FAA Accounts Recievable Management
CASH & MARKETABLE SECURITY MANAGEMENTCASH MANAGEMENTCASH MANAGEMENT‡ It is the maintaining of liquidity of a firm to minimize the risk of insolvency. ‡ It is also about the proper balancing of keeping cash without letting it idling around. ‡ Good cash management means: Knowing when, where, and how your c
Content
CASH & MARKETABLE SECURITY MANAGEMENT
GROUP 6 Apoorva Charu (117) Swati Seshadri (118) Meenal Shah (119) Ankit Sharma (418) Arpit Vijay (419) Divi Khanna (420) Juhi Rupani (421)
CASH MANAGEMENT
Juhi Rupani MBA Tech (Telecom) Roll No : 421
CASH MANAGEMENT
It is the maintaining of liquidity of a firm to minimize the risk of insolvency. It is also about the proper balancing of keeping cash without letting it idling around. Good cash management means: Knowing when, where, and how your cash needs will occur. Knowing what the best sources are for meeting additional cash needs. Being prepared to meet these needs when they occur, by keeping good relationships with bankers and other creditors.
MOTIVES FOR HOLDING CASH
The 3 motives for holding cash as advocated by the British Economist, John Maynard, are:
1. Transaction motive:
Maintaining cash for the purpose of meeting cash needs arising in the ordinary course of doing business. Includes regular payments like wages, utilities, acquisition of fixed assets and inventories.
2. Speculative motive:
Holding cash for potential profit making situation like purchasing raw materials in bulk in anticipation of a fall in price.
MOTIVES FOR HOLDING CASH contd.
3. Precautionary motive:
Maintaining of cash balance as buffer for UNEXPECTED needs that may arise. Either holding in cash or marketable securities that can be liquidated easily
Marketable securities are very liquid securities that can be converted into cash quickly at a reasonable price and tend to have maturities of less than one year.
CASH MANAGEMENT SYSTEM
CASH MANAGEMENT SYSTEM contd.
From the figure we can see that the firm will benefit by speeding up cash receipts and slowing down cash payouts. The firm wants to speed up the collection of accounts receivable so that it can have the use of money sooner. Conversely, it wants to pay accounts payable as late as is consistent with maintaining the firms credit standing with suppliers so that it can make the most use of the money it already has.
CASH MANAGEMENT SYSTEM contd.
CASH COLLECTION:
It is the management of receivables, customer payments and incoming cash flows of a firm.
CASH DISBURSEMENT:
A payment of money or simply a payment. Usually, the writing of a check to pay for an item previously obligated to be paid, such as loan payment, salary payment or accounts receivable payment.
HP AND IBM
Parameter MARKET CAPITALIZATION SUBSCRIBER BASE (JUNE 2008) PRESENCE ORIGIN LISTED ON RANKING IN INDIA HP Approx 95004 crores 45 million Global California NYSE 5 IBM Approx 563490 crores 119.68 million Global New York NYSE 7
HP specializes in developing and manufacturing computing, storage, and networking hardware, software and services. Major product lines include personal computing devices, enterprise servers, related storage devices, as well as a diverse range of printers and other imaging products.
IBM manufactures and sells computer hardware and software (with a focus on the latter), and offers infrastructure services, hosting services, and consulting services in areas ranging from mainframe computers to nanotechnology.
Speeding Up Cash Receipts & Slowing Down Cash Payments
Apoorva Charu Sawhney MBA Tech (IT) Roll No : 117
SPEEDING UP CASH RECEIPTS
Acceleration of Collections: 1. Early preparation and mailing of invoice 2. Accelerate payment from customers 3. Reduce time when payments remain uncollected funds
COLLECTION FLOAT: Total time between the mailing of the check by the customer and the availability of cash to the receiving firm.
COLLECTION FLOAT TIME-LINE
BOB JONES ORDER OF
2048
Customer mails check
Firm receives check
Company deposits check
Company¶s bank account credited
PROCESSING FLOAT
AVAILABILITY FLOAT
MAIL FLOAT DEPOSIT FLOAT
COLLECTION FLOAT
WAYS TO REDUCE COLLECTION FLOAT
Earlier billing/Outsource the billing function Pre-authorized debt Use of Lockbox systems Concentration banking ± Depository transfer check ± Automated Clearing House (ACH) Transfer ± Wire Transfer
EARLIER BILLING
Accelerated preparation and mailing of invoices Use of computerized billing/ fax Enclose invoices with shipped goods Request for advance payments of goods Outsourcing the billing function: ± Allows firm to focus on clients ± Allows firm to save labour costs ± Allows firm to relocate resources
PRE-AUTHORIZED DEBT
Arrangement that allows firms to transfer payments directly from customer accounts to firm s accounts, with customer's advance authorization. Reduces mail float and processing float
ADVANTAGES: ± Eliminates billing and postage costs, clerical processing costs ± Eliminates regular billing for customers ± Increased working cash
LOCKBOX SYSTEM
Firm sets up a lock box service with their bank , customers send their payments directly to lockbox. The bank deposits payments directly to the company's account.
ADVANTAGES: ± Reduces mail float and processing float ± Reduces clerical functions (bank handles receiving, totaling, depositing) ± Early knowledge of dishonored checks
CONCENTRATION BANKING
Firms move funds from several geographically situated regional banks to a main concentration account in a primary bank.
ADVANTAGES:
± Improves control over cash inflow/outflow ± Reduces idle balances ± Allows more effective investments
DEPOSITORY TRANSFER CHECKS (DTCs)
Firms use pre-printed, non-negotiable check drawn on a local bank, payable to a single company account at a concentration bank.
ADVANTAGES: ± Lower levels of excess cash ± Eliminates billing, postage and clerical processing costs ± Reduces mail float and processing float DISADVANTAGES: ± funds not immediately available on DTC receipt ± Mail-based collection of check
AUTOMATED CLEARINGHOUSE TRANSFER
The Automated Clearing House is an electronic system used to transfer funds between banks.
ADVANTAGES: ± Electronic version of DTC, hence is faster ± Funds available 1 business day later ± Better coordination between bank branches DISADVANTAGES: ± Hard to stop payment on the physical check
WIRE TRANSFER
Electronic transfer of funds using two-way communications system Primary bank sends message to the receiving bank requesting them to effect payment in accordance with the instructions given.
ADVANTAGES: ± Simple procedure; funds available immediately DISADVANTAGES: ± expensive
SLOWING DOWN CASH PAYOUTS
DISBURSEMENT FLOAT: ± The total time period between when a check is prepared by the firm and when the check is presented for payment.
BOB JONES ORDE R OF
204 8
Firm mails check
Creditor receives check
Creditor deposits check
Firm¶s account is debted
DELIVERY FLOAT
PROCESSING FLOAT
TRANSIT FLOAT
DISBURSEMENT FLOAT
NET FLOAT
NET FLOAT: ± The total amount of float in a bank account. ± The net float, when added to or subtracted from the book balance, shows how much money is in the bank account. ± Accurate estimation is necessary for playing the float . NET FLOAT = DISBURSEMENT FLOAT COLLECTION FLOAT
Money spent by the firm but not yet taken out of its account money deposited by the customer but not yet cleared to firm¶s account
CONTROL OF DISBURSEMENTS
Centralized disbursement system Payable through drafts (PTD) Zero-Balance Accounts Controlled disbursements Remote Disbursements Outsourcing
CENTRALIZED SYSTEM
Payables centralized into one account. Sophisticated computer system that provide necessary information about excess funds. ADVANTAGES: ± Excess funds transferred automatically from other accounts ± Disbursements made precisely when required DISADVANTAGES: ± Operating procedures should be common for all accounts and well-established
PAYABLE THROUGH DRAFT (PTD)
It is Payable-on-demand When presented to issuer s bank for collection, bank presents it for acceptance. The funds are disbursed after acceptance. ADVANTAGES: ± Delays the time firm has to maintain funds to cover the draft ± Allows firm to maintain smaller bank balances ± Payment can be stopped if necessary DISADVANTAGES: ± Banks impose higher service charge for drafts
ZERO BALANCE ACCOUNT (ZBA)
One master account services subsidiary accounts. Just enough cash is transferred daily from the firm s master account to subsidiary accounts to maintain zero balance account ADVANTAGES: ± Allows more control over cash outflows ± No idle cash in subsidiary accounts DISADVANTAGES: ± Daily transfer of cash required ± Efficient management of master account required
OTHER METHODS
CONTROLLED DISBURSEMENTS: ± Bank provides a daily report, that provides the amount of disbursements that will be charged to the firm's account. ± This early knowledge of daily funds requirement allows firm to invest any surplus in intra-day investment opportunities. REMOTE DISBUSREMENTS: ± Payments are issued through a remote branch of a bank and firm is able to delay the payment due to increased float time. OUTSOURCING: ± Firm can hire outside services to perform disbursement functions.
