1
2
2
KANAKA MAHA LAKSHMI THALLI
THIS BOOK IS DEDICATED TO THE ALMIGHTY, WHO
ALWAYS SHOWERS HER BLESSINGS ON HER
CHILDREN.
3
2007, POME, Gautam_Koppala, All Rights Reserved
PROJECTS AND OPERATIONS
MANAGEMENT EXPOSED
(POME)
Part “PROJECT’S ACCOUNTING”
A COLLECTION AMELIORATED BY
GAUTAM KOPPALA V.T.
4
2007, POME, Gautam_Koppala, All Rights Reserved
5
2007, POME, Gautam_Koppala, All Rights Reserved
6
6
You are the only person who can revolutionise your life.
You are the only person who can influence your happiness,
your realisation and your success.
You are the only person who can help yourself.
Your life does not change, when your boss changes,
when your friends change, when your parents change,
when your partner changes, when your company changes.
Your life changes when YOU change,
when you go beyond your limiting beliefs,
when you realize that you are the only one responsible for your life.
19 Materials Handling Product Packaging (Inventoriable Cost) & Raw materials/Production parts warehousing costs X X
20 Other Memberships, Subscriptions, All Other X X
Exclude:
Pro-rate and Transfers Any allocations from Corporate, Shared Services, GTS, GCTS, Spend Should Be
Reported By the Source Organization
Contributions Charitable Contributions/Donations
Marcom Marketing & Communications, Advertising X
Distribution and Logistics Warehousing costs; Lease or rental costs of Railcars, Tractors, Tankers, Shipping
Containers, etc.; and Logistics labor costs including employee related costs, All
Associated with Post Manufactured Goods
Freight (In / Out) Inbound and Outbound (Standard and Premium) X
Direct/Raw Materials Including Associated Duties and Taxes
Patent and Royalties Licensing Fees
Bad Debt
Warranty
Prototype
Other Exclusions
ACS Project and Services Spend, UOP Equipment Business and Services Spend
Capital
Legal Settlements
Grants
SM Production Catalyst
IV. Other Financial Metrics
Revenue / Operating Income Conversion %
Current Period
Operating Income Measuremen t Basis (HFM 906100) -
Comparison Period
Operating Income Measuremen t Basis (HFM 906100)
÷
Current Period
Net Sales & Operating Revenue - External (HFM 410000) -
Comparison Period
Net Sales & Operating Revenue - External (HFM 410000)
This metric is primarily used to analyze period over period revenue conversion to operating income.
This metric is primarily used to review quarterly performance.
Compounded Average Growth Rate (CAGR) %
Current Period
Net Sales & Operating Revenue – External (FM 410000)
^ [1/ -1
÷
# of Years - 1]
Comparison Period
Net Sales & Operating Revenue – External (FM 410000)
339
2007, POME, Gautam_Koppala, All Rights Reserved
This metric is primarily used in analyzing growth rates in revenues and income over multiple periods.
It is used primarily during the Strategic Planning (STRAP) process.
Average Annual Growth Rate (AAGR) %
Sum of Annual Growth Rate Percentages:
(Yr 1 Annual Growth Rate % + Yr 2 Annual Growth Rate % + X3 + X4)
÷
Total Number of Years
This metric is primarily used in analyzing growth rates in revenues and income over multiple periods.
Return On Investment (ROI) 13 pt %
NIBI – On Going (Recent 12 Months) (FM 906306)
÷
Business Net Investment - 13pt Average (FM 991315)
The NIBI – On Going (Recent 12 Months) is the summation of the last 12 months of Net Income
captured in the Income Statement within Net Income Measurement Basis (On-Going) (FM 906300)
account plus last 12 months of interest captured in the Income Statement within Interest & Expense
(FM 620991) account net of taxes; interest balance is multiplied by (1 – Effective Tax Rate) to exclude
taxes.
The Business Net Investment – 13pt Average is calculated by taking the last 13 months Business Net
Investment EOP (FM 991300) ending balances and dividing by 13.
DuPont Analysis
As an extension of traditional ratio analysis, financial analysts have long sought to understand the
interrelationship between different ratios and what they suggest about the way that a company is
being managed and what is happening to the company overall. Analysts at DuPont have long been
among the most creative and insightful reviewers of financial information and of a form of analysis that
serves to integrate several ratios into a commentary on a company’s situation. Long ago they
340
2007, POME, Gautam_Koppala, All Rights Reserved
recognized the importance of Return on Equity (ROE) as a measure of the reward to the shareholder,
but they recognized that Return on Equity was a consequence and not a predictor of company
performance. They also recognized that looking at ROE in terms of other ratios would provide a
different insight. Therefore, they looked at ROE much as we looked at relationships during our early
school years. They suggested that ROE, presented as a ratio could be restated into component ratios
in the following manner:
And that this relationship could be further analyzed as:
where the first ratio is now Return on Sales, the second is Total Asset Turnover, and the third is known
as the Equity Multiplier. When decomposed into these three elements, Return on Equity can be
analyzed for its cause or causes.
The level of return to the shareholders may be as a result of profitability on sales, or utilization of
assets in generating sales, or the relative amounts of debt and equity making up the sources of
financing for the company. By determining the cause of a business’s success or lack of success, an
analyst is in a position to assess management performance or to make recommendations for future
management actions.
Some of these ratios can predict what’s going to happen, even as they tell what has already happened.
Though traditional ratio analysis groups ratios into several clearly defined categories, it focuses on
explaining the current condition of the company. However, financial analysis is really useful in guiding
management actions in the future, because, after all, we cannot change what has already happened.
By regrouping the traditional ratios into those that are the consequence of prior decisions and those
that are anticipatory or predictive of future results, Project Managers are able to focus more attention
on actions that will improve future results. Those ratios that point to future results can be classified as
causal rather than as consequent or effect ratios. Consider the following examples.
Profit after Tax
Shareholders’ Equity
Profit after Tax
Shareholders’ Equity
341
2007, POME, Gautam_Koppala, All Rights Reserved
Total Assets
×
Shareholders’ Equity
You can easily construct other ratios to tell you interesting information. Consider what you can learn
by constructing a ratio such as Miscellaneous Assets to Net Worth, which may be very meaningful
particularly in privately held companies.
Miscellaneous Assets are often those assets that make working for the company enjoyable but do not
return any income to the Corporation Based Projects . They often include such things as loans to
officers, loans to employees, recreation facilities for employees (such as a boat or a racquetball court),
fine art for the company headquarters lobby, and investments (often in companies unrelated to the
business).
These assets generally do not earn a return on their investment. In other words, sooner or later such
nonprofitable investments can be expected to affect overall financial performance negatively. In
addition, they have diverted funds, and possibly management attention, away from productive use by
the company.
When we think about analyzing financial statements, we start with the chart of accounts, the
systematic listing of categories into which we separate all financial information. If we set up the chart
of accounts so that it is easily grouped into the sequential lines of the financial statements—by
tradition the Balance Sheet comes first, followed by the Income Statement—the routine recognition of
activities and obligations will almost automatically produce appropriate financial statements.
Furthermore, the user of the financial statements, generally an owner or Project Manager, will know
exactly where to get additional detail whenever a particular account or financial statement line item
raises questions, either favorable or unfavorable.
We begin this analysis by looking at the Income Statement, followed by the Balance Sheet.
Interestingly, we tend to look at financial statements by focusing first on the Income Statement, the
report of performance, before looking at the Balance Sheet, the results of performance, even though
the Chart of Accounts starts with the balance sheet accounts. This is because performance leads to the
changes in the Balance Sheet accounts, rather than the other way around. We then consider a variety
of financial ratios grouped in a different way, tied to the source of the information or to links to other
measures. Unlike ratios grouped by liquidity, activity, profitability, and debt management, looking at
these ratios in the context of their interrelationships provides a different insight.
As you remember, the Income Statement summarizes all of the financial activity that took place during
the period shown in the statement heading. Because it covers only one period, it relates expenses and
profits to revenues achieved. By comparing the Income Statement from one period to that of another,
342
2007, POME, Gautam_Koppala, All Rights Reserved
whether previous or future, we can validate our conclusions or impressions by looking at other
statistics or by analyzing detailed information that may be available to us.
When we are inside the Projects, whether as analysts or as Project Managers, we have access to
detailed data that help explain the results summarized in the Income Statement. The ratios that we
look in POME will help us focus our analysis on the aspects of our operations that cause particular
ratios and relationships to come out as they do. Initially, in Exhibit below we consider the information
presented in the Income Statement, as it is really the measure of business performance.
Exhibit: The Income Statement
POME Prescribe
J
Just do it!
POME Prescribe
343
2007, POME, Gautam_Koppala, All Rights Reserved
CORPORATE
GOVERNANCE
344
2007, POME, Gautam_Koppala, All Rights Reserved
Corporate Governance
Corporate governance is not a new topic. It has been around for many years, often described as the
“agency issue.” However, in recent years it has taken on increased significance, demanding increased
attention. Since 2001 in particular, the corporate marketplace has seen a significant number of
headline grabbing scandals involving major Corporation Based Projects s. These scandals have raised
new questions about corporate governance and, as a direct consequence of some of these situations,
the U.S. Congress passed a very broad piece of legislation called the Sarbanes-Oxley Act of 2002. This
law has had a wide range of consequences directly affecting large public Corporation Based Projects
and public accounting firms and, less specifically, smaller public firms, private Corporation Based
Projects s, not-for-profit organizations, and regulatory entities in many different ways.
POME Case Study:
The Importance of Financial Reliability
“I’m glad you called this meeting, Koppala.”
“Why is that, Jonas?”
“Well, as you know, we have a new division Project Manager in my division and last week he called me
to ask about the quarterly financial report I had submitted. He specifically asked me if I really believed
the numbers in the report. I told him that ‘To the best of my knowledge, they are correct.’ And he then
asked me to certify that they were and to sign the certification, which I did. What’s that all about?”
“In July of 2002 Congress passed a law called the Sarbanes-Oxley Act that requires CEOs and CFOs of
public companies to certify that their financial statements are correct. Your division Project Manager
has to certify that the division numbers are right before our senior executives will certify to the
corporate financial statements, and he was just trying to make sure that the people who produce the
numbers believe them before he signs.”
The issues raised by this vignette are very important. Sarbanes-Oxley was developed and passed in
the aftermath of two very large and dramatic corporate failures, Enron and WorldCom. These
multibillion-dollar Corporation Based Projects s appeared to be very successful, but it turns out that
much of their success was not real, but was fabricated through elaborate schemes to create the
appearance of success and wealth. The U.S. Congress passed Sarbanes-Oxley to make it more difficult
to perpetrate the types of fraud these companies’ stories represent.
Defining Corporate Governance
345
2007, POME, Gautam_Koppala, All Rights Reserved
Corporate Governance
After the revelation of serious scandals in leading
multinational companies, attention was focused on
the need of strengthened “corporate governance”.
However, it had to settle with liberalization,
privatization, and de-regulation.
“Regulation is an unnecessary barrier to trade in
services.” (WTO)
1
Fundamentally, it relates to
how a Corporation Based Projects is overseen. It is not management. Rather, it is oversight, the
overriding guidance and direction of the entity and the standards and values it reflects. In recent years
corporate governance has come to encompass the ethics of management, the recognition and delivery
of the essence of corporate responsibility to stockholders, employees, and community.
According to Robert A. G. Monks and Nell Minow in Corporate Governance (third edition, Malden, MA:
Blackwell Publishing, 2004), “corporate governance is the structure that is intended to make sure
that the right questions get asked and that checks and balances are in place to make sure that the
answers reflect what is best for the creation of long-term, sustainable value.”
Corporate governance addresses, in essence, how the Projects is guided and directed. What is implied
is that we should know and practice good corporate governance in our roles as corporate Project
Managers, directors, and investors. Clearly, in the scandals summarized in the next section, and this
list is by no means exhaustive, the Project Managers of these companies were not responsive to the
needs, interests, or expectations of the shareholders or to the interests of the general public, either.
As a result of these scandals and a broader concern for ethics and financial integrity in American
industry, as noted earlier, the U. S. Congress, in July 2002, passed a strong law called the Sarbanes-
Oxley Act of 2002, which mandated a number of significant changes to the way that businesses
operate, Project Managers manage, and external service providers perform their duties. The provisions
of this act are summarized after a summary of some of the most significant examples of Project
Managerial and reporting problems.
346
2007, POME, Gautam_Koppala, All Rights Reserved
The Major Corporate Scandals
Over the past several years numerous financial scandals have tested the financial systems and raised
the awareness of everyone as to the importance of accurate and timely financial information. Following
are some of the most significant instances of corporate and Project Managerial fraud. These cases have
resulted in several new laws that are designed to hold Project Managers accountable for the results
their Corporation Based Projects s report.
Enron
The Enron Corporation Based Projects grew out of a regional oil and gas supplier to become the
largest and most profitable and successful energy trading Projects in the country, if not the world. A
Wall Street darling, Enron’s stock rose to record levels and the Projects garnered much favorable
publicity for its creative products and extraordinary success in the world energy markets.
Its leaders were recognized for their success in creating wealth for themselves and their shareholders.
In the summer of 2001, some questions were raised about some of the contracts that Enron was
creating. These questions led to other questions, but the answers that were provided didn’t really
make sense, raising still more questions. During this time the executives of Enron were publicly
reassuring stockholders and analysts that everything was terrific at Enron. As more questions were
raised, some related to accounting transactions and the creation of special purpose entities,
tangentially related companies that served to facilitate some of the trading transactions. (The
treatment and disclosure of special purpose entities is specifically addressed in the Sarbanes-Oxley Act
of 2002.) The more analysts and investigators looked into Enron, the more confusing the whole
situation became. Ultimately, it was estimated that Enron Project Managers had established as many
as 3,500 of these questionable entities to effect their scheme.
At the same time it came out in the press that most if not all of the Projects’ 401(k) plan funding, the
primary retirement savings plan for Enron employees, was invested in Enron stock, and while for quite
some time this was very profitable and the 401(k) funds grew very rapidly, in the midst of the
questioning, the stock price began to drop and the value of the retirement funds declined. A provision
of the Enron 401(k) plan prohibited the trustees for the employees from selling the Enron stock in the
fund, so the value of the retirement funds declined precipitously and there was nothing the employees
could do about it. While the shareholders in the 401(k) plans were precluded from stock transactions,
the senior Project Managers of Enron sold stock and reaped millions of dollars. (Trading by senior
executives in times when trustees of pension funds and other retirement funds may not is specifically
addressed by the Sarbanes-Oxley Act of 2002.) In the end all of the value in those retirement accounts
was lost.
347
2007, POME, Gautam_Koppala, All Rights Reserved
At the same time that senior Enron executives were making very strong public statements assuring
that the Projects was sound, they were privately selling their personal stakes in the Projects for
millions and millions of dollars and arranging to protect their personal gains from legal attack through
trusts and assignments. The story of Enron has been told in several books and innumerable articles.
One good one is Power Failure by Mimi Swartz with Sherron Watkins, who was a CPA and a vice
president of Enron who asked a number of questions about some of the entries she saw and ultimately
went to the authorities and the press and spotlighted the problems.
Along the way, a partner in a major public accounting firm was accused of, and later admitted to,
shredding documents and helping hide the circumstances. Later, it became apparent that policies in his
accounting firm, Arthur Andersen & Projects, one of the largest accounting firms in the world,
authorized actions that served to cover up the fraud that was going on. (There are several provisions
of the Sarbanes-Oxley Act of 2002 relating to the role that auditors may play and may not play at
client firms.) It also turned out that Arthur Andersen had many very lucrative consulting contracts with
Enron, raising questions about its ability to be independent in its audit function.
Although this summary is very short and incomplete, it should be obvious that there were many illegal
and inappropriate actions being undertaken. Ultimately, Enron declared bankruptcy, wiping out the
personal wealth of thousands of people who worked for Enron and causing billions of dollars of
investment losses for the individual investors and mutual funds that held the Enron stock.
Outcome
The Enron story is not yet finished at this writing. Several corporate officers have pleaded guilty and
have been sentenced to jail, including Andrew Fastow, former CFO (10 years in jail plus fines), Lea
Fastow, Andrew’s wife and a former Enron executive (1 year in jail), and former Enron Treasurer Ben
Glisan Jr. (5 years in jail), and others. Most recently, Richard Causey, the chief accountant at Enron,
pled guilty to securities fraud and agreed to testify against Jeffrey Skilling (former CEO) and Kenneth
Lay (former CEO and Chairman of the Board). The Board of Directors of Enron has committed to
paying $25 million in restitution funds. Arthur Andersen partner David Duncan, who was accused of
destroying evidentiary documents, pled guilty. His CPA firm, Arthur Andersen & Projects, was found
guilty of obstruction of justice and ordered to pay a substantial fine, was precluded from providing
audit services to any publicly owned Corporation Based Projects s, and was forced to disband as a
major public accounting firm. Its conviction was overturned on appeal in 2005, but that will not enable
the firm to be reconstituted.
WorldCom
WorldCom is another example of success leading to greed leading to fraud leading to massive failure.
WorldCom began as a small regional telecommunications Projects in Mississippi under the leadership of
Bernie Ebbers, who wanted to establish a leading Projects. He began small and grew by aggressive
348
2007, POME, Gautam_Koppala, All Rights Reserved
acquisitions and creative programs that attracted customers and publicity. His Projects, LDDS,
acquired numerous small telecom companies and grew during the booming telecommunications and
high technology period of the 1990s. In the mid-1990s, LDDS acquired MCI, a much larger Projects,
changed its name to WorldCom, and became a major player in the telecommunications industry.
However, in the latter years of the 1990s it became clear that there was severe overcapacity in the
telecommunications industry, and that the demand that had been anticipated was not going to
materialize and competition became fierce within the industry.
Many of the companies in the telecom industry began to have financial difficulties and several failed.
