Vol 35 pp 628-632.

28) Blum M. (1969) "The Failing Company Doctrine" PhD thesis, Columbia University

29) Blum M. (1974) "Failing Company Discriminant Analysis" Journal of Accounting Research, vol 12, pp 1-25.

30) Burns T.

J.

(1970) "the Behavioural ASpects of Data for Performance Evaluation"

Accounting

Columbus, 0. USA.

31) Burts C. and Banks C. (1947), "A Factor Analysis of Body Measurements for British Adult Males", Annals of Eugenics, Vol 13, pp 238-256.

32)

Burts C.

(1949), "Alternative Methods of Factor

Analysis and their relation to Pearson's Method of Principal Axes" Psychological Statistics sect. 2 pp 98-121. vol

33)

Calman R.

F.

(1968) "Linear Programming and Cash

Management" Cambridge

34) Chambers R. J.

(1966), "Accounting Evaluation and

Economic Behaviour", Prentice -Hall.

35)

Charnes A.

and Cooper W. W. (1961), "Management

Models and Industrial Applications of Linear

348

Programming" John Wiley & Sons Inc.

36)

Courtis J. K. (1978), "Modelling A Financial Ratios Categoric Frame Work", Journal of Business Finance & Accounting Vol 5 No. 4 pp 371-387.

37)

Comrey A. L. (1962), "The Minimum Residual Method of Factor Analysis" Psychological Reports, vol 11 pp 15-18.

38)

Comrey A.

L.

(1973), "A First Course in Factor

Analysis", Academic Press Inc. New York, London.

39) Cooly W. W. and Lohnes P. R. (1962), "Multivariate Procedures for the Behavioural Science", John Wiley and Sons, Inc. New York.

40) Cooly W. W. & Lohnes P.

R.

(1971) "Multivariate

Data Analysis" John Wiley & Sons.

41)

Davis B. E. & Elzinga D. J. (1972), "The Solution of an Optimal Control Problem in Financial Modelling" Operations Research Vol 19, pp 1419-1433.

42) Deakin E.

B.

(1972) "A Discriminant Analysis of of Business Failure" Journal of

Predictors

Accounting Research, vol 10, pp 150-185

43)

Duckworth W.

E.(1968) "Statistical Techniques in Methuen and Co. Ltd.

Technological Research" London.

44) Dun & Bradstreet (1963),"Course

in Credit

and Financial

349

Analysis" Dun & Bradstreet Ltd. New York.

45)

Dun & Bradstreet (1973) "The Failure Records" Dun and Bradstreet Inc. New York

46) Dunn 0. J. and Clark V. A. (1974), "Applied Statistics: Analysis of Variance and Regression", Wiley.

47) Edminster R. 0.(1972), "An Empirical Test of Financial Ratio Analysis for Small Business Failure

Prediction", Journal of Finance and Quantitative Analysis, vol 7, pp 1477-1493.

48)

Edminster R. 0. (1972) "Financial Ratios as Discriminant Predictors of Small Business Failure" Journal of Finance Vol 27, 139-40

49)

Elliott J.

W.

(1972) "Control, Size, Growth, and

Financial Performance in the Firm" Journal of Financial and Quantitative Analysis Vol 35 pp 628632.

50) et al, (1975), "Statistical Package f r the Social Sciences", New York, Mc Graw Hill.

51) Exstat User Manual (1977), "Extel Company Ltd. London.

52) Fadel H. Financial

A.

H.(1977), "The Predictive Power of Ratios", Ph.D Thesis, University of

Bradford, UK.

53)

Fitzpatrick A.

A.

(1967),"Pricing

Methods

of

350

Industry" Pruett Press.

54)

Foulke R. A. (1961), "Practical Financial Statement Analysis" Mc Graw-Hill.

55) Francis J. G. F. (1961) "The Q.R. Computer Journal, Vol 4, pp 265-271.

