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Financial Management
Innovation and Technology Set
coordinated by
Chantal Ammi

Volume 6

Financial Management

USGAAP and IFRS Standards

Aldo Lévy
Faten Ben Bouheni
Chantal Ammi
First published 2018 in Great Britain and the United States by ISTE Ltd and John Wiley & Sons, Inc.

Apart from any fair dealing for the purposes of research or private study, or criticism or review, as
permitted under the Copyright, Designs and Patents Act 1988, this publication may only be reproduced,
stored or transmitted, in any form or by any means, with the prior permission in writing of the publishers,
or in the case of reprographic reproduction in accordance with the terms and licenses issued by the
CLA. Enquiries concerning reproduction outside these terms should be sent to the publishers at the
undermentioned address:

ISTE Ltd John Wiley & Sons, Inc.

27-37 St George’s Road 111 River Street
London SW19 4EU Hoboken, NJ 07030
UK USA

www.iste.co.uk www.wiley.com

© ISTE Ltd 2018

The rights of Aldo Lévy, Faten Ben Bouheni and Chantal Ammi to be identified as the authors of this
work have been asserted by them in accordance with the Copyright, Designs and Patents Act 1988.

Library of Congress Control Number: 2018931941

British Library Cataloguing-in-Publication Data

A CIP record for this book is available from the British Library
ISBN 978-1-78630-145-1
 Contents

Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . xi

Chapter 1. Value: IFRS vs. US GAAP . . . . . . . . . . . . . . . . . . . . . . . . 1

1.1. Value and the time . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
1.1.1. Cost of money, interest rate (nominal and real) . . . . . . . . . . . . . . 2
1.2. The time value of money: US GAAP . . . . . . . . . . . . . . . . . . . . . . . 3
1.3. Future value and present value: capitalization
and discounting in discrete time . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4
1.3.1. Simple interest . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4
1.3.2. Compound interest . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9
1.4. US GAAP: future value and present value
of rules of time travel . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10
1.4.1. US GAAP: Effective annual rate and
annual percentage rate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13
1.4.2. US GAAP: the determinants of interest rates . . . . . . . . . . . . . . . . . 16
1.5. Annuities and unearned income: IFRS . . . . . . . . . . . . . . . . . . . . . . . 19
1.5.1. Value of a sum of constant annuities . . . . . . . . . . . . . . . . . . . . . 19
1.5.2. Current value of a sum of constant annuities . . . . . . . . . . . . . . . . . 20
1.5.3. The updating of constant sums over an
infinite period: the return . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21
1.6. Calculating net present value and
future value: US GAAP . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22
1.6.1. Constant annuities of cash flows. . . . . . . . . . . . . . . . . . . . . . . . 22
1.6.2. Perpetuity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28
1.6.3. Growing cash flows . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30
1.7. Market value . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 35
1.7.1. Relation required rate: value . . . . . . . . . . . . . . . . . . . . . . . . . . 36
1.7.2. Valuation of fixed rate debt . . . . . . . . . . . . . . . . . . . . . . . . . . 37
vi Financial Management

1.8. Actuarial rate of return . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 38

1.9. Value and risk . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 40
1.9.1. Probabilities and expected returns . . . . . . . . . . . . . . . . . . . . . . . 40
1.9.2. Uncertain expected rate of return . . . . . . . . . . . . . . . . . . . . . . . 41
1.9.3. Couple profitability, a risk: representation
of expectation/standard deviation . . . . . . . . . . . . . . . . . . . . . . . . . . . 41
1.9.4. Introduction to diversification: the case of two assets . . . . . . . . . . . . 42
1.9.5. Notions of diversification and non-diversifiable risk . . . . . . . . . . . . 43
1.9.6. Modeling randomized profitability
with a two-factor model . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 45
1.10. Value and information . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 46
1.10.1. Information and uncertainty . . . . . . . . . . . . . . . . . . . . . . . . . 46
1.10.2. Information efficiency . . . . . . . . . . . . . . . . . . . . . . . . . . . . 50
1.10.3. Exercises . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 50

Chapter 2. Diagnosis of Financial Statements: IFRS . . . . . . . . . . . . . . 57

2.1. Economic and financial analysis of business data . . . . . . . . . . . . . . . . 57
2.1.1. Principles and levels of study . . . . . . . . . . . . . . . . . . . . . . . . . 57
2.1.2. Typology of financial analysis . . . . . . . . . . . . . . . . . . . . . . . . . 61
2.1.3. Destination of the financial statement analysis . . . . . . . . . . . . . . . . 63
2.2. Financial reading of the balance sheet . . . . . . . . . . . . . . . . . . . . . . . 66
2.2.1. Principles of financial statement preparation . . . . . . . . . . . . . . . . . 67
2.2.2. Mechanism . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 70
2.2.3. Functions: financing, investment,
exploitation and distribution . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 79
2.2.4. Investment study . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 95
2.2.5. Random analysis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 114
2.2.6. Undetermined analysis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 125

Chapter 3. Analysis of the Financial Structure:

IFRS vs. US GAAP . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 131
3.1. Major functions of the French Accounting Plan . . . . . . . . . . . . . . . . . 131
3.1.1. Assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 131
3.1.2. Current liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 133
3.1.3. Sustainable resources . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 135
3.1.4. Fixed assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 141
3.1.5. Calculation of global net revolving fund . . . . . . . . . . . . . . . . . . . 142
3.2. The need for working capital requirement (WCR) . . . . . . . . . . . . . . . . 144
3.2.1. WCRE (or WCE) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 145
3.2.2. WCREE . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 145
3.2.3. Recommendations on the need for working capital . . . . . . . . . . . . . 147
3.2.4. WCR in days of HVAC . . . . . . . . . . . . . . . . . . . . . . . . . . . . 149
 Contents vii

3.3. Net cash. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 154

3.3.1. Cash flow and the result are linked
without being correlated . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 155
3.3.2. Analysis and recommendations . . . . . . . . . . . . . . . . . . . . . . . . 156
3.3.3. Financial analysis in market value. . . . . . . . . . . . . . . . . . . . . . . 160
3.3.4. Presentation of the balance sheet
in net asset values . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 162
3.3.5. Structural risks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 164
3.3.6. The risk of imminent failure . . . . . . . . . . . . . . . . . . . . . . . . . . 164
3.3.7. Recommendations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 164
3.4. Balance sheet analysis: US GAAP . . . . . . . . . . . . . . . . . . . . . . . . . 164
3.4.1. Balance sheet features . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 165
3.4.2. Balance Sheet Diagnosis . . . . . . . . . . . . . . . . . . . . . . . . . . . . 170

Chapter 4. Analysis of Activity: Analysis of Profit

and Loss Account: IFRS vs. US GAAP . . . . . . . . . . . . . . . . . . . . . . . 179
4.1. Profitability and management performance . . . . . . . . . . . . . . . . . . . . 179
4.1.1. Intermediate Management Balances. . . . . . . . . . . . . . . . . . . . . . 180
4.1.2. Current exploitation. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 183
4.1.3. Non-operating current . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 191
4.2. Management indicators of the Banque de France . . . . . . . . . . . . . . . . . 193
4.2.1. Partial or current indicators . . . . . . . . . . . . . . . . . . . . . . . . . . 194
4.2.2. Global indicators . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 198
4.3. Correspondences of FCA indicators – Banque de France . . . . . . . . . . . . 200
4.4. CAF cash flow . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 202
4.4.1. Principles . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 202
4.4.2. FCA approach . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 204
4.4.3. Analysis of the Order of Chartered Accountants . . . . . . . . . . . . . . . 205
4.5. Renewed indicators (IFRS) of management . . . . . . . . . . . . . . . . . . . . 205
4.5.1. EBITDA . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 206
4.5.2. ROA . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 206
4.5.3. ROE . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 206
4.5.4. NOPAT . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 206
4.5.5. ROCE . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 206
4.5.6. COFROI . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 206
4.5.7. Free cash flow . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 207
4.5.8. EVA MVA . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 207
4.6. Income statement analysis: US GAAP . . . . . . . . . . . . . . . . . . . . . . . 207
4.6.1. Case study 1: Mydeco Corporation . . . . . . . . . . . . . . . . . . . . . . 221
4.6.2. Case study 2: Atlas . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 224
viii Financial Management