Electronic Commerce and Outsourcing
Ankit Sharma MBA Tech (Telecom) Roll No : 418
ELECTRONIC COMMERCE
Electronic commerce is the exchange of business information in an electronic format as an alternative to the paper based system. EC spectrum can be divided into: ± Unstructured messaging: utilize technologies such as faxes and e-mails ± Structured messaging: utilize technologies such as electronic data interchange (EDI)
ELECTRONIC DATA INTERCHANGE
It involves the transfer of business information such as invoices, purchase orders, and shipping information in a computer readable format. It involves direct computer to computer data transfer as well as transfer through physical storage such as CDs, disks etc.
ELECTRONIC FUNDS TRANSFER
ELECTRONIC DATA INTERCHANGE
FINANCIAL EDIs
ELECTRONIC FUNDS TRANSFER
Electronic transfer of a certain monetary value takes place in which a depository institution sends or receives electronic payments. It can be applied to: Cardholder-initiated transactions, where a cardholder makes use of a payment card Direct deposit payroll payments for a business to its employees, possibly via a payroll services company Direct debit payments from customer to business, where the transaction is initiated by the business with customer permission Electronic bill payment in online banking, which may be delivered by EFT or paper check Wire transfer via an international banking network (generally carries a higher fee)
ELECTRONIC FUNDS TRANSFER contd.
Instruction for transfer set by two major societies: SWIFT (Society for worldwide interbank financial telecommunication) CHIPS (Clearing house interbank payment systems)
In January 1999, a regulation passed required all federal government payments except tax refunds and special waiver situations, be made electronically This will:
provide more security than paper checks and be cheaper to process for the government.
FINANCIAL EDI
Is the computer-to-computer exchange of payment and payment-related information between companies using a standard format. A bank must be involved. The buyer and seller must work closely with their respective banks to effect a Financial EDI transaction. Examples include: ± Lockbox remittance information ± Bank balance information
STEPS IN FINANCIAL EDI
The buyer, or originator, electronically extracts payment information from the company's accounts payable system. The buyer formats the data into an EDI ANSI standard, the ANSI 820 transaction set using an EDI software. The buyer then transmits an ANSI 820 format to bank for processing. The bank then takes the 820 data and puts it into a format so that it can be sent through the Automated Clearinghouse. The ACH network then delivers the payment data to the seller's, or receiver's, bank.
COSTS AND BENEFITS OF EDI
Costs
Computer hardware and software expenditures Increased training costs to implement and utilize an EDI system Additional expenses to convince suppliers and customers to use the electronic system Loss of float
Benefits
Information and payments move faster and with greater reliability Improved cash forecasting and cash management Customers receive faster and more reliable service Reduction in mail, paper, and document storage costs
OUTSOURCING
Shifting an in-house operation to outside firm in a view to reduce company s costs Operation to be outsourced is critical but non-core process of the company The subcontractor uses special expertise and economies of scale to perform an outsourced business operation The company gets the service it needs at a lower cost and higher quality; can focus on its core business
OUTSOURCING: IBM
The company s major operations in outsourcing are: Global technology services: Comprehensive IT services integrated with business insight working with clients to reduce costs and improve productivity through accepting the outsourcing of processes and operations Global business services: primarily provides professional services and application outsourcing services, delivering business value and innovation to clients through solutions which leverage industry and business process expertise. IBM leverages its supply-chain expertise for clients through its supply-chain business transformation outsourcing service to optimize and help operate clients end-to-end supply-chain processes, from procurement to logistics.
REVENUE FROM OUTSOURCING: IBM
CASH BALANCES: HEWLETT PACKARD
Total cash and cash equivalents declined approximately 10% to $10.2 billion in 2008 from $11.3 billion in 2007 due to increased investment spending on acquisitions and increased borrowings. Cash balances according to them are sufficient to cover cash outlays expected in fiscal 2009 associated with additional stock repurchases, acquisitions, company bonus payments, and other operating cash requirements.
Investments in Marketable Securities
Arpit Vijay MBA Tech (Telecom) Roll No : 419
GENERAL SCENARIO
In general, firms try to maintain some target level of cash for meeting : ± Transaction requirement ± Compensating Balances requirement Beyond this, they invest in marketable securities as near-cash investments ± Interest lost on idle cash balances ± Greater opportunity cost incurred on maintaining idle cash balances Securities are called marketable securities when : ± The firm can readily convert them into cash and ± Intends to do so when it needs cash If this does not apply, it is called as Investment in securities
BALANCE SHEET REPRESENTATION
Cash Equivalents Most liquid assets found within any firm s balance sheet. Readily convertible into cash Maturity with 3 months Low risk, Low Return Includes Treasury Bills, Bank Certificate of Deposits, Other money market instruments. Short Term Investments Securities that are held for less than one year Return on investment in form of : ± Financial income i.e. dividend income, interest income ± Capital appreciation
VALUATION OF MARKETABLE SECURITIES
At Acquisition Marketable Securities are initially recorded at acquisition cost which includes purchase price plus any commission, taxes or other costs related to acquisition. This the same rule as the general rule for valuing assets at acquisition. After Acquisition Because there exists a market value, marketable securities can be reliably written up or down to the market value giving a more current estimate of economic worth This also results in a holding gain or loss which is not due to the normal operations of a firm.
THREE CLASSES OF MARKETABLE SECURITIES
For the purposes of valuation after acquisition, there are three classes of marketable securities: ± Debt held to maturity ± Trading securities ± Securities available for sale
DEBT HELD TO MATURITY
Debt securities for which a firm has both the positive intent & ability to hold to maturity Shown on the balance sheet at the amortized acquisition cost Amortized acquisition cost means that the securities are amortized like a mortgage or bond ± The acquisition cost is assumed to be the present value. ± The maturity value and maturity date are known from the bond certificate.
TRADING SECURITIES
Trading securities are assumed to be held for short-term profit Characterized by frequent & active buying & selling with the object of generating profit Typically only financial institutions hold trading securities Since trading securities are acquired for short-term profit, unrealized gains or losses that result from adjustments to market value pass through the income statement & increase or reduce net income before there is a sale of the securities
SECURITIES AVAILABLE FOR SALE
Securities available for sale are neither trading securities or securities held to maturity. They are an intermediate class and are typically tied to a specific cash need. They are held by non-financial companies For example, a manufacturing firm may build a large fund of securities to pay for a renovation to its plant or to retire bonds that will come due. Since they are acquired for longer-term return, unrealized gains or losses that result from adjustments to market value do not pass through the income statement but stay on the balance sheet as an equity account.
COMPARISON
Trading Securities The unrealized holding gain or loss for trading securities is considered income; it is close to income and increases or decreases net income. Securities Available for Sale While the unrealized holding gain or loss for available for sale securities is not closed but remains on the balance sheet. When these securities are sold, this account must then be closed.
MARKETABLE SECURITIES PORTFOLIO
Free cash segment (F)
Ready cash segment (R)
Controllable cash segment (C)
READY CASH SEGMENT (R)
Optimal balance of marketable securities held to take care of probable deficiencies in the firm s cash account Can be sold quickly to build up cash Ideally, Cash Inflows >= Cash Outflows, each day
Free cash segment (F)
Ready cash segment (R)
Controllable cash segment (C)
CONTROLLABLE CASH SEGMENT (C)
Market securities held for meeting controllable (knowable) outflows such as taxes and dividends Accumulated funds for such purposes can be invested temporarily to earn interest
Free cash segment (F)
Ready cash segment (R)
Controllable cash segment (C)
FREE CASH SEGMENT (F)
free marketable securities available for unassigned purposes It is just extra idle cash with the company invested in Marketable securities.
Free cash segment (F)
Ready cash segment (R)
Controllable cash segment (C)
VARIABLES FOR SELECTION
Variables for selection for Marketable Securities : ± Safety ± Marketability ± Yield ± Maturity
SAFETY
With regard to the principal amount
Refers to the likelihood of getting back the same number of rupees you originally invested (principal)
MARKETABILITY
Also known as Liquidity
The ability to sell a significant volume of securities in the short period of time in the secondary market without significant price concession
YIELD
Also known as Return
The variability in the market price of a security caused by the changes in interest rates
Yield
Lower Interest Risk
Higher Interest Risk
Time
MATURITY
The life of a security i.e. amount of time before the principal amount of a security becomes due
Longer the maturity, greater the yield , but also more exposure to yield risk.
MARKETABLE SECURITIES
IBM IBM ended 2008 , with $ 12.9 billion of marketable securities Cash and Cash equivalents : $ 12,741 million Short term marketable securities : $ 166 million
HP
HP ended 2008, with 10.2 billion of marketable securities Cash and Cash equivalents : $ 10,153 million Short term Investments : $ 93 million
CONTROVERSY ABOUT MARKETABLE SECURITIES
The accounting for marketable securities has been controversial. The accounting issues are: ± Whether to report these instruments at historical cost (or some method based on historical cost) or at market value, and ± If at market value, whether to report the changes from period to period as part of that period s income or to await the period when the firm sells or otherwise disposes of the instrument to record the gain or loss in income.