Others merged with competitors, combining in an effort to remain viable. Throughout this time
WorldCom continued to report strong growth and earnings, bucking the trend in the rest of the
industry. Their strong financial results and apparent success attracted a lot of investment and a great
deal of positive analyst commentary. In fact, one analyst, Jack Grubman of Salomon Smith Barney,
wrote exceptionally favorable analyst reports on WorldCom that made it easier for WorldCom to issue
stock and debt to finance growth while the rest of the industry was contracting. It would turn out later
that Grubman received bonuses from his firm and from WorldCom and other benefits as a result of his
writing these very favorable reports. (The relationship of stock analysts and investment bankers to
client companies and the compensation of analysts are addressed directly in the Sarbanes-Oxley Act of
2002.)
After several years of industry-bucking results an internal auditor at WorldCom, Cynthia Cooper, raised
some questions regarding some entries she found. When she did not get satisfactory answers from the
chief financial officer of WorldCom, she pursued her audit surreptitiously until she determined that
there was fraud. She raised her questions publicly and exposed the problems. It turns out that the
WorldCom audit firm was Arthur Andersen & Projects, the same firm that audited the books of Enron.
Again, WorldCom engaged Arthur Andersen & Projects in numerous lucrative consulting and tax
advisory contracts, raising the independence issue again.
Ultimately, it became apparent that WorldCom had been making massive accounting entries to
increase sales, decrease expenses, and overstate its financial performance for years. It became very
clear that WorldCom had told increasingly greater lies to cover up its earlier lies. The final tally was
that WorldCom had constructed false accounting entries totaling more than $11 billion, making its
fraud the largest in history (at the time).
Outcome
The consequence of the WorldCom debacle was that WorldCom declared bankruptcy and Project
Managerial control was transferred to Michael Capellas, formerly president of Hewlett-Packard and CEO
of Compaq, who cleaned up the organization. Eventually, the Projects moved its headquarters from
Mississippi to Virginia, changed its name to MCI, Inc., emerged from bankruptcy, and ultimately
349
2007, POME, Gautam_Koppala, All Rights Reserved
agreed to be acquired by Verizon for approximately $9 billion. Several of the banks and investment
institutions that participated, knowingly or not, in the massive investment fraud paid billions of dollars
in fines. Several executives, including Scott Sullivan, the CFO who oversaw the accounting for the
Projects, pleaded guilty to fraud and were fined and sentenced to jail. Bernie Ebbers was convicted of
fraud in a celebrated trial in New York. Mr. Ebbers was sentenced to 25 years in jail and must serve 85
percent of the term before he is eligible for parole. In addition, Mr. Ebbers has agreed to transfer
nearly all of his personal assets (between $25 and $40 million) to a liquidation trust to settle a civil
suit (Wall Street Journal Online, June 30, 2005). Jack Grubman paid fines of $15 million and has been
barred from the securities industry for life.
Tyco International
The management at Tyco directed a very aggressive acquisition strategy that grew the Projects
dramatically over a relatively short time. Over only a few years, Tyco acquired more than 1,000
companies, absorbing them into the Projects’ divisions and reporting significant sales growth year after
year. The Projects management moved the official corporate headquarters to Bermuda to avoid federal
and state taxes on income. During this time the senior management of Tyco, at least in some cases,
without the approval, or even the knowledge, of the Board of Directors, developed very lucrative loan
and bonus programs for the senior executives. The principal beneficiaries of these programs were the
CEO, Dennis Kozlowski, and the CFO, Mark Swartz, although many other senior Project Managers
received very large loans and bonuses. As part of his Project Managerial prerogative, the CEO, Dennis
Kozlowski, awarded bonuses of millions of dollars to Project Managers and executives he liked or who
provided personal services for him. Kozlowski and Swartz used extraordinarily generous and flexible
“relocation” loan programs to provide themselves with millions of dollars of corporate funds, and then
arranged to have the loans forgiven, creating multimillion-dollar bonuses for themselves. Kozlowski, in
particular, used corporate funds for personal expenditures that caught public attention for their
lavishness.
The scandal first came to light when Kozlowski was accused of purchasing millions of dollars worth of
artwork for his Manhattan apartment with corporate funds and then having the artwork shipped to
New Hampshire to avoid the New York state and city sales taxes. The apartment and its furnishings
were among the daily revelations of excessive personal benefits for key individuals that were reported
during the public analysis of the Tyco scandal.
In all, Kozlowski and Swartz were accused of taking about $600 million in illegal and unauthorized
bonuses and stock sales gains, using their authority and inappropriate accounting transaction to hide
their actions. Kozlowski was also accused of having paid for numerous extremely expensive personal
purchases with corporate funds, obviously failures of internal controls. (Internal controls are
specifically addressed kin the Sarbanes-Oxley Act of 2002.)
Outcome
350
2007, POME, Gautam_Koppala, All Rights Reserved
Kozlowski and Swartz were tried for illegally diverting corporate funds and defrauding stockholders and
other investors. Their first trial ended in a mis-trial when a juror received a death threat after
apparently signaling positively to Kozlowski. In the second trial, both Kozlowski and Swartz were
convicted. In addition to each receiving 25 years in prison, the two men were required to make
restitution to Tyco of a total of $134 million and were fined an additional $105 million.
Adelphia Communications
Adelphia Communications was initially established by John Rigas as a privately owned
telecommunications Projects, providing voice and data services and subsequently cable television
services to several communities in the Northeast. Relatively quickly, the Projects was successful and
grew substantially, in part through acquisitions. Within a few years, the Projects went public, selling
shares to outside investors, providing funds for operations, acquisitions, and even more rapid growth,
although John Rigas and members of his family continued to hold key management positions.
Apparently over many years, John Rigas and other members of his family continued to operate
Adelphia as if it were a private Projects, using corporate resources, which, because it was a publicly
owned Projects, belonged to the shareholders, for personal purposes. The amounts of money so
converted totaled several billion dollars and involved John Rigas, his son Timothy, who served as the
corporate CFO, and several other members of the Rigas family. In 2002 the Rigases were accused of
falsifying financial records from 1999 through 2002 to hide the massive fraud that had taken place.
Their trial included numerous disclosures of financial malfeasance and misuse of corporate funds.
Outcome
After a highly publicized trial, John Rigas and his son Timothy were convicted of fraud, sentenced to
jail, and fined. John Rigas, age 79, was sentenced to 15 years. Timothy Rigas was sentenced to 20
years. Another son, Michael, was found not guilty of conspiracy, but the jury could not reach verdicts
on other counts. The prosecution has not decided at this time whether to retry these other charges.
The former assistant treasurer of Adelphia, Michael Mulcahy, was acquitted of all counts. A quote
attributed to Mulcahy is revealing. In testimony in his own defense, Mulcahy said, “I understand the
Corporation Based Projects is owned by the shareholders. The owners of the Projects are indirectly my
bosses, but that’s not who I reported to.” (Quoted on MSNBC.com
(http://www.msnbc.msn.com/id/5396406), July 8, 2004 from The Associated Press) This statement
reflected the problem and some of the confusion that has led to the financial scandals and the overall
problem.
Parmalat
Included here in part to demonstrate that financial scandal is not just an American phenomenon, the
Parmalat story repeats some of the characteristics of other scandals, but it adds new twists. Parmalat
is an Italian dairy and food products Projects, the largest such Projects in Europe, with subsidiaries in
several countries in Europe as well as in the United States. Over the years, Parmalat has developed a
351
2007, POME, Gautam_Koppala, All Rights Reserved
very complex structure of affiliated companies that, whether intentional or not, obscures its operations
and management organization. Begun as a family business, it grew and expanded, utilizing leverage to
make its equity more valuable. The debt, as well as the equity it raised, was used to acquire
companies, expand the business, and finance the lifestyles of Fausto Tanzi, the original founder, and
his family. Some of the Parmalat money was used to finance a travel business operated, at a
substantial loss, by Tanzi’s daughter, and the Parma football (soccer) team, also a financial disaster.
As the Parmalat story unfolded, it appears that someone (unknown at this time) confirmed on Bank of
America stationery, a deposit of 3.9 billion euros (approximately $5 billion) that did not exist. This
forgery added to the confusion and increased the complexity of the fraud at Parmalat. Also adding to
the confusion is the organizational structure of numerous interrelationships among companies that
loaned money to each other and made cross-Projects investments that have made it difficult to
determine just how much money has disappeared. Estimates have suggested that the amount is in
excess of $12.6 billion, making Parmalat a bigger fraud than WorldCom.
Outcome
Although trials have not yet begun, Fausto Tanzi has already pleaded guilty and been sentenced to
prison. Numerous other people inside Parmalat and in lenders and service providers have pleaded
guilty to participating in the fraud. However, the prison terms in Italy are far shorter and other
sentences are also far more lenient than in the United States and as a result, only a few people will
actually receive any punishment and it will not be severe. There may be less deterrence to similar
crimes in Europe as a result. However, an affiliate of the large U.S. accounting firm Grant Thornton has
come under a great deal of scrutiny, which has carried over to include the U.S. firm as well.
Global Crossing
Global Crossing is another telecommunications Projects that got caught up in the boom and then bust
in the telecom industry. The Projects, originally founded as the result of the merger of two companies
in different sectors of the telecommunications industry, grew rapidly during the boom years, expanding
capacity in anticipation of continued growth. When the growth did not materialize, as a result of
reduced demand and increased competition during the period from 1999 through 2001, Global
Crossing entered into cross-selling agreements with other companies that had the effect of artificially
increasing reported sales and profits.
In addition, as we have seen with several of the other companies, Global Crossing had lucrative and
liberal loan programs for its executives, resulting in substantial (multimillion dollar) loan forgiveness
bonuses, even as the Projects was heading rapidly toward bankruptcy.
Outcome
Global Crossing settled the case against it brought by the SEC, agreeing to cease-and-desist from its
inappropriate accounting activities. The SEC found that the Projects had not complied with certain
352
2007, POME, Gautam_Koppala, All Rights Reserved
reporting requirements and the Projects agreed not to commit any more violations. Three senior
executives were fined $100,000 each and the Corporation Based Projects and its former senior
executives, all having left the Projects, were required to agree to the order. During the SEC
investigation, the Projects cooperated with the investigators and the consequences were far less
onerous than were imposed on other companies.
HealthSouth
HealthSouth is a very large healthcare services provider with both inpatient and outpatient
rehabilitation facilities, outpatient surgical centers, and more than 330 hospitals. The Projects and its
senior executives were accused of falsifying accounting records and inflating revenues and profits
substantially in order to maintain the price of the Projects’s stock. The fraud totaled more than $1.4
billion and the Projects was accused of inflating profits in some years by up to 4,700 percent.
What makes this case important is that it was the first to accuse an executive, in this case the CEO,
Richard Scrushy, of violations of the Sarbanes-Oxley Act. He was charged with knowingly certifying to
false and misleading financial statements in late 2002, after the enactment of Sarbanes-Oxley. During
the trial, five former CFOs testified against Scrushy, insisting that he was not only aware of the fraud,
but was instrumental in its perpetration. His defense was that the CFOs were managing the whole
process and kept the facts and the situation from him. He insisted he was unaware that there was
anything wrong.
Outcome
Richard Scrushy was acquitted of all of the 36 charges remaining of the original 85 indictments against
him. Ten other HealthSouth executives have already pleaded guilty and been sentenced, generally to
minimal penalties. Only one received a jail term, and it was short. One former CFO, who also has
pleaded guilty but has not been sentenced, testified at length against Mr. Scrushy, but the jury
apparently did not believe him. The trial lasted a long time and jury deliberations lasted more than a
month and a half, and in the end, the prosecution did not prove its case, so the provisions of
Sarbanes-Oxley have not yet been successfully applied. According to the Boston Globe (July 6, 2005,
p. C6) the SEC, shortly after the acquittal was announced, planned to file a $785 million civil suit
against Scrushy. It remains to be seen whether the civil suit, which allows for a lower burden of proof
than does a criminal trial, will be more successful. In addition, Scrushy still faces several other civil
charges and lawsuits. In light of his acquittal, he has sued HealthSouth for several million dollars of
lost pay and is seeking to regain involvement in the Projects.
353
2007, POME, Gautam_Koppala, All Rights Reserved
There are obviously many ways that Project Managers and executives, generally in collusion with
others, can make the numbers come out they way they want. However, there is now much more
pressure to deliver proper financial information and to assure that it is correct. Nevertheless, these
cases and others have demonstrated that the system really depends on the integrity of the Project
Managers and executives and the diligence of the directors, auditors, and other interested parties. The
importance of corporate governance—that oversight and guidance that directs businesses—cannot be
overestimated. Clearly, everyone involved has a responsibility to assure that information is clear, well-
understood, and properly analyzed at all levels.
The Sarbanes-Oxley Act of 2002
In light of the corporate scandals of the past few years Congress passed the Sarbanes-Oxley Act in an
effort to restore faith in the accounting and reporting practices of public Corporation Based Projects s.
The Act seeks to direct the behavior of companies and Project Managers according to a legally defined
standard with specifically prescribed requirements for reporting and confirmation of financial
information, mandated senior executive confirmation and certification of reporting accuracy and
reliability, and independent confirmation not only of fair representation of financial information but also
of the systems and procedures that produce that information. The legislation also precludes the
continuation of certain relationships between Corporation Based Projects s and their professional
service providers, auditors, and consultants and imposes harsh penalties for failure to meet these
strict standards. The law has also accelerated public reporting requirements in part to make it more
difficult for companies to effect fraudulent reporting without raising questions and concerns.
A Summary of the Act’s Key Provisions
Section 101. Establishment of the Public Companies Accounting Oversight Board
(PCAOB)
The Act establishes this independent oversight authority as a reflection of Congress’s dissatisfaction
with the effectiveness of the public accounting profession’s ability to assure the integrity of financial
information. The profession has been overseen by the Financial Accounting Standards Board (FASB)
and the American Institute of Certified Public Accountants (AICPA), a membership organization that
has attempted to self-regulate the profession. The Congress, in light of the corporate scandals
described (and others), decided that there needs to be another agency to oversee and regulate the
performance of the accounting profession.
Section 103. Auditing, Quality Controls, and Independence Standards and Rules
Because many of the scandals involved members of public accounting firms serving in multiple and
potentially conflicting roles in serving their corporate clients, the Act sets very specific rules as to what
public accountants may and may not do, how they are to maintain their independence so that they are
354
2007, POME, Gautam_Koppala, All Rights Reserved
in a position to render objective opinions and reports, and so the public will feel that the auditors’
statements can be relied upon in making investment decisions. This section defines audit record
retention rules (in response to document destruction issues at Enron), separate partner confirmation of
audit reports, and internal control procedures confirmed and reported on (described in Section 404)
and focusing attention on audit failures in all of the scandals.
Section 201. Services Outside the Scope of Practice of Auditors
This section prescribes the roles that public accountants may play in relationship with their audit
clients. It precludes many of the services that members of the audit firm have previously provided to
their audit clients, often as a result of the referral from the auditor. Over the years consulting,
advisory, tax guidance, and other services have generated far higher fees for the audit firm than has
the traditional audit work. As a result, more and more emphasis has been placed on generating
consulting assignments, potentially resulting in conflicts of interest, making the audit less likely to
report performance or fraud problems. In several of the scandal Corporation Based Projects s, the
auditors, most notably Arthur Andersen (although it was not the only one involved), were also the
beneficiaries of very large and long-running consulting arrangements. This was certainly true at Enron.
Additionally, Enron and other companies routinely hired former auditors to be senior financial
executives. The Act (in Section 206) specifically addresses the hiring of auditors, making it illegal to do
so for anyone who worked on an audit in any capacity within one year.
Section 302. Corporate Responsibility for Financial Reporting
This section has received some of the most vigorous public discussion. It specifically requires the CEO
and the CFO to personally “certify in each annual or quarterly report” that “based on the officer’s
knowledge, the report does not contain any untrue statement of a material fact . . .” (Quoted from the
Sarbanes-Oxley Act of 2002.) This section holds these senior officers personally responsible for the
accuracy and completeness of financial reporting. It is the requirement that they personally sign the
statements that has created a wave of internal requirements similar to that described in the vignette
at the beginning of this chapter. Before these senior executives will certify, they frequently require
similar internal certifications by their financial and operating subordinates.
Section 404. Management Assessment of Internal Controls
In Section 103, the Act required auditor confirmation of internal controls and internal control
procedures. Section 404 requires a management statement and an auditor’s confirmation that the
internal control procedures in place are sufficient to assure the accuracy and integrity of corporate
financial reporting. Auditors have used this section of the Act to impose extensive documentation
requirements on clients and have enhanced dramatically their review of internal controls before being
willing to attest to their adequacy. The result has been dramatic increases in the time and the cost of
audits to conform to this section and to the Act. The PCAOB and the SEC extended the deadline for
compliance with Section 404 to early 2005 and companies have spent millions and millions of dollars
355
2007, POME, Gautam_Koppala, All Rights Reserved
developing systems and documentation to assure compliance. Although major Corporation Based
Projects s are now required to certify to the effectiveness of their internal control procedures, these
provisions of the Act continue to be delayed, most recently until
July 2006 for public Corporation Based Projects s with less than $125 million in revenues or market
capitalization.
In testing the internal controls, there are three levels of compliance failure:
Control deficiency, which could adversely affect the Projects’s ability to deliver accurate
financial reporting;
Significant deficiency, a control deficiency or combination of control deficiencies that result in a
more than remote likelihood of a misstatement of the Projects’s financial statements;
Material weakness, a significant deficiency or combination of significant deficiencies that result
in more than a remote likelihood of a material mis-statement of the Projects’s financial
statements.
The first tests of Section 404 compliance identified a significant number of companies that reported
“material weaknesses” in their internal control systems. Of the first 2,984 companies to report, 364
companies, more than 12 percent, were recognized as having material weaknesses.
Although several other provisions of the Act also express very strong statements of the anger
Congress felt over the financial scandals, this summary provides a flavor of the Act and its intent.
Many of the specific issues highlighted in the scandals were addressed very specifically in Sarbanes-
Oxley, and Congress sought to send an additional message that it would not tolerate the kinds of
practices that were evident in the aftermath of Enron and WorldCom and these other corporate
examples.