Chapter 5. Analysis of Operational Profitability

and Risk: IFRS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 227
5.1. Profitability according to the chosen full cost model . . . . . . . . . . . . . . . 228
5.1.1. Results Achieved in Full Cost by Analysis
Centers and Unit Cost of Indirect Costs . . . . . . . . . . . . . . . . . . . . . . . 228
5.1.2. Study . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 232
5.1.3. Results obtained in full cost by
activity (Activity by Costing) . . . . . . . . . . . . . . . . . . . . . . . . . . . . 232
5.2. Budget based on normal activity . . . . . . . . . . . . . . . . . . . . . . . . . . 235
5.2.1. Activity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 236
5.2.2. Budget for which indirect costs are unbundled
in terms of being variable and fixed . . . . . . . . . . . . . . . . . . . . . . . . . 236
5.2.3. Cost-effectiveness. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 236
5.2.4. Profitability . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 246
5.3. The breakeven point . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 249
5.3.1. Representation. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 250
5.3.2. Indicators of profitability . . . . . . . . . . . . . . . . . . . . . . . . . . . . 252
5.3.3. Decision-making . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 253
5.4. Operating leverage . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 262
5.5. Return on equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 270
5.5.1. Economic profitability . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 271
5.5.2. Leverage . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 272
5.5.3. Financial Leverage . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 272

Chapter 6. Analysis by Ratios: IFRS . . . . . . . . . . . . . . . . . . . . . . . . . 277

6.1. Composition and evolution ratios . . . . . . . . . . . . . . . . . . . . . . . . . 277
6.1.1. Flow/Level . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 279
6.1.2. Level/Level . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 280
6.1.3. Levels/Flows . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 283
6.1.4. Flux/Flux . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 285
6.1.5. Flow/Level . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 286
6.1.6. Combination . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 287
6.2. Database . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 289
6.2.1. Activity ratios, profitability, balance, investment,
debt, profitability of the Banque de France . . . . . . . . . . . . . . . . . . . . . 290
6.2.2. Expeditious method of credit managers . . . . . . . . . . . . . . . . . . . . 300

Chapter 7. Analysis by Flux Tables: IFRS vs. US GAAP . . . . . . . . . . . . 305

7.1. Functional chart of the French Accounting Plan . . . . . . . . . . . . . . . . . 306
7.1.1. Table of changes in total net working capital WC . . . . . . . . . . . . . . 306
7.1.2. Table of changes in working capital requirement . . . . . . . . . . . . . . 323
 Contents ix

7.1.3. Synoptic diagram of the links between

two-year financial statements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 326
7.2. Financing table of the Banque de France . . . . . . . . . . . . . . . . . . . . . 327
7.2.1. Functional balance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 327
7.2.2. Cash flow statement . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 330
7.3. Cash flow statement of the French Association
of Chartered Accountants . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 339
7.3.1. Net cash flows from operations . . . . . . . . . . . . . . . . . . . . . . . . 339
7.3.2. Net cash flows from investments . . . . . . . . . . . . . . . . . . . . . . . 342
7.3.3. Net cash flows related to financing . . . . . . . . . . . . . . . . . . . . . . 342
7.3.4. Change in balance sheet cash position . . . . . . . . . . . . . . . . . . . . 343
7.3.5. Diagnosis of the financing table of the French
Association of Chartered Accountants . . . . . . . . . . . . . . . . . . . . . . . . 343
7.4. Free cash flow table spanning several years . . . . . . . . . . . . . . . . . . . . 345
7.4.1. The method . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 347
7.5. Summary of the restatements of financing and flow tables . . . . . . . . . . . 353
7.5.1. Table . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 353
7.5.2. Risk diagnosis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 354
7.6. Statement of cash flow analysis: US GAAP . . . . . . . . . . . . . . . . . . . . 359
7.6.1. Features of cash flow statement . . . . . . . . . . . . . . . . . . . . . . . . 359
7.6.2. Cash flow statement diagnosis . . . . . . . . . . . . . . . . . . . . . . . . . 362
7.7. Statement of stockholders’ equity . . . . . . . . . . . . . . . . . . . . . . . . . 364

Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 367

Glossary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 369

Bibliography . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 379

Index . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 381
 Introduction

The International Financial Reporting Standards (IFRS) are standards issued by

the IFRS Foundation and the International Accounting Standards Board (IASB)1 to
provide a common global language for company accounts. IFRS are understandable
and comparable across international boundaries even in the context of alternative
finance [LEV 15]. They are particularly important for companies that have dealings
in several countries. They are progressively replacing the different national
accounting standards. They represent rules to be followed by accountants to
maintain books of accounts which are comparable, understandable, reliable and
relevant as per the users, internal or external.

Generally Accepted Accounting Principles (GAAP or US GAAP) is the

accounting standard adopted by the U.S. Securities and Exchange Commission
(SEC)2. The GAAP are a common set of accounting principles, standards and
procedures that companies must follow when they compile their financial
statements. GAAP is a combination of authoritative standards and the commonly
accepted ways of recording and reporting accounting information.

1 “The International Accounting Standards Board (IASB) is an independent, private-sector

body that develops and approves International Financial Reporting Standards (IFRSs). The
IASB operates under the oversight of the IFRS Foundation. The IASB was formed in 2001 to
replace the International Accounting Standards Committee” [DEL 17].
2 The U.S. Securities and Exchange Commission (SEC) is an independent agency of the
United States federal government. The SEC holds primary responsibility for enforcing the
federal securities laws, proposing securities rules, and regulating the securities industry, the
nation’s stock and options exchanges, and other activities and organizations in the United
States. “During the peak year of the Depression – passed the Securities Act of 1933. This law,
together with the Securities Exchange Act of 1934, which created the SEC, was designed to
restore investor confidence in our capital markets by providing investors and the markets
with more reliable information and clear rules of honest dealing” [SEC 34].
xii Financial Management

The US GAAP are the accounting standards used in the USA, while IFRS is the
accounting standard used in over 110 countries around the world. GAAP is
considered a more “rules based” system of accounting, while IFRS is more
“principles based”.

IFRS standards were proposed to harmonize accounting across the EU, but then
these standards quickly became very attractive around the world. While the SEC has
stated that it intends to move from US GAAP to the International Financial
Reporting Standards (IFRS), the latter differs considerably from US GAAP.

Convergence between IFRS and US GAAP has looked increasingly uncertain

over the past few years and now, with the International Accounting Standards Board
(IASB) and the Financial Accounting Standards Board (FASB)3 pursuing their own,
independent agendas and today US GAAP converge more and more to IFRS, the
most used accounting standards in the world.

Consequently, it continues to be essential for the US to be involved in the

development and application of IFRS because of: (1) the number and significance of
foreign private issuers using IFRS in the US capital markets; and (2) the number of
US companies investing abroad and having either to issue IFRS financial statements
within the group, or use and analyze IFRS financial statements to manage their joint
arrangements and other investment opportunities.

Thus, an understanding of the differences between IFRS and US GAAP

continues to be important for preparers and users of financial statements. In this
book, we attempt to present and analyze financial statements and financial analysis
differences. This book does not discuss every possible difference; rather, it is a
summary of those areas encountered frequently where the principles differ or where
there is a difference in emphasis or specific application guidance.

3 “Established in 1973, the Financial Accounting Standards Board (FASB) is the

independent, private-sector, not-for-profit organization based in Norwalk, Connecticut, that
establishes financial accounting and reporting standards for public and private companies
and not-for-profit organizations that follow Generally Accepted Accounting Principles
(GAAP). The FASB is recognized by the Securities and Exchange Commission as the
designated accounting standard setter for public companies. FASB standards are recognized
as authoritative by many other organizations, including state Boards of Accountancy and the
American Institute of CPAs (AICPA). The FASB develops and issues financial accounting
standards through a transparent and inclusive process intended to promote financial
reporting that provides useful information to investors and others who use financial reports”
[FAS 17].
 Introduction xiii

Following US GAAP, we discuss some of the financial ratios that investors and
analysts use to assess a firm’s performance and value. Recall that U.S. public
companies are required to file their financial statements with the SEC on a quarterly
basis on form 10-Q and annually on form 10-K. They must also send an annual
report with their financial statements to their shareholders each year. Private
companies often prepare financial statements as well, but they usually do not have to
disclose these reports to the public. Financial statements are important tools through
which investors, financial analysts, and other interested outside parties (such as
creditors) obtain information about a corporation. They are also useful for managers
within the firm as a source of information for corporate financial decisions. Every
public company is required to produce four financial statements: the balance sheet,
the income statement, the statement of cash flows and the statement of stockholders’
equity. These financial statements provide investors and creditors with an overview
of the firm’s financial performance.