Common Investment Instruments
Meenal Shah MBA Tech (IT) Roll No : 119
Money Market
A segment of the financial market in which financial instruments with high liquidity and very short maturities are traded. There are two modes of investment in money market viz ± Direct Investment in Money Market Instruments & ± Investment in Money Market Funds.
Common Money Market Instruments
The money market encompasses a wide range of instruments with maturities ranging from one day to a year, issued by the government and by banks and corporates of varying credit rating, and traded in markets of varying liquidity. The money market is also intimately linked with the foreign exchange market Consequently, they are considered to be near-cash equivalents.
Common Money Market Instruments
Treasury Bills
Short term borrowing instruments issued by Central Bank (RBI in India) on behalf of Government of India Minimum of 25000 and its multiple Sold at a discount and repaid at maturity Yield determined by money market forces one of the safest money market instruments
Common Money Market Instruments
Certificates of Deposit
Unsecured interest paying negotiable instruments issued by commercial banks and also financial institutes Having maturity ranging from 30 days to 3 years. CD s are issued in denominations of Rs. 0.5 million.
Common Money Market Instruments
Commercial Paper
Money market instrument introduced by RBI and consists of short term, unsecured promissory notes Generally issued by finance companies with sound financial position and a high credit rating. Commercial Paper is issued at a discount which is determined by the money market forces It can be issued in denomination of Rs 5 lakh or in multiples of it for 15 days to 1 year
Common Money Market Instruments
Inter- corporate Deposits
Inter-corporate deposits are unsecured loans offered by one company to another company, and usually carry a term of six months Advantage : no legal issues Disadvantage : high risk
Common Money Market Instruments
Ready Forward or Repo or Buyback
Short term loans in which two parties agree to sell and repurchase the same security. Between the parties approved by RBI Repo - the seller sells securities with an agreement to repurchase the same at a mutually decided future date and price Reverse Repo - the buyer purchases the securities with an agreement to resell the same to the seller on an agreed date at a predetermined price.
Common Money Market Instruments
Bill of Exchange
± Issued in the form of promissory notes usually for the purpose of some transactions
consisting of goods and services.
± It is a buyer s promise to pay to the seller a certain specified amount at certain date. ± The same is guaranteed by the banker of the buyer in exchange for a claim on the
goods as collateral.
Bill Discounting
± While discounting a bill, the Bank buys the bill before it is due and credits the value
of the bill after a discount charge to the customer's account.
± The transaction is practically an advance against the security of the bill and the
discount represents the interest on the advance from the date of purchase of the bill until it is due for payment.
Common Money Market Instruments
Short Term Debentures
Issued by corporate bodies The funds borrowed are in excess to the funds already available to the corporate from its consortium bankers.
Fixed Deposits
FDs are fixed-income debt securities issued by banks. Putting money into an FD is like giving a loan to the bank, in return for which the bank pays you interest.
Common Money Market Instruments
Mutual Funds Schemes
Mutual fund is the most popular investment instrument for a common man as it offers a diversified professionally managed basket of securities at a low cost. The mutual fund industry offers various types of investment schemes like equity instrument, debt instrument or balanced instruments. These could be broadly classified as
± Open-ended scheme. ± Close-ended scheme ± Interval scheme
Selecting Securities for Portfolio Segments
Selecting Securities for Portfolio Segments
Ready Cash Segment Criterion 1. Safety and 2. ability to convert to cash
Controlled Cash Segment Free Cash Segment 1. Date to cash should be known 2. Mature at time of cash needs 1. Base choice on yield subject to risk-return risktradetrade-offs. 2. Marketability with some loss of principal tolerable if yield is high Any money market instrument may be selected for this segment
Select
Treasuries
CD s, commercial paper, and inter-corporate deposit
Portfolio Management
A portfolio is a group of investments. A well-managed portfolio is diversified to ensure a continuous ROI over time. There are three major portfolio management policies: ± Aggressive policy: (capital appreciation) ± Defensive policy: (capital preservation) ± Balanced policy: (Total Return)
RATIO ANALYSIS
Swati Seshadri MBA Tech (IT) Roll No: 118
CURRENT RATIO
FORMULA : CURRENT ASSETS + CURRENT INVESTMENTS CURRENT LIABILITIES + SHORT-TERM DEBT 2007-08 HP IBM 0.98 1.15 2006-07 1.21 1.2 YOY (%) (19) (4) INDUSTRY AVERAGE 1.4
The current ratio for both HP and IBM has plummeted for the year 2008. The YoY decrease is more for HP showing its lack of liquid assets in the year 2008.
Current ratio of HP has reduced from 1.21 to 0.99 (less than 1).This indicates that HP s ability to meet its payment obligations was very poor in FY 07-08.
The cash and cash equivalents with the total value of $2250 million decreases over the FY 07-08. This and the decrease in marketable securities and financing receivables led to a decrease in the solvency of IBM.
ACID TEST RATIO
FORMULA : CURRENT ASSETS + CURRENT INVESTMENTS PREPAID EXPENSES - INVENTORY CURRENT LIABILITIES + SHORT-TERM DEBT 2007-08 HP IBM 0.75 0.99 2006-07 0.96 1.05 YOY (%) (22) (6) INDUSTRY AVERAGE 0.8
The Quick ratios for both the companies have shown a decrease, with HP showing a greater decrease (0.22) as compared to IBM(0.06). This shows that IBM has greater solvency as compared to HP.
Quick ratio shows that IBM is much more liquid than HP according to the current industry averages.
LIQUIDITY RATIO ANALYSIS
HP
Cash and cash equivalents at October 31, 2008 totaled $10.2 billion, a decrease of $1.1 billion from the October 31, 2007 balance of $11.3 billion. The amount and terms of any acquisition-related borrowings affects liquidity and financial condition and potentially credit ratings. Thus HP's liquidity reduced in 2008 due to it acquisition of EDS. HP uses cash generated by operations as the primary source of liquidity. Internally generated cash flows support business operations, capital expenditures and the payment of stockholder dividends.
IBM
IBM's liquidity positions were strong as the cash on hand was $12,741 million. Total debt decreased $1,349 million year to year, and the company generated $18,812 million in operating cash flow in 2008. The company provides for additional liquidity through several sources: maintaining a sizable cash balance, access to global funding sources, a committed global credit facility and other committed and uncommitted lines of credit worldwide
DEBT TO EQUITY RATIO
FORMULA : TOTAL DEBT SHAREHOLDER S EQUITY 2007-08 HP IBM 0.46 2.52 2006-07 0.21 1.23 YOY (%) 119 105
In the case of HP the total debts have shown an substantial increase in the year 2008 as compared to the previous year whereas the stockholder s equity has remained almost constant. This shows that the debts used to finance the company is increasing compared to the equity.
In this case IBM has a lesser difficulty with creditors even if the debt to equity ratio has increased because their total debts have shown a decrease in the FY 08 with the shareholder s equity being halved.
DEBT TO TOTAL ASSETS RATIO
FORMULA : TOTAL DEBT TOTAL ASSETS 2007-08 HP IBM 0.16 0.31 2006-07 0.09 0.29 YOY (%) 77 7
In IBM the total assets have decreased more as compared to the total debts. Thus showing an increase in the YOY ratio.
In case of HP the debts are increasing substantially as compared to the total assets. IBM has a higher debt to total asset ratio showing that it has higher financial risk in terms of the total assets accumulated by the firm.
LONG TERM DEBT TO TOTAL CAPITALIZATION RATIO
FORMULA : LONG-TERM DEBT TOTAL CAPITALIZATION 2007-08 HP IBM 0.13 0.34 2006-07 0.10 0.30 YOY (%) 30 13
IBM shows a decrease in the total capitalization whereas HP shows an increase in it. In case of HP the long term debts are increasing substantially leading to an increase in the ratio (though not substantial as total capitalization is also increasing)
Long term debt and total capitalization in case of IBM have both decreased though the decrease in the long term debt is less as compared to decrease in the total capitalization.
DEBT RATIO ANALYSIS
IBM:
Global Financing is a segment of the company and as such, is supported by the company s overall liquidity position and access to capital markets. Cash generated by Global Financing was primarily deployed to pay intercompany payables and dividends to the company in order to maintain an appropriate debt-to-equity ratio. Stockholders equity decreased $15,004 million, net of tax, primarily as a result of changes from pension re-measurements and current year activity within accumulated gains and (losses) not affecting retained earnings. This is a non-cash impact to equity and does not affect the company s access to capital markets or its ability to meet its obligations. Stockholders equity of $13,465 million decreased $15,004 million versus 2007. Total debt of $33,926 million decreased $1,349 million from prior year-end levels. and the company generated $18,812 million in operating cash flow in 2008. Within total debt, on a net basis, the company utilized $2,444 million in net cash to retire debt versus $12,112 million in net cash proceeds in 2007. The net cash used to retire debt in 2008 was comprised of: $10,248 million in cash payments to settle debt and net payments of $6,025 million in short-term borrowings, partially offset by $13,829 million of new debt issuances.