Extended Application of Sarbanes-Oxley
It is interesting to note that Sarbanes-Oxley was enacted specifically to apply to large, publicly owned
Corporation Based Projects s. However, increasingly, smaller public companies, privately held
companies, and not-for-profit organizations are finding that Sarbanes-Oxley applies to them as well. In
order for large Corporation Based Projects s to assure their compliance with the Act, many of them are
requiring their suppliers to assure that they too comply with the Act with regard to the accuracy of
information supplied to the large Corporation Based Projects s. In addition, banks and other lenders,
as well as insurance companies, are requiring Sarbanes-like certifications even from smaller companies
seeking their services. Foundations and other funders, including government agencies, are requiring
similar certifications from their not-for-profit grantees and service providers. Several state legislatures
have considered legislation that would require Sarbanes-type compliance from all entities paying
corporate taxes. Though none of this legislation has yet passed, there is a high likelihood that
356
2007, POME, Gautam_Koppala, All Rights Reserved
additional reporting and control requirements will be imposed on those companies that are not
formally subject to the Sarbanes-Oxley Act.
The Broader Aspects of Corporate Governance
There is much more to corporate governance than just the integrity of financial information, although if
the financial statements are correct and appropriate, it will go a long way toward meeting the
standards for Project Managerial responsibility. Corporate governance also reflects the decision-making
process and the choices that the governing authorities, Project Managers, and members of the Board
of Directors exercise.
Traditional finance courses and finance texts have long described the issues of corporate governance in
terms of “agency,” arguing that corporate Project Managers, because they are not the owners of the
Projects, are responsible to manage the Projects on behalf of the owners, and they are to be
compensated for doing so. These texts spend a fair amount of time describing the “agency problem,”
which is the potential conflict between the interests of the individual Project Managers and those of the
shareholders for whom they are supposed to be working. If a Project Manager will get a bonus for
achieving a specific objective, he or she will concentrate on achieving that objective. If it turns out that
that objective does not really benefit the shareholders, the conflict and the agency problem arise.
Project Managers and Boards make decisions all the time. An examination of those decisions provides
a commentary on the various aspects of corporate governance by which the management is measured.
We are told that the responsibility of management is to assure the integrity of the Projects’s assets
and to maximize the wealth of the shareholders.
However, when decisions are made, it is not always clear how the outcome will affect the wealth of the
shareholders. Just recently, for example, Allmerica Financial Corp. announced its quarterly results. The
announcement indicated that the Projects had a very strong quarter, with sales rising and profits
increasing by nearly 300 percent over the comparable prior year period, significantly outperforming
the analysts’ estimates. The Projects also announced that its outlook for the remainder of the year was
positive. The same day, the Projects’ stock price declined by more than 6 percent and more than two
dollars per share, in a market day that was substantially positive. It certainly seems as if the corporate
management was doing all the right things for shareholder wealth, but the day’s trading activity
suggests that the market was not satisfied, at least for that day.
EVA and MVA
Clearly then, when making decisions, management must be focused on the long term, the ongoing
impact on the Projects, and on wealth. A financial management focus called Economic Value Added
(EVA) was developed by a consulting firm (Stern, Stewart & Co., New York City) and described in a
book by G. Bennett Stewart, The Quest for Value (New York, NY: Harper Business, 1991). EVA is
357
2007, POME, Gautam_Koppala, All Rights Reserved
supposed to measure the contribution to shareholder value made by the Projects. Many companies
have adopted EVA, often giving the program another name, Shareholder Value Added. It measures
NOPAT – k(∆I), that is, Net Operating Profit after Tax (Operating Profit minus Taxes) less the Cost of
Capital (the rate of return required to satisfy the sources of capital) multiplied by the incremental
investment (∆I) required to generate that NOPAT. If the difference NOPAT – k(∆I) is positive, then the
Projects has increased the value the shareholders own, and the mandate has been accomplished.
However, it is often possible to increase NOPAT – k(∆I) significantly by eliminating all capital
investment in the current year. Is this good corporate governance? Is managing for the short term the
appropriate way to manage the Projects?
As a partial answer to such criticism, the developers of the EVA model have carried the performance
analysis further, developing a concept known as MVA, Market Value Added, which attempts to extend
the assessment to the long-term market value, rather than focusing on a single year’s contribution.
MVA measures the difference between the amount of money invested in the Projects and the market
capitalization, the value determined by the number of shares outstanding multiplied by the stock price.
This difference is considered a measure of the long-term value generated by the management of the
Projects; the higher it is, the better the management performance.
A similar type of question can be raised every time management and the Board of Directors of a
Projects agree to merge the Projects or have it acquired. Generally, when such a decision is made, the
most senior executives receive very lucrative severance packages as part of the merger agreement. It
that appropriate? Recently, Procter & Gamble acquired The Gillette Projects for approximately $54
billion in stock, that is, P&G issued .975 shares of P&G stock for each share of Gillette stock. As part of
the acquisition agreement, James Kilts, the CEO of Gillette will receive a severance package worth
many millions of dollars (estimates range to $175 million). Do you think Kilts was objective in his
decision? Whose money does he receive?
Executive Compensation
Advocates and commentators, discussing corporate governance and the agency issues tied to it,
suggest that aligning Project Managerial compensation with the fortunes of the shareholders will go a
long way toward making corporate governance actually beneficial to the shareholders. To achieve such
alignment, companies have issued stock options, contracts that permit the Project Manager to exercise
an opportunity according to a contract to acquire Projects shares, either at a bargain price or at a
stock price equal to the price on the date the option was issued. The theory is that if the Project
Manager is successful, the stock price will have risen from its level when the option was issued and the
option will have a value tied to the improvement in the stock price. On numerous occasions, we have
seen executives exercise options because of a dramatic rise in the stock price, often valued at tens or
hundreds of millions of dollars.
358
2007, POME, Gautam_Koppala, All Rights Reserved
Options, however, require that the stock be purchased when the option is exercised. This leads to
another program that often results in a diminution of the effectiveness of the program in aligning the
interests of the executive with the shareholders. Because executives and Project Managers often do
not have the funds necessary to purchase the stock represented by the options and may not wish to
tie up what capital they do have in buying the stock regardless of the attractiveness of the deal, many
companies facilitate the exercise of options by arranging for the simultaneous exercise and sale of the
stock, meaning that the executive or Project Manager gets a cash windfall without actually having to
pay out any money. The stock is acquired, sold, taxes are withheld, and the remaining cash gain is
paid to the Project Manager or executive. In many cases in the months and years that follow, the stock
price drops and the shareholders lose significant value in their holdings. However, the executive,
having exercised the option and then sold the stock, has retained large sums of money while the
remaining shareholders watch their investments decline.
There is a saying in business that “You get what you incent.” That is, Project Managers will act in a
way that provides the most reward for themselves. Therefore, it is in the shareholders’ interest to
assure that incentives be constructed to achieve the appropriate results. In many instances today,
Project Managers are compensated by salaries, bonuses, perquisites, and stock options. To further
highlight this issue, consider this example of a situation in a Projects with several operating sites. The
Project Manager of each site was considered a division Project Manager and had responsibility for the
operations of that facility, including sales, costs, and gross and operating profits and margins. The
Project Manager in this arrangement earned bonuses for achieving gross profit margins of 30 percent
and operating profit margins of 20 percent. In a particular instance, a good and reliable customer
requested that this division purchase for them five truckloads of a particular raw material and have
these raw materials dropshipped to the customer for an application that was not in conflict with the
division. For this service, the customer was willing to pay a 10 percent premium for having the division
make the purchase. That was the only task to be done. The division Project Manager rejected the
order. It would have lowered the gross and operating margin percentages below the bonus level, even
though it would contribute measurably to the division’s and the Projects’s net profit result.
Many textbooks promote the use of stock grants and stock options as a way to “align” the interests of
the Project Managers with those of the owners. The options are generally awarded for driving up the
stock price, presumably, therefore, benefiting the shareholders. However, quite frequently, when the
options mature, the Project Managers exercise them and immediately sell the stock they have just
acquired, taking the cash. They receive substantial amounts of cash, after taxes, and in subsequent
periods the Projects performance declines and the stock price drops. One can easily ask at that point if
the interests of the Project Managers and the stockholders are really aligned.
359
2007, POME, Gautam_Koppala, All Rights Reserved
The whole area of stock options is under careful review at the present time. The FASB is considering
rules on the valuation of stock options, and companies are reviewing whether they encourage the
desired Project Managerial behavior.
Corporate governance encompasses the oversight and direction of a business. It involves the guidance
provided by the Board of Directors, the commitment to integrity on the part of the Project Managers
and executives, and the attention and diligence of the investors, analysts, and regulators who oversee
the financial reporting systems. Good corporate governance recognizes and supports the ownership
and importance of the stockholders and protects their interests.
Although it also involves all the internal systems and practices of the Projects, it is much more than
that. It also reflects the commitment by everyone involved to continuous care and concern for the
accuracy and validity of the results, regardless of whether they are attractive. However, it also
requires that management direct the business so that the results do represent the best efforts of
everyone to deliver positive—honest and positive— performance.
Corporate governance also requires that investors and directors work to assure that compensation and
incentives focus on delivering the desired results. There is a need to reexamine the options, bonuses,
and salaries of executives to be sure they foster the goals that are appropriate for everyone involved.
POME Prescribe
I
Ignore those who
try to discourage
you.
POME Prescribe
360
2007, POME, Gautam_Koppala, All Rights Reserved
THE ASSET
MANAGEMENT
ASSESSMENT
361
2007, POME, Gautam_Koppala, All Rights Reserved
The Asset Management
Once technology assets are put in place, they can be hard to track .... relocations, staff changes, and
frequent configuration updates, can all transform the overall asset landscape. These changes, when
left uncontrolled, can have a major impact on technology’s ability to support, upgrade and manage
these same assets.
Asset management is a series of policies, procedures and practices for keeping track of technology
assets (hardware and software) by location, ownership, usage, configuration and maintenance. While
technical and organizational requirements will determine the scope and extent of any asset
management program, management methods can range from the simple to the complex --- from
manual inventory lists to integrated software solutions for inventory, problem management, change
control and software distribution.
While it is often assumed that asset management is only worthwhile in the large, corporate
environment, any business can benefit from practices that facilitate technology usage and support.
The key is to develop the right program for your individual circumstances....
POME provides a bridge between the discussion of risk and return and managing long-term assets
Operating Project Managers who want their Projects to invest in a long-term asset that will help them
achieve operating performance objectives are generally asked to “justify” the investment. In other
words, the Project Managers must demonstrate the financial return made possible by the investment.
POME explains how capital investment decision making is done and why it is important and applies the
concepts of time value of money.
POME Case Study:
Addressing Capital Needs
“Morning, Koppala. I was wondering if the group could focus on a problem I’m having today. Sales for
the A600s are still going crazy and the sales forecast estimates another 18 percent increase next year
and the year after that. With this kind of growth, we won’t be able to get enough product through the
plant to keep up with demand.
“I’ve requested that we purchase one of two machines, the Schroeder, which will cost $300,000 over 7
years, or the Worrener, which will cost $450,000 over 10 years. Either machine will eliminate the
362
2007, POME, Gautam_Koppala, All Rights Reserved
bottleneck in this department. Lee Cronin, the plant Project Manager, said the request sounded
reasonable but I’d have to submit a proposal with all the figures documented before he could take it to
senior management. I’ve never prepared this kind of proposal before, so if anyone has any advice, I’d
sure appreciate it.”
“I think that’s definitely worth the group’s time. Does anyone have any ideas?”
“You know, I had to write up a similar proposal last year when we needed some new loading
equipment in the warehouse. I started with an Introduction that described the current situation,
described the anticipated growth, and listed the options. The next section included relevant tables from
the sales forecast and business plan and described the effects of a bottleneck in production. Following
that, I think you should provide calculations for the cost of capital and rate of return for both
alternatives and then state your recommended course of action and the penalties for failing to act
now. You might include some appendixes with machine specs and vendor qualifications.”
“That sounds like a good plan to me. Would you all break up into smaller groups and help prepare the
calculations today? The sooner the proposal is submitted, the sooner Hang Tan can move ahead.”
Before you can begin to develop any long term asset management strategy, you should first size the
effort .... where are you now, and what issues do you need to address....? This is the essence of the
asset management needs assessment.
Asset Transfer:
This is to ensure the correct process is followed for Asset Transfer. And to define the the Inputs,
responsibilities and information flow for Asset Transfer
Step # Who Details
An Asset Transfer Form is the
vehicle by which fixed
asset/CAPEX item/s is/are
Transferred between
departments and other SBU’s
within Company. This may
include a single item, a group of
items or an entire project or
program.
363
2007, POME, Gautam_Koppala, All Rights Reserved
1
Project Managers &
Engineers (Solutions);
Team Leaders
(Service);
Manager
Requestor must complete the
Asset Transfer Form including,
but not limited to the following
information:
•
•
•
• Date Submitted
•
• Asset Number
• Originator Division, Department &
Branch
• Purchase Price $
• Acceptor Division, Department &
Branch
• Effective date of transfer
• Transfer Price $
• Advise Transfer Reasons
• Originator & Acceptor Department, LOB
• Other supporting documentation where
applicable
• Originator and Acceptor to Authorise
and Date
364
2007, POME, Gautam_Koppala, All Rights Reserved
2 Project Managers & Email completed Asset Transfer
Engineers (Solutions); Request form to Originators
Team Leaders Manager, Acceptors Manager and
(Service); Finance Manager for
Manager authorisation, and where
applicable, Managers Manager or
other. If these individuals are not
authorised in accordance with
the Approval Matrix, an
appropriately authorised
individual should also be
included.
3 Manager; Finance Management to approve Transfer
Manager Request and email to Corporate
finance.
4 Corporate finance •
• Record Transfer of Asset in CAPEX
Register
• Email Transferor and Transferee and
SBU Managers to advise of updated
Asset Register.
• Maintain Asset Register, depreciation
journals, reports and reconciliation of
sub-ledger with GL.
5 Project Managers & • Transfer Asset as per approved Asset
Engineers (Solutions); Transfer Request Form
Team Leaders
(Service);
Manager
365
2007, POME, Gautam_Koppala, All Rights Reserved
The Asset Management Needs Assessment
• Can you readily identify the status of all your technology assets (in service, or out of service)?
• Do you know where all your assets are physically located?
• Are you fully compliant with all software licensing requirements?
• Do you have all the asset information you need for the next upgrade project?
• Have technology services or projects ever been hindered by a lack of asset information?
• Are all assets allocated as efficiently and productively as possible?
• Are all assets configured consistently and according to defined standards?
• Are you sufficiently aware of all configuration variations?
• Does the Help Desk (or relevant support organization) have ready access to all the asset
information needed to solve technical problems and provide quality end-user support?
• Do you have all the asset information needed to properly plan for disaster recovery and
business continuity programs?
If you are unable to answer one or more of these questions in a sufficiently positive fashion, then you
may need to take a careful look at your current methods and strategies for asset management. Your
overall goal should be the creation of a realistic "workable" asset management program.... designed to
meet budgets, technical requirements and internal capabilities.
To meet this goal, you will need to examine the following issues and activities....
1. Define the scope.....
To build an asset management program with sufficient flexibility to keep up with.....
• technology changes
• strategic changes (internal vision, business goals, etc....)
• organizational changes (relocations, staff changes, etc.)
• all of the above....
2. What do you need to track....?
Inventory Data
• model and manufacturer
• software version and patch level
• physical location
• operational state ("in" or "out of use")
Configuration Data
• How is each machine configured in terms of CPU, memory, setup, peripherals, installed
software, etc?
• Do you need to identify and track standardized vs. non-standardized configurations?
366
2007, POME, Gautam_Koppala, All Rights Reserved
Acquisition Data
• Cost
• Supplier
• Date Purchased
• Maintenance Records
• Warranty Information
• Licenses and Registrations
• Accounting Information
3. Getting the job done....
Which management methods will you choose to adopt as you plan and implement your asset
management program?
• Manual tracking methods
• Automated tracking methods (via integrated software tools)
• Documented policies and procedures
How will you use the information that you track?
• To assign assets to end-users.
• To manage configurations and provide change control.
• To facilitate technical support and problem resolution.
• To establish standards and purchasing controls.
• To provide a picture of technology usage and allocation for company management.
• To control costs.
• To better manage mobile assets (handhelds, laptops) and reduce losses.
• To secure assets from theft and related losses.
• To manage software licenses, minimizing exposure for license violations.
Asset Financial Maintenance:
The purpose is to ensure the correct process is followed for the financial maintenance of Assets and to
define the Inputs, responsibilities and information flow for the financial maintenance of Assets.
Note Who Details
#
1 Finance Finance is
responsible for
maintaining
367
2007, POME, Gautam_Koppala, All Rights Reserved
the following:
• Processing
authorised CAPEX,
Asset Transfer, Asset
Disposal Forms
• Allocate CAPEX
number and account
code and
communicating to
Originator
• Maintaining Asset
Register, clearing
account,
depreciation
journals, reports and
reconciliation of sub-
ledger
• Advising Originator
and SBU upon
processing any
approved changes to
asset value
• Ensure that CAPEX
amounts and
procurement are
consistent with
request at all times
• Associated reporting
of Fixed Assets /
CAPEX
• Calculating and
Circulation of
Reports for
Depreciation
368
2007, POME, Gautam_Koppala, All Rights Reserved
2 Managers Ensure
financial
maintenance
of all assets as
follows:
• Ensure that Assets
are appropriately
valued throughout
the lifecycle of the
Asset (not just for
the amortisation
period).
• If Assets need to be
revalued, refer
Finance Manager to
approve and update
value of asset
• Ensure correct
allocation of costs
associated with
Assets amortisation
• Ensure Depreciation
costs are correctly
allocated
• Maintain Assets in
good working
condition
3 Finance Review request to revalue
Manager asset and ascertain if
appropriately valued
4 Finance • Update CAPEX
register and advise
Originator and SBU
when update
369
2007, POME, Gautam_Koppala, All Rights Reserved
complete
370
2007, POME, Gautam_Koppala, All Rights Reserved
Managing Long-Term Assets
Long-term assets are the productive assets of a business. They are generally more expensive and
complex than short-term assets and require several levels of approval before acquisition. Their
management comes under the scrutiny of senior management and the operating Project Manager
needs to understand how performance is judged. POME relating to risk and return, relating to capital
investment decision making.