Transformation"

56)

Frank W. & Weigandt J. (1971) "A Prediction Model of Convertible Debentures" Journal of Accounting Research, vol 9 pp 111-132

57)

Freear

J.

(1980), "The Management of Business

Finance", Pitman Publishing Ltd. London.

58) Friend I. & Blume M. (1970) "Measurement of Portfolio Performance under Uncertainty" the American Economic Review Vol 60 pp 561-575.

59) Fruchter B. (1954), "Introduction to Factor Analysis" Van Nostrand- Reinhold, New York.

60)

Gillingham D.

W.

(1980) "A Comparison between the

Attribute Profiles of Profitable and Unprofitable Companies in the UK and Canada" Management

International Review, vol 20, pp 60-85.

61) Gonedes N. (1974) "Capital Market Equilibrium and Annual Accounting Numbers" Journal of Accounting Research, vol 12, pp 20-68

62)

Goodman L.

(1970) "The Multivariate Analysis of

Quantitative Data" Journal of American Statistical

351

Association vol 60 226-256.

63)

Graham B., Dood D. L. (1962), "Security Analysis", McGrow-Hill Book Company, New York.

64) Guertin W. H. & Bailey J. R.

(1970) "Introduction

to modern Factor Analysis" Ann Arbor: Edwards

65)

Haley K.

B.

(1967) "Mathematical Programming for

Business and Industry" The Macmillan Co.

66) Harley J. R.& Cattell R. B.(1962) "Producing direct Rotation Test a hypothesized factor structure" Behavioural Science vol 7 258-262.

67)

Harman H.

H.

(1970), "Modern Factor Analysis",

University of Chicago Press.

68)

Harman H. H. & Jones W. H. (1966) "Factor Analysis by Minimising Residuals" Psychometric 31 pp 351-368.

69)

Harrington L. T. & Ingham H. (1958) "Interfirm comparison for management" London, British Institute of Management

70)

Harrington L.

T.

(1977) "Management Policies and I,

Practices and Business Performance" Project Centre for Interfirm Comparison, London.

71)

Harris A.

(1968), "Work Done and Resources Used"

Financial Times, 16 August.

72) Harvey A. (1970), "Factors Making for Implementation Success and Failure" Management Science Vol 16 No.

352

16 February.

73)

Harvis

R.

J.(1975), "A Primer of Multivariate

Statistics" Academic Press, New York.

74)

Haslem J.

A.

& Longbroke W.

A.

(1971)

"A

Discriminant Analysis of Bank Profitability", Quarterly Review of Business and Economics, vol 11 pp 30-48.

75)

Haugen R.

A.

(1970) "Expected Growth, Required

Return, and the Variability of Stock Price" Journal of Financial and Quantitative Analysis Vol 5 pp 297308.

76) Hendrickson A. E. & White (1964), "A Quick Method for Rotation to Oblique Simple Structure" British Journal of Statistical psychology vol 17 pp 65-70.

77) Hochman E., Hochman 0. and Razin A. (1973) "Demand for Investment in Productive and Financial Capital" European Economic Review 4 pp 67-83.

78)

Hoshino Y. (1982) "The Performance of Corporate Mergers in Japan" Journal of Business Finance and Accounting, vol 9, pp 151-175

79)

Horrigan J. 0.(1965), "Some Empirical Bases of Financial Ratio Analysis", The Accounting Review, Vol 40, pp 550-570.

80) Horrigan J.

0.(1968), "A Short History of Ratio

Analysis", The Accounting Review, Vol 43, pp 275-

353

295.

81) Horst P. (1965) "Factor Analysis of Data Matrices" New York: Holt, Richard and Winston,

82)

Hotelling H. (1933) "Analysis of a Complex of Statistical Variables into Principal Components" Journal of Educational Psychology, vol 24, pp 410448

83)

Hotelling H. (1957) "The Relation of the Newer Multivariate Statistical Methods to Factor Analysis" Br. J. Statist. Psychol. vol 10 pp 69-79.