This review can be read continuously or sequentially according to the needs of

the readers.

Each chapter, relatively independent of the others, alternates between theoretical

elements, practical elements and corrected application exercises.

In the first chapter, we approach the notion of value, a basic element, essential
for a good understanding of the rest of the book.

Chapter 1 – Value: IFRS vs. US GAAP

We will see successively the notions of time, risk and information:

– Value and time, where the following notions will be addressed:
- Costs of money (interest rates);
- Value of money according to US GAAP;
- Future value and present value (simple interest and compound interest);
- Future value and present value under US GAAP;
- Annuities and unearned income: IFRS;
- Calculation of net and future values in accordance with US GAAP;
- Market value (valuation of debt);
- Actuarial rate of return;
xiv Financial Management

– The value and risk of the notions of:

- Probabilities and expected returns;
- Expected uncertain rate of return;
- Profitability–risk couple;
- Introduction to diversification;
- Diversification and non-diversifiable risks;
- Modeling randomized profitability with a two-factor model;
– Value and information, where the following notions will be addressed:
- Information and uncertainty, (financial market, value, information and market
price (stocks and bonds);
- Information efficiency.

To analyze in detail the financial states used in Corporate Finance (in France
with the PGC or abroad with IFRS standards), we will follow the six steps taken by
financial analysts that will constitute the different chapters of this book.

Chapter 2 – Diagnosis of Financial Statements: IFRS

The classical approach to an investigation takes place in four stages:

– the analysis that identifies the nature of a problem, a situation, etc., by
interpreting the elements;
– the diagnosis which consists of a thorough examination of the elements to
make them more accessible, determine the content, study their relative autonomy,
and assess their purpose and their efficiency;
– the prognosis that aims to predict the evolution of a situation based on the
study of theoretical and practical data and information;
– a preconization that proposes advice and recommendations for the perpetuation
or even the liquidation of an entity.

We shall detail in turn:

– economic and financial analysis of company data;
– the financial reading of the balance sheet.
 Introduction xv

Chapter 3 – Analysis of the Financial Structure: IFRS vs. US GAAP

Functional analysis of financial statements relates to the balance sheet structure

and operating flows in the income statement. The asset is presented in an ascending
order of liquidity and the liabilities per growing demand.

We will discuss in turn:

– The main functions in the French chart of accounts (assets and liabilities),
Finance, Investment, Operations and Allocation, which are presented in the order of
possible liquidity (Financing, Operations).
– The analysis of working capital requirements (WCR), which can be carried out
over one year (static) or over several years (dynamic) and deals with the structural
analysis of the balance sheet.
– The treasury, which consists of cash availabilities and equivalents. The
treasury is composed of immediate availability and cash equivalents of highly liquid
short-term investments that are readily convertible to cash.
– Balance sheet analysis in accordance with US GAAP.

Chapter 4 – Analysis of Activity: Analysis of Profit and Loss Account:

IFRS vs. US GAAP

The analysis of the company’s activity, which is the starting point for any
diagnosis, is based on the short term, and allows us to appreciate the growth of the
company and measure its profitability.

We shall analyze in turn the following points:

– The notion of profitability and managerial performance: profitability, the
propensity to yield a profit (profit margin), relates to the net accounting result and to
performance indicators such as intermediate balances of management of the PCG or
the few indicators under IFRS. It should not be confused with efficiency which, in
turn, yields the result on invested capital and is strictly based on a balance sheet
analysis (balance sheet profit and balance sheet capital).
– The Banque de France’s (Bank of France) management indicators: they are
based on the analysis of the behavior of companies grouped together in different
sectors of activity, and are therefore closer to the logic of IFRS than to that of PCG.
xvi Financial Management

– The correspondence of the PGC-Bank of France indicators: the Banque de

France complies with the analysis of the PCG for the allocation of accounts, taxes
and similar payments and interest which are no longer considered systematically as
remuneration of the State in the first case or of personnel in the second.
– Cash flow: profit sheets consist of two types of cash flows, those having an
influence on the cash position during the year and those that have no influence. We
will discuss the approach by the PGC and then by the Order of Chartered
Accountants.
– Renewed management indicators (IFRS): management accounts have been
renewed by the ascendancy of IFRS. EBITDA, ROA, ROE, NOPAT, ROCE,
COFROI, FREE CASFLOW and EVA MVA have been added to the old indicators
without any standardization.
– Analysis of results in accordance with US GAAP standards.

Chapter 5 – Analysis of Operational Profitability and Risk: IFRS

Efficiency, profitability, cash flow, etc., depend on the financial accounting

results (balance sheet and income statement). However, these come from the
elements of the social accounts which themselves are composed of items that do not
all originate from an invoice.

We shall therefore see successively the following elements:

– The tree structure of the models for calculation of costs.
– Profitability depending on the full cost model chosen: company profit depends
on the sales of the products and the necessary expenses. Since expenses are
components of costs, the way they are calculated influences the outcome.
– The budget: a distinction is made between budgets in partial costs and those in
full cost. The resulting performance varies according to the budgetary choice.
– Break-even point: profitability is determined by the ratio between two items in
the income statement variable cost margin VCM/Sales Turnover.
– Operating leverage: leverage allows us to multiply an action. There is an
operating leverage effect that measures the sensitivity of the current result Cr,
compared with a Δ of the turnover and the leverage effect that depends primarily on
the financial burden on the company’s profitability.
– Return on equity: profitability is calculated by dividing the annual net profit of
the income statement and the balance sheet into equity; this ratio is called Return on
Equity (ROE).
 Introduction xvii

Chapter 6 – Analysis by Ratios: IFRS

The diagnosis must be enriched by the determination of the relative values

allowing us to situate the company in space and in time.

We will detail the following:

– Composition and evolution ratios: ratio analysis compares data on the Balance
Sheet and the restated income statement for financial analysis, in order to derive
relevant data for diagnosis and recommendations (Flux/Level, Level/Level,
Level/Flux, Flux/Flux, Flux/Level).
– The database of the Central Balance Sheets, CBS. The information managed
by the BdF constitutes “a database of companies monitored individually over time”.
The CBD is based on the French NAF Activity List, which codifies the activity of
the different companies according to their main activity code EPA.

Chapter 7 – Analysis by Flux Tables: IFRS vs. US GAAP

Dynamic analysis of fund flows and cash flows is used to judge the company’s
ability to prevent potential failures. The tables explaining the change in the cash
position of the balance sheet can be classified into two main categories:
– The financing chart of the PCG General Chart of Accounts explains the change
in treasury by the difference between the change in working capital and the change
in the working capital requirement.
– The cash flow tables explain the change in fund flows by its origins in the main
functions: current, investment and financing.

We will discuss the different financing and existing cash flow tables:
– the PGC functional funding table;
– the Banque de France’s financing table is typical of a comparative analysis. It
falls between the functional analysis of the General Chart of Accounts and the IFRS
for the purposes of international comparison;
– the cash flow chart for the Ordre des Experts Comptables explains the change
in the cash position of the balance sheet, not as recommended by the PCG but by
finding cash flows within each of the functions that generated them: activity,
financing and investment;
xviii Financial Management

– the multi-annual Free Cashflow table: the current activity of a company

generates cash, but also consumes a portion of this cash through the necessary
maintenance of fixed assets and the financing of the positive variations in the
working capital requirement;
– the synthesis of the restatements of the financing tables and the useful flows to
compare the different components that constitute them;
– analysis of the statement of cash flows according to US GAAP;
– the statement of equity.

This book will end with a Glossary of Economic and Financial Concepts

We hope this book is useful to you. Do not hesitate to go back to some chapters
and start the exercises again if necessary.

