The Practice of Financial Management among Large United States Corporations

Presented by:Anjana JoshiAshik BaselAshrit MaskeyBandana KhadkaBijay PandeyBindu PanthaDan Bahadur Bhandari

Contents

1. Research Context2. Purpose of the Study3. Literature Review4. Survey procedures5. Survey Result6. Major Findings7. Conclusion

Research ContextThe research examines how large corporation from the US have responded to challenges of globalization during the 1980s and early 1990.

The survey was conducted among the Fortune 500 corporations.

The survey was conducted regarding their specific usage of a variety of working capital, capital budgeting, and sales forecasting techniques.

Furthermore, the survey inquired about their usage of the futures markets to hedge a variety of financial risks.

Comparisons with earlier surveys reveal that corporations in general have noticeably increased their use of sophisticated financial management techniques.

Purpose of the study

The main objective of this study is to examine the challenges faced by globalization and what will the remedies for this various challenges i.e. volatile interest rates, failure of commercial banks, lack of financial sources, thread of hostile takeover.

Moreover, the survey also examines how well the U.S companies address to these issues by employing various financial analysis tools, such as cash budget, break-even analysis, financial and operating leverage, sources and uses of capital, security portfolio model, account receivable models, inventory management models, average ROR, payback, NPV, IRR, expected return, variance of return, correlation of returns, etc.

Literature Review

Many other researchers have conducted various survey on similar topic and have reached to various conclusions.

Petry (1975) analysed the use of multiple measures of project worth by the Fortune 500.

Scapen and Sale (1981) examined the relationship between methods of controlling capital investment, measures of divisional performance, and level of organizational autonomy.

Gitman and Maxwell (1985) surveyed the Fortune 1000 and found that firms devote the majority of their time to the management of short-term working capital assets.

Moore and Reichert (1983) found that as firm begins to introduce decision-making models in one area, they are likely to begin to employ sophisticated analytical tools in other areas as well.

Reichert, Moore, and Byler (1988) found that a significant percentage of large U.S. corporations used financial futures to hedge foreign currency risk and regularly employed formal cash management models to minimize operating cash requirements.

Trahan and Gitman (1993) analyzed possible gap between the theory and practice of financial management by surveying the Fortune 500 and Forbes 500 Best Companies.

The purpose of the various surveys is to extend the literature regarding the current practice of financial management among large U.S. corporations.

Survey Procedures

Primary data was used through mailed questionnaire method.

The questionnaire was mailed during 1991 to the Chief Financial Officer (CFO) of each of the companies listed in the April 1990 Fortune Magazine directory.

The survey was able to generate a response rate 30.2% out of 500 approached, 151 completed the questionnaire.

The sample was representative of a broad cross section of major industrial firms with only one industry, the music, toy, and sports industry, unrepresented.

The vice president of finance (27.4%), the assistant treasurer (16.3%), and the treasurer (15.6%) were the most likely to have completed the questionnaire.

Survey Result

The result obtained was regarding composite, chi-square and coefficient of variation.

Composite % measures the percent of the overall industry using particular financial tool.

Chi-square is used to measure whether there is significances in observed industry averages or not.

CV is used to measure the variability in the use of different financial techniques among different U.S. corporations.

The survey was carried out for different set of firms and industry.

Major Findings

Proj. Cash

Budget

Break eve

n Analysis

Fin & oper. L

everag

e

Source

s & uses o

f Fund

91.9

37.959.7

9095.5

46.563

91.294

37.5

66.989.6

General Financial Management Techniques(%)1980 1985 1991

Exhibit 1. Analysis of Working capital Techniques

Industry 1991 sample size Proj.cash budgetBreak-even

analysisFin. &oper.