INTEREST COVERAGE RATIO
FORMULA : EBIT INTEREST EXPENSES 2007-08 HP IBM 31.83 25.84 2006-07 30.17 24.71 YOY (%) 6 5 INDUSTRY AVERAGE 24.2
This ratio shows the company s ability to meet its interest payments to avoid bankruptcy. It shows a firm s capacity to take new debts. Higher ratios are preferred.
Both HP and IBM have shown amore interest paying capacity year on year showing that both of them are strengthening their capacity to pay back long term debts.
Hp s interest coverage ratio is better than that of IBM.
RECEIVABLE TURNOVER RATIO
FORMULA : ANNUAL NET CREDIT SALES RECEIVABLES 2007-08 HP IBM 6.13 3.67 2006-07 6.53 3.34 YOY (%) (6) 10 INDUSTRY AVERAGE 4.8
Receivable turnover ratio of HP is greater than that of IBM. Infact it is also greater that the industry average(good sign). This shows that the collection methods are better managed by HP.
RECEIVABLE TURNOVER IN DAYS
FORMULA : DAYS IN A YEAR RECEIVABLE TURNOVER RATIO 2007-08 HP IBM 60 100 2006-07 56 110 YOY (%) 7 (9) INDUSTRY AVERAGE 77
The increase in receivable turnover in days for HP was due primarily to a higher accounts receivable balance during the fourth quarter of fiscal 2008 compared to the same period in fiscal 2007 and the effect of the EDS acquisition.
Receivables in case of IBM have reduced thus the ratio has increased and the receivable turnover in days i.e average collection period has decreased which is a good sign as it speeds up the receivables.
RATIO ANALYSIS
Divi Khanna MBA Tech (Telecom) Roll No: 420
PAYABLE TURNOVER RATIO
FORMULA : ANNUAL NET CREDIT PURCHASES PAYABLES 2007-08 HP IBM 6.35 8.09 2006-07 6.64 6.89 YOY (%) (4) 17 INDUSTRY AVERAGE 6.99
Cash generated by Global Financing was primarily deployed to pay
intercompany payables and dividends to the company (IBM).Hence the payables showed a decrease which increases the payable turnover ratio.
PAYABLE TURNOVER IN DAYS
FORMULA : DAYS IN A YEAR PAYABLE TURNOVER RATIO 2007-08 HP IBM 53 46 2006-07 55 53 YOY (%) (4) (13) INDUSTRY AVERAGE 53
The slight decrease in payable turnover in days for HP was due primarily to purchasing linearity and improved 66 accounts payable management.
In fact the payable turnover in days is less than the industry standards showing that it pays back its debts faster than the other firms.
INVENTORY TURNOVER RATIO
FORMULA : COST OF GOODS SOLD INVENTORY 2007-08 HP IBM
2006-07 9.78 20.91
YOY (%) 16 0.4
INDUSTRY AVERAGE 11
11.37 20.99
Commercial financing receivables relate primarily to inventory and accounts receivable financing for dealers and remarketers of IBM and non-IBM products. Payment terms for inventory and accounts receivable financing generally range from 30 to 90 days. Accounts payable drove a use of cash of $718 million; and A decrease in cash of $284 million driven by growth in inventory. The net impact of the purchases and sales of marketable securities and other investments resulted in an increase in cash of $642 million.
INVENTORY TURNOVER IN DAYS
FORMULA : DAYS IN A YEAR INVENTORY TURNOVER 2007-08 HP IBM 32 18 2006-07 37 18 YOY (%) (14) (0) INDUSTRY AVERAGE 34
The decrease in inventory turnover in days for HP was due primarily to
more efficient inventory management, higher cost of goods sold during the fourth quarter of 2008 as a result of increased revenues and the effect of the EDS acquisition.
OPERATING CYCLE
FORMULA : INVENTORY TURNOVER IN DAYS + RECEIVABLE TURNOVER IN DAYS 2007-08 HP IBM 92 118 2006-07 93 128 YOY (%) (1) (8) INDUSTRY AVERAGE 110
IBM is making attempts to reduce its OC .This is shown by the greater decrease in the OC as compared to that of HP.
IBM maintains a very short inventory turnover in days .However its receivable turnover in days is very high, leading to its greater operating cycle.
CASH CYCLE
FORMULA : OPERATING CYCLE PAYABLE TURNOVER IN DAYS 2007-08 HP IBM 34 72 2006-07 38 75 YOY (%) (11) (4) INDUSTRY AVERAGE 58
The combined effect of changes in the payable, receivable and inventory turnover ratios for HP(as already mentioned above) contributed to the decrease in FY 2008 cash conversion cycle compared to the prior year.
IBM s cash cycle is quite high as compared to HP. Thus to a certain extent HP s cash management is better as it is quick to collect cash from its sales once the purchases have been paid for.
TOTAL ASSET TURNOVER RATIO
FORMULA : NET SALES TOTAL ASSETS 2007-08 HP IBM 1.04 0.92 2006-07 1.17 0.8 YOY (%) (11) 15 INDUSTRY AVERAGE 0.8
IBM s asset turnover ratio has increase by 15 % due to increase in sales and a decrease in the total assets (Total assets decreased $10,907 million).
Hp s asset turnover ratio is quite high as compared to industry standards showing very good management of assets in the sales. It is also because the OC and the CC are high. From the cash flow statement of IBM it can be seen that the net gain on asset sales is very high for the year 2008.
GROSS PROFIT MARGIN
FORMULA : NET SALES COST OF GOODS SOLD NET SALES 2007-08 (%) HP IBM 24.07 43.88 2006-07 (%) 24.37 42.04 YOY (%) (1) 4 INDUSTRY AVERAGE 23.5
Gross profit margin is a financial ratio used to assess the profitability of a firm's core activities, excluding fixed costs. Gross profit margin indicates the relationship between net sales revenue and the cost of goods sold. A high gross profit margin indicates that a business can make a reasonable profit on sales, as long as it keeps overhead costs in control.
PRE-TAX MARGIN
FORMULA : EBT NET SALES 2007-08 (%) HP IBM 8.88 16.54 2006-07 (%) 8.39 15.02 YOY (%) 6 10 INDUSTRY AVERAGE 6.6
It shows the rate of earning on sales after the interest cost but before the tax. It indicates the margin to be included in sales to meet all expenses.
Pre-tax income from continuing operations grew 15.4 percent and net income from continuing operations increased 18.4 percent reflecting an improvement in the company s tax rate.
NET PROFIT MARGIN
FORMULA : EAT NET SALES 2007-08 (%) HP IBM 7.06 12.2 2006-07 (%) 6.99 10.8 YOY (%) 2 13 INDUSTRY AVERAGE 5.6
It measures profitability of sales after adjusting all income, expenses and taxes. A low profit margin indicates a low margin of safety: higher risk that a decline in sales will erase profits and result in a net loss.
PROFITABILITY RATIO ANALYSIS
IBM
Gross profit margins improved, reflecting the shift to higher value businesses, pricing for value and the continued focus on productivity and cost management Increase in Net cash used in investing and financing activities
HP
Total company gross margin decreased slightly in fiscal 2008 from fiscal 2007. There was a favorable currency due to movement of the dollar against the euro
RETURN ON INVESTMENT
FORMULA : EAT TOTAL ASSETS 2007-08 (%) HP IBM 7.35 11.26 2006-07 (%) 8.19 8.65 YOY (%) (10) 30 INDUSTRY AVERAGE 23.9
It is the ratio of money gained or lost on an investment relative to the amount of money invested. IBM has shown a substantial increase in the ROI due to decrease in total assets and an increase in the net income. 10% decrease in case of HP because of a decrease in total asset turnover ratio and net profit margin increased only marginally.
RETURN ON EQUITY
FORMULA : EAT SHAREHOLDER S EQUITY 2007-08 (%) HP IBM 21.39 91.6 2006-07 (%) 18.85 36.59 YOY (%) 14 150 INDUSTRY AVERAGE 49.7
Return on Equity measures the rate of return on the ownership interest of the common stock owners. It measures a firm's efficiency at generating profits from every unit of shareholders' equity IBM has very firm investment opportunities for its future stakeholders. IBM is a better investment firm for its stakeholders.
DU PONT APPRAOCH ROI AND ROE
FORMULA(ROI) : NET PROFIT MARGIN x TOTAL ASSET TURNOVER 2007-08 (%) HP IBM 7.34 11.22 2006-07 (%) 8.18 8.64 YOY (%) (10) 30
FORMULA(ROE) : NET PROFIT MARGIN x TOTAL ASSET TURNOVER x EQUITY MULTIPLIER 2007-08 (%) HP IBM 21.36 91.25 2006-07 (%) 18.86 36.55 YOY (%) 13 150
SUGGESTIONS
Curtail cash expenditure and increase cash in hand, cash at bank, and marketable securities. Increase liquid assets and decrease current liabilities so that firm can meet out the current liabilities. Increase other current assets for payment of short term liability. Curtail long term borrowings from short term funds so that financial obligation may be managed properly.