84)

Johnson C. C. (1970), "Ratio Analysis and the Prediction of Firm Failure", Journal of Finance, Vol 25, No. 5 pp 1160-1186.

85)

Jones G.

L.

(1976), "Financial Measurement for

Managers", Edward Arnold Ltd. London.

86) Joreskog K.

J.

(1963) "Statistical Estimation in

Factor Analysis" Almgrist and Wiksell, Stockholm.

87) Joreskog K. J. and Lawley B. N. (1968) "New Methods in Maximum Likelihood Factor Analysis" Br. Jnl math & Statist. psychol. vol 21 pp 85-96.

88)

Kaiser

H.

(1958), "The Varimax Criterion for Rotation in Factor Analysis",

analytical

Psychometric, Vol 23 pp 180-205.

89)

Kaiser H.

(1960), "The Application of Electronic

354

Computers to Factor Analysis", Educational Psychological Measurement, Vol 20, pp 140-165.

and

90)

Kaiser H.

F.(1959) "Computer Program for Varimax Educational and

Rotation in Factor Analysis"

Psychological Measurement vol 19 pp 413-420.

91)

Klemkowsky R. & Petty J. W. (1973) "A Multivariate Analysis of Stock Price Variability", Journal Of Business Research, vol 1, pp 1-24.

92)

Krouse C. G.(1972), "Optimal Financing and Capital Structure Programs for the Firm" Journal of Finance Vol 27 pp 1057-1071.

93)

Krouse C. G.(1973), "On the Theory of Optimal Investment, Dividends, and Growth in the Firm" American Economic Review Vol 63 pp 269-279.

94)

Krouse C. G.& Lee W. Y. (1973), "Optimal Equity Financing of the Corporation" Journal of Financial and Quantitative Analysis Vol 8 pp 539-563.

95)

Laurent C. R.(1979), "Improving the Efficiency and Effectiveness of Financial Ratio Analysis", Journal of Business Finance and Accounting Vol 6, pp 400424.

96) Lawley D. N. (1953), "A modified method of Estimation in Factor Analysis and some large sample results" Uppsala symposium on Psychological Factor Analysis, Nordisk psychlogies monograph series no. 3 pp 35-

355

42.

97) Lawley D. N. (1963), "On Testing a set of Correlation Coefficients for Equality" Ann. math. statist. 34 pp 149-151.

98)

Lawley D.

N.(1967), "Some new results in Maximum Edinb,

likelihood Factor Analysis" Proc. R. Soc. A 67 pp 256-264.

99)

Lawley D. N. and Maxwell A. E.(1971), "Factor Analysis as a Statistical Method", Butterworth, London.

100)

Lerner E. M.and Carlton W. T.(1966), "A Theory of Financial Analysis", Harcourt, Brace & World, Inc. USA.

101)

Lev B. (1969) "Industry Average as Targets for Financial Ratios" Journal of Accounting Research, vol 8, pp 285-300

102)

Lev B. (1974), "Financial Statement Analysis : A New Approach", Prentice - Hall.

103) Linderman R. H., Merenda P. F. and Gold R. Z. (1980), "Introduction to Bivariate and Multivariate Analysis", Scott Foresman and Company.

104) Lintner J. (1963) "The Cost of Capital and Optimal Financial of Corporate Growth" Journal of Finance Vol 18 pp 292-310.

356

105) Litzenberger R. H.& Joy O. M. (1971) "Target Rates of Return and Corporate Asset and Liability Structure under uncertainty" Journal of Financial and Quantitative Analysis Vol 6 pp 675-686.

106) Mao J. C. T.(1976), "Corporate Financial Decisions", Pavan Publishers, Calif. USA

107) Martin J. & Scott D. (1974) "A Discriminant Analysis of the Corporate Debt Equity Decision" Financial Management, vol 17, pp 100-115

108) Mattsson A., Olsson U. and Rosen M. (1966), "The Maximum Likelihood Method in Factor Analysis with special consideration to the problem of Improper Solution" Research Report, Institute of Statistics. University of Uppsala Sweden.