Enjoy!
 1

Value: IFRS vs. US GAAP

“... value does not wait for the number of years ...” wrote P. Corneille. This may
be true for humans but certainly not for capital. It is of course not equivalent to have
a sum of money now or later. If we invest this amount, we will not hold it until
maturity and we lose the opportunity to invest it elsewhere. This time lost
opportunity has a cost. The latter, which would make immediate or later provision
equivalent, is called interest. The legal or normal person who needs money and the
person who wants to make capital available will agree on the price, that is to say, the
equivalent interest rate. Therefore, value and time (1.1) are functions of the interest
rate. As in the future, there is no certainty that the expected value carries a share of
risk (1.2) that is paid in proportion to the risk incurred, so there will be a risk
premium to pay. The better the investor is informed about the readability of his
investment horizon, the better he can adjust the requested rate. Therefore, the value
and the information (1.3) available are correlated. Thus, the interaction between
value, time, risk and available information is discussed in this chapter.

1
1.1. Value and the time

“Is it worth the cost” – is this common sense often referred to? For financial
investment, this cost of money is an expected profit, called interest rate.

1 A portion of the French version of section 1.1 was written by David Heller, professor at ISC
Paris.

Financial Management: USGAAP and IFRS Standards, First Edition.

Aldo Lévy, Faten Ben Bouheni and Chantal Ammi.
© ISTE Ltd 2018. Published by ISTE Ltd and John Wiley & Sons, Inc.
2 Financial Management

1.1.1. Cost of money, interest rate (nominal and real)

The rates fixed for financial transactions are annual. If the latter takes place on a
space–time less than the year (months, quarters, semesters), the rate is pro-rated at
the annual rate.

EXAMPLE.– An annual rate of 5% is equivalent to the following rates:

– monthly: 5% / 12 = 0.42%;
– quarterly: 5% / 4 = 1.25%;
– half-yearly: 5% / 2 = 2.5%.

The economic agents can choose a fixed rate (rate unchanged until the end of the
transaction) or a variable rate (rate revised according to a reference rate based on the
money or bond market).

The real interest rate corresponds to the nominal interest rate adjusted for
inflation. Let:

1 + n = (1 + r) × (1 + i)

1+r=

where:
– n: nominal rate
– r: real rate
– i: inflation rate

EXAMPLE.– The one-year inflation rate is 1.5%. What is the real interest rate for a
paid investment at 4%?
%
1+r= = 1.0246
. %

r = 2.46% Only

The non-disposition of annual sums at a cost results in interest. If an amount is

saved each year for retirement, e.g. in order to dispose at the end of a capital, this is
called capitalization. If, on the other hand, we wonder how much they will have at
the end if they invest a sum of money at present at a certain rate over a certain
period of time, this is called discounting.
 Value: IFRS vs. US GAAP 3

1.2. The time value of money: US GAAP

A timeline is a linear representation of the timing of potential cash flows. Thus,

drawing a timeline of the cash flows will help you visualize the financial problem.

Example 1

Assume that you expect to receive two payments, one at the end of each year
over the next two years.

The time line of your inflows is the following:

It is very important to differentiate between two types of cash flows

– Inflows are positive cash flows;
– Outflows are negative cash flows, which are indicated with a – (minus) sign.

Example 2

Assume that you are investing $10,000 today and that the project will generate
two annual $6,000 cash flows. The first cash flow at date 0 (today) is represented as
a negative sum because it is an outflow (investment). The expected profits for the
two next years are Inflows. The timeline of this project can be represented as
follows:

Example 3

You have a bank loan and you make monthly payments of $2000. The mortgage
has 26 years to go. Show the timeline from your perspective. How would the
timeline differ if you created it from the bank’s perspective?
4 Financial Management

Answer

You make a monthly payment (Outflows) of $2000 over 26 years (26*12 = 312
months):

0 1 2 3 4 312

–2000 –2000 –2000 –2000 –2000

From the bank’s perspective, the timeline would be identical except with
opposite signs (inflows).

1.3. Future value and present value: capitalization and discounting in

discrete time

Capitalization corresponds to the value acquired from an initial amount, placed

at rate i, after n periods. Actualization results from the inverse process, that is to say,
from a known amount at a future date, hence it is possible to determine the present
value (at the date of the decision).

Two methods of calculating remuneration via interest rates can be envisaged: simple
interest for investments of one-year duration and compound interest for investments with
a maturity of more than one year, including interest from previous years.

1.3.1. Simple interest

In principle, interest is paid once, when the funds are repaid to the investor at
maturity. The interest rate is necessarily nominal, that is to say, annual.

Figure 1.1. Future value of a placement by simple interest

If the term of investment is one year, the compensation is equal to the product of
the nominal rate multiplied by the amount of the investment and the final value of
the investment is:
= + = (1 + )
 Value: IFRS vs. US GAAP 5

where:
– V1: value of the final placement after one year;
– V0: initial offering amount;
– i: interest rate (investment compensation).

EXAMPLE.– An investor invests €150 over one year at a nominal rate of 2%. What is
the final value of the investment at the end of the year?

V = 150 × (1 + 2%) = €153

If the duration of the investment is less than one year, a remuneration

proportional to that period (pro rata temporis) should be calculated. Thus, if the
duration of the investment is one month, it is legitimate for the compensation to be
12 times lower than the remuneration of a one-year investment since the term of the
capital is not the same. Moreover, in the case of treasury operations lasting up to one
year, French banks consider a 360-day business year with a 30-day period each
month. Only banks in Great Britain and the former Commonwealth countries
assume one year to be 365 days. Therefore, we have:

= 1+

where:
– Vn: final value of the financial investment after n days;
– V0: initial value of financial capital;
– i: interest rate = return on investor investment = cost of borrower;
– n: number of days before maturity.

Conversely, if we know the value that will be acquired Vn of an investment after

n days, we can deduce its current or updated value V0.

Figure 1.2. Value of a simple interest investment

6 Financial Management

In this case, the formula is:

We can then deduce n and i:

– The profitability or the annualized return in which the rate i of an investment
for n days:

= 1+

−1=

= −1

– The duration in n days allowing an initial capital V0, placed at nominal rate i,
to become Vn:

= −1

These formulae are used in particular to value securities issued by companies

wishing to take on a debt without resorting to the bank loan called negotiable debt
instrument (NDI). Investors (individuals, companies, UCITS, etc.) of excess
liquidity then subscribe. The name of the TCN varies according to the issuer, and it
is called:
– a treasury bill when the issuer is an industrial or commercial enterprise;
– a certificate of deposit where the issuer is a bank;
– a treasury bill when the issuer is a state.

To the extent that the investor needs to regain liquidity, it is possible for the
investor to resell his NDI before the end of the investment.

EXAMPLE.– An investor with €500,000 of cash to invest for 4 months subscribes to

the issuance of a Treasury bill from Alpha. The characteristics of the equity are as
follows:
– the nominal value is € 500,000. This is the amount borrowed by Alpha and will
therefore have to be repaid at maturity (without taking interest into account);
 Value: IFRS vs. US GAAP 7

– the nominal rate of the investment is 3%. This is the rate on the basis of which
the interest will be paid by Alpha at maturity to the bearer of the Treasury. Note that
this is regardless of the evolution of rates on the money market;
– the lifetime of the NDI is 4 months. In other words, the maturity date of the
Treasury Note is 4 months after its issue.

After 3 months, liquidity needs lead the investor to resell his NDI. At that date,
the reference rate on the money market increased to 5%.
1) Determine the amount received if the security is held to maturity.

= 1+

%×
V = 500 000 × 1 + = €505, 000

NB: 4 months correspond to 120 days (4 × 30 days)

2) Determine the resale price of the Treasury bill after three months.

Let P be the resale price after 3 months. P ratio must be set so that the return that
will be provided to the new NDI buyer is the same as the return they would obtain
from a money market investment (5%) over the same period as that remaining
before the deadline (30 days). To the extent, Alpha pays the sum of € 505,000 at the
due date, regardless of whether the holder of the security (calculated in question 1),
P, satisfies:
%×
1+ = €505 000

Knowing that:

Here, V0 corresponds to P. We then have:

= %× = €502,905

3) Determine the rate of return of the investment during these three months.
8 Financial Management

The initial investor placed €500 000 for 90 days and resold the NDI at €502, 905.
Let ‘i’ be the effective return of his investment:

500 000 1 + = 502 905

−1 =

= − 1 = 2.32%

Rising rates lead the initial investor to obtain a lower yield than he would have
obtained by retaining his title until maturity.