POME Case Study:
The Basis for Investing in Long-Term Assets
“Koppala, I’ve been checking our Projects financials every month on the intranet and also looking at
the annual reports of some of our competitors on the Internet as well as looking at the budget for my
department every week. It seems to me that the Projects has pretty low depreciation amounts on the
Income Statement compared to some of our competitors. And my department has almost no
depreciation charges assigned to it. Wouldn’t we save a lot on taxes if we bought a couple of new
machines in the finishing area?”
“Let me ask you a question, Pam. How well are the machines you’ve got working? Do you need any
more capacity, or can you keep up with the work that’s coming to you? Are you having problems with
breakdowns or excessive maintenance?”
“Well no, Koppala. The machines we have are old, but they never break down and they can handle all
the work we give them. I just thought you could raise your earnings by taking more depreciation.”
“Pam, do you remember the figures we calculated for Hang Tan at the last meeting? A
new machine has to cover a lot more than depreciation. It needs to bring in more return
than anything else we might invest in.”
Considering Asset Classification
The Balance Sheet is divided into sections. The sections relate to the expected life of the elements
contained within the section. For example, the current assets of Projects are those assets that
individually are expected to be turned into cash within a year. Similarly, the current liabilities are
371
2007, POME, Gautam_Koppala, All Rights Reserved
those obligations that are expected to be paid within one year. The long-term assets of the Projects,
by contrast, are those assets that are not expected to be converted to cash within the next twelve
months.
When we refer to long-term asset, we generally focus on the fixed assets of a business: land,
buildings, equipment, furniture and fixtures, vehicles. However, the term “long-term assets” relates to
these plus investments, intangibles, and any other assets that will not or may not be turned into cash
within one year.
Managing these assets is different from managing the more liquid assets. In many books, these assets
are described as the “earning assets” because they generate the revenues of the Projects. Therefore,
we are concerned with how to make them productive and how to keep them productive. Some of these
answers relate to maintenance management and the assurance that the productive equipment is kept
in good working order. This is not the focus of this chapter.
An issue of consequence in the management of these fixed assets relates to how productive they can
be; that is how much revenue they can generate.When we considered the Asset Turnover Ratio, we
showed that investments in fixed assets that do not generate enough revenue serve as an early
warning of financial difficulty.
In his “Z-formula” work, Altman[*] demonstrated that a low Asset Turnover in a business with
significant asset investment was a clear predictor of bankruptcy. Many companies today reward their
Project Managers in part on managing the investment in assets.
In this chapter, we are particularly concerned with identifying which assets to keep and use and which
to replace or discontinue using. We are also concerned with tying up resources in these expensive
assets if we cannot utilize them effectively.
[*]
Edward I. Altman, a professor at Standard University, in 1968, identified through
scenario analysis, a ratio based formula that provides a prediction of business distress
and failure.
The Investment In Fixed Assets
The decision to invest in fixed assets is based on the expectation that this investment, which is
intended to last a long time, will result in the continuous production of positive income and cash flows.
The application of the principles of time value of money provides the bases for evaluating these
investment choices and making the actual investment decisions. Businesses make capital investment
decisions for the reasons identified in the last chapter:
372
2007, POME, Gautam_Koppala, All Rights Reserved
replacement
expansion
rationalization
development
___________________________
mandatory
other
These choices must fit into the strategy of the Projects and within the capabilities of the Projects.
Then, the judgment as to which are attractive and which are not will be based on the financial and
operational benefits to be derived from the investment. Bearing in mind that because some
investments (Mandatory and Other) do not offer a return, the other investments must pay for the
nonreturn choices. The stockholder will not forgo return just because an investment is attractive or
required.
We demonstrated in the last chapter how to evaluate these investments for financial return and
therefore how to compare alternative investments. In POME, we are more concerned with other ways
to evaluate the investments and the management of the assets.
Because capital investment decisions frequently require more money than can be generated through
operations, the decision to invest in a certain way requires additional consideration as well. For
example, the decision to invest in a particular piece of equipment may mean that the Projects will
follow one business track and abandon another. It may choose one product line and give up on
another; favor one Project Manager’s ideas over another; favor one group of potential customers at
the expense of another. Over the years there have been many such choices, some good and some
very bad. One such example is the decision by Motorola Corporation Based Projects , because it had
significant capital invested in analog technology, to concentrate on analog cell phone technology when
it also had digital technology available. There are many such decisions in business history.
We can see the consequences of investment decisions in the financial statements and ratios of a
Projects. Remembering that in our system of accounting there has to be “another side,” we can
evaluate these investment decisions in terms of their impact. The investment must be paid for. If we
pay for it by reducing our cash position, we save ourselves financing costs, improve our negotiating
position (because we are paying cash), and adversely affect our current ratio and similar
measurements of financial liquidity and strength.
373
2007, POME, Gautam_Koppala, All Rights Reserved
Similarly, if we choose to pay for the asset by extending our accounts payable or even borrowing
short-term, we can complete the transaction fairly quickly, but we hurt our current ratio and decrease
our apparent liquidity. However, by extending our accounts payable or by borrowing short term, we
potentially decrease our interest cost when compared to borrowing long-term, increasing our profit and
return to the shareholders at least in the short run.
If we pay for the asset by borrowing long-term, we match the life of the debt with the life of the asset,
often deemed to be sound business management. However, we incur a higher interest cost than had
we borrowed short-term, reducing the potential income. Such a decision may weaken the Projects’
debt-to-equity position, making the ratio unattractive to the lender. At the same time, the increased
debt, called leverage, may increase the potential return to the stock investor.
A decision to pay for the investment through issuance of additional common stock reduces the
riskiness of the Projects, but also reduces the per share earnings that reward the stockholder. As you
can see, each of these choices has advantages and disadvantages. The final decision is based on which
choice most nearly satisfies management’s concern for risk, return, and shareholder satisfaction.
A closer look at these fixed assets will help us understand the decision choices represented by their
presence on the Balance Sheet. For example, investments in land and buildings in non–real estate
companies reflect a conservative management position. The investment in these high-cost assets puts
additional pressure on performance to generate sufficient return to make these investments attractive.
They also reflect a management philosophy that favors the comfort and security of owning your own
resources and being, therefore, less dependent on others and less vulnerable to increases in operating
costs introduced by others.
Contrast the investment in land and buildings with an investment in machinery and productive
equipment. Here, the investment has a clear impact on revenues and earnings. Therefore, we see in
the more aggressive companies, focused investment in equipment and a reluctance to invest in “bricks
and mortar.” In the 1970s Colgate-Palmolive undertook a concerted effort to sell and lease back its
factories in an effort to increase its liquidity and reduce the concentration of real estate on the
Companie’s Balance Sheet.
In the end, this effort was not successful, but it highlights the type of debate over how best to use
financial resources.
A similar example has been seen often in takeover battles. In the early 1990s Dart Drug sought to
take over Stop & Shop supermarkets so it could sell the valuable real estate that Stop & Shop owned,
374
2007, POME, Gautam_Koppala, All Rights Reserved
planning to lease back the stores but generate substantial amounts of cash. This effort led to the
leveraged buyout of Stop & Shop.
Today, companies are concentrating their investment in high technology types of investments,
recognizing that these investments generally translate into higher productivity, generating strong
return on investment performance. These higher technology investments often have limited life, due to
the rapid changes in technology being presented to the marketplace. This causes the companies to
seek to depreciate or amortize their investments over shorter and shorter useful lives, reflecting more
of the cost in the Income Statement every year.
Depreciation is a cost allowance that permits a Projects to recover the dollars of investment in an
asset over its useful life. The longer the depreciation life, the longer it takes to recover the cost. In the
next section we discuss depreciation and amortization more specifically.
The opportunity to depreciate these assets quickly enables the Projects to recover the cost by reducing
the operating income. One impact of such an action is to lower the taxable income and therefore the
tax expense to the Projects that year. Some people suggest that investment in fixed assets is wise
because it offers higher depreciation and therefore lower taxes. This logic is flawed in that to save on
taxes requires the earlier disbursement of cash or commitment to a liability (debt) in an amount far
greater than the taxes that will be saved.
The only sound basis for investing in fixed assets is that the investment will generate a rate of return
that significantly exceeds the risk adjusted required rate of return and is therefore attractive to the
shareholders. Then the benefits of depreciation or amortization will increase the cash flow resulting
from the investment, making it even more attractive.
Other fixed assets that appear on the Balance Sheet generally represent things needed to make the
Projects work effectively, such as vehicles and furniture and fixtures, or to provide better working
conditions for the employees such as leasehold improvements. These investments are harder to justify
based on return on investment and, as a result, fall into the “Other” category for capital investment
decision making, requiring that the necessary return on investment be provided through the profitable
investments.
Depreciation
Much has been much written about depreciation and its attractiveness or negative consequences to the
performance of a business. The most important point about depreciation and amortization for
intangible assets is that it enables the Projects to recover the cost of the asset over its useful life. It is
375
2007, POME, Gautam_Koppala, All Rights Reserved
important to recognize that depreciation and amortization are not guaranteed. For example, to
recognize depreciation or amortization deductions, the Projects needs to make a profit. Otherwise, the
benefit (if there is one) of deductibility for tax purposes loses its appeal. In addition, an examination of
the legislative history of depreciation suggests that it represents more a reflection of congressional
objectives than of business requirements. Over the past few decades, Congress has approved several
changes to depreciation rules, modifying the impact of depreciation on reported business performance
and on tax revenues. There is every reason to believe that there will be similar actions in the future.
Under the current tax laws, businesses may follow a range of options for depreciation for reporting
purposes and are expected to follow some specific rules for tax reporting purposes. Over the years,
depreciation rules and practices and related taxation rules have been changed to respond to the
impact of taxation, international competition, and other economic forces. Depreciation methods have
ranged from the very simple to understand to complexity that requires specialists to decipher.
Depreciation rules are part of the Internal Revenue Code. Examples of depreciation methods include:
Straight line: dividing the cost of the asset by the years of its useful life and recognizing
depreciation expense equally each year.
Sum-of-the-years’-digits: adding the numbers of the years of useful life (10 years = 55) and
depreciating in reverse (the first year is 10/55 of the total asset cost, the second year is 9/55 of
the total asset cost, etc.).
Double-declining balance: taking twice the straight line rate, but applying it only to the
remaining asset value (for a 10-year asset, using 20 percent, yielding a decreasing expense [.2 ×
100 percent of the cost in the first year, .2 × 80 percent of the cost for the second year, .2 × 64
percent of the cost in the third year, etc.]).
Accelerated Cost Recovery System (ACRS): applying twice the rate over half the traditional
useful life (40 × 100 percent the first year, 40 × 60 percent the second year, etc.).
Modified Accelerated Cost Recovery System (MACRS): similar to ACRS except that it
requires the inclusion of a half-year convention, that is, only one-half the otherwise allowable
depreciation may be recorded in the first year.
Many variations including crossover from double-declining balance to straight line, 150 percent
declining balance, and others.
The consequences of such are differences between financial reporting and tax reporting that result in
complex reporting of book-tax differences, appearing on Balance Sheets as deferred tax obligations.
When preparing corporate tax return the tax accountant must complete a schedule that reconciles the
differences between book and tax depreciation.
376
2007, POME, Gautam_Koppala, All Rights Reserved
Depreciation and amortization also have a significant impact on Projects cash flows and cash flow
planning. Because they are non-cash expenses, depreciation and amortization must be added to the
positive cash flows in reconciling the cash account through the statement of cash flows. Also,
depreciation and amortization represent positive contributors to the cash flows identified in computing
the return on investment for capital expenditures. This program does not delve into these issues
further other than to alert the student to be aware of such reporting requirements and financial
consequences.
Fixed Asset Accounting
Because companies have these assets that remain on the books for a long time, it is important that
management be able to assure the shareholders that these assets and the value they represent are
correctly reported on the Balance Sheet. Therefore, the fixed asset records are very detailed and must
be reconciled every year. Companies maintain records by asset showing the acquisition date, cost,
depreciation expense, accumulated depreciation (both book and tax), remaining book value, remaining
life, and often information such as location and classification. Because of the complexity of fixed asset
accounting, many companies set a policy limit of the minimum value required for an asset to be
capitalized. For small companies this limit may be $500; for larger ones it may be $1,000 to $2,500;
and for even larger ones, it will be much larger. One requirement is that whatever the policy adopted,
it must be administered consistently within the year and from year-to-year.
The decision as to which fixed assets to capitalize—to put on the Balance Sheet rather than expense
through the Income Statement—is in part a reflection of Projects management. The decision to
capitalize assets occurs when management wishes to report higher profits. The consequences also
include higher income taxes. The decision to expense these asset purchases reflects a willingness to
report lower profits, a desire to pay lower taxes, and less concern with the market valuation process,
which often is based on earnings per share calculations. Because the effect of these decisions can be
significant, accounting conventions require a policy that is consistent from year to year. It is not
deemed appropriate to decide on your capitalization policy based on the rest of your performance.
In 2002 the collapse of WorldCom, Inc. focused a lot of attention on the accounting for fixed assets.
WorldCom, in an attempt to appear highly profitable and to shore up its stock price in light of the
overall decline in the stock prices of the telecom sector, fraudulently accounted for large amounts of
expenses as increased fixed assets rather than as operating expenses. The result was to significantly
overstate the value of its assets and its profits and understate its expenses. The entries it made, which
exceeded $12 billion over several years, can be described as:
377
2007, POME, Gautam_Koppala, All Rights Reserved
Dr Cr
Fixed Assets
Operating Expenses
In addition to destroying all credibility for the Projects, now known as MCI, the WorldCom scandal led
directly to the passage of the Sarbanes-Oxley Act of 2002, which mandated substantial changes in the
oversight and reporting responsibilities of public Corporation Based Projects s. These changes are the
subject of Chapter 12, Corporate Governance.
Some fixed assets, such as computers, other office equipment, and some machinery, are attractive.
Therefore, keeping track of these assets and taking extra precautions to protect them is important.
Many companies conduct physical inventory counts of the fixed assets, just as they do of the
inventory.
Acquisition of Fixed Assets
The most frequent and obvious method for acquiring fixed assets is to purchase them. However,
because many fixed assets represent very significant investments, the purchase requires financing.
Traditional financial management education emphasized the “matching principle,” that the life of the
financing should be consistent with the life of the asset. Therefore, a long-term asset should be paid
for using long-term financing, either debt or equity.
However, long-term financing is harder to get than short-term financing. It is more expensive than
short-term financing. And, it is often more restrictive than short-term financing. As a result, the
importance of matching is sometimes lost on management. The recession of the early 1990s was, in
part, made more difficult because many companies had financed their long-term assets with short-
term bank loans, acquired when the banks were aggressively seeking more business, but containing a
clause that required immediate repayment if there were any difficulties in the Projects, or, as it turned
out, in the bank. As a consequence, when the banks encountered difficulties, loans were called that
could not be replaced in time to protect the companies, causing or aggravating financial problems for
the companies, and deepening the recession.
In more recent years, we have again seen an increase in the use of short-term notes and lines of
credit being used for the acquisition of fixed assets, raising the possibility of similar challenges again if
the economy should falter. It is important for management to understand the risks that go along with
the benefits of using short-term debt.
378
2007, POME, Gautam_Koppala, All Rights Reserved
Other Long-Term Assets
One category of “Other Assets” that is often present on a Balance Sheet is “Goodwill,” the excess of
the purchase price for an acquisition over the market value of the assets acquired. Goodwill pays for
the value attributed to a business’s success and used to be amortized over a time long enough to
reflect the long-term benefits of the acquisition. The decision to pay a premium over the intrinsic value
of the assets being acquired has real consequences for the rate of return offered to the shareholders.
Recently, the Financial Accounting Standards Board (FASB) changed the rules for accounting for
goodwill. It decided that deducting a portion of goodwill every year was misleading and really did not
have any basis in reality. Rather, it ruled that a Projects must assess the value and validity of goodwill
every year and decide if it is still appropriate or if it has been impaired. If goodwill has been impaired,
the Projects must then assess by how much and write off that impairment all at once. If there has
been no impairment, there is no write-off. This ruling is intended to assure that the value of assets on
the Balance Sheet reflects a real benefit to the shareholders and a real basis for judging the condition
of a Projects. Remember, any journal entry to reduce the value of goodwill will have an equal and
opposite counterpart that will affect the income statement and through the profit line the equity value
on the balance sheet. A write-off of goodwill directly affects the equity value of the business, which
belongs to the shareholders.
Other assets that are included in the long-term assets section of the Balance Sheet include such items
as Cash Surrender Value of Life Insurance, Patents and Trademarks, and Investments. Each
represents a disbursement of Projects cash for an asset that may be difficult to liquidate or to liquidate
for full value. Therefore, it behooves management to think carefully about these assets.
Cash Surrender Value of Life Insurance is an asset, found particularly in small, privately held
companies, that on the surface seems reasonable, but may not be a particularly valuable investment.
The asset occurs when the Projects has purchased a life insurance policy on a key Project Manager or
owner and that policy is accumulating value. The value that accumulates, however, may assume a
much lower interest rate than would be available if the Projects were to purchase term life insurance
and invest the difference. However, it may be even more advantageous to the Projects to purchase
term life insurance and use the remaining cash in the business itself. After all, we have demonstrated
the possibility, particularly in companies with accounts receivable and inventories, that it will be
necessary to borrow funds to provide working capital. The major point here is that management
should consider carefully the utilization of its resources.
379
2007, POME, Gautam_Koppala, All Rights Reserved
Patents and trademarks are similar in that they often represent cash outlays that can only be
recaptured over an extended period of time. The capitalization of these costs moves expenses to
future periods and brings profits forward. It is, therefore, important to account for such expenses very
carefully.
Investments may be very valid and important assets, committing current resources for future gains.