109) Maxwell A.

E.

(1961), "Recent Trends in Factor

Analysis" J. R. statistics soc. vol 124 pp 49-59.

110) Miller C. D. & Lial M. L. (1979),"Mathematics with Applications: in the management, natural and social sciences" Glenview, Ill. London

111) Mulaik S. A.

(1973), "The Foundations of Factor

Analysis" Mc Graw Hill.

112)

Mulondo J. K. (1981), "Company Reorganisation as a Business Turnaround Strategy", Ph.D Thesis,

University of Bradford.

113)

Nelson A. T. (1963), "Capitalised Leases-The Effect

357

on Financial Ratios" Journal of Accountancy Vol 116, pp 49-58.

114)

Overall J.

E.

and Klett C. J. (1972), "Applied

Multivariate Analysis", Mc Grow-Hill.

115) Page C. S.& Canaway E.

E.

(1966), "Finance for

Management" Heinemann : London

116)

Park W.

R.& Jackson D. E.(1984) "Cost Engineering

Analysis" John Wiley & Sons, New York.

117) Pinches G. E., Eubank A.

A., Mingo K.

A.

and

Caruthers J. K. (1975), "The Hierarchical Classification of Financial Ratios", Journal of Business Research, Vol 3 pp 293-320.

118)

Pinches G. E. and Kent A.

M.

(1973), "A

Multivariate Analysis of Industrial Bond Ratings" Journal of Finance Vol 28 pp 1-18.

119)

Pohlam

R.

A.

and Hollinger R.

D.

(1981)

"Information Redundancy in Sets of Financial Ratios" Journal of Business Finance and Accounting, vol 8, pp 510-530

120) Prasad B. S. (1966), "Problem Solving Trends in Management Science" Management Science, Vol 13 No. 2.

121) Pringle J. J. (1973) "Price/Earning Ratios, Earnings Per Share and Financial Management" Financial Management Vol 2 pp 34-40.

358

122) Radnor M., Rubenstein A. H. and Ben A. S. (1968) "Integration and Utilization of Management Sciences Activities in Organisations" Operational Research Quarterly Vol 19

123)

Rao C. R. (1973), "Linear Statistical Inference and its Applications", Wiley.

124) Raven A. D. (1971), "Profit Improvement by Value Analysis, Value Engineering and Purchase Price Analysis" Cassell, London.

125)

Richard M.

(1964)

"Accounting

and Analytical

Merthods" Richard D. Irwin Inc. Homewood, Illinois

126) Roosta A. (1979),"A Risk and Reliability Management Appraisal of Company Failure", Ph.D Thesis, University of Bradford UK.

127) Samuels J. M.and Wilkes F. M. (1975), "Management of Company Finance", Clarke, Doble & Brendon Ltd. Plymouth UK.

128) Saunders D. R. (1953) "An Analytical Method for Rotation to an Orthogonal Simple Structure" Research Bulletin, Princeton University

129) Saunders D. R. (1960), "A Computer Program to find the best fitting orthogonal factors for a given hypothesis" Psychometric vol 25 pp 199-205.

130) Schick R. & Verbrugge J.

(1975) "An Analysis of

Banking and Research" vol 6, pp 140-155

359

131) Schilderick J. H. F. (1977), "Regression and Factor Analysis Applied in Economics".

132) Schoeffler S. (1974) "Impact of Strategic Planning on Profit Performance", Harvard Business Review, vol 57, pp 127-153.

133)

Sharpe W.

F.

(1963) "A Simplified Model for

Portfolio Analysis" Management Science Vol 10 pp 277-293.

134)

Shashua L.

and Goldsmith Y. (1974), "An Idea for Journal of

Evaluating Financial Performance", Finance Vol 29, pp 790-811.

135)

Simons L.

(1974) "the Basic Arts of Financial

Management" Business Books Ltd. London.