Conversely, if the reference rate had been reduced to 1% 30 days before maturity
(the date of resale of the NDI), the resale price P ‘of the Treasury Note would have
been:
%×
′ 1+ = €505,000

Knowing that:

Here, V0 corresponds to P’. We then have:

′= %× = €504,580

Let i’ be the return on investment:

500 000 1 + = €504,580

−1 =

= − 1 = 3.67%

In this case, the decline in interest rates benefits the original investor who gets a
higher return on his investment by reselling his NRS rather than retaining it until
maturity.
 Value: IFRS vs. US GAAP 9

1.3.2. Compound interest

To the extent that compound interest consists of investments or borrowings with

a maturity date of more than one year, interest earned in each year will in turn be of
interest. This involves capitalization or the composition of interests.

If V0 corresponds to the amount invested at the nominal rate i for n years and Vn
is the value of the investor’s assets after n years, then Vn bears the name of the
acquired value.

Figure 1.3. Future value of an investment by compound interest

V = V + iV = (1 + i)V

V = V + iV = (1 + i)V = (1 + i)(1 + i)V = (1 + i) V

V =V + iV = (1 + i)V = (1 + i) … (1 + i)V = (1 + i) V

V = (1 + i) V n times

EXAMPLE.– An investor places €10, 000 in a savings book A for 5 years at 1%. The
amount of its assets at the end of the 5 years is as follows:

V = (1 + 1%) × 10 000 = €10, 510

So, €510 interest.

Conversely, if we know the acquired value Vn of an investment after n years, it

is possible to deduce its current (or updated) value V0.
Another random document with
no related content on Scribd:
 other foreigners, 15,558;"
total, 148,928.

SOUTH AFRICA:
The Transvaal: A. D. 1894.
The "Commandeering" question.
Visit of the British High Commissioner to Pretoria.
Demonstration of British residents.

The first question which came to a sharp issue between the

government of the South African Republic and the British
subjects resident in the gold fields related to the claim
which the former made on the latter for military service in
the wars of the Republic with neighboring native tribes. The
demand for such service was made, in each case, by what was
called a "commando," the commando being defined in the
military law of the Boers as follows: "By commando is
understood a number of armed burghers and subjects of the
state called together to suppress rebellion amongst the
natives, or disturbances amongst the white population."
British residents protested against the requirement of this
service from them; and the British Government, in 1894, opened
negotiations with that of the Boer Republic to obtain their
exemption from it. It was acknowledged that there is "nothing
contrary to international comity in the application of such a
law as the commando law to a foreigner"; but, said the British
Colonial Secretary, in a despatch (June 8, 1894) giving
instructions to the British High Commissioner in South Africa,
"Her Majesty's Government consider that a special reason for
now claiming exemption for our people is afforded by the fact
that treaties have been concluded by the South African
Republic under which, as they understand, the subjects of no
less than seven Powers—Portugal, Holland, Belgium, Germany,
France, Italy, and Switzerland—are now exempt from this
liability; and they consider that they can hardly be expected
to acquiesce in a state of things under which Her Majesty's
subjects, whose interests in the South African Republic are
 greater and more intimate than those of any other Power,
should remain in a position of such marked disadvantage. I
have therefore to instruct you to address, in moderate and
courteous terms, a friendly representation to the Government
of the South African Republic on the subject."

Negotiations on the subject were then opened, which led to a

visit to the Boer capital by the British High Commissioner,
Sir H. B. Loch, on invitation from President Kruger. His
arrival at Pretoria (June 25) gave occasion for a
demonstration on the part of British residents which showed
the state of feeling existing more plainly, no doubt, than it
had appeared before. The circumstances were reported a few
days later by the High Commissioner, as follows: "When I
entered the carriage with President Kruger, two men got on to
the box with a Union Jack, and the crowd, notwithstanding the
President's remonstrances, took the horses out and dragged the
carriage to the hotel, a distance of nearly a mile, singing all
the way 'God save the Queen,' and 'Rule Britannia.'
{461}
On arrival at the hotel, the address was presented, to which I
briefly replied, and then called for three cheers for the
President, which were heartily given. He was then dragged in
his carriage to the Government Office. I am satisfied that no
personal insult was intended, by this demonstration, to the
President, and any annoyance with which he viewed the
occurrence seemed to be caused from the fact of the
arrangements for keeping order having been so defective. The
political atmosphere, however, was charged with such an amount
of electricity that every moment an explosion was imminent.
The Legislative and Executive enactments which press heavily
on the great industry which contributes upwards of £1,000,000
annually out of a total revenue of little more than a million
and a quarter, without the population that produces this
wealth possessing any franchise rights, or voice in the
government of the country, has created a deep-seated feeling
of dissatisfaction, shared alike by the English, American,
German, and other foreign residents in the country. The
compulsory commandeering was the last straw that broke down
the patience they had hitherto exhibited. … The Transvaal
Government were, before my arrival, seriously alarmed at the
state of feeling at Johannesburg, but when they came to
consider the real meaning of the demonstration on my arrival
at Pretoria, which showed to them how general the
dissatisfaction was amongst all classes of British subjects,
who formed the majority of the whole population of the
Republic, they, for the first time, realised the imminent
danger of the situation, and told me of their dread of a
collision that at any moment might occur between the Boer
burghers, who were in considerable numbers in the town, and
the English and foreign residents."

To avoid any further excitement of feeling, the Commissioner

declined to visit Johannesburg, which he had intended to do.
During his stay at Pretoria, he submitted to President Kruger
the draft of a Convention stipulating that "the subjects of
Her Majesty the Queen whilst residing within the limits of the
South African Republic, and the citizens of the South African
Republic whilst residing within the dominions of Her Majesty
the Queen, shall enjoy the same rights and privileges as the
subjects of the most favoured nation with regard to military
service and all obligations of a like nature"; and he received
from President Kruger a counter proposition, for the
negotiation of a new agreement, to take the place of the
London Convention of 1884, embodying the desired provision
concerning military service, along with other amendments of
the old Convention. To this proposal, President Kruger added:
"In order, however, to meet the request of Her Majesty's
Government, the Government will, in the meantime,
provisionally, no more commandeer British subjects for
personal military service." Practically, this assurance
disposed of the commandeering grievance; but no Convention on
the subject was attained.
 Great Britain, Parliamentary Publication.
(Papers by Command, C. 8159).

"A great mass meeting was held at Johannesburg (July 14) for
the purpose of demanding that the franchise should be extended
to all aliens, and insisting that the Constitution should be
amended and made more genuinely democratic. In consequence of
this meeting the Volksraad passed at one sitting two readings
of a bill restricting severely the right of public meeting. No
outdoor meetings or addresses were to be allowed, and an
assemblage of six persons would be considered a public
meeting. The police were given power by this bill to order
those present to disperse, and everyone attending was made
liable to imprisonment for two years, while the callers of any
meeting that the police might consider to be against the
public peace might be fined £500 or sentenced to two years
hard labour. … On the return of the 'commandeered' men from
the war [with the rebellious chief Malaboch] President Kruger
welcomed them, and said that no doubt the Volksraad would
bestow on them the rights of full citizenship. The effect of
the Franchise Act passed in June, however, was in general to
prevent any citizen from obtaining the franchise unless his
father was born in the State or had been naturalized. The
formation of committees by aliens for the support of political
candidates was rendered penal. … The Volksraad postponed for
one year the consideration of the Government proposal to grant
the franchise to the foreign residents who had recently served
in the various 'commandos' against the Kaffir rebels."

Annual Register, 1894, page 369.

SOUTH AFRICA:
British South Africa Company: A. D. 1894-1895.
Extended charter and enlarged powers of the Company.
Its master spirit, Mr. Cecil J. Rhodes.
Attitude towards the South African Republic.
 The British South Africa Company, royally chartered in 1889
for the promotion of "trade, commerce, civilization and good
government" in "the region of South Africa lying immediately
to the north of British Bechuanaland, and to the north and
west of the South African Republic, and to the west of the
Portuguese dominions," was now in full possession, both
politically and commercially, not only of the great domain of
the Matabeles and the Mashonas, stretching to the Zambesi
River, but likewise of a vast territory beyond that stream.
Its charter had been extended in 1891, to cover the whole
sphere of British influence north of the Zambesi, except the
strip of country called Nyassaland, which borders the western
shore of Nyassa Lake. It had subjugated the Matabeles,
extinguished their kingdom, driven its native sovereign, Lo
Bengula, to exile and death.