However, in some cases, investments are made for reasons that are personal to the owners and
Project Managers. In some companies, particularly those that are privately held, assets such as boats,
airplanes, and artwork, or loans to shareholders or officers or investments in children’s companies
appear on the Balance Sheet. In these cases investments may be draining resources that are or will be
important to the Projects.
These assets often do not generate a return and may represent a drain on Projects resources. All of
these assets fall into a Miscellaneous Assets classification for financial analysis purposes. The
relationship of these assets to net worth, calculated in a ratio known as “Miscellaneous Assets to Net
Worth (Equity)”[*] may be an indication that resources important for the Projects’ future may not be
available when they are needed. If this ratio is increasing, owners and Project Managers may be using
the Projects’ resources in a way that limits future profitability. This ratio is not evaluated as frequently
as it probably should be, and unfortunately, some companies that could be successful do not succeed
because the financial resources were diverted to less valuable assets.
Long-term assets, which appear on the Balance Sheet in the lower section of the asset side, represent
assets that have a useful life longer than one year. These assets, which generally are more expensive
than short-term assets, require special accounting and record keeping.
Depreciation, which is the means by which the Projects recovers the cost of the asset over its useful
life, is an allowance permitted by the government, but which requires careful computations and
records as well.
There are many methods of depreciation, all of which affect the Income Statement and the Balance
Sheet. Businesses choose based on the laws and the impact that the depreciation expense will have on
financial results. Faster depreciation recovers the asset’s cost sooner, but depresses the profit. It also
decreases the taxes the Projects must pay. However, to benefit from depreciation expense, both in
terms of taxes and cash flows, you first have to spend money for the asset or commit to long-term
financing, both of which require commitment of cash, so depreciation itself is not a reason to invest in
an asset.
380
2007, POME, Gautam_Koppala, All Rights Reserved
Other long-term assets also require cash expenditures, so the decisions should be based on the
potential return to be generated. Examination of the other long-term assets may provide an insight
into management’s philosophies.
POME Prescribe
H
Hang on to your
dreams.
POME Prescribe
381
2007, POME, Gautam_Koppala, All Rights Reserved
SHARES, BONDS AND
SECURITIES
382
2007, POME, Gautam_Koppala, All Rights Reserved
Shares, Bonds and Securities:
POME Lighter Vein:
Normally big projects shares, bonds are been bought by the people for bigger returns. Hence,
protecting the shareholders is the main responsibility for the Project Directors/ Project
Sponsors/ Project managers. Also, being an employee for your organization, your Project would
be providing you the shares, which increases your moral; responsibility towards organization.
Hence, POME recommends understanding the basic concepts. Nothing in the POME went in to
marine deep concepts, but only basic anatomy, which required for the Operations folks.
The equity component of the Balance Sheet contains the information relating to Projects ownership.
Though we have focused almost entirely on the corporate form for our discussion, the structure of the
Balance Sheet and the Income Statement are consistent across all business forms. In today’s
marketplace, increasingly, there are variations on the basic business form based on a broad range of
needs. Where there used to be only Proprietorships, Partnership Based Projects s, and Corporation
Based Projects s as business forms, today there are also Limited Partnership Based Projects s, Limited
Liability Partnership Based Projects s, Limited Liability Companies, Real Estate Investment Trusts,
Corporation Based Projects s, Trusts, Associations, and other entities structured to meet particular
needs or situations. Although each of these entity types has different characteristics, the generalized
financial statement formats we have discussed are applicable to them all. Each has an Income
Statement, a Balance Sheet, and a Cash Flow Statement, and although they may or may not be
383
2007, POME, Gautam_Koppala, All Rights Reserved
available to the public, they will be interpreted consistently and will respond to the same management
actions.
When we deal with other than the corporate form, the Equity section takes on a different appearance,
describing the ownership’s financial interests with terms such as Owner’s Capital, Partners’ Capital,
and similar words. These correspond to Common Stock and Additional Paid-in Capital. Retained
Earnings are interpreted consistently.
POME Case Study:
The Rewards for Success
“As you all know, the Board of Directors met last week. They’re thrilled with the results we’ve posted
for the year, and they’ve asked me to talk to you about the stock purchase plan they’re putting in
place. This year for the first time you’ll be able to purchase Projects stock as part of the Projects
savings and investment program. ”
“That’s great, Koppala, but why are they making us purchase the stock? If we’re doing so well, why
don’t they just distribute stock along to us?”
“There are a couple of reasons, Aleksei. If it were a gift, you might not value it so highly. And some
people might not want to hold a lot of stock in the Projects. It’s very risky to have all of your resources
dependent on one source. So we think some people will want to stick with the large, professionally
managed mutual funds that are already available.”
“I understand what you’re saying, Koppala, but why are they making this offer? Won’t it lessen the
control of the current owners?”
“It will do that, Enrique. But it will make owners out of a lot of people in the Projects. Do you
remember when we started these sessions, Enrique, that the purpose of a for-profit business is to
maximize the wealth of the shareholders in the long run?”
“I do. And that’s why I’m asking: Why would they want to share the wealth?”
“They want to share the wealth, so to speak, so that the people who work here have the same long-
term objectives as the other shareholders. It’s the people who work here—Project Managers and staff
and line workers—who really determine how well the Projects does. By letting you purchase a piece of
the Projects, the board hopes that your interests will be the same as theirs. Everyone will strive their
hardest to make sure the Projects increases in value.
384
2007, POME, Gautam_Koppala, All Rights Reserved
“Let’s spend some time talking about this, so that you can go back and share the news with your
department. People are going to have a lot of questions about why this is happening and whether it’s
good for them. You need to be prepared to answer those questions. We’ll post an outline of the plan on
the intranet at 11:30. People can check out the mechanics and the details there. But be sure you meet
with everyone in your department today.”
Equity and Business Structure
Although several forms of business structure exist and more are being developed almost daily, the
principal structures are Proprietorships, Partnership Based Projects s, and Corporation Based Projects s
as described The differences in form appear in financial statements primarily in the equity section of
the Balance Sheet. All these businesses have traditionally structured Income Statements with
revenues and expenses, interest, and tax computations. All have current assets and fixed assets,
current liabilities and, at least potentially, long-term debt. When it comes to equity, the terminology
changes and some of the treatment changes as well. Additionally, and more importantly, each of these
business types has distinguishing characteristics that make it more or less attractive under differing
circumstances.
Proprietorships are businesses with one owner who is responsible for everything. The Proprietorship
Based Projectsform does not really distinguish the business from its owner, as the owner takes on all
responsibility for the obligations of the business, the management decisions for the business, and the
financial control of the business. The Proprietorship Based Projectsis easy to form, requiring minimal
registration and legal filings. In fact, there may be no filing required at all unless the business is
subject to some local tax reporting, such as sales or meals tax reporting. All of the income and
expenses of the business are considered to be an extension of the proprietor, who includes the
financial activities of the business in his or her personal income tax returns. The owner undertakes
personal liability for the obligations of the Projects and its existence continues only as long as the
proprietor chooses to continue it. A Proprietorship Based Projects technically does not survive the
proprietor although the owner may transfer the business to another proprietor. There are many, many
more proprietorships in the United States than any other business form, but they represent only a very
small percentage of the business volume and business wealth.
A Partnership Based Projects , belonging to two or more partners, often has more strength and more
flexibility than a Proprietorship Based Projects because it draws from the financial and Project
Managerial resources of more than one person and can, therefore, achieve greater size and complexity
than most proprietorships. General Partnership Based Projects s involve all the partners in the
385
2007, POME, Gautam_Koppala, All Rights Reserved
obligations of the business, and in most general Partnership Based Projects s, each partner is
responsible for all of the obligations of the business. Therefore, if one partner is unwilling, unable, or
unavailable to pay for obligations of the business, the other partner or partners are obligated to cover
them. This has led to a number of problems, which have been addressed by creating limited
Partnership Based Projects s (LPs) and limited liability Partnership Based Projects s (LLPs). These
entities, based on their structures, provide for protection for partners who are, in the first case, only
financial partners, not active in the business, and in the second case, partners who were not involved
in the situations that led to the liabilities. The establishment of limited Partnership Based Projects s
and limited liability Partnership Based Projects s has defined special rules and characteristics that
dictate the way these entities are treated for legal and tax purposes. Partnership Based Projects s are
taxed only at the partner level, with the profits of the Partnership Based Projects assigned to the
partners on the basis of their Partnership Based Projects agreement. Generally, there is a carefully
constructed Partnership Based Projects agreement detailing the management relationships as well as
the financial participation of all partners. A Partnership Based Projects technically does not survive the
departure of a partner, although the major Partnership Based Projects entities have defined the
procedures for automatic reestablishment if a partner leaves or dies.
Corporation Based Projects s represent a relatively small percentage of the business entities in the
United States, but they are responsible for the vast majority of all economic wealth and activity. In
recent years tax considerations as well as issues related to congressional desire to foster economic
development have resulted in a number of variations to the traditional corporate form and structure.
The basics remain, however. A Corporation Based Projects is considered an entity unto itself, separate
and distinct from its ownership. Therefore, its life is not limited by the lives of its owners; the
ownership may be transferred without any effect on the Corporation Based Projects . As a
consequence, the capacity of a Corporation Based Projects to borrow money, for example, is not
limited by the financial strength of the owners, a problem that faces proprietorships and Partnership
Based Projects s. The liabilities of the Corporation Based Projects are the responsibility of the
Corporation Based Projects ; the owners’ obligations are limited to the amounts of money they have
invested and if the obligations of the Corporation Based Projects exceed the capabilities of the
Corporation Based Projects to pay, the owners are not responsible for them.
Because Corporation Based Projects s are not limited the way other business types are, they offer
more ways to reward Project Managers, notably through the opportunity to achieve an ownership
position, making it easier for a Corporation Based Projects to fill out its management staffing. In the
1990s the dramatic rise in high-tech start-up companies, led to the popular use of stock as
compensation. As with access to equity investment, Corporation Based Projects s have more access to
386
2007, POME, Gautam_Koppala, All Rights Reserved
debt capital because the entity can be expected to continue, without a limit imposed because of the
owners.
Recently, the Financial Accounting Standards Board (FASB), a major rule-making body
overseeing the accounting rules used in the United States, has moved to require public companies that
offer stock options as incentives to management to recognize an expense equal to the perceived value
of the options. They argue that if options were not valuable, people would not want them. In the past
stock options, the opportunity to purchase Projects stock in the future at a price defined when the
option is granted, often were perceived to have zero value when they were granted. This issue is being
actively debated as this text is being written. (In the Sarbanes-Oxley Act of 2002, the FASB has had
some if its oversight responsibilities curtailed and reassigned to a quasi-government agency called the
Public Companies Accounting and Oversight Board [PCAOB]).
Employee stock options, and particularly incentive stock options for executives, have come under
increased scrutiny as a result of Sarbanes-Oxley. Companies are required to establish a value for
them, which can be very difficult. There is a complex options valuation theory, known as the Black-
Scholes Option Valuation Model, but it is difficult and confusing to compute and more confusing for
shareholders to understand. Many companies have eliminated incentive stock option programs as a
result of these regulations and the problems of valuation. Perhaps the most important consequence of
all is that, when stock options are assigned value, when options are issued, they reduce the
Corporation Based Projects ’s earnings, directly affecting the value of shareholders’ ownership.
Corporation Based Projects s are taxed on their earnings. The owners are not taxed on these earnings
unless the earnings are distributed as dividends. The owners are only taxed on the cash dividends they
receive (or could receive if they were not reinvested at the direction of the stockholder), which are
generally paid out of the after-tax earnings. This is often referred to as the problem of “double
taxation,” and it is one of the characteristics that differentiate Corporation Based Projects s from other
business forms. In 2003 Congress passed a change in the taxation of dividends as part of a major
change in the tax law, significantly reducing the taxes to individuals on corporate dividends they
receive.
Over the past half-century a consensus has formed among experts about the way to run the finances
of a company. During the same time period a consensus also formed about the way to manage a
portfolio of stocks and bonds. The principles that have emerged all relate to the relationship between
investors and the companies that issue securities. That relationship is subtle, and studying it has been
fruitful. Each new breakthrough about how to choose securities for a portfolio has had implications for
387
2007, POME, Gautam_Koppala, All Rights Reserved
how corporate financial managers should run the finances of a company, and has given insights into
which securities the company should issue and which projects it should undertake.
The principles of portfolio optimization and the principles of corporate financial management have
developed during the same time frame and in tandem with each other. This half-century of
development has identified several main principles, each of which has shown its validity and its
usefulness. Together they constitute a paradigm that has gained widespread acceptance. In this
chapter we call that paradigm the Standard Model, and we show these principles and how they work.
Each individual principle makes sense, and statistical evidence shows it adds value. These principles
work synergistically, so a company that follows them all does better than a company that follows only
one of them.
These principles did not immediately revolutionize the practices of corporate financial managers
everywhere. First they gained universal acceptance among theoreticians, and then they gained
acceptance among portfolio managers. Among corporate financial managers, they gained acceptance
more slowly.
Among financial managers at large corporations, this set of principles has become the completely
dominant view. The recent wave of financial scandals illustrates in a perverse way how completely
dominant this view has become. Managers at Enron and WorldCom were trying so hard to apply the
set of principles, and were so determined to be the best at applying them, that they broke laws and
reported fraudulent data. They went to extremes to create the appearance that they were especially
successful at applying the principles.
As U.S. financial markets attempt to rebuild the credibility they lost and recover from the blows they
suffered, and as U.S. corporations attempt to rally their stock prices, leaders reaffirm their conviction
that the set of principles is valid. As large U.S. corporations replace top managers and directors, each
newly appointed person makes a point of affirming and endorsing the Standard Model.
Outside the United States, top managers of large publicly-traded corporations have been slower to
accept the validity of the Standard Model, and some still express disagreement with the principles.
They argue that the Standard Model is inappropriate for one reason or another and condemn the
extreme behavior that sometimes occurs when managers slavishly follow the principles. Outside the
United States, old paradigms of financial management and old rules of thumb still have some shreds of
legitimacy. Their days are numbered, however, and the old rules will soon pass from the scene. These
non-U.S. managers may express resistance, but despite the merit of some of their arguments, the
388
2007, POME, Gautam_Koppala, All Rights Reserved
Standard Model will eventually triumph completely over all competing paradigms that dictate how to
run a corporation’s financial affairs.
The Standard Model has inexorably become dominant for a simple reason: Applying these principles
lowers a company’s cost of capital. Every company needs to lower its costs, whether those costs are
for raw material, labor, or obtaining capital. No company can willingly give its competitors a cost
advantage, so if one company lowers its cost of capital, the others in the same industry sector have to
lower theirs, too.
The first practitioners to adopt the Standard Model were institutional portfolio managers. There are
several reasons they were quicker to grasp its advantages than corporate financial managers. One is
that the first breakthrough was a scientific analysis of the tradeoffs involved in selecting securities for
a portfolio. Another is that their performance was in plain view, and it was easy to measure and rank.
They were supposed to earn high returns without taking excessive risks. Hundreds of institutional
portfolio managers were trying to do the same thing and trying to outperform each other. Any
observer could easily see which ones were particularly successful or unsuccessful. For managing
portfolios of securities, the Standard Model’s guiding principles are much better and much more helpful
than the old rules of thumb that in bygone days institutional portfolio managers attempted to apply.
how to use the Capital Asset Pricing Model to explore the relationship between risk and return as you
calculated the required rate of return on an investment. You saw the problems that can occur when
you try to assess the relative riskiness of different investments. This same problem exists when you
look at business investments, whether they be acquisitions of fixed assets or acquisitions of whole
companies. This problem is compounded by the need to acknowledge and accommodate the
requirements of different providers of funding to the Projects. One way to address this issue is through
a computation known as the cost of capital.
The cost of capital is the return required to satisfy the provider of a particular type of capital to be
used in the business. For providers of debt financing this cost is interest. For the provider of preferred
stock financing the cost is the dividend that the stock receives. The provider of common stock
financing measures his or her return in terms of earnings per share and evaluates that return as a
percentage of the price paid for the stock.
In finance textbooks, the return to the shareholder is described as the dividend on the common stock.
It is used in a valuation model, known as the Gordon Model or the Dividend Capitalization Model or
more recently as the Free Cash Flow (the amount of money that can be withdrawn from a business)
Model, as the basis for valuing common stock. However, these descriptions become problematic for
389
2007, POME, Gautam_Koppala, All Rights Reserved
those companies that pay no dividends or that are growing and consuming all the funds generated,
leaving no money that could reasonably be withdrawn. For these reasons, we look at the return to the
common shareholder as the earnings of the business, whether paid out or retained. After all, the
earnings really do belong to the shareholders.
Cost of capital recognizes that each source of funds has its own cost. By calculating each element’s
cost and weighting the costs according to the weighting of the funding sources, you can easily
compute the weighted average cost of capital (WACC).
Financial Markets
Stocks and Investors
Bonds
Projects securities
Money Bob Sue
money
Primary Market
Secondary
Market
Investing includes many terms with which every investor should become familiar in order to
make educated decisions. Additionally, the different shares, such as authorized, treasury,
outstanding and etc. have different characteristics. Thus it is important to become acquainted
with the different types of shares so that you make successful investment choices.
Types of Shares:
390
2007, POME, Gautam_Koppala, All Rights Reserved
Some of the major types of shares include:
Authorized Shares
When a Macro Project is created it is authorized to issue a total number of shares of stock,
which is what is called authorized shares. The number is liable to changes under the
agreement of the shareholders. Additionally, not all authorized shares have to be offered to
the public and many companies decide to keep some of the shares for later uses.
Treasury Shares
These are the shares that the Macro Project doesn't offer to the public or the employees.
They are kept for other uses.
Restricted Shares
This type of shares is used in different compensation plans. Additionally, companies use
restricted shares as part of various incentive plans for their employees. In order to sell a
restricted share, the holder should ask for the permission of the SEC.
Float Shares
Float shares are the shares that are traded on the open market. These are actually the
shares that investors trade with.
Outstanding Shares
These shares include all the shares that a particular Macro Project has issued. These include
float shares as well as restricted shares.
