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CHAPTER3LONG-TERMFINANCIALPLANNINGANDGROWTHAnswerstoConceptsReviewandCriticalThinkingQuestions1.Timetrendanalysisgivespictureofchangesinthecompany’sfinancialsituationovertime.Comparingafirmtoitselfovertimeallowsthefinancialmanagertoevaluatewhethersomeaspectsofthefirm’soperations,finances,orinvestmentactivitieshavechanged.Peergroupanalysisinvolvescomparingthefinancialratiosandoperatingperformanceofaparticularfirmtoasetofpeergroupfirmsinthesameindustryorlineofbusiness.Comparingafirmtoitspeersallowsthefinancialmanagertoevaluatewhethersomeaspectsofthefirm’soperations,finances,orinvestmentactivitiesareoutoflinewiththenorm,therebyprovidingsomeguidanceonappropriateactionstotaketoadjusttheseratiosifappropriate.Bothallowaninvestigationintowhatisdifferentaboutacompanyfromafinancialperspective,butneithermethodgivesanindicationofwhetherthedifferenceispositiveornegative.Forexample,supposeacompany’scurrentratioisincreasingovertime.Itcouldmeanthatthecompanyhadbeenfacingliquidityproblemsinthepastandisrectifyingthoseproblems,oritcouldmeanthecompanyhasbecomelessefficientinmanagingitscurrentaccounts.Similarargumentscouldbemadeforapeergroupcomparison.Acompanywithacurrentratiolowerthanitspeerscouldbemoreefficientatmanagingitscurrentaccounts,oritcouldbefacingliquidityproblems.Neitheranalysismethodtellsuswhetheraratioisgoodorbad,bothsimplyshowthatsomethingisdifferent,andtellsuswheretolook.2.Ifacompanyisgrowingbyopeningnewstores,thenpresumablytotalrevenueswouldberising.Comparingtotalsalesattwodifferentpointsintimemightbemisleading.Same-storesalescontrolforthisbyonlylookingatrevenuesofstoresopenwithinaspecificperiod.3.Thereasonisthat,ultimately,salesarethedrivingforcebehindabusiness.Afirm’sassets,employees,and,infact,justabouteveryaspectofitsoperationsandfinancingexisttodirectlyorindirectlysupportsales.Putdifferently,afirm’sfutureneedforthingslikecapitalassets,employees,inventory,andfinancingaredeterminedbyitsfuturesaleslevel.4.Twoassumptionsofthesustainablegrowthformulaarethatthecompanydoesnotwanttosellnewequity,andthatfinancialpolicyisfixed.Ifthecompanyraisesoutsideequity,orincreasesitsdebt-equityratio,itcangrowatahigherratethanthesustainablegrowthrate.Ofcourse,thecompanycouldalsogrowfasterthanitsprofitmarginincreases,ifitchangesitsdividendpolicybyincreasingtheretentionratio,oritstotalassetturnoverincreases.5.Thesustainablegrowthrateisgreaterthan20percent,becauseata20percentgrowthratethenegativeEFNindicatesthatthereisexcessfinancingstillavailable.Ifthefirmis100percentequityfinanced,thenthesustainableandinternalgrowthratesareequalandtheinternalgrowthratewouldbegreaterthan20percent.However,whenthefirmhassomedebt,theinternalgrowthrateisalwayslessthanthesustainablegrowthrate,soitisambiguouswhethertheinternalgrowthratewouldbegreaterthanorlessthan20percent.Iftheretentionratioisincreased,thefirmwillhavemoreinternalfundingsourcesavailable,anditwillhavetotakeonmoredebttokeepthedebt/equityratioconstant,sotheEFNwilldecline.Conversely,iftheretentionratioisdecreased,theEFNwillrise.Iftheretentionrateiszero,boththeinternalandsustainablegrowthratesarezero,andtheEFNwillrisetothechangeintotalassets.6.Common-sizefinancialstatementsprovidethefinancialmanagerwitharatioanalysisofthecompany.Thecommon-sizeincomestatementcanshow,forexample,thatcostofgoodssoldasapercentageofsalesisincreasing.Thecommon-sizebalancesheetcanshowafirm’sincreasingrelianceondebtasaformoffinancing.Common-sizestatementsofcashflowsarenotcalculatedforasimplereason:Thereisnopossibledenominator.7.Itwouldreducetheexternalfundsneeded.Ifthecompanyisnotoperatingatfullcapacity,itwouldbeabletoincreasesaleswithoutacommensurateincreaseinfixedassets.8.Presumablynot,but,ofcourse,iftheproducthadbeenmuchlesspopular,thenasimilarfatewouldhaveawaitedduetolackofsales.9.Sincecustomersdidnotpayuntilshipment,receivablesrose.Thefirm’sNWC,butnotitscash,increased.Atthesametime,costswererisingfasterthancashrevenues,sooperatingcashflowdeclined.Thefirm’scapitalspendingwasalsorising.Thus,allthreecomponentsofcashflowfromassetswerenegativelyimpacted.10.Financingpossiblycouldhavebeenarrangedifthecompanyhadtakenquickenoughaction.Sometimesitbecomesapparentthathelpisneededonlywhenitistoolate,againemphasizingtheneedforplanning.11.Allthreewereimportant,butthelackofcashor,moregenerally,financialresourcesultimatelyspelleddoom.Aninadequatecashresourceisusuallycitedasthemostcommoncauseofsmallbusinessfailure.12.Demandingcashupfront,increasingprices,subcontractingproduction,andimprovingfinancialresourcesvianewownersornewsourcesofcreditaresomeoftheoptions.Whenordersexceedcapacity,priceincreasesmaybeespeciallybeneficial.13.ROEisabettermeasureofthecompany’sperformance.ROEshowsthepercentagereturnfortheyearearnedonshareholderinvestment.Sincethegoalofacompanyistomaximizeshareholderwealth,thisratioshowsthecompany’sperformanceinachievingthisgoalovertheperiod.14.TheEBITD/Assetsratioshowsthecompany’soperatingperformancebeforedepreciation,amortization,andtaxes.Thisratiowouldshowhowacompanyhascontrolledcosts.Whiletaxesareacost,anddepre