GROUP 6 Apoorva Charu (117) Swati Seshadri (118) Meenal Shah (119) Ankit Sharma (418) Arpit Vijay (419) Divi Khanna (420) Juhi Rupani (421)
CASH MANAGEMENT
Juhi Rupani MBA Tech (Telecom) Roll No : 421
CASH MANAGEMENT
It is the maintaining of liquidity of a firm to minimize the risk of insolvency. It is also about the proper balancing of keeping cash without letting it idling around. Good cash management means: Knowing when, where, and how your cash needs will occur. Knowing what the best sources are for meeting additional cash needs. Being prepared to meet these needs when they occur, by keeping good relationships with bankers and other creditors.
MOTIVES FOR HOLDING CASH
The 3 motives for holding cash as advocated by the British Economist, John Maynard, are:
1. Transaction motive:
Maintaining cash for the purpose of meeting cash needs arising in the ordinary course of doing business. Includes regular payments like wages, utilities, acquisition of fixed assets and inventories.
2. Speculative motive:
Holding cash for potential profit making situation like purchasing raw materials in bulk in anticipation of a fall in price.
MOTIVES FOR HOLDING CASH contd.
3. Precautionary motive:
Maintaining of cash balance as buffer for UNEXPECTED needs that may arise. Either holding in cash or marketable securities that can be liquidated easily
Marketable securities are very liquid securities that can be converted into cash quickly at a reasonable price and tend to have maturities of less than one year.
CASH MANAGEMENT SYSTEM
CASH MANAGEMENT SYSTEM contd.
From the figure we can see that the firm will benefit by speeding up cash receipts and slowing down cash payouts. The firm wants to speed up the collection of accounts receivable so that it can have the use of money sooner. Conversely, it wants to pay accounts payable as late as is consistent with maintaining the firms credit standing with suppliers so that it can make the most use of the money it already has.
CASH MANAGEMENT SYSTEM contd.
CASH COLLECTION:
It is the management of receivables, customer payments and incoming cash flows of a firm.
CASH DISBURSEMENT:
A payment of money or simply a payment. Usually, the writing of a check to pay for an item previously obligated to be paid, such as loan payment, salary payment or accounts receivable payment.
HP AND IBM
Parameter MARKET CAPITALIZATION SUBSCRIBER BASE (JUNE 2008) PRESENCE ORIGIN LISTED ON RANKING IN INDIA HP Approx 95004 crores 45 million Global California NYSE 5 IBM Approx 563490 crores 119.68 million Global New York NYSE 7
HP specializes in developing and manufacturing computing, storage, and networking hardware, software and services. Major product lines include personal computing devices, enterprise servers, related storage devices, as well as a diverse range of printers and other imaging products.
IBM manufactures and sells computer hardware and software (with a focus on the latter), and offers infrastructure services, hosting services, and consulting services in areas ranging from mainframe computers to nanotechnology.
Speeding Up Cash Receipts & Slowing Down Cash Payments
Apoorva Charu Sawhney MBA Tech (IT) Roll No : 117
SPEEDING UP CASH RECEIPTS
Acceleration of Collections: 1. Early preparation and mailing of invoice 2. Accelerate payment from customers 3. Reduce time when payments remain uncollected funds
COLLECTION FLOAT: Total time between the mailing of the check by the customer and the availability of cash to the receiving firm.
COLLECTION FLOAT TIME-LINE
BOB JONES ORDER OF
2048
Customer mails check
Firm receives check
Company deposits check
Company¶s bank account credited
PROCESSING FLOAT
AVAILABILITY FLOAT
MAIL FLOAT DEPOSIT FLOAT
COLLECTION FLOAT
WAYS TO REDUCE COLLECTION FLOAT
Earlier billing/Outsource the billing function Pre-authorized debt Use of Lockbox systems Concentration banking ± Depository transfer check ± Automated Clearing House (ACH) Transfer ± Wire Transfer
EARLIER BILLING
Accelerated preparation and mailing of invoices Use of computerized billing/ fax Enclose invoices with shipped goods Request for advance payments of goods Outsourcing the billing function: ± Allows firm to focus on clients ± Allows firm to save labour costs ± Allows firm to relocate resources
PRE-AUTHORIZED DEBT
Arrangement that allows firms to transfer payments directly from customer accounts to firm s accounts, with customer's advance authorization. Reduces mail float and processing float
ADVANTAGES: ± Eliminates billing and postage costs, clerical processing costs ± Eliminates regular billing for customers ± Increased working cash
LOCKBOX SYSTEM
Firm sets up a lock box service with their bank , customers send their payments directly to lockbox. The bank deposits payments directly to the company's account.
ADVANTAGES: ± Reduces mail float and processing float ± Reduces clerical functions (bank handles receiving, totaling, depositing) ± Early knowledge of dishonored checks
CONCENTRATION BANKING
Firms move funds from several geographically situated regional banks to a main concentration account in a primary bank.
ADVANTAGES:
± Improves control over cash inflow/outflow ± Reduces idle balances ± Allows more effective investments
DEPOSITORY TRANSFER CHECKS (DTCs)
Firms use pre-printed, non-negotiable check drawn on a local bank, payable to a single company account at a concentration bank.
ADVANTAGES: ± Lower levels of excess cash ± Eliminates billing, postage and clerical processing costs ± Reduces mail float and processing float DISADVANTAGES: ± funds not immediately available on DTC receipt ± Mail-based collection of check
AUTOMATED CLEARINGHOUSE TRANSFER
The Automated Clearing House is an electronic system used to transfer funds between banks.
ADVANTAGES: ± Electronic version of DTC, hence is faster ± Funds available 1 business day later ± Better coordination between bank branches DISADVANTAGES: ± Hard to stop payment on the physical check
WIRE TRANSFER
Electronic transfer of funds using two-way communications system Primary bank sends message to the receiving bank requesting them to effect payment in accordance with the instructions given.
ADVANTAGES: ± Simple procedure; funds available immediately DISADVANTAGES: ± expensive
SLOWING DOWN CASH PAYOUTS
DISBURSEMENT FLOAT: ± The total time period between when a check is prepared by the firm and when the check is presented for payment.
BOB JONES ORDE R OF
204 8
Firm mails check
Creditor receives check
Creditor deposits check
Firm¶s account is debted
DELIVERY FLOAT
PROCESSING FLOAT
TRANSIT FLOAT
DISBURSEMENT FLOAT
NET FLOAT
NET FLOAT: ± The total amount of float in a bank account. ± The net float, when added to or subtracted from the book balance, shows how much money is in the bank account. ± Accurate estimation is necessary for playing the float . NET FLOAT = DISBURSEMENT FLOAT COLLECTION FLOAT
Money spent by the firm but not yet taken out of its account money deposited by the customer but not yet cleared to firm¶s account
CONTROL OF DISBURSEMENTS
Centralized disbursement system Payable through drafts (PTD) Zero-Balance Accounts Controlled disbursements Remote Disbursements Outsourcing
CENTRALIZED SYSTEM
Payables centralized into one account. Sophisticated computer system that provide necessary information about excess funds. ADVANTAGES: ± Excess funds transferred automatically from other accounts ± Disbursements made precisely when required DISADVANTAGES: ± Operating procedures should be common for all accounts and well-established
PAYABLE THROUGH DRAFT (PTD)
It is Payable-on-demand When presented to issuer s bank for collection, bank presents it for acceptance. The funds are disbursed after acceptance. ADVANTAGES: ± Delays the time firm has to maintain funds to cover the draft ± Allows firm to maintain smaller bank balances ± Payment can be stopped if necessary DISADVANTAGES: ± Banks impose higher service charge for drafts
ZERO BALANCE ACCOUNT (ZBA)
One master account services subsidiary accounts. Just enough cash is transferred daily from the firm s master account to subsidiary accounts to maintain zero balance account ADVANTAGES: ± Allows more control over cash outflows ± No idle cash in subsidiary accounts DISADVANTAGES: ± Daily transfer of cash required ± Efficient management of master account required
OTHER METHODS
CONTROLLED DISBURSEMENTS: ± Bank provides a daily report, that provides the amount of disbursements that will be charged to the firm's account. ± This early knowledge of daily funds requirement allows firm to invest any surplus in intra-day investment opportunities. REMOTE DISBUSREMENTS: ± Payments are issued through a remote branch of a bank and firm is able to delay the payment due to increased float time. OUTSOURCING: ± Firm can hire outside services to perform disbursement functions.
