© 2000 John Petroff
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© 2000 John Petroff |
A- Purpose of analysis
In this chapter, the goal is to study whether companies use fixed assets of the proper size and type, and whether they use them efficiently. This is a natural next step after the study of sales. The purpose is to verify that the company employs the resources that will allow the company to achieve the production volume necessary for its sales objectives. Note that it would be incorrect to study assets before sales. While it is true that the volume of sales is determined by the assets available to the firm, the sales volume is what is important not the size of the assets. It is the responsibility of management to put into use all the needed plant and equipment necessary for the desired sales level.
| This approach is drastically different from the Russian study of fixed assets, in which the purpose is to verify that the assets are not idle, that the assets do not disappear, and that, in fact, they are expanding. In the Western approach, the analysis is directed toward the future: projected sales, projected cash flows and targeted profit contribution are the focus, not balance sheet stocks. The stocks of assets are justifiable by the flows, but do not have a goal in themselves, as they do in Russian financial analysis. |
The analysis of acquisition and upkeep of fixed assets is generally known as capital budgeting: the study of the allocation of available permanent funds among competing purposes. Capital budgeting is at the heart of corporate finance. A complete treatment of the subject discussed in this chapter can be found in any up-to-date corporate finance or capital budgeting textbook. This chapter will summarize the key aspects of capital budgeting essential for financial analysis of individual projects, which are necessary to analyze the overall composition and size of fixed assets.
The time framework of this analysis is generally beyond one year and the decisions investigated are long term. One would normally think of replacement of assets, expansion of production and introduction of new product lines as typical decisions under consideration. Should production be automated or not? Should a new advertisement campaign be undertaken to expand sales? Will new equipment result in cost saving and merchandise delivery improvements? These are the types of questions asked in this aspect of financial analysis.
Those involved with this type of analysis are top managers of the company (in particular, executives responsible for production and for long range strategy), but also commercial and investment bankers, insurance company officers and other long term lenders. The later provide loans or oversee new stock issues to finance these long term projects. They must receive the relevant information to arrange for the most appropriate loan structure or stock flotation.
| Today, in Russia, long term loans are extremely rare, primarily because of hyperinflation, but also because of the lack of familiarity with some of the analysis presented below. In addition, there is a lack of practice among Russian bankers in conducting such long run analysis in the private sector because, less a decade ago, all decisions pertaining to this field were made in the Gossplan on a countrywide basis. Now bankers are faced individually with these decisions on the scale of a company, or even a single project, one at a time. Again, these decisions must not be taken in isolation, but in the context of the sales forecasts discussed in the previous chapter and in the presence of aggressive competitors, neither of which most obviously exist under communism. |
See review questions Q-10A.1 through Q-10A.5.
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