See in volume 4,
SOUTH AFRICA: A. D. 1885-1893.

By a new agreement with the British Government, signed on the

23d of May, 1894, it had received political authority over
this imperial domain, in addition to the powers and privileges
which its broad charter gave.

The administration of the government of the region was to be

conducted by the Company, under an Administrator and a Council
of four members composed of a Judge and three other members.
The Administrator to be appointed by the Company, with the
approval of the Colonial Secretary, and to be removed either
by the Secretary or by the Company, with the approval of the
Secretary. The Judge, appointed by the Company, with the
approval of the Colonial Secretary, and removable only by the
Secretary, was to be a member of the Council ex officio.
{462}
The members of the Council, other than the Judge, to be
appointed by the Company, with the approval of the Secretary,
and to be removable by the Company. … The Administrator
should, as representative of the Company, administer the
government, but must take the advice of his Council on all
questions of importance. In cases of emergency, when he found
it impracticable to assemble a quorum, the Administrator might
take action alone, but must report such action to the Council
at its next meeting. Moreover, he might overrule the Council,
but must, in that case, report the matter forthwith to the
Company, with the reasons for his action; and the Company
might rescind the decision of the Administrator, whether made
with, or without, or against, the advice of the Council. With
the concurrence of at least two members of the Council, and
with the approval of the British High Commissioner for South
Africa, the Administrator was empowered to frame and issue
regulations, which should have the force of law; but the
Colonial Secretary or the Company could veto any such
regulation at any time within twelve months of the date of
approval by the High Commissioner. This power of making
ordinances included the power to impose such taxes as might be
necessary, and the right to impose and to collect customs
duties. The armed forces of the Company were expressly
forbidden to act outside the defined limits of its territory
without the permission of Her Majesty's Government.

The master spirit of the Company which exercised these

imperial powers of government over so great a dominion in
Africa was Mr. Cecil J. Rhodes, Premier of Cape Colony,
organizer and chief of the De Beers Consolidated Mining Co. in
the diamond fields,—millionaire projector and manager of
everything stupendous in the enterprises of the African world.
He seemed, in fact, to be more than a master spirit in the
Company. Apparently he had created it as an instrument of his
ambitions, and it moved in his shadow throughout. Its
Administrator, Dr. Leander S. Jameson, was his closely
confidential friend. Presently it stamped his name on the
broad empire which bore already the stamp of his personality
and will, by proclaiming (May 1, 1895): "The territories now
or hereafter placed under the control of the British South
 Africa Company shall be named collectively Rhodesia. The
provinces at the present time included in the territory of
Rhodesia are Mashonaland, Matabeleland, and Northern
Zambesia." Great ambitions—imperial ambitions—had thus come
to be powerfully embodied in a corporation which practically
served the will of one remarkably able man. They were
ambitions which had been in conflict from the beginning with
the interests as well as the ambitions of the Boers of the
South African Republic, and the conflict was not to be ended
by the triumph which the Rhodesians had won. Naturally the
Boer was jealous and distrustful of the energetic men who had
seized lands which he desired and hemmed his republic in.
Naturally, too, the bold adventurers of Rhodesia, arrogant in
their success and as little scrupulous as "empire-builders"
are apt to be, looked with contempt and impatience at the
plodding Boer, as an obstacle to their booming development in
Africa of a civilization "up to date." Between the two
incongruous neighbors rose the cry of the angry Uitlanders at
Johannesburg, threatening the one and appealing to the
sympathy of the other. The consequences soon appeared.

SOUTH AFRICA:
The Transvaal: A. D. 1895 (July).
Opening of Delagoa Bay Railway.-

The opening of the railway to Delagoa Bay was celebrated with

much ceremony at Pretoria on the 8th of July.

SOUTH AFRICA:
The Transvaal: A. D. 1895 (September-December).
Closing of Vaal River "drifts" (fords) as ports of entry.
Anger in Cape Colony.
A threatening situation.

In September, the government of the South African Republic

adopted a measure, for the benefit of its new railway,
connecting Delagoa Bay with Pretoria, and for the development
of foreign trade via Delagoa Bay rather than through Cape
Colony, which raised a storm of indignation at the Cape,
giving birth to a grievance there which became for a time more
threatening than the grievances of the Uitlanders of the Rand.
The measure in question was one that closed the "drifts" or
fords of the Vaal River, between Cape Colony and the
Transvaal, as ports of entry for the importation of over-sea
goods. As stated by the British High Commissioner, in a
despatch (October 7) to Mr. Chamberlain, the British Colonial
Secretary, the history of the case is as follows:

"In the year 1891 the Cape Government came to an agreement

with the Transvaal Government and the Netherlands Railway
Company to advance the latter £600,000 towards the
construction of the railway from the Vaal river to
Johannesburg, receiving in exchange for such advance
Netherlands Railway Company 4 per cent. bonds at £93,
guaranteed by the Transvaal Government. It was stipulated in
the agreement that the Cape Government might fix the traffic
rates on the Transvaal extension until the close of 1894, or
until the completion of the railway from Delagoa Bay to
Pretoria, if such completion should take place before that
date. The railway extension from the Vaal river so provided
for was opened in September, 1892, and the Cape Government
secured thereby, during the continuance of the agreement,
practically the monopoly of the Johannesburg traffic. The
agreement terminated on the 31st December, 1894, the Delagoa
Bay to Pretoria Railway having shortly before been completed
and commenced working. Up to the close of the agreement the
through-traffic rates from the coast to Johannesburg had been
fixed by the Cape at the average rate of about 2.4d. per ton
per mile. After the close of the agreement the Netherlands
Railway Company raised the rates on its 52 miles of railway,
from the Vaal river to Johannesburg, to an average of nearly
8d. per ton per mile. Upon this importers began to remove a
portion of their goods from the railway at the Vaal river, and
to send them on by road and bullock-waggon to their
 destination in the Transvaal, instead of by the Netherlands
Railway to Johannesburg and elsewhere as before. This move has
recently been met by the Transvaal Government issuing a
Proclamation closing the drifts on the Vaal river alongside
the railway as ports of entry for over-sea goods, leaving them
open for other goods, the produce of South Africa. Importers of
over-sea goods have thus only the choice between making use of
the Netherlands line from the Vaal to Johannesburg at the
enhanced traffic rates imposed on that line, or of importing
via Delagoa Bay or Durban."
{463}
Vigorous remonstrances against this measure were made
instantly by the government of Cape Colony, not only on the
ground of its unfriendliness to the Colony, but also as being
an infraction of the 13th article of the London Convention of
1884 (see above: A. D. 1884-1894), and the British government
was appealed to for its interference. To this appeal the
British Colonial Secretary replied with much caution, on the
1st of November, in a communication cabled to the High
Commissioner, as follows: "Subject to the conditions stated
further on, I am prepared to authorize you to send to the
Government of the South African Republic a message to the
following effect.:—'I am advised by the Law Officers of the
Crown (who, it is hardly necessary to state, have examined the
question from a purely legal standpoint) that the recent
action of the South African Republic is a breach of Article
XIII. of the London Convention. I am further advised that the
Government of the South African Republic cannot now set itself
right by making general the prohibition of entry by the
drifts, so as to include Colonial goods, if and when they
reissue their Proclamation, which, I am surprised to observe,
they appear to have some intention of doing. Her Majesty's
Government accept the legal advice which they have received;
but independently of their Conventional rights they are of
opinion that the closing of the drifts, and especially the
extension of that measure to Colonial goods, is so unfriendly
an action as to call for the gravest remonstrance on their
part. While anxious for an amicable settlement of the
question, they must therefore protest against what they regard
as an attempt to force the hand of the Cape Government in
Conference by a proceeding which almost partakes of the nature
of an act of hostility.' You will communicate this message
confidentially to your Ministers in writing, pointing out that
when once it is sent Her Majesty's Government cannot allow the
matter to drop until they have obtained a compliance with
their demands, even if it should be necessary to undertake an
expedition for that purpose. Her Majesty's Government do not
intend that such au expedition should, like most previous
Colonial wars, be conducted at the entire cost of this
country; and you should explain to your Ministers that you are
therefore instructed to require from them a most explicit
undertaking in writing that, if it becomes necessary to send
an expedition, the Cape Parliament will bear half the gross
expense, and that the Local Government will furnish a fair
contingent of the fighting force, so far as its resources in
men may suffice, besides giving the full and free use of its
railways and rolling stock for military purposes. If your
Ministers cannot give you such assurances you will report
fully by telegraph, and defer action pending further
instructions from me; but if you obtain these assurances in
writing, explicitly and without qualification, you may send
the above message to the Government of the South African
Republic."