Electronic Commerce and Outsourcing
Ankit Sharma MBA Tech (Telecom) Roll No : 418
ELECTRONIC COMMERCE
Electronic commerce is the exchange of business information in an electronic format as an alternative to the paper based system. EC spectrum can be divided into: ± Unstructured messaging: utilize technologies such as faxes and e-mails ± Structured messaging: utilize technologies such as electronic data interchange (EDI)
ELECTRONIC DATA INTERCHANGE
It involves the transfer of business information such as invoices, purchase orders, and shipping information in a computer readable format. It involves direct computer to computer data transfer as well as transfer through physical storage such as CDs, disks etc.
ELECTRONIC FUNDS TRANSFER
ELECTRONIC DATA INTERCHANGE
FINANCIAL EDIs
ELECTRONIC FUNDS TRANSFER
Electronic transfer of a certain monetary value takes place in which a depository institution sends or receives electronic payments. It can be applied to: Cardholder-initiated transactions, where a cardholder makes use of a payment card Direct deposit payroll payments for a business to its employees, possibly via a payroll services company Direct debit payments from customer to business, where the transaction is initiated by the business with customer permission Electronic bill payment in online banking, which may be delivered by EFT or paper check Wire transfer via an international banking network (generally carries a higher fee)
ELECTRONIC FUNDS TRANSFER contd.
Instruction for transfer set by two major societies: SWIFT (Society for worldwide interbank financial telecommunication) CHIPS (Clearing house interbank payment systems)
In January 1999, a regulation passed required all federal government payments except tax refunds and special waiver situations, be made electronically This will:
provide more security than paper checks and be cheaper to process for the government.
FINANCIAL EDI
Is the computer-to-computer exchange of payment and payment-related information between companies using a standard format. A bank must be involved. The buyer and seller must work closely with their respective banks to effect a Financial EDI transaction. Examples include: ± Lockbox remittance information ± Bank balance information
STEPS IN FINANCIAL EDI
The buyer, or originator, electronically extracts payment information from the company's accounts payable system. The buyer formats the data into an EDI ANSI standard, the ANSI 820 transaction set using an EDI software. The buyer then transmits an ANSI 820 format to bank for processing. The bank then takes the 820 data and puts it into a format so that it can be sent through the Automated Clearinghouse. The ACH network then delivers the payment data to the seller's, or receiver's, bank.
COSTS AND BENEFITS OF EDI
Costs
Computer hardware and software expenditures Increased training costs to implement and utilize an EDI system Additional expenses to convince suppliers and customers to use the electronic system Loss of float
Benefits
Information and payments move faster and with greater reliability Improved cash forecasting and cash management Customers receive faster and more reliable service Reduction in mail, paper, and document storage costs
OUTSOURCING
Shifting an in-house operation to outside firm in a view to reduce company s costs Operation to be outsourced is critical but non-core process of the company The subcontractor uses special expertise and economies of scale to perform an outsourced business operation The company gets the service it needs at a lower cost and higher quality; can focus on its core business
OUTSOURCING: IBM
The company s major operations in outsourcing are: Global technology services: Comprehensive IT services integrated with business insight working with clients to reduce costs and improve productivity through accepting the outsourcing of processes and operations Global business services: primarily provides professional services and application outsourcing services, delivering business value and innovation to clients through solutions which leverage industry and business process expertise. IBM leverages its supply-chain expertise for clients through its supply-chain business transformation outsourcing service to optimize and help operate clients end-to-end supply-chain processes, from procurement to logistics.
REVENUE FROM OUTSOURCING: IBM
CASH BALANCES: HEWLETT PACKARD
Total cash and cash equivalents declined approximately 10% to $10.2 billion in 2008 from $11.3 billion in 2007 due to increased investment spending on acquisitions and increased borrowings. Cash balances according to them are sufficient to cover cash outlays expected in fiscal 2009 associated with additional stock repurchases, acquisitions, company bonus payments, and other operating cash requirements.
Investments in Marketable Securities
Arpit Vijay MBA Tech (Telecom) Roll No : 419
GENERAL SCENARIO
In general, firms try to maintain some target level of cash for meeting : ± Transaction requirement ± Compensating Balances requirement Beyond this, they invest in marketable securities as near-cash investments ± Interest lost on idle cash balances ± Greater opportunity cost incurred on maintaining idle cash balances Securities are called marketable securities when : ± The firm can readily convert them into cash and ± Intends to do so when it needs cash If this does not apply, it is called as Investment in securities
BALANCE SHEET REPRESENTATION
Cash Equivalents Most liquid assets found within any firm s balance sheet. Readily convertible into cash Maturity with 3 months Low risk, Low Return Includes Treasury Bills, Bank Certificate of Deposits, Other money market instruments. Short Term Investments Securities that are held for less than one year Return on investment in form of : ± Financial income i.e. dividend income, interest income ± Capital appreciation
VALUATION OF MARKETABLE SECURITIES
At Acquisition Marketable Securities are initially recorded at acquisition cost which includes purchase price plus any commission, taxes or other costs related to acquisition. This the same rule as the general rule for valuing assets at acquisition. After Acquisition Because there exists a market value, marketable securities can be reliably written up or down to the market value giving a more current estimate of economic worth This also results in a holding gain or loss which is not due to the normal operations of a firm.
THREE CLASSES OF MARKETABLE SECURITIES
For the purposes of valuation after acquisition, there are three classes of marketable securities: ± Debt held to maturity ± Trading securities ± Securities available for sale
DEBT HELD TO MATURITY
Debt securities for which a firm has both the positive intent & ability to hold to maturity Shown on the balance sheet at the amortized acquisition cost Amortized acquisition cost means that the securities are amortized like a mortgage or bond ± The acquisition cost is assumed to be the present value. ± The maturity value and maturity date are known from the bond certificate.
TRADING SECURITIES
Trading securities are assumed to be held for short-term profit Characterized by frequent & active buying & selling with the object of generating profit Typically only financial institutions hold trading securities Since trading securities are acquired for short-term profit, unrealized gains or losses that result from adjustments to market value pass through the income statement & increase or reduce net income before there is a sale of the securities
SECURITIES AVAILABLE FOR SALE
Securities available for sale are neither trading securities or securities held to maturity. They are an intermediate class and are typically tied to a specific cash need. They are held by non-financial companies For example, a manufacturing firm may build a large fund of securities to pay for a renovation to its plant or to retire bonds that will come due. Since they are acquired for longer-term return, unrealized gains or losses that result from adjustments to market value do not pass through the income statement but stay on the balance sheet as an equity account.
COMPARISON
Trading Securities The unrealized holding gain or loss for trading securities is considered income; it is close to income and increases or decreases net income. Securities Available for Sale While the unrealized holding gain or loss for available for sale securities is not closed but remains on the balance sheet. When these securities are sold, this account must then be closed.
MARKETABLE SECURITIES PORTFOLIO
Free cash segment (F)
Ready cash segment (R)
Controllable cash segment (C)
READY CASH SEGMENT (R)
Optimal balance of marketable securities held to take care of probable deficiencies in the firm s cash account Can be sold quickly to build up cash Ideally, Cash Inflows >= Cash Outflows, each day
Free cash segment (F)
Ready cash segment (R)
Controllable cash segment (C)
CONTROLLABLE CASH SEGMENT (C)
Market securities held for meeting controllable (knowable) outflows such as taxes and dividends Accumulated funds for such purposes can be invested temporarily to earn interest
Free cash segment (F)
Ready cash segment (R)
Controllable cash segment (C)
FREE CASH SEGMENT (F)
free marketable securities available for unassigned purposes It is just extra idle cash with the company invested in Marketable securities.
Free cash segment (F)
Ready cash segment (R)
Controllable cash segment (C)
VARIABLES FOR SELECTION
Variables for selection for Marketable Securities : ± Safety ± Marketability ± Yield ± Maturity
SAFETY
With regard to the principal amount
Refers to the likelihood of getting back the same number of rupees you originally invested (principal)
MARKETABILITY
Also known as Liquidity
The ability to sell a significant volume of securities in the short period of time in the secondary market without significant price concession
YIELD
Also known as Return
The variability in the market price of a security caused by the changes in interest rates
Yield
Lower Interest Risk
Higher Interest Risk
Time
MATURITY
The life of a security i.e. amount of time before the principal amount of a security becomes due
Longer the maturity, greater the yield , but also more exposure to yield risk.
MARKETABLE SECURITIES
IBM IBM ended 2008 , with $ 12.9 billion of marketable securities Cash and Cash equivalents : $ 12,741 million Short term marketable securities : $ 166 million
HP
HP ended 2008, with 10.2 billion of marketable securities Cash and Cash equivalents : $ 10,153 million Short term Investments : $ 93 million
CONTROVERSY ABOUT MARKETABLE SECURITIES
The accounting for marketable securities has been controversial. The accounting issues are: ± Whether to report these instruments at historical cost (or some method based on historical cost) or at market value, and ± If at market value, whether to report the changes from period to period as part of that period s income or to await the period when the firm sells or otherwise disposes of the instrument to record the gain or loss in income.
Common Investment Instruments
Meenal Shah MBA Tech (IT) Roll No : 119
Money Market
A segment of the financial market in which financial instruments with high liquidity and very short maturities are traded. There are two modes of investment in money market viz ± Direct Investment in Money Market Instruments & ± Investment in Money Market Funds.