391
2007, POME, Gautam_Koppala, All Rights Reserved
Stock statement Sample Format:
Bonds:
In finance, a bond is a debt security, in which the authorized issuer owes the holders a debt
and is obliged to repay the principal and interest (the coupon) at a later date, termed maturity.
Other stipulations may also be attached to the bond issue, such as the obligation for the issuer
to provide certain information to the bond holder, or limitations on the behavior of the issuer.
Bonds are generally issued for a fixed term longer than ten years.
A bond is simply a loan, but in the form of a security, although terminology used is rather
different. The issuer is equivalent to the borrower, the bond holder to the lender, and the
coupon to the interest. Bonds enable the issuer to finance long-term investments with external
funds.
Note: The certificates of deposit (CDs) or commercial paper are considered to be money market
instruments and not bonds.
392
2007, POME, Gautam_Koppala, All Rights Reserved
In some nations, both terms bonds and notes are used irrespective of the maturity. Market
participants normally use the terms bonds for large issues offered to a wide public and notes for
smaller issues originally sold to a limited number of investors. There are no clear demarcations.
There are also "bills" which usually denote fixed income securities with terms of three years or
less, from the issue date, to maturity. Bonds have the highest risk, notes are the second highest
risk, and bills have the least risk. This is due to a statistical measure called duration, where
lower durations mean less risk and are associated with shorter term obligations.
Valuation of Securities
• Time Value of Money
• Valuation of Bonds – NCD, PCD & FCD
• Coupon Rate, Current Yield and YTM
• Computation of Current Yield & YTM
• Valuation of Shares
• Shares with constant Dividend
• Shares with constantly growing Dividend
• Fundamental Analysis & Technical Analysis
393
2007, POME, Gautam_Koppala, All Rights Reserved
Computation of Current Yield & YTM
Current Yield Annual Interest Income
p.a.
for a Bond = Current Market Price
Yield to Maturity for a Bond is that yield for which -
Market Price = Sum of the Present Values of all
Inflows from the Bond till its maturity
Annual Interest Redemption Value – Market Price
Income + Residual maturity in years
YTM (approx.) =
Market Price + Redemption Price
2
Investment Decisions
• Intrinsic Value & Market Price
• If Market Price > Intrinsic Value,
Security is overvalued, sell it
• If Market Price < Intrinsic Value,
Security is undervalued, buy it
Bonds and stocks are both securities, but the major difference between the two is that stock-
holders are the owners of the Macro Project (i.e., they have an equity stake), whereas bond-
holders are lenders to the issuing Large Project. Another difference is that bonds usually have a
defined term, or maturity, after which the bond is redeemed, whereas stocks may be
394
2007, POME, Gautam_Koppala, All Rights Reserved
outstanding indefinitely. An exception is a consol bond, which is perpetuity (i.e., bond with no
maturity).
Features of Bonds:
The most important features of a bond are:
• Nominal, principal or face amount—
The amount on which the issuer pays interest, and which has to be repaid at the end.
• Issue price—
The price at which investors buy the bonds when they are first issued, typically $1,000.00. The net
proceeds that the issuer receives are calculated as the issue price, less issuance fees, times the
nominal amount.
• Maturity date—
The date on which the issuer has to repay the nominal amount. As long as all payments have been
made, the issuer has no more obligations to the bond holders after the maturity date. The length of
time until the maturity date is often referred to as the term or tenor or maturity of a bond. The
maturity can be any length of time, although debt securities with a term of less than one year are
generally designated money market instruments rather than bonds. Most bonds have a term of up to
thirty years. Some bonds have been issued with maturities of up to one hundred years, and some even
do not mature at all. In early 2005, a market developed in euros for bonds with a maturity of fifty
years. In the market for U.S. Treasury securities, there are three groups of bond maturities:
o short term (bills): maturities up to one year;
o medium term (notes): maturities between one and ten years;
o long term (bonds): maturities greater than ten years.
• Coupon—
The interest rate that the issuer pays to the bond holders. Usually this rate is fixed throughout the life
of the bond. It can also vary with a money market index, such as LIBOR, or it can be even more
exotic. The name coupon originates from the fact that in the past, physical bonds were issued which
coupons had attached to them. On coupon dates the bond holder would give the coupon to a bank in
exchange for the interest payment.
• Coupon dates—
395
2007, POME, Gautam_Koppala, All Rights Reserved
The dates on which the issuer pays the coupon to the bond holders. In the U.S., most bonds are semi-
annual, which means that they pay a coupon every six months. In Europe, most bonds are annual and
pay only one coupon a year.
• Indenture or covenants—
A document specifying the rights of bond holders. commercial laws apply to the enforcement of those
documents, which are construed by courts as contracts. The terms may be changed only with great
difficulty while the bonds are outstanding, with amendments to the governing document generally
requiring approval by a majority (or super-majority) vote of the bond holders.
• Optionality:
A bond may contain an embedded option; that is, it grants option like features to the buyer or issuer:
o Callability—some bonds give the issuer the right to repay the bond before the maturity
date on the call dates.. These bonds are referred to as callable bonds. Most callable
bonds allow the issuer to repay the bond at par. With some bonds, the issuer has to pay
a premium, the so called call premium. This is mainly the case for high-yield bonds.
These have very strict covenants, restricting the issuer in its operations. To be free from
these covenants, the issuer can repay the bonds early, but only at a high cost.
o Puttability—some bonds give the bond holder the right to force the issuer to repay the
bond before the maturity date on the put dates; Also, known as put option.
Call dates and put dates—the dates on which callable and puttable bonds can
be redeemed early.
• sinking fund provision
Of the corporate bond indenture requires a certain portion of the issue to be retired periodically. The
entire bond issue can be liquidated by the maturity date. If that is not the case, then the remainder is
called balloon maturity. Issuers may either pay to trustees, which in turn call randomly selected bonds
in the issue, or, alternatively, purchase bonds in open market, then return them to trustees.
• Convertible bond
Lets a bondholder exchange a bond to a number of shares of the issuer's common stock.
• Exchangeable bond
Allows for exchange to shares of a corporation other than the issuer.
396
2007, POME, Gautam_Koppala, All Rights Reserved
Types Of Bonds:
Fixed rate bonds
Bonds have a coupon that remains constant throughout the life of the bond.
Floating rate notes (FRN's)
Bonds have a coupon that is linked to a money market index, such as LIBOR. for example three
months USD LIBOR + 0.20%. The coupon is then reset periodically, normally every three months.
High yield bonds
Bonds that are rated below investment grade by the credit rating agencies. As these bonds are
relatively risky, investors expect to earn a higher yield. These bonds are also called junk bonds.
Zero coupon bonds
Bonds do not pay any interest. They trade at a substantial discount from par value. The bond holder
receives the full principal amount as well as value that has accrued on the redemption date.
Inflation linked bonds,
Bonds, in which the principal amount is indexed to inflation. The interest rate is lower than for fixed
rate bonds with a comparable maturity. However, as the principal amount grows, the payments
increase with inflation.
indexed bonds,
Bonds, for example equity linked notes and bonds indexed on a Projects indicator (income, added
value) or on a country's GDP.
Asset-backed securities
They are bonds whose interest and principal payments are backed by underlying cash flows from other
assets. Examples of asset-backed securities are mortgage-backed securities (MBS's), collateralized
mortgage obligations (CMOs) and collateralized debt obligations (CDOs).
Subordinated bonds
They are those that have a lower priority than other bonds of the issuer in case of liquidation. In case
of bankruptcy, there is a hierarchy of creditors. First the liquidator is paid, then government taxes, etc.
The first bond holders in line to be paid are those holding what is called senior bonds. After they have
been paid, the subordinated bond holders are paid. As a result, the risk is higher. Therefore,
subordinated bonds usually have a lower credit rating than senior bonds. The main examples of
397
2007, POME, Gautam_Koppala, All Rights Reserved
subordinated bonds can be found in bonds issued by banks, and asset-backed securities. The latter are
often issued in tranches. The senior tranches get paid back first, the subordinated tranches later.
Perpetual bonds
They are also often called perpetuities. They have no maturity date. The most famous of these are the
UK Consols, which are also known as Treasury Annuities or Undated Treasuries. Some of these were
issued back in 1888 and still trade today. Some ultra long-term bonds (sometimes a bond can last
centuries: West Shore Railroad issued a bond which matures in 2361 (i.e. 24th century)) are
sometimes viewed as perpetuities from a financial point of view, with the current value of principal
near zero.
Bearer bond
It is an official certificate issued without a named holder. In other words, the person who has the
paper certificate can claim the value of the bond. Often they are registered by a number to prevent
counterfeiting, but may be traded like cash. Bearer bonds are very risky because they can be lost or
stolen. Especially after federal income tax began in the United States, bearer bonds were seen as an
opportunity to conceal income or assets.
Registered bond
It is a bond whose ownership (and any subsequent purchaser) is recorded by the issuer, or by a
transfer agent. It is the alternative to a Bearer bond. Interest payments, and the principal upon
maturity, are sent to the registered owner.
Municipal bond
It is a bond issued by a state, Country, local government, or their agencies. Interest income received
by holders of municipal bonds is often exempt from the federal income tax and from the income tax of
the state in which they are issued, although municipal bonds issued for certain purposes may not be
tax exempt.
Book-entry bond
It is a bond that does not have a paper certificate. As physically processing paper bonds and interest
coupons became more expensive, issuers (and banks that used to collect coupon interest for
depositors) have tried to discourage their use. Some book-entry bond issues do not offer the option of
a paper certificate, even to investors who prefer them.
Lottery bond
398
2007, POME, Gautam_Koppala, All Rights Reserved
It is a bond issued by a state. Interest is paid like a traditional fixed rate bond, but the issuer will
redeem randomly selected individual bonds within the issue according to a schedule. Some of these
redemptions will be for a higher value than the face value of the bond.
War bond
It is a bond issued by a country to fund a war.
Gilt-edged bonds:
Highly rated bonds, whose issuers have a long-standing reputation of paying interest on time.
Term bonds: Bullet bonds
Bonds, whose principal is payable at maturity.
Back bond: Virgin Bond
A Eurobond created by the exercise of a warrant.
Cushion bonds:
High-coupon bonds which sell at only a moderate Premium because they are callable at a price
below.
Junk bonds:
High-risk bonds issued by companies with credit ratings below investment grade (a ranking
given by the credit rating agencies). Such bonds are also called high-yield bonds as they offer
investors higher yields than bonds of financially sound companies. They are usually issued to
finance leverage buy-out operations.
Collateral bonds:
An American term, to indicate those bonds which are secured by collateral, such as the pledging
of mortgages (collateral mortgage bonds).
Eurobond:
A Bond issued by a company or a government in a market other than that of its currency of
denomination. Eurobonds are then sold internationally and not in just one domestic market (e.g.
a German corporation may issue euro-dollar bonds on the London capital market). The main
Eurobonds include the Eurodeutsche Mark bonds, Eurodollar bonds, Euro French Franc bonds,
Euro sterling bonds and Euro yen bonds, although the nationally denominated European
Eurobonds will be phased out within Europe.
Convertible bond; convertibles:
399
2007, POME, Gautam_Koppala, All Rights Reserved
Bonds issued by a corporation which may be converted into the corporation's Common
stock/Ordinary shares within a specified time period and at a specific price, at the option of the
holder.
Guaranteed bond:
A bond issue where a third party (e.g. parent company) guarantees the fulfillment of the terms
of the issue.
Clip and strip bonds:
These are bonds whose principal and coupon portions may be split and sold separately.
Debenture:
A term indicating a fixed-interest Bond secured against the issuing Project’s assets (these may
consist either of specific assets of the Project or of its assets in general). Debenture bonds are
distinct from ordinary bonds, the latter being unsecured. Debentures will be paid whether the
issuing Project makes a profit or not and, in case of Liquidation, debenture holders have priority
over ordinary bond holders on the Project's remaining assets. Debentures can be bought and
sold on a stock Exchange.
Preferred Stock
We continue our discussion of equity focusing on corporate form, so the discussion that follows looks
at owners’ equity specifically from a corporate perspective. In some Corporation Based Projects s, the
first line of the Equity section is Preferred Stock. Corporation Based Projects, whose management
wishes to distinguish owners from other investors who may not have an ownership role, issue
Preferred Stock.
Preferred Stock is so named because it has certain preferences under special circumstances. For
example, preferred stock does not generally have a vote on corporate matters or actions. However,
under certain circumstances, such as if the Projects has not paid any preferred stock dividends for a
specified number of periods, preferred stock owners may not only have votes, but may actually control
the voting process. This preference for ownership of the interests of the preferred stockholders gives
these investors some control over the management of their investment.
Other preferences include the right to receive cash dividends before any cash dividends may be paid to
common stockholders. If the preferred stock is “cumulative,” preferred shareholders have the right to
receive all back dividends that were not paid before any cash dividends may be paid to common
stockholders; and the right to receive repayment of invested amounts before any such redemption
400
2007, POME, Gautam_Koppala, All Rights Reserved
payments may be made to common stockholders if the management decides to liquidate the Projects.
Unlike common stock dividends, dividend amounts for preferred stock are generally specifically
defined, providing a clear value for each share. These preferences are really not very important,
except if there is some prospect of financial difficulties.
However, some investors are interested in specific and predictable cash flows, and the dividends for
preferred stock are generally higher than is interest on debt, because preferred stock, falling below
debt in the repayment hierarchy, is riskier than debt, even subordinated debt. Therefore, the
predictable dividends offered by companies through their preferred stock may be attractive to
investors. Another reason for investing in preferred stock is a tax preference offered to Corporation
Based Projects s that invest in the stock of other Corporation Based Projects s. The Internal Revenue
Code offers a “dividends received deduction” equal to 70 percent of the value of such a dividend to the
receiving Corporation Based Projects , increasing the after-tax value of such dividends. As a result,
Corporation Based Projects s with excess cash that they expect to be able to hold for at least 46 days,
to satisfy a qualification rule, may choose to invest in the preferred stock of other Corporation Based
Projects s, purchasing the preferred stock so as to qualify for the dividend, holding the stock for the
requisite time period, and selling the stock to reestablish the cash position in advance of its
requirement. Thus, we can see how the marketable securities investment practices of one type of
Projects relate to the capital funding needs of another.
Preferred stock has some hybrid characteristics that make issuing it interesting and complex. From a
lender’s perspective, preferred stock looks like equity: its return is paid out of after-tax income and is
paid after interest is paid on debt, its claim on assets is subordinate to that of the lender, and it
provides capital to the Projects that serves as security for the loans. However, to the common stock
holder preferred stock looks much like debt: it receives its payment before any payment to the
shareholders, it has a higher priority claim on assets in the event of financial distress, and under
normal circumstances its owners have no say in corporate decisions.
Some preferred stock issues offer another type of opportunity for investors. Convertible preferred
stock, in addition to the preferences identified above, may also offer the shareholder the opportunity,
if desired, to convert the preferred stock into common stock at a defined rate. Often, this conversion
privilege is offered when the stock price is low but expected to increase. The shareholder has the
option to convert or not as he or she chooses, but receives the higher dividends as long as the
investment is held in preferred stock form. Therefore, if the common stock price is well below the
conversion price, preferred stock will be held. If the common stock price rises, the shareholder has the
choice, but can continue to hold the preferred stock and receive the dividends. If, at some point, the
common stock price rises enough, the shareholder may opt to convert the preferred stock into
401
2007, POME, Gautam_Koppala, All Rights Reserved
common stock and then may choose to sell all of the common stock for cash that will be significantly
higher than the original investment, or sell some of the common stock in order to recover the
investment while continuing to hold some of the common stock in order to continue to benefit from the
rising market price.
As you can see, understanding how finance works contributes to the shareholder’s ability to judge
investment alternatives. Obviously, the investor’s ability to anticipate what will happen to the Projects
and to its stock also helps. This ability comes from understanding financial management and financial
reporting and being able to interpret the information contained in the financial statements and
explanatory information provided by the Projects.
Common Stock
Common stock represents the actual ownership of the Projects. The shares of common stock, if there
is only one class, each signify an equal portion of the Projects. There may be a few shares, each with a
relatively large portion or millions or billions of shares outstanding, each of which owns an infinitesimal
part of the ownership. However, in widely held companies a relatively small percentage may represent
a substantial and influential position.
Common stock may be issued for cash investment or as a reward for effort on behalf of the Projects.
In the stock market of 1999, for example, there were numerous examples of companies entering the
public market through an Initial Public Offering (IPO) and instantly making employees of the Projects,
who received part of their early pay in stock, extremely wealthy. These employees, who may own a
very small percentage of the Projects, benefit from the sale to the public of a large number of shares,
resulting in a significant dilution of their ownership position, but also translating into very substantial
increases in their wealth in terms of the market price of the shares after offering multiplied by the
number of shares they hold.
Common stock ownership conveys certain rights to the owner, including the right to vote on certain
corporate matters including the membership of the Board of Directors, the right to vote on the number
of shares to be issued, the right to vote on matters that guide management, and sometimes the right
to preserve their ownership position in the event the Projects issues additional stock. This last right,
included in the by-laws of some Corporation Based Projects s and mandated by law in some states, is
called a preemptive right, and assures that a shareholder cannot be diluted from a position of
influence to one without influence without his or her consent. Perhaps the most important ownership
right is to vote for the Board of Directors and through that vote to influence the direction of the
Projects.
402
2007, POME, Gautam_Koppala, All Rights Reserved
The value of the common stock shown on the Balance Sheet reflects only the par value of a share of
common stock multiplied by the number of shares outstanding. It does not represent the amount paid
for the common stock unless either the par value and the amount paid per share are the same or there
is no par value for a share. The par value represents the minimum per share value that a share owner
would be responsible for if the Projects fails. If the shareholder has already paid that amount, then the
entire amount that he or she could lose is the amount already invested. This differs from the exposure
to risk of proprietors or general partners in the other principal forms of Projects organization structure.