levelSource and use of

capital Mining, Crude Oil Production 5 100% 40% 80% 100%Food, Beverage, Tobacco 14 86 43 77 79Textiles, Apparel, Vinyl Floor 6 100 67 83 83Paper 12 92 36 67 100Publishing 7 100 17 86 100Chemicals 17 94 38 69 94Petrolem Refining 14 100 64 50 93Rabber & Plastic 3 100 33 100 100Glass, Concrete, Abrasives 5 80 20 40 100Metal Manufacturing 8 86 33 71 100Metal Products Fabrication 5 100 40 60 100Electric & Appliances 14 100 36 71 62Shipbuilding, RR, Trans, Eqmt 4 100 25 50 67Scientific & Photographic Eqmt 5 80 40 60 80Motor Vehicles 6 100 40 60 100Aerospace 4 75 50 100 100Pharmaceuticals, Soap 6 100 0 50 83Office Equip& Computers 5 100 40 40 100Industrial & Farm Equipment 11 91 20 64 91

 Number of Responses 149 144 145 144Coefficient of Variation (CV) 9 43.5 26.2 13.61991 Composite 94 37.5 66.9 89.61991 Level of Chi-square Sig 94.0 0.73 0.79 0.211985 Composite 95.2 46.5 63.8 91.21980 Composite 91.2 37.9 59.7 90.0

Cash M

anag

ement models

Secu

rity P

ortfolio

model

Accounts

Receiva

ble models

Inventory

Manag

ement Model

61.7

0 10.156

71

23.553.8 60.370.3

20.3 59.4 59.4

Working Capital Techniques(%)1980 1985 1991

Exhibit 2. Analytical Techniques Used in Project (Percentage of firms by Industry Indicating "Frequent" Use

Industry Cash Mgt ModelsSecurity Portfolio

ModelAccount Rec

ModelsInventory Mgt

ModelsMining, Crude Oil Production 100% 20% 60% 60%Food, Beverage, Tobacco 46 83 43 46Textiles, Apparel, Vinyl Floor 67 17 67 50Paper 67 17 67 54Publishing 33 0 67 33Chemicals 75 27 67 69Petrolem Refining 86 31 57 43

Rubber & Plastic 67 33 67 33Glass, Concrete, Abrasives 60 20 40 60Metal Manufacturng 83 0 100 50Metal Products Fabrication 60 0 25 75Electric & Appliances 86 36 64 79Shipbuilding, RR, Trans, Equip 100 33 33 0Scientific & Photographic Equip 80 50 50 60Motor Vehicles 50 0 50 50Aerospace 100 75 75 100Pharmaccuticals, Soap, Cosmetic 67 0 50 33Office Equipment & Computers 100 0 80 100Industrial & Farm Equipment 46 10 55 64

 Number of Responses 145 138 143 143Coefficient of Variation (CV) 28.2 96.7 29.6 49.61991 Composite 70.3 20.3 59.4 59.41991 Level of Chi-square Significance 0.16 0.207 0.83 0.461985 Composite 71.0 23.5 53.8 60.31980 Composite 61.7 NA 10.1 56

ARR Pay back NPV IRR NPV or IRR0

102030405060708090

100

Capital Budgeting Techniques(%)

198019851991

Exhibit 3. Analysis of Capital Budgeting Techniques (Percentage of Firms by Industry Indicating “Frequent” Use of Various Techniques)

Industry Average ROR Payback NPV(DCF) IRR 1991 NPV or IRR 1991Mining, Crude Oil Production 50 75 100 100 100Food, Baverage, Tobacco 62 71 86 70 93Textiels, Apparel, Vinyl Floor 60 83 83 33 83Paper 58 75 83 92 92Publishing 43 75 100 100 100Chemicals 63 77 88 88 88Petrolem Refining 36 50 86 93 100Rabber & Plastic 67 67 100 100 100Glass, Concrete, Abrasives 40 60 80 100 100Metal Manufacturng 0 50 88 88 88Metal Products Fabrication 40 60 100 100 100Electric & Appliances 43 50 86 79 86Shipbuilding, RR, Trans, Equip 25 25 25 25 25Scientific & Photographic Equipment 80 60 100 100 100Motor Vehicles 0 33 50 67 67Aerospace 75 100 75 100 100Pharmaccuticals, Soap, Cosmetic 50 67 100 67 100Office Equipment & Computers 20 40 50 60 80Industrial & Farm Equipment 36 82 91 82 100

 Number of Responses 144 150 150 150 151Coefficient of Variation (CV) 50 29.7 24.7 28 20.31991 Composite 45.8 63.3 84.7 81.8 90.71991 Level of Chi-square Significance 0.27 0.55 0.082 0.018 0.0161985 Composite 59.3 75.9 82.8 79.6 89.51980 composite 59.1 79.9 68.1 66.4 86.2