136) Simple Plot (1985) "Bradford University Services Ltd." J. Butland, UK

137)

Singh A. and Whittington G. (1968),"Growth, Profitability and Valuation", Cambridge University Press.

138)

Smith K.

V.

(1965)"Classification of Investment

Securities Using M.D.A" Institute for Research in Behavioral, Economic and Management Science, Purdue University

139)

Smith K.

V.

(1979) "Guide to Working Capital

Management" McGraw-Hill, New York, London

360

140)

Smith K. V. (1971) "Portfolio Management: theoretical and empirical studies of portfolio" Holt, Rinehart and Winston, New York

141) Spencer A. & Tucker (1961) "Successful Managerial Control by ratio analysis" McGraw-Hill.

142)

Stokes P. M. (1968) "A Total Systems Approach to Management Control" American Management Association, Inc.

143) Taffler R. J. (1977), "Finding those Firms in Danger using Discriminant Analysis and Financial Ratio Data", City University Working Paper 3.

144)

Taffler R. J. (1982) "Forcasting Company Failure in the UK Using Discriminant Analysis and Financial Ratio Data" Journal of the Royal Statistical

Society, vol 145, pp 315-362

145) Tamari M.

(1978) "Financial Ratios: analysis and

application" Elek, London

146)

Tamari M. (1977) "Some Internationa Comparisons of Industrial Financing" Technology Ltd.

147) Tamari M. (1966), "Financial Ratios as a Mean of Forecasting Bankruptcy", Management International Review vol 4, pp 10-41.

148) Thomson G. H.

(1951) "The Factorial Analysis of

Human Ability" 4th edition, Boston: Houghton

361

149)

Thornton G. C. and Byham W. C. (1982) "Assessment Centres and Managerial Performance" Academic Press

150)

Thurstone L. L. (1947), "Multiple Factor Analysis", University of Chicago Press.

151) Tucker L. R., Koopman R. F.& Linn R. L. (1969) "Evaluation of Factor Analytic Research Procedures by means of Simulated correlation Matrices" Psychometrika vol 34 pp 421-459.

152)

Tucker S. A. (1961), "Successful Managerial Control by Ratio Analysis" Mc Graw-Hill book Co. Inc. New York, London.

153)

Vickers D. (1966), "Profitability and Reinvestment Ratios: A Note on the Gordon Paradox" Journal of Business Vol 39 pp 366-370.

154)

Wagner W. H.and Lau S. C.(1971) "The Effect of Diversification on Risk" Financial Analysts Journal, Nov-Dec pp 48-53.

155)

Wall A. and Dunning R. W. (1928), "Ratio Analysis of Financial Statements", Harper Brothers.

156)

Walter J.

E.(1957) "Determination of

Technical

Insolvency" Journal of Business Vol 30 pp 30-43.

157)

Walter J.

A.

(1959) "Discriminant Function for Ratios of Large Industrial

Earning-Price

Corporations" Review of Economics and Statistics, vol 41, pp 25-48

362

158) Weston J. F.and Brigham E. F.(1975), "Managerial Finance", fifth Edition, The Dryden Press, Hinsdale, Illinois.

159)

Westwick C.

A.

(1974) "How to Use Management

Ratios", London Gower Press Work book.

160)

White R. A. (1975) "Multivariate Analysis of Common Stock Quality Ratings", Financial Management Association Meeting, October USA.

161)

Whittington G.(1972) "The Profitability of Retained Earnings" Rewiew of Economics and Statistics Vol 54 pp 152-160.

162)

Wippern R. F. (1966) "Financial Structure and the Value of the Firm" Journal of Finance Vol 21 pp 615634.

163)

Wood E.

G.(1978), "Added Value", Edward Geoffrey

Wood, London.

164) Wright M.

G.(1973) "Discounted Cash Flow" Second

edition McGraw-Hill.

363

Sign up to vote on this title
UsefulNot useful