Additional Paid-In Capital
The difference between the par value and the issue price of a share goes into the line identified as
“Additional Paid-in Capital.” On some balance sheets Additional Paid-In Capital is identified as “Paid In
Surplus” or “Capital in Excess of Par.” Regardless of its identification, Additional Paid-In Capital is
positioned on the balance sheet immediately below Common Stock and represents the rest of the
capital invested by the shareholders that was received by the Projects. It has nothing to do with the
price of a share paid on any stock exchange, over the counter, or between shareholders. For example,
if a Projects issues shares having a par value of $1.00 for $25.00 each, the $24.00 difference between
issue price and par value would be Additional Paid-in Capital. For shares issued in a public stock
offering, after the initial sale, when a second investor purchases the shares from the first shareholder
(through a broker) for $40.00 per share, the shareholder receives the whole $40.00 and recognizes a
capital gain of $15.00 (net of commissions and fees), reflecting the difference between the issue price,
$25.00, and the purchase price, $40.00, and no additional money goes to the Projects.
Retained Earnings
The amount of profit that the Projects earns and retains in the business, that is, does not pay out in
dividends, is recorded as Retained Earnings. These amounts, adjusted each period for the profits after
taxes and dividends, reflect the perceived success of the Projects and enhance the “shareholders’
wealth.”
The section of the Balance Sheet made up of Common Stock, Additional Paid-in Capital, and Retained
Earnings represents the book value of the shareholders’ ownership. The relationship of the book value
to the market value is determined by the price-earnings ratio. Although it has less to do with the book
value of the shares than the current market atmosphere, it is generally felt that those Corporation
Based Projects s that are performing well and increasing the book value of the shares are also going to
perform well in the market. Therefore, the measures of performance and financial success generally
focus on Balance Sheet and Income Statement performance measures.
Stock Repurchase Plans
403
2007, POME, Gautam_Koppala, All Rights Reserved
More and more frequently companies are establishing stock repurchase programs, arranging to buy
back common stock from shareholders, generally at prices higher than the current market prices.
These programs enable the companies to transfer cash and value to only those shareholders who want
it, whereas a dividend would be distributed to all shareholders, possibly costing the Projects more and
requiring the shareholders to deal with tax and investment issues on their own. If a stock repurchase
takes place at a price higher than the shareholder paid, it results in capital gains, and may offer a tax
benefit (although as a result of the tax changes in 2003, taxes on dividends and on capital gains are
approximately the same). Other consequences of stock repurchase programs include concentrating
ownership in management and shareholders who support management, raising earnings per share and
therefore possibly raising the stock price in the market, and utilizing excess cash for a purpose that
enhances the return on equity.
The Investment Marketplace
Companies that are looking for equity, whether for the first time or the umpteenth time, often look to
the public for funding. The sale of common stock is the most frequent method of raising substantial
capital. The first time stock of a particular Projects is sold to the public is called the Initial Public
Offering (IPO) and it often occurs with substantial publicity. Because these companies are often
unknown to the investing public, a complex series of meetings and presentations are arranged to bring
the Projects to visibility in the investment community. The IPO process is a very exciting and
challenging time for the Projects, and provides a unique opportunity for the management to tell its
story to the investment press and the investment bankers and brokers who will help make the offering
successful. There is a lot written about the IPO process, a very specialized marketing effort.
Subsequent offerings, to add more equity and provide funding for expansion or acquisitions, generate
less publicity and are managed carefully to provide capital and not disrupt the orderly market for the
stock. In some cases the additional equity is marketed to one or a limited number of institutional
investors in a private placement that effectively brings substantial capital into the Projects and limits
the disruption to management inside or the existing market outside.
When companies go public, that is, issue stock in a public offering, they often seek to be listed in a
stock market that provides a place or a system for the orderly purchase and sale of the Projects’s
stock from shareholder to shareholder. These markets do not directly involve the Projects at all,
although the management is very aware of the value placed on the shares in the market. There are a
number of organized exchanges where Projects shares are traded. The largest and most well known of
these is the New York Stock Exchange (NYSE). The NASDAQ (National Association of Securities Dealers
Automated Quotation) market has become the center for much stock market activity. Daily trading
404
2007, POME, Gautam_Koppala, All Rights Reserved
volume on NASDAQ is comparable to that on the NYSE and is increasing. More recently, an alternative
marketplace has arisen through the Internet and it is likely that electronic stock trading will become
the predominant means of exchanging shares in the years to come. In fact, a number of smaller
companies have issued their shares to the public over the Internet, bypassing the traditional markets
entirely.
Accounting For Equity
One of the ways to consider the accounting effect of different transactions is to consider what will
happen to equity as a result. For example, if a Projects incurs a loss, the ultimate effect, through the
closing of the Income Statement into retained earnings is a reduction in shareholders’ equity.
Similarly, if a Projects increases its sales and profits, the ultimate effect will flow through the Income
Statement to affect the owners’ wealth. Though many analysts focus on the effect on cash of different
actions, the real concern should be directed toward the net worth of the Projects
Consider this flo Assume that the sales department wants the Projects to carry more inventory in order
to satisfy customers’ desires for faster delivery. To purchase more inventory, the Projects will have to
either use its cash or borrow funds from a bank. If it uses the cash, the Projects reduces its ability to
invest the cash and increase its income. If the Projects borrows money, it incurs interest expense,
lowering both profits and retained earnings. The cost of carrying the inventory, as we saw, results in
higher expenses and therefore has a depressing effect on profits until it is sold. The test of the
suggestion, therefore, must be to assess whether the higher investment in inventory will add to or
detract from the profits of the Projects, ultimately affecting the equity on the Balance Sheet.
To complicate this analysis a bit, consider whether the impact will be to lower profits this year, but
increase them in future years. Now we must add time value of money considerations as well as
assessment of the likelihood of the forecast to the assessment. These kinds of considerations are a
significant part of the financial management of a business and require that the Project Managers
understand the financial implications of such decision making.
The equity on the Balance Sheet reflects the ownership of the Projects. Whether the Projects is a
proprietorship, Partnership Based Projects , or Corporation Based Projects , or some variation on one
of these, the equity remains the reflection of the ownership values.
The principal forms of business structure are:
1. Proprietorship
single owner
405
2007, POME, Gautam_Koppala, All Rights Reserved
general liability
limited access to capital
ease of establishment and dissolution
single level of taxation
2. Partnership Based Projects
multiple owners
general liability
somewhat limited access to capital
Partnership Based Projects agreement usually required
automatic dissolution when partner leaves
single level of taxation
Corporation Based Projects
one or more owners
limited liability
required legal documentation for establishment
easier access to capital
unlimited life
double taxation of earnings on distribution
Common Stock represents ownership and has certain rights, such as voting for directors and on major
corporate actions.
Preferred stock is investment that may include an ownership interest under certain circumstances and
provides certain preferences, predominantly related to the distribution of corporate assets.
Most accounting transactions eventually have an impact on equity, generally through the Income
Statement, where the net income after taxes and dividends becomes the change in retained earnings.
POME Prescribe:
About Planning
Plan ahead: Before you plunge headlong into work, spend some time planning your project.
Break down work into tasks(WBS): Breaking down the project into smaller tasks (and mini-tasks if required)
ensures that you have a systematic approach.
Keep it visible and visual: Plotting a chart or graph about work progress and tacking it in a prominent place on
your soft board (or keeping the softcopy on your desktop) ensures that your progress is visible to you.
406
2007, POME, Gautam_Koppala, All Rights Reserved
Infrastructure: A reliable server lays the foundation for efficient work. Good infrastructure and equipment
translate to smooth functioning for any task.
A step-by-step plan is the best way to ensure you know where you are going.
In project management, the bulk of the work happens after the planning phase. How well this implementation
of the plan happens depends on how thorough and specific the planning and documentation was. Bad
planning translates to bad implementation.
Good planning alone does not ensure good implementation. Follow-through becomes vital here. As the
leader, the project manager ensures that the team sticks to the plan.
As a project manager, you need to check that everyone is following the functional spec and style guide, that
they are using the proper naming conventions and version controls, and that backup files are being saved on
the server. Rules are useful only insofar as they are implemented and followed.
Be prepared: Know your stuff front-wards, back-wards, and every way in between. This does not mean that
you need to say everything you know. Being prepared helps you to quickly answer questions and convey that
you know what you are talking about.
Understanding the goals: A project is truly successful only when you are meeting the need for which it was
created. Identifying the scope and requirements at the outset and also acknowledging that in the real world,
these can change is a good starting point.
Getting it right from the outset: The most important part of a project’s life cycle is the identification of its
requirements.
407
2007, POME, Gautam_Koppala, All Rights Reserved
F
Family and friends are
hidden treasures, seek
them and
enjoy their riches. POME Prescribe
POME LIGHTER VEI&:
Too many Meetings:
Finally! Meetings get a purpose (other than boredom).
408
2007, POME, Gautam_Koppala, All Rights Reserved
409
2007, POME, Gautam_Koppala, All Rights Reserved
ACCOUNTING
SCHEDULE’S
410
2007, POME, Gautam_Koppala, All Rights Reserved
Accounting Schedules:
What is accounting management?
Normally the small and medium Project managers wont be involving in the Accounting
schedules of their respective Organizations, but for a macro Projects of a company, do decide
the fate of the company, and hence Project Managers involve in the accounting schedules,
especially a Projects like International AirPort, large refineries and space programmes.
It also involves the Project Managers of the Business Implementation Projects, which starts with an
opportunity, with a business concept. And concludes When the process is operational, When the
process has been running smoothly for a defined period, When the business benefits are starting to
become visible( assessed through accounting) Which evaluates When the process has been running
smoothly( sustained accounting figures) for a defined period and When the business benefits are
starting to become visible. Over the lifetime of the process. The project produces an operationally
effective process, through the figures of accounting.
Though the small time managers does not involve in accounting schedule, but recommended
to study the accounting schedule in this POME Chapter in order to know hoe we are directly or
indirectly responsible to stake holders, how the Property of our organization is asses, how the
financial statements denote, where the future of the organization to be.
Accounting information is generally used for three distinct purposes:
411
2007, POME, Gautam_Koppala, All Rights Reserved
• Internal reporting to project managers for day-to-day planning, monitoring and control.
• Internal reporting to managers for aiding strategic planning.
• External reporting to End Users, government, regulators and other outside parties.
To complete this introduction to accounting, some additional terms and concepts need explanation.
The first of these is GAAP, generally accepted accounting principles.
From time to time you will hear people talk about GAAP (pronounced “gap”), perhaps asking if such
and such has been handled according to GAAP. GAAP has been defined by the Accounting Principles
Board as follows: “Generally accepted accounting principles encompass the conventions, rules, and
procedures necessary to define accepted accounting practice at a particular time.”
This definition is not particularly helpful, especially to the nonaccountant. However, because all public
companies and most others prepare their financial statements and accounting information according to
GAAP, what it means, and what GAAP really does, is assure that financial information is prepared
consistently and may be understood in the same way as other financial information similarly prepared.
Therefore, GAAP assures that analysts and other readers of financial statements should understand the
same structures and descriptions the same way and can compare financial statements and arrive at
reasonable and supportable conclusions.
Other accounting terms such as accrual accounting, materiality, and auditor’s opinion also create
confusion. This is an appropriate place to define some of these terms as well.
Accruals and accrual accounting recognize that it is important to match revenues and expenses in
the same time period. They also acknowledge that the recording of accounting transactions cannot
always be completed quickly enough to produce timely, usable financial statements. Accruals,
therefore, are accounting transactions that estimate revenues, or more probably, expenses so that the
period’s financial reports will reflect that period’s results appropriately. Accruals also reflect
transactions that were not really complete at the end of the accounting period but that should be
reported. An example of such is Accrued Wages, wages earned during the period, but not due or
payable at the end of that period. For example, assume that December 31 falls on a Wednesday and
that payday is Friday. The wages earned in December should be reported as December transactions,
but the amount so earned is not due or payable on December 31, the end of the accounting period.
The wages earned through December 31 will, therefore, be accrued, charged into the December
accounting period.
Materiality is another attempt to make the accounting process reasonable. Some transactions are
really very small relative to the operations of the entire business, but to be perfectly accurate, need to
412
2007, POME, Gautam_Koppala, All Rights Reserved
be recognized. The concept of materiality acknowledges that if we try to account for all the
transactions at the end of a period, we may spend far more time or energy than will be worthwhile
when compared to the value of the transactions involved. Therefore, GAAP recognizes that if not
accounting for such a transaction properly will not change the quality or usefulness of the overall
financial information, the transaction may be deemed “not material.” Accountants have agreed that if a
transaction is not material, it does not have to be completed or reported if such reporting will delay the
completion of the reporting. Therefore, you may hear people talk about some information as not being
material.
The auditor’s opinion is one place where GAAP and materiality come together. All public companies and
many other companies employ outside auditors to review the accounting information to assess their
accuracy and completeness. The auditor reviews the records and transactions of the company and
provides an opinion as to whether or not they “present fairly, in all material respects, the financial
position of the company as of December 31, XXXX.” Analysts, investors, management, and others use
this opinion as an assurance that a competent outsider has reviewed the accounting information and
found it sound. These people then feel they can rely on the information to make Project Managerial or
investment decisions.
Sometimes, the auditors believe that there is a problem with the company or its records. They will,
under those circumstances, issue a “qualified” opinion and explain the qualification they have
identified. The users of the financial statements, thus informed, can make appropriate decisions. The
management, after receiving a qualified opinion, will be under great pressure to correct whatever
deficiency has been identified.
Similarly, auditors may decline to express an opinion, known as a “Disclaimer,” if they do not feel
there is sufficient assurance of accuracy and completeness in the financial information provided by the
company. In the most negative circumstances, the auditor may issue an “Adverse Opinion,” stating
that in their opinion the financial statements presented by the company do not “present fairly” the
financial condition as at the identified dates. Adverse opinions have all kinds of negative consequences
and companies try to avoid them if at all possible.
External reports are constrained to particular forms and procedures by contractual reporting
requirements or by generally accepted accounting practices. Preparation of such external reports is
referred to as financial accounting. In contrast, cost or managerial accounting is intended to aid
internal managers in their responsibilities of planning, monitoring and control.
413
2007, POME, Gautam_Koppala, All Rights Reserved
Project costs are always included in the system of financial accounts associated with an organization.
At the heart of this system, all expense transactions are recorded in a general ledger. The general
ledger of accounts forms the basis for management reports on particular projects as well as the
financial accounts for an entire organization. Other components of a financial accounting system
include:
• The accounts payable journal is intended to provide records of bills received from vendors,
material suppliers, subcontractors and other outside parties. Invoices of charges are recorded in
this system as are checks issued in payment. Charges to individual cost accounts are relayed or
posted to the General Ledger.
• Accounts receivable journals provide the opposite function to that of accounts payable. In
this journal, billings to clients are recorded as well as receipts. Revenues received are relayed
to the general ledger.
• Job cost ledgers summarize the charges associated with particular projects, arranged in the
various cost accounts used for the project budget.
• Inventory records are maintained to identify the amount of materials available at any time.
We use some consistent and easily applied tools to provide a context and a framework for conducting
the analysis. Keep these questions in mind throughout this POME Chapter and whenever you are
looking at financial information.
Comparative Analysis
Financial analysis is generally cast as a comparative analysis, in a comparative analytical structure.
The comparisons are based on the current company information and either industry or competitive
information or historic company information. When the comparison is to other companies in the
industry, whether identified as direct and specific competitors or as averages drawn from industry
summaries, the analysis is described as cross-sectional or competitive analysis. It serves to
benchmark a company against other members of its industry and gives management an idea of the
company’s relative performance.
This kind of analysis, however, is often of limited Project Managerial use because the companies in an
industry are frequently not comparable, particularly if the company is relatively small. In addition,
companies often define their data differently, making comparisons difficult. Also, management
philosophies differ, resulting in different practices and choices of financing and operations, again
making comparisons difficult.
414
2007, POME, Gautam_Koppala, All Rights Reserved
If you choose to undertake an industry or competitive analysis, it is important to have reliable source
data and to understand their limitations. There are a number of published sources for industry data
and they are presented in a number of ways. Here are a few industry data sources:
Dun & Bradstreet (D&B)
Drawn from corporate filings and company-provided information, D&B statistics provide information by
North American Industry Classification System (NAICS) code, which in 2002 officially replaced the
Standard Industrial Classification (SIC) code system, which had been in place for many years as a
classification system used by the United States Census Bureau to categorize companies by the type of
business they do. NAICS, first adopted in 1997, was updated in 2002 and will be updated again in
2007. It was developed to “provide new comparability in statistics about business activity across North
America,” according to the U.S. Census Bureau’s web-site. However, whereas company-provided data
are summarized and presented by D&B, they are not independently validated or confirmed.
Risk Management Association (RMA), formerly Robert Morris Associates (RMA)
Drawn from information provided by the bank members of RMA, industry data are presented in
quartile form. (Exhibit below illustrates a quartile presentation.) There is some belief that, because
they come from filings made with their banks, the company-provided data may be more reliable than
data from some other sources. RMA also segregates its quartile data into company-size quartiles as
well.
Exhibit: Financial Ratios as Quartile Data
Trade Associations
Trade association data may be more specific than D&B or RMA data by general NAICS code, but it may
be of limited value because of reporting rules. For example, the trade association, mindful of the
confidential nature of proprietary information, may restrict data that would identify a specific company.
This renders the comparisons of limited value.
415
2007, POME, Gautam_Koppala, All Rights Reserved
Investment Analysts
Investment analysts publish industry data as part of the investment research function. Here, too, the
particular opinions and biases of the analysts may influence the presentation of data. Investment
analysts are frequently employed by investment advisory firms and their use of ratios and other
performance data may be chosen to bolster their analysis and the opinions they are expressing.
Financial ratios are frequently presented as quartile data. The quartiles represent the average ratios for companies
falling at the respective quartiles, in terms of annual sales volume, within their industry, usually determined by NAICS.
Trend Analysis
By contrast to industry comparison, comparing a company to itself over time, called historic or trend
analysis, permits the analyst to track progress. In most cases, whether financial or not, an analyst
looking at historic analysis knows whether the company is improving. If a company is improving year
after year, that is good. Even if it trails the industry averages, continuous improvement is a predictor
that it won’t be behind for long.