This was followed by a further cautionary message, November 3,

in these words: "Referring to my telegrams of the 1st
November, although willing to support your Ministers on the
conditions already stated, I should think it would be well, in
their own interests, and those of South African commerce
generally, if they will be as moderate as they can find it
consistent with their duty to be in their demands as to their
share of railway business. I have no doubt that you have
availed yourself of any chances you may have had of impressing
such a view on them and if you think it expedient you may tell
them, confidentially, that such is my view." On the 4th, Sir
Hercules Robinson replied: "My Ministers, including Schreiner
and Faure, the two Dutch Members, were unanimous in their
decision to accept your conditions. I am assured by Mr. Rhodes
that he can count on the support of the majority in the Cape
Parliament, and there are no facts before me which would lead
me to a different view; but I do not think that the question
will arise, as the Government of the South African Republic
will not hold out against the united action of the Cape and
Her Majesty's Government." On the same day he transmitted to
President Kruger the message contained (as above) in Secretary
Chamberlain's despatch of November 1. On the 21st of November
the reply of the Transvaal Government was given, as follows:

"This Government most deeply regrets that the Cape Colony has
by its own acts created a condition of things, in consequence
of which it afterwards found itself compelled to invoke the
intervention of the British Government, and it still more
deeply regrets that Her Majesty's Government, on the 'ex
parte' representations of the Cape Colony, felt itself
constrained to telegraph to this Government in the terms of
the communication of the 3rd instant. From the reply of this
Government, it will be evident to your Excellency that it
wishes to contribute in every possible way to preserve the
good understanding in South Africa, and it therefore considers
a passage such as occurs in your Excellency's telegram of the 3rd
instant, 'An attempt to force the hand of the Cape Government
at the Conference by a measure which almost resembles the
nature of a hostile act,' not justified as regards this
Republic. This Government adheres to its opinion and view that
it has an undoubted right to regulate the ports of entrance on
the borders of the Republic, and if Her Majesty's Government
calls this an unfriendly act, this Government can only say
that it was the consequence of an unfriendly act of the Cape
Colony. In order not to be the cause of disturbance in South
Africa, this Government is prepared to submit the regulating
of the ports of entrance on the borders to arbitration, it
 being convinced of the justice of its assertion that the
regulating of the ports of entrance on its borders by it is no
infringement of Article 13 of the Convention of London."

Great Britain,
Papers by Command: 1897, C. 8474, pages 11-21.

SOUTH AFRICA: The Transvaal: A. D. 1895 (November).

The state of discontent among the Uitlanders, and its causes.
The franchise question.
Growth of British Imperialistic designs.

The suspension of commandeering went a very little way towards

removing the grievances of the British residents in the
Transvaal. Underlying that and all other causes of discontent
was the evident determination of the Boer inhabitants of the
Republic to keep in their own hands the whole power of
government, both state and municipal, and to deal with the
increasing multitude of incomers from the outside world (whom
they called Uitlanders, or Outlanders) permanently as aliens,
excluded from citizenship by as many bars as a jealous
legislature could raise.
{464}
Until 1882, a foreigner, settling in the Transvaal, could
become a citizen and a voter after a residence of two years.
The required residence was then raised to five years, and in
1887 it was carried up to fifteen. By this time the immigrant
population was growing numerous, and its complaints of
disfranchisement and non representation in the Volksraad, or
Legislature, soon took on angry tones. In 1890 a nominal
concession was made to the discontented Uitlanders, by the
creation of a Second Volksraad (see, in this volume,
CONSTITUTION OF THE SOUTH AFRICAN REPUBLIC—the
bracketed
amendments or added articles following Article 29), to which
they could elect representatives. The suffrage in elections to
this new chamber was given after two years residence, on the
taking of an oath of allegiance to the Republic, and
qualification for sitting in it was acquired after a residence
of four years. But the Second Volksraad had no independent
power. It could act only on certain specified subjects,
taxation not included, and all that it did was subject to
overruling by the First Volksraad, while the enactments of the
latter were entirely valid without its consent. The Second
Volksraad, in fact, was no actual branch of the national
legislature, but a powerless appendage to it, where an
appearance of representation in the government could be given
to the Uitlander population without the reality.

Naturally, this aggravated rather than pacified the discontent

of the new comers. They were a rapidly increasing multitude,
congregated, for the most part, in one district, where it was
easy for them to feel and act in combination. By 1895 there
was said to be 100,000 of them in the 'Witwatersrand, and some
60,000 natives were working in their mines. They were being
heavily taxed, and they complained that they could get nothing
adequate in return for the taxation,—neither an efficient
police, nor decent sanitary regulations, nor a proper water
supply, nor a safe restraint upon the sale of liquors to their
native work people. At the same time it was charged that
corruption prevailed in the omnipotent First Volksraad, and
among public officials, and that, on the whole, the Republic
was in bad as well as in ignorant hands. This was not alone
the view of the complaining foreign residents, but was shared
more or less by unprejudiced visitors to the country,
including Mr. James Bryce, who travelled in the Transvaal in
1895, and who wrote of the grievances of the Uitlanders in
quite a sympathetic vein.

Until the gold-seekers came into it, the Republic had been
poor and its revenues small. Their coming gave it a full
treasury. They were the principal consumers of the imported
goods on which its tariff was laid. Their large use of
dynamite and other explosives in mining gave the government an
opportunity to make a highly profitable monopoly of the
manufacture, afterwards exchanged for an equally profitable
concession to a monopolistic company. Their mines were the
proper subject of a tax which yielded large returns. In fact,
the Republic was taking much to itself from the Uitlanders,—no
more, perhaps, than it had a fair right to take,—but,
according to what seems to be trustworthy testimony, it was
giving them far less in return for it than they had a just
right to demand, and it was offering them no prospect of
anything better in time to come.

It seems to be certain that responsibility for whatever was

hostile and unjust in the treatment of the foreign population
rested largely upon the President of the Republic, Mr. Paul
Kruger, who had been at the head of the government for many
years. He exercised an influence and authority that had
scarcely any limit. The Volksraad was obedient to his will,
and most of its legislation was understood to emanate from him
and from those whose council he took. There can be little
doubt that he practically shaped the whole policy of the Boer
Republic in its dealing with the Uitlanders, and that it
expressed the attitude of his mind toward foreigners in
general and Englishmen in particular. He distrusted even the
Dutch of Cape Colony, and sought Hollanders for the public
service when he needed qualifications which his own people did
not possess.

"While within the Transvaal there was growing discontent,

matters were so shaping themselves without as to still further
complicate the situation. The idea of a Confederation of
British South Africa and the extension of the British sphere
to the Zambesi, had long been the dream of imperialists, and
the ruling classes at the Cape had persistently urged this
upon the home government. … After the consolidation of the
diamond companies. Mr. Cecil Rhodes became the imperialist
leader in South Africa and marshaled behind him all the
corporate interests and combined influence of his many
 associates. The Boer Republics stood in the way of the success
of imperialistic enterprise. Then too the 'scramble for
Africa,' which began with the efforts of the King of Belgium
to consolidate the native tribes of central Africa under
Belgian rule and which resulted in the carving out of the
Congo Free State, the assertion of German protection over
Damaraland and Namaqueland, and the joint effort of European
powers to check the British sphere, all lent zest to ambition
and brought the English popular mind into temper for concerted
action. Under such circumstances the 'little England' party
lost its standing and an imperial policy gained fullest
support. With such an atmosphere surrounding the Transvaal the
grievances of the 'aliens' within could not long be
disregarded without serious trouble."

F. A. Cleveland,
The South African Conflict
(The American Academy of Political and Social Science,
Number 265), pages 19-22.

SOUTH AFRICA: The Transvaal: A. D. 1895-1896.

Revolutionary conspiracy of disaffected Uitlanders
at Johannesburg with Rhodesians.
The Jameson Raid and its results.