Common Money Market Instruments
The money market encompasses a wide range of instruments with maturities ranging from one day to a year, issued by the government and by banks and corporates of varying credit rating, and traded in markets of varying liquidity. The money market is also intimately linked with the foreign exchange market Consequently, they are considered to be near-cash equivalents.
Common Money Market Instruments
Treasury Bills
Short term borrowing instruments issued by Central Bank (RBI in India) on behalf of Government of India Minimum of 25000 and its multiple Sold at a discount and repaid at maturity Yield determined by money market forces one of the safest money market instruments
Common Money Market Instruments
Certificates of Deposit
Unsecured interest paying negotiable instruments issued by commercial banks and also financial institutes Having maturity ranging from 30 days to 3 years. CD s are issued in denominations of Rs. 0.5 million.
Common Money Market Instruments
Commercial Paper
Money market instrument introduced by RBI and consists of short term, unsecured promissory notes Generally issued by finance companies with sound financial position and a high credit rating. Commercial Paper is issued at a discount which is determined by the money market forces It can be issued in denomination of Rs 5 lakh or in multiples of it for 15 days to 1 year
Common Money Market Instruments
Inter- corporate Deposits
Inter-corporate deposits are unsecured loans offered by one company to another company, and usually carry a term of six months Advantage : no legal issues Disadvantage : high risk
Common Money Market Instruments
Ready Forward or Repo or Buyback
Short term loans in which two parties agree to sell and repurchase the same security. Between the parties approved by RBI Repo - the seller sells securities with an agreement to repurchase the same at a mutually decided future date and price Reverse Repo - the buyer purchases the securities with an agreement to resell the same to the seller on an agreed date at a predetermined price.
Common Money Market Instruments
Bill of Exchange
± Issued in the form of promissory notes usually for the purpose of some transactions
consisting of goods and services.
± It is a buyer s promise to pay to the seller a certain specified amount at certain date. ± The same is guaranteed by the banker of the buyer in exchange for a claim on the
goods as collateral.
Bill Discounting
± While discounting a bill, the Bank buys the bill before it is due and credits the value
of the bill after a discount charge to the customer's account.
± The transaction is practically an advance against the security of the bill and the
discount represents the interest on the advance from the date of purchase of the bill until it is due for payment.
Common Money Market Instruments
Short Term Debentures
Issued by corporate bodies The funds borrowed are in excess to the funds already available to the corporate from its consortium bankers.
Fixed Deposits
FDs are fixed-income debt securities issued by banks. Putting money into an FD is like giving a loan to the bank, in return for which the bank pays you interest.
Common Money Market Instruments
Mutual Funds Schemes
Mutual fund is the most popular investment instrument for a common man as it offers a diversified professionally managed basket of securities at a low cost. The mutual fund industry offers various types of investment schemes like equity instrument, debt instrument or balanced instruments. These could be broadly classified as
± Open-ended scheme. ± Close-ended scheme ± Interval scheme
Selecting Securities for Portfolio Segments
Selecting Securities for Portfolio Segments
Ready Cash Segment Criterion 1. Safety and 2. ability to convert to cash
Controlled Cash Segment Free Cash Segment 1. Date to cash should be known 2. Mature at time of cash needs 1. Base choice on yield subject to risk-return risktradetrade-offs. 2. Marketability with some loss of principal tolerable if yield is high Any money market instrument may be selected for this segment
Select
Treasuries
CD s, commercial paper, and inter-corporate deposit
Portfolio Management
A portfolio is a group of investments. A well-managed portfolio is diversified to ensure a continuous ROI over time. There are three major portfolio management policies: ± Aggressive policy: (capital appreciation) ± Defensive policy: (capital preservation) ± Balanced policy: (Total Return)
RATIO ANALYSIS
Swati Seshadri MBA Tech (IT) Roll No: 118
CURRENT RATIO
FORMULA : CURRENT ASSETS + CURRENT INVESTMENTS CURRENT LIABILITIES + SHORT-TERM DEBT 2007-08 HP IBM 0.98 1.15 2006-07 1.21 1.2 YOY (%) (19) (4) INDUSTRY AVERAGE 1.4
The current ratio for both HP and IBM has plummeted for the year 2008. The YoY decrease is more for HP showing its lack of liquid assets in the year 2008.
Current ratio of HP has reduced from 1.21 to 0.99 (less than 1).This indicates that HP s ability to meet its payment obligations was very poor in FY 07-08.
The cash and cash equivalents with the total value of $2250 million decreases over the FY 07-08. This and the decrease in marketable securities and financing receivables led to a decrease in the solvency of IBM.
ACID TEST RATIO
FORMULA : CURRENT ASSETS + CURRENT INVESTMENTS PREPAID EXPENSES - INVENTORY CURRENT LIABILITIES + SHORT-TERM DEBT 2007-08 HP IBM 0.75 0.99 2006-07 0.96 1.05 YOY (%) (22) (6) INDUSTRY AVERAGE 0.8
The Quick ratios for both the companies have shown a decrease, with HP showing a greater decrease (0.22) as compared to IBM(0.06). This shows that IBM has greater solvency as compared to HP.
Quick ratio shows that IBM is much more liquid than HP according to the current industry averages.
LIQUIDITY RATIO ANALYSIS
HP
Cash and cash equivalents at October 31, 2008 totaled $10.2 billion, a decrease of $1.1 billion from the October 31, 2007 balance of $11.3 billion. The amount and terms of any acquisition-related borrowings affects liquidity and financial condition and potentially credit ratings. Thus HP's liquidity reduced in 2008 due to it acquisition of EDS. HP uses cash generated by operations as the primary source of liquidity. Internally generated cash flows support business operations, capital expenditures and the payment of stockholder dividends.
IBM
IBM's liquidity positions were strong as the cash on hand was $12,741 million. Total debt decreased $1,349 million year to year, and the company generated $18,812 million in operating cash flow in 2008. The company provides for additional liquidity through several sources: maintaining a sizable cash balance, access to global funding sources, a committed global credit facility and other committed and uncommitted lines of credit worldwide
DEBT TO EQUITY RATIO
FORMULA : TOTAL DEBT SHAREHOLDER S EQUITY 2007-08 HP IBM 0.46 2.52 2006-07 0.21 1.23 YOY (%) 119 105
In the case of HP the total debts have shown an substantial increase in the year 2008 as compared to the previous year whereas the stockholder s equity has remained almost constant. This shows that the debts used to finance the company is increasing compared to the equity.
In this case IBM has a lesser difficulty with creditors even if the debt to equity ratio has increased because their total debts have shown a decrease in the FY 08 with the shareholder s equity being halved.
DEBT TO TOTAL ASSETS RATIO
FORMULA : TOTAL DEBT TOTAL ASSETS 2007-08 HP IBM 0.16 0.31 2006-07 0.09 0.29 YOY (%) 77 7
In IBM the total assets have decreased more as compared to the total debts. Thus showing an increase in the YOY ratio.
In case of HP the debts are increasing substantially as compared to the total assets. IBM has a higher debt to total asset ratio showing that it has higher financial risk in terms of the total assets accumulated by the firm.
LONG TERM DEBT TO TOTAL CAPITALIZATION RATIO
FORMULA : LONG-TERM DEBT TOTAL CAPITALIZATION 2007-08 HP IBM 0.13 0.34 2006-07 0.10 0.30 YOY (%) 30 13
IBM shows a decrease in the total capitalization whereas HP shows an increase in it. In case of HP the long term debts are increasing substantially leading to an increase in the ratio (though not substantial as total capitalization is also increasing)
Long term debt and total capitalization in case of IBM have both decreased though the decrease in the long term debt is less as compared to decrease in the total capitalization.
DEBT RATIO ANALYSIS
IBM:
Global Financing is a segment of the company and as such, is supported by the company s overall liquidity position and access to capital markets. Cash generated by Global Financing was primarily deployed to pay intercompany payables and dividends to the company in order to maintain an appropriate debt-to-equity ratio. Stockholders equity decreased $15,004 million, net of tax, primarily as a result of changes from pension re-measurements and current year activity within accumulated gains and (losses) not affecting retained earnings. This is a non-cash impact to equity and does not affect the company s access to capital markets or its ability to meet its obligations. Stockholders equity of $13,465 million decreased $15,004 million versus 2007. Total debt of $33,926 million decreased $1,349 million from prior year-end levels. and the company generated $18,812 million in operating cash flow in 2008. Within total debt, on a net basis, the company utilized $2,444 million in net cash to retire debt versus $12,112 million in net cash proceeds in 2007. The net cash used to retire debt in 2008 was comprised of: $10,248 million in cash payments to settle debt and net payments of $6,025 million in short-term borrowings, partially offset by $13,829 million of new debt issuances.