The chart in Exhibit below highlights the limitations of an industry comparison and the clarity of
historic analysis at the same time. For this reason, many analysts try to incorporate elements of both
types of analysis into their assessment.
Exhibit: Comparative Performance
Assumptions in the below Accounting Schedules for better understanding:
1. GG ORG(“the POME assumed Company”) financial statements, assumed the year ended
31 March 2006, taken to illustrate the methodology in normal Operations in big
corporates.
416
2007, POME, Gautam_Koppala, All Rights Reserved
2. ‘Accounting Standards’ issued by the Institute of Chartered Accountants of India have
been implemented in the presentation of these financial statements.
3. Work in progress (WIP) to be valued at material cost.
4. Finished goods are always to be valued at the lower of cost or net realisable value.
Cost is determined on the basis of first in first out method and includes labour cost
absorbed on a pre-determined basis.
5. Traded goods are to be valued at lower of cost and net realisable value. Cost is
determined on the basis of first in first out method and includes expenses incurred in
bringing the same to its current location.
6. Raw Materials and components are to be valued at the lower of cost and net realisable
value. Cost is determined on the basis first in first out method and includes all costs in
bringing the inventories up to its present location and condition.
7. ‘Cost’ is defined as being all expenditure which has been incurred in bringing the
product or service to its present location and condition
8. Consumables and stores as and when purchased are expensed as consumption. The
value of such items at the period end is not significant.
9. The manufacturing overheads are not absorbed for the purpose of inventory valuation
as the same is not material.
10. Stocks do not include:
a. goods purchased for which liabilities have not been provided; and
b. Goods returned by customers without credit to their accounts.
11. Provision, when material, has been made for :
a. loss to be sustained in the fulfilment of, or inability to fulfil, any sales
commitments.
b. loss to be sustained as a result of purchase commitments for inventory or other
assets at quantities in excess of normal requirements or at prices in excess of
prevailing market prices.
c. loss resulting from defaults in principal, interest, sinking fund or redemption
provisions with respect to any issue of share or loan capital or credit
arrangement, or any breach of covenant of an agreement.
417
2007, POME, Gautam_Koppala, All Rights Reserved
1. Significant accounting Schedule policies
Basis of preparation of financial statements
The financial statements must have been prepared and presented under the historical cost convention
on the accrual basis of accounting and comply with the Accounting Standards issued by the Chartered
Accountants of respective regions and the relevant provisions of the respective regions Companies
Acts and norms, to the extent applicable.
Assumptions:
The preparation of financial statements in conformity with generally accepted accounting principles
(GAAP) requires management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and the disclosure of contingent liabilities on the date of the financial statements.
Actual results could differ from those estimates. Any revision to accounting estimates is recognised
prospectively in current and future periods.
418
2007, POME, Gautam_Koppala, All Rights Reserved
The financial statements in this POME Chapter are presented in thousands of Indian rupees.
Fixed assets and depreciation
Fixed assets are to be carried at cost of acquisition or construction less accumulated depreciation. The
cost of fixed assets also includes the exchange differences (favorable as well as unfavorable) arising in
respect of foreign currency liabilities incurred for the purpose of their acquisition or construction from a
country.
Borrowing costs related to the acquisition or construction of the qualifying fixed assets for the period
up to the completion of their acquisition or construction are capitalized. Acquired intangible assets are
recorded at the consideration paid for acquisition.
Leases under which the Company assumes substantially all the risks and rewards of ownership are
classified as finance leases.
Depreciation is provided on the straight-line method from the beginning of the month in which the
asset is ready for use. If the management’s estimate of the useful life of a fixed asset at the time of
acquisition of the asset or of the remaining useful life on a subsequent review is shorter than that
envisaged in the aforesaid schedule, depreciation is provided at a higher rate based on the
management’s estimate of the useful life/remaining useful life. Pursuant to this policy, depreciation on
assets has been provided at the rates based on the following POME estimated useful lives of fixed
assets:
Asset Category Useful life
(Years)
Buildings 30
Plant and machinery 12
Office equipment 16
Air conditioner 8
Data processing equipment 5
Computer software 3
Furniture and fixtures 10
419
2007, POME, Gautam_Koppala, All Rights Reserved
Vehicles 5
Licenses and technical knowhow 5 to 6
Equipment leased to others 12
Freehold land is not depreciated. Assets individually costing certain specified amount, are depreciated
fully in the year of purchase. Depreciation is charged on a proportionate basis for all assets purchased
and sold during the year.
Leased assets to be depreciated over the lease term or the useful life, whichever is shorter.
Advances paid towards acquisition of fixed assets and the cost of assets acquired but not ready for
use as at the balance sheet date are disclosed under capital work-in-progress.
Investments
Long-term investments to be carried at cost less any other-than-temporary diminution in value,
determined separately for each individual investment.
Inventories
(i) Inventories to be carried at the lower of cost and net realizable value.
(ii) Cost comprising purchase price and all incidental expenses incurred in bringing
the inventory to its present location and condition. The method of determination
of cost is as follows:
Raw materials and components - on a first in first out method.
Work-in-progress – includes cost of conversion.
Stores and spares - on a first in first out method.
Manufactured finished goods - includes costs of conversion.
Traded finished goods - at landed cost on a first in first out method.
420
2007, POME, Gautam_Koppala, All Rights Reserved
(iii) The comparison of cost and net realizable value is made on an item-by-item
basis.
(iv) The net realizable value of work-in-progress is determined with reference to the
net realizable value of related finished goods. Raw materials and other supplies
held for use in production of inventories are not written down below cost except
in cases where material prices have declined, and it is estimated that the cost of
the finished products will exceed their net realizable value.
(v) The provision for inventory obsolescence is assessed on a quarterly basis and is
provided as considered necessary.
Retirement benefits
Contributions to superannuation fund, which is a defined contribution scheme, are to be made at
pre-determined rates to the Life Insurance Corporations of the respective regions, on a monthly basis.
Gratuity and leave encashment costs, which are defined benefit schemes, are accrued based on
actuarial valuation at the balance sheet date, carried out by an independent actuary.
Contributions payable to the recognized provident fund, which is a defined contribution scheme, are
charged to the profit and loss account.
Revenue recognition
Revenue from sale of both manufactured and traded goods, including scrap, is to be recognized on
transfer of all significant risks and rewards of ownership to the buyer. The amount recognized as sale
is exclusive of sales tax and trade and quantity discounts. The Company must provide for probable
sales returns on an estimated basis based on past trends as a reduction from revenue. Revenue from
sale of goods has been presented both gross and net of excise duty, if applicable.
421
2007, POME, Gautam_Koppala, All Rights Reserved
The Balance-Sheet Model of the
Project
The Capital Budgeting Decision
(Investment Decision)
Current
Current Liabilities
Assets Long-Term
Debt
Fixed What
Assets long-term Shareholder
1 Tangible investmen s’ Equity
2 Intangible ts should
the firm
engage
in?
Software services comprise income from time and material contracts. Revenue from time and material
contracts is recognized on the basis of software developed and billable in accordance with the terms of
the contract with the clients.
Income from annual maintenance contracts is recognized on a pro-rata basis over the period of
the contract, over which the service is delivered.
Commission on sales comprises income earned on sales orders procured on behalf of its group
companies and is recognized on shipment of goods by such group company.
Lease rental income is recognized when billable in accordance with the terms of the contract with
the clients.
Interest on deployment of surplus funds is recognised using the time proportionate method based
on underlying interest rates.
422
2007, POME, Gautam_Koppala, All Rights Reserved
Foreign exchange transactions
Foreign currency transactions are recorded at the rates of exchange prevailing on the dates of the
respective transaction. Exchange differences arising on foreign exchange transactions settled during
the year are recognized in the profit and loss account of the year, except that exchange differences
related to acquisition of fixed assets from a country outside India are adjusted in the carrying amount
of the related fixed assets.
Monetary assets and liabilities denominated in foreign currencies as at the balance sheet date are
translated at the closing exchange rates on that date; the resultant exchange differences are
recognized in the profit and loss account except those related to acquisition of fixed assets from a
country outside India which are adjusted in the carrying amount of the related fixed assets.
Warranties
Warranty costs are estimated by the management on the basis of a technical evaluation and past
experience. Provision is made for estimated liability in respect of warranty costs in the year of sale of
goods.
Provisions and contingent liabilities
The Company must recognize, a provision when there is a present obligation as a result of a past
event that probably requires an outflow of resources and a reliable estimate can be made of the
amount of the obligation. A disclosure for a contingent liability is made when there is a possible
obligation or a present obligation that may, but probably will not, require an outflow of resources.
Where there is a possible obligation or a present obligation that the likelihood of outflow of resources is
remote, no provision or disclosure is made.
Income taxes
Income-tax expense comprises current tax (i.e. amount of tax for the period determined in accordance
with the income-tax law) and deferred tax charge or credit (reflecting the tax effects of timing
differences between accounting income and taxable income for the year). The deferred tax charge or
credit and the corresponding deferred tax liabilities or assets are recognized using the tax rates that
have been enacted or substantively enacted by the balance sheet date.
423
2007, POME, Gautam_Koppala, All Rights Reserved
Deferred tax assets are recognised only to the extent there is reasonable certainty that the assets can
be realized in future; however, where there is unabsorbed depreciation or carried forward loss under
taxation laws, deferred tax assets are recognised only if there is a virtual certainty of realization of
such assets.
Deferred tax assets are reviewed as at each balance sheet date and written down or written-up to
reflect the amount that is reasonably/virtually certain (as the case may be) to be realized. The
Company offsets, on a year on year basis, the current tax assets and liabilities, where it has a legally
enforceable right and where it intends to settle such assets and liabilities on a net basis.
Impairment of assets
The Company must assess at each balance sheet date whether there is any indication that an asset
including goodwill may be impaired. If any such indication exists, the Company estimates the
recoverable amount of the asset. If such recoverable amount of the asset or the recoverable amount
of the cash generating unit to which the asset belongs is less than its carrying amount, the carrying
amount is reduced to its recoverable amount. The reduction is treated as an impairment loss and is
recognised in the profit and loss account. If at the balance sheet date there is an indication that if a
previously assessed impairment loss no longer exists, the recoverable amount is reassessed and the
asset is reflected at the recoverable amount. In respect of goodwill the impairment loss will be
reversed only when it was caused by specific external events and its effect has been reversed by
subsequent external events.
424
2007, POME, Gautam_Koppala, All Rights Reserved
The Balance-Sheet Model of the Project
The Capital Structure Decision
(Financing Decision)
Current
Current Liabilities
Assets
Long-Term
Debt
How can the
firm raise the
money for the
Fixed Assets
required
1 Tangible Shareholders’
investments?
2 Intangible Equity
Earnings/loss per share
The basic and diluted earnings/(loss) per share are computed by dividing the net profit/(loss)
attributable to equity shareholders for the year by the weighted average number of equity shares
outstanding during the year. The Company did not have any potentially dilutive equity shares
outstanding during the year.
In traditional bookkeeping systems or PMIS, day to day transactions are first recorded in journals.
With double-entry bookkeeping, each transaction is recorded as both a debit and a credit to particular
accounts in the ledger. For example, payment of a supplier's bill represents a debit or increase to a
project cost account and a credit or reduction to the company's cash account. Periodically, the
425
2007, POME, Gautam_Koppala, All Rights Reserved
transaction information is summarized and transferred to ledger accounts. This process is called
posting, and may be done instantaneously or daily in computerized systems.
In reviewing accounting information, the concepts of flows and stocks should be kept in mind. Daily
transactions typically reflect flows of dollar amounts entering or leaving the organization. Similarly, use
or receipt of particular materials represents flows from or to inventory. An account balance represents
the stock or cumulative amount of funds resulting from these daily flows. Information on both flows
and stocks are needed to give an accurate view of an organization's state. In addition, forecasts of
future changes are needed for effective management.
Information from the general ledger is assembled for the organization's financial reports, including
balance sheets and income statements for each period. These reports are the basic products of the
financial accounting process and are often used to assess the performance of an organization. Table
below shows a typical income statement for a small construction firm, indicating a net profit of $
330,000 after taxes. This statement summarizes the flows of transactions within a year.
TABLE Illustration of an Accounting Statement of Income
Income Statement
for the year ended December 31, 20xx
Gross project revenues $7,200,000
Direct project costs on contracts 5,500,000
Depreciation of equipment 200,000
Estimating 150,000
Administrative and other expenses 650,000
Subtotal of cost and expenses 6,500,000
Operating Income 700,000
Interest Expense, net 150,000
Income before taxes 550,000
Income tax 220,000
Net income after tax 330,000
Cash dividends 100,000
Retained earnings, current year 230,000
Retention at beginning of year 650,000
Retained earnings at end of year $880,000.</< td>
426
2007, POME, Gautam_Koppala, All Rights Reserved
Table below shows the comparable balance sheet, indicated a net increase in retained earnings equal
to the net profit. The balance sheet reflects the effects of income flows during the year on the overall
worth of the organization.
TABLE Illustration of an Accounting Balance Sheet
Balance Sheet
December 31, 20xx
Assets Amount
Cash $150,000
Payments Receivable 750,000
Work in progress, not claimed 700,000
Work in progress, retention 200,000
Equipment at cost less accumulated depreciation 1,400,000
Total assets $3,200,000
Liabilities and Equity
Liabilities
Accounts payable $950,000
Other items payable (taxes, wages, etc.) 50,000
Long term debts 500,000
Subtotal 1,500,000
Shareholders' funds
40,000 shares of common stock
(Including paid-in capital) 820,000
Retained Earnings 880,000
Subtotal 1,700,000
Total Liabilities and Equity $3,200,000
Notes to the accounts
As a result, complementary procedures to those used in traditional financial accounting are required to
accomplish effective project control, as described in the preceding and following sections. While
financial statements provide consistent and essential information on the condition of an entire
organization, they need considerable interpretation and supplementation to be useful for project
427
2007, POME, Gautam_Koppala, All Rights Reserved
management. This POME Chapter is designed to identify and define the key standard Financial Reports
and Metrics required by Company Corporate Leadership to consistently and systematically measure
financial results and key performance indicators across all the Strategic Business Groups (SBGs),
where an SBG is defined as an operating business unit
The first main section of this POME Chapter, General Guidelines and Definitions, is intended to address
the overarching concepts found throughout this POME Chapter. The second section, Financial Reports
and Metrics, addresses the standard reports required by Corporate including account names and metric
calculation detail. The Key Concepts section provides links to term definitions used throughout the
POME Chapter.
The Corporate Business Analysis and Planning organization owns the content of this POME Chapter.
Any questions or suggestions should be directed through the SBG Controller/FP&A Leader.
Company has an existing Corporate Controllers’ Policy that may help clarify some of the points made
within this document.
Any exceptions or deviations to these policies and procedures require prior, written consent by the
Corporate Controllers and Corporate Business Analysis and Planning (BAP) departments. General
Guidelines and Definitions
Financial reports and metrics are compiled by the Company Finance function and reported to Corporate
leadership and operating business unit management; however, at the discretion of the Strategic
Business Group (SBG) or Strategic Business Unit (SBU), additional reports and metrics may be used
for their own internal management reporting purposes.
Operating business units may not alter metric calculations or report to Company Corporate metrics
using definitions other than those described in this POME Chapter. Operating business units are
encouraged to minimize the proliferation of financial reports and metrics that differ in format and
content than those described in this POME Chapter.
Financial Management
Financial Management (FM) is Company’s standard financial reporting system. It is the source of all
financial data used for external reporting and internal management reporting purposes. The FM
account code structure is based on Company’s common Chart of Accounts (COA) and uses the
convention of parent and child accounts.
“External” View
428
2007, POME, Gautam_Koppala, All Rights Reserved
SBG financial information contained in these reports and the basis for the metric calculations captures
revenues and margins based on an “external” view in which inter-company (between SBGs)
transactions are excluded. Even though internally driven revenues are reported separately by each
SBG, externally generated revenues and margins are the key measures for evaluating each SBG’s
contribution to Company’s Net Income. SBG external sales and corresponding margins are used for
external reporting purposes and for internally measuring operating results.
“Measurement Basis”
The term “Measurement Basis” is used to identify key SBG Income Statement financial data such as
Operating Income Measurement Basis or Net Income Measurement Basis. This term simply indicates
that standard General Ledger Income Statement components have been adjusted to reflect
adjustments approved by the Corporate Controller’s department (i.e. Corporate assessments).
Company’s Corporate Financial Management (FM) system facilitates the adjustments and reporting of
“Measurement Basis” financial data which is used for measuring the SBG’s operating results.
Comparative Analysis Formats
Comparison data shown in dollar amounts or percentages uses the convention of positive numbers or
percentages equating to favorable variances, and negative numbers or percentages equating to
negative variances versus the comparison period(s).
Financial Reports and Metrics
This section provides: 1) an inventory of key financial reports and metrics, 2) a brief description of
each key report, and 3) the calculation of key financial metrics used in the report including reference
to Company’s common Chart of Accounts (COA). Report examples are provided.
Key Financial Reports and Metrics
Report Name Responsibility Date Issued Distribution List
10. Sales Flash BAP CEO/CFO
11. Income Statement BAP CEO/CFO
12. Free Cash Flow BAP CEO/CFO
Statement
13. Orders BAP CEO/CFO/SBG
Presidents
14. Working Capital BAP CEO/CFO
15. Income Variance SBG FP&A CFO/BAP/IR
429
2007, POME, Gautam_Koppala, All Rights Reserved
16. Functional Census & Cost FT Finance CEO/CFO/Corporate
Sr. VPs/SBG
Functional VPs and FT
Leaders
17. General & Administrative FT Finance CEO/CFO/Corporate
Expense Sr. VPs
18.Indirect Spend BAP CEO/CFO/Corporate
Sr. VPs/SBG
Presidents
1. Contingent liabilities and capital commitments ( POME Sample)
31 March 31 March
2006 2005
Rs ‘000 Rs ‘000