In the fall of 1895, certain of the disaffected Uitlanders at

Johannesburg, leaders of an organization called the Transvaal
National Union, abandoned attempts to obtain what they sought
from the President and the Volksraad by petition and
agitation, and either invited or accepted proposals of
assistance from the armed forces of the British South Africa
Company, with a view to some kind of a revolutionary
undertaking. The story of the plot has been told with great
frankness by one of the actors in it, Mr. Alfred P. Hillier,
who writes:

{465}
"Mr. Cecil Rhodes, … accustomed as he was to success, quick
movement and rapid developments, in his great career, had …
watched with impatient eyes the setting back of the clock
within the South African Republic. His chief lieutenant, Dr.
Jameson, who had shared with him the labour of reclaiming from
barbarism and developing Rhodesia, and whose ambition was no
less than his superior's, discussed with him the desirability
of some active outside pressure; and between them was evolved
what is known as the Jameson plan. Mr. Beit, the capitalist
most largely interested in the mines of the Rand, an old
financial colleague of Mr. Rhodes, both in the De Beers
amalgamation and in the establishment of the Chartered
Company, promised both his influence and his purse in support
of the plan. Overtures were then made to Mr. Lionel Phillips,
who was at the head of the Chamber of Mines, and Mr. Charles
Leonard, the Chairman of the National Union. … The plan at
this early stage was presented in a very attractive form. A
force under Dr. Jameson was to be quietly gathered on the
border. The Johannesburg agitation, reinforced with capitalist
support, was to be steadily pushed forward. Rifles and
ammunition were to be smuggled into Johannesburg. Both the
High Commissioner and the Colonial Office might be counted on,
it was said, to support a vigorous forward movement for
reform. Mr. Phillips and Mr. Leonard, sick and weary of the
hopelessness of unsupported constitutional action, and of the
continual set back in Boer politics, already casting round in
their minds for some new departure, accepted and from that
time forth co-operated with Mr. Rhodes and Dr. Jameson in the
development of the Jameson plan.

"In October, 1895, a meeting took place at Groote Schuur, Mr.

Rhodes' residence near Cape Town, at which were present, in
addition to Mr. Cecil Rhodes, Mr. Lionel Phillips, Mr.
Hammond, Mr. Charles Leonard, and Colonel Frank Rhodes. At
this meeting the plan was more fully discussed and matured;
and in November, 1895, when Dr. Jameson visited Johannesburg,
the details were finally settled. The letter of invitation was
written, signed and handed to Dr.Jameson, and the date of
combined action provisionally fixed for the end of December.
Dr. Jameson's force was to be about 1,000 strong, and the
start to be made when finally summoned by the signatories of
the letter. In the meantime the Johannesburg leaders were to
have sent in to them 4,500 rifles and 1,000,000 rounds of
ammunition, and were, if possible, to arrange for an attack on
the Pretoria Arsenal simultaneously with the move from
outside. With regard to the letter of invitation which was
subsequently used by Dr. Jameson as a justification for his
start, … Mr. Leonard, Colonel Rhodes, and Mr. Phillips have
all distinctly stated that this letter was never intended as
an authority to Dr. Jameson to enter the Transvaal, unless and
until he received a further summons from them. Such was in
brief the history of the Jameson plan as far as concerned
Johannesburg. And it is necessary here to refer to the
position with regard to it of the bulk of the men who
subsequently constituted the Reform Committee. They at this
time, with the exception of a few of their number, of which I
personally was one, were entirely ignorant of what was going
on. … The Johannesburg leaders, relying on the general
sentiment of the community, assumed the responsibility of
arranging a basis of operations. So that the plan when it was
gradually revealed to various men had either to be accepted by
them in its entirety or rejected. … Men demanded and received
assurance that the movement was to be a republican one, and in
no way to be an attempt on the independence of the country. A
sufficient number of rifles were also to be forthcoming, and
the High Commissioner was to be on the spot to expedite the
adjustment of matters immediately disturbances arose."

A. P. Hillier,
Raid and Reform,
pages 47-53.

The practical working of the conspiracy proved less easy than

the planning of it. Arms and ammunition were smuggled into
Johannesburg, but not in sufficient quantities. The time of
action had been fixed for the 28th of December. When it came
near there were found to be only 2,500 rifles at hand, instead
of the 10,000 that were wanted. A scheme for the surprising of
the Boer arsenal at Pretoria was pronounced at the last moment
impracticable. Still more disconcerting to many was a report
which came from Cape Town, that Jameson would require the
rising to be made under and in favor of the British flag. "The
movement within the Transvaal," says Mr. Hillier, "had from
its outset been one in favour, not of a British Colony, but of
a sound Republic. … Many Americans and South Africans had
accorded their support only on this understanding." Until a
clearer arrangement with the Rhodesians on this point could be
reached, the leaders in Johannesburg determined not to act.
Accordingly, on the 26th of December, two days before the
appointed date of insurrection, they telegraphed to Jameson,
in covert language which he understood, that it was
"absolutely necessary to postpone the flotation." On the
following day they issued a lengthy manifesto, setting forth
all their grievances, and deferring until the 6th of January a
general meeting of the National Union which had been called
for the 27th of December—the eve of the intended rising. The
manifesto concluded as follows:

"We have now only two questions to consider:

(a) What do we want?
(b) how shall we get it?

I have stated plainly what our grievances are, and I shall

answer with equal directness the question, 'What do we want?'
We want:

(1) the establishment of this Republic as a true republic:

(2) a Grondwet or Constitution which shall be framed by

competent persons selected by representatives of the whole
 people and framed on lines laid down by them—a constitution
which shall be safeguarded against hasty alteration;

(3) an equitable franchise law, and fair representation;

(4) equality of the Dutch and English languages;

(5) responsibility of the Legislature to the heads of the

great departments;

(6) removal of religious disabilities;

(7) independence of the courts of justice, with adequate and

secured remuneration of the judges;

(8) liberal and comprehensive education;

(9) efficient civil service, with adequate provision for pay

and pension;

(10) free trade in South African products.

That is what we want. There now remains the question which is

to be put before you at the meeting of the 6th January. viz.,
How shall we get it?"

Great Britain: Papers by Command, 1896, C.—7933.

{466}

Acting, as appears, on his own responsibility, Dr. Jameson

refused to be stopped by the postponement at Johannesburg,
and, on the evening of December 29, he entered the Transvaal
territory, from Pitsani-Pitlogo, in Bechuanaland, with a force
of about 500 men. His movement created consternation in all the
circles of the conspiracy, and received no effectual support.
It was promptly disavowed and condemned by the British
authorities, and by the home officials of the British South
Africa Company. Cecil Rhodes could do nothing but tacitly
acknowledge his responsibility for what his lieutenant had
done (though the precipitation of the raid was evidently a
surprise and a trouble to him) by resigning the premiership of
Cape Colony. Meantime, the invaders had learned that the Boers
were not to be ridden over in the easy fashion they supposed.
Hasty levies had intercepted their march, had repulsed them at
Krugersdorp, with a heavy loss in killed and wounded,
surrounded them at Doornkop, and forced them to surrender on
New Year's day. A few days later, the Uitlanders at
Johannesburg, some of whom had made a confused and ineffectual
attempt to take arms, proclaiming a provisional government,
and around whose town the excited Boers had gathered in large
force, were persuaded by the British High Commissioner to
submit to the Transvaal authorities, and more than fifty of
the leaders were placed under arrest.

"With great difficulty, President Kruger overcame the desire

of his people that Jameson and his officers should be brought
to trial and punished in the country they had outraged by
their invasion, and they were handed over to the British
government for removal to England and trial by an English
court. The trial took place in July (20-28), before the Lord
Chief Justice (Lord Russell of Killowen), Baron Pollock, and
Justice Hawkins, with a special jury. The charge on which the
prisoners were tried was that of having fitted out a warlike
expedition against a friendly state, in violation of the
Foreign Enlistment Act. The charge of the Lord Chief Justice
gave the following questions to the jury: Were preparations
for a raid made by the defendants? Did they aid, abet,
counsel, or procure such preparation? Were they employed in
the actual expedition? Did the Queen exercise dominion and
sovereignty in Pitsani-Pitlogo? The jury returned affirmative
answers, which were held to constitute a verdict of "guilty,"
and sentence was pronounced,—fifteen months of imprisonment
for Dr. Jameson, and terms varying from five to ten months for