Input Price Output Price Foreign Exhange

24.4

13.1

51

32.2

18.2

52

Future Markets(%)1985 1991

Exhibit 4. Use of Future Markets for Risk Hedging (Percentage of Firms by Industry Indicating "Frequent" Use of Various Techniques in 1991

Industry Raw Material Output Prices Foreign Exchange Mining, Crude Oil Production 20 40 40Food, Beverage, Tobacco 54 30 46Textiles, Apparel, Vinyl Floor 33 0 50Paper 17 8 33Publishing 0 0 45Chemicals 44 25 59Petrolem Refining 79 64 50Rabber & Plastic 0 0 67Glass, Concrete, Abrasives 0 0 40Metal Manufacturng 13 0 13Metal Products Fabrication 40 25 40Electric & Appliances 36 14 71Shipbuilding, RR, Trans, Equipment 25 0 50Scientific & Photographic Equipment 0 0 80Motor Vehicles 40 0 17Aerospace 50 0 75Pharmaccuticals, Soap, Cosmetic 20 20 67Office Equipment & Computers 20 20 60Industrial & Farm Equipment 20 10 82

 Number of Responses 146 143 150Coefficient of Variation (CV) 79 130.2 37.61991 Composite 32.2 18.2 521991 Level of Chi-square Significance 0.019 0.008 0.31985 Composite 24.4 13.1 51

Expected ReturnVariance of Return

Correlation of Return

0

20

40

60

80

100 88.7

21.244.7

82.4

21.442.9

1985 1991

Project Evaluation(%)

Exhibit 5. Analytical Techniques Used in Project (Percentage of firms by Industry Indicating "Frequent" Use

Industry Raw Material Output Prices Foreign Exchange Mining, Crude Oil Production 100 40 50Food, Beverage, Tobacco 71 15 39Textiles, Apparel, Vinyl Floor 100 0 67Paper 75 17 58Publishing 100 17 33Chemicals 82 33 40Petrolem Refining 92 42 25Rubber & Plastic 67 67 67Glass, Concrete, Abrasives 60 0 0Metal Manufacturng 86 17 43Metal Products Fabrication 80 20 60Electric & Appliances 71 43 50Shipbuilding, RR, Trans, Equipment 100 25 50Scientific & Photographic Equipment 100 20 80Motor Vehicles 80 30 40Aerospace 100 0  Pharmaccuticals, Soap, Cosmetic 67 0 60Office Equipment & Computers 80 0 0Industrial & Farm Equipment 82 0 27

 Number of Responses 148 140 140Coefficient of Variation (CV) 16 94.3 47.71991 Composite 82.4 21.4 42.91991 Level of Chi-square Significance 0.75 0.196 0.481985 Composite 88.7 21.2 44.7

Conclusions

More sophisticated financial techniques has increased rapidly over the past twenty years.

More than 90% of large U.S. corporations now regularly use either NPV or IRR techniques.

Only 3% of their sample measured covariance of projects returns.

Almost 44% of the firms report the use of covariance analysis.

Over 50% of the firm use the futures market to hedge foreign exchange risk.

More specifically, the six financial techniques utilized by at least 80% of the Fortunes 500 are projected cash budgets, sources and uses of funds, NPV, IRR, projected expected return, and sale forecasting models.

Most widely used financial techniques relate to the financial forecasting and capital budgeting process.

But, less sophisticated techniques, such as average rate of return and payback period have continued to decline its importance.

Similarly, various specialized techniques, such as security portfolio models are less commonly used.

The use of futures market as a means of controlling both borrowing costs and raw material prices is increased.

The aerospace industry consistently appears to employ a wide range of sophisticated financial analysis techniques.

On the contrary, the shipbuilding, railroad, and transportation equipment industry is consistently below average.

So, this survey suggests that the modern analytical models and techniques being taught in school and colleges are widely being adopted by large U.S. corporations.

The various analytical techniques designed and adopted by large corporations will definitely improve corporate profitability and will better prepare these companies to cope up with economic downturns.

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