INTEREST COVERAGE RATIO
FORMULA : EBIT INTEREST EXPENSES 2007-08 HP IBM 31.83 25.84 2006-07 30.17 24.71 YOY (%) 6 5 INDUSTRY AVERAGE 24.2
This ratio shows the company s ability to meet its interest payments to avoid bankruptcy. It shows a firm s capacity to take new debts. Higher ratios are preferred.
Both HP and IBM have shown amore interest paying capacity year on year showing that both of them are strengthening their capacity to pay back long term debts.
Hp s interest coverage ratio is better than that of IBM.
RECEIVABLE TURNOVER RATIO
FORMULA : ANNUAL NET CREDIT SALES RECEIVABLES 2007-08 HP IBM 6.13 3.67 2006-07 6.53 3.34 YOY (%) (6) 10 INDUSTRY AVERAGE 4.8
Receivable turnover ratio of HP is greater than that of IBM. Infact it is also greater that the industry average(good sign). This shows that the collection methods are better managed by HP.
RECEIVABLE TURNOVER IN DAYS
FORMULA : DAYS IN A YEAR RECEIVABLE TURNOVER RATIO 2007-08 HP IBM 60 100 2006-07 56 110 YOY (%) 7 (9) INDUSTRY AVERAGE 77
The increase in receivable turnover in days for HP was due primarily to a higher accounts receivable balance during the fourth quarter of fiscal 2008 compared to the same period in fiscal 2007 and the effect of the EDS acquisition.
Receivables in case of IBM have reduced thus the ratio has increased and the receivable turnover in days i.e average collection period has decreased which is a good sign as it speeds up the receivables.
RATIO ANALYSIS
Divi Khanna MBA Tech (Telecom) Roll No: 420
PAYABLE TURNOVER RATIO
FORMULA : ANNUAL NET CREDIT PURCHASES PAYABLES 2007-08 HP IBM 6.35 8.09 2006-07 6.64 6.89 YOY (%) (4) 17 INDUSTRY AVERAGE 6.99
Cash generated by Global Financing was primarily deployed to pay
intercompany payables and dividends to the company (IBM).Hence the payables showed a decrease which increases the payable turnover ratio.
PAYABLE TURNOVER IN DAYS
FORMULA : DAYS IN A YEAR PAYABLE TURNOVER RATIO 2007-08 HP IBM 53 46 2006-07 55 53 YOY (%) (4) (13) INDUSTRY AVERAGE 53
The slight decrease in payable turnover in days for HP was due primarily to purchasing linearity and improved 66 accounts payable management.
In fact the payable turnover in days is less than the industry standards showing that it pays back its debts faster than the other firms.
INVENTORY TURNOVER RATIO
FORMULA : COST OF GOODS SOLD INVENTORY 2007-08 HP IBM
2006-07 9.78 20.91
YOY (%) 16 0.4
INDUSTRY AVERAGE 11
11.37 20.99
Commercial financing receivables relate primarily to inventory and accounts receivable financing for dealers and remarketers of IBM and non-IBM products. Payment terms for inventory and accounts receivable financing generally range from 30 to 90 days. Accounts payable drove a use of cash of $718 million; and A decrease in cash of $284 million driven by growth in inventory. The net impact of the purchases and sales of marketable securities and other investments resulted in an increase in cash of $642 million.
INVENTORY TURNOVER IN DAYS
FORMULA : DAYS IN A YEAR INVENTORY TURNOVER 2007-08 HP IBM 32 18 2006-07 37 18 YOY (%) (14) (0) INDUSTRY AVERAGE 34
The decrease in inventory turnover in days for HP was due primarily to
more efficient inventory management, higher cost of goods sold during the fourth quarter of 2008 as a result of increased revenues and the effect of the EDS acquisition.
OPERATING CYCLE
FORMULA : INVENTORY TURNOVER IN DAYS + RECEIVABLE TURNOVER IN DAYS 2007-08 HP IBM 92 118 2006-07 93 128 YOY (%) (1) (8) INDUSTRY AVERAGE 110
IBM is making attempts to reduce its OC .This is shown by the greater decrease in the OC as compared to that of HP.
IBM maintains a very short inventory turnover in days .However its receivable turnover in days is very high, leading to its greater operating cycle.
CASH CYCLE
FORMULA : OPERATING CYCLE PAYABLE TURNOVER IN DAYS 2007-08 HP IBM 34 72 2006-07 38 75 YOY (%) (11) (4) INDUSTRY AVERAGE 58
The combined effect of changes in the payable, receivable and inventory turnover ratios for HP(as already mentioned above) contributed to the decrease in FY 2008 cash conversion cycle compared to the prior year.
IBM s cash cycle is quite high as compared to HP. Thus to a certain extent HP s cash management is better as it is quick to collect cash from its sales once the purchases have been paid for.
TOTAL ASSET TURNOVER RATIO
FORMULA : NET SALES TOTAL ASSETS 2007-08 HP IBM 1.04 0.92 2006-07 1.17 0.8 YOY (%) (11) 15 INDUSTRY AVERAGE 0.8
IBM s asset turnover ratio has increase by 15 % due to increase in sales and a decrease in the total assets (Total assets decreased $10,907 million).
Hp s asset turnover ratio is quite high as compared to industry standards showing very good management of assets in the sales. It is also because the OC and the CC are high. From the cash flow statement of IBM it can be seen that the net gain on asset sales is very high for the year 2008.
GROSS PROFIT MARGIN
FORMULA : NET SALES COST OF GOODS SOLD NET SALES 2007-08 (%) HP IBM 24.07 43.88 2006-07 (%) 24.37 42.04 YOY (%) (1) 4 INDUSTRY AVERAGE 23.5
Gross profit margin is a financial ratio used to assess the profitability of a firm's core activities, excluding fixed costs. Gross profit margin indicates the relationship between net sales revenue and the cost of goods sold. A high gross profit margin indicates that a business can make a reasonable profit on sales, as long as it keeps overhead costs in control.
PRE-TAX MARGIN
FORMULA : EBT NET SALES 2007-08 (%) HP IBM 8.88 16.54 2006-07 (%) 8.39 15.02 YOY (%) 6 10 INDUSTRY AVERAGE 6.6
It shows the rate of earning on sales after the interest cost but before the tax. It indicates the margin to be included in sales to meet all expenses.
Pre-tax income from continuing operations grew 15.4 percent and net income from continuing operations increased 18.4 percent reflecting an improvement in the company s tax rate.
NET PROFIT MARGIN
FORMULA : EAT NET SALES 2007-08 (%) HP IBM 7.06 12.2 2006-07 (%) 6.99 10.8 YOY (%) 2 13 INDUSTRY AVERAGE 5.6
It measures profitability of sales after adjusting all income, expenses and taxes. A low profit margin indicates a low margin of safety: higher risk that a decline in sales will erase profits and result in a net loss.
PROFITABILITY RATIO ANALYSIS
IBM
Gross profit margins improved, reflecting the shift to higher value businesses, pricing for value and the continued focus on productivity and cost management Increase in Net cash used in investing and financing activities
HP
Total company gross margin decreased slightly in fiscal 2008 from fiscal 2007. There was a favorable currency due to movement of the dollar against the euro
RETURN ON INVESTMENT
FORMULA : EAT TOTAL ASSETS 2007-08 (%) HP IBM 7.35 11.26 2006-07 (%) 8.19 8.65 YOY (%) (10) 30 INDUSTRY AVERAGE 23.9
It is the ratio of money gained or lost on an investment relative to the amount of money invested. IBM has shown a substantial increase in the ROI due to decrease in total assets and an increase in the net income. 10% decrease in case of HP because of a decrease in total asset turnover ratio and net profit margin increased only marginally.
RETURN ON EQUITY
FORMULA : EAT SHAREHOLDER S EQUITY 2007-08 (%) HP IBM 21.39 91.6 2006-07 (%) 18.85 36.59 YOY (%) 14 150 INDUSTRY AVERAGE 49.7
Return on Equity measures the rate of return on the ownership interest of the common stock owners. It measures a firm's efficiency at generating profits from every unit of shareholders' equity IBM has very firm investment opportunities for its future stakeholders. IBM is a better investment firm for its stakeholders.
DU PONT APPRAOCH ROI AND ROE
FORMULA(ROI) : NET PROFIT MARGIN x TOTAL ASSET TURNOVER 2007-08 (%) HP IBM 7.34 11.22 2006-07 (%) 8.18 8.64 YOY (%) (10) 30
FORMULA(ROE) : NET PROFIT MARGIN x TOTAL ASSET TURNOVER x EQUITY MULTIPLIER 2007-08 (%) HP IBM 21.36 91.25 2006-07 (%) 18.86 36.55 YOY (%) 13 150
SUGGESTIONS
Curtail cash expenditure and increase cash in hand, cash at bank, and marketable securities. Increase liquid assets and decrease current liabilities so that firm can meet out the current liabilities. Increase other current assets for payment of short term liability. Curtail long term borrowings from short term funds so that financial obligation may be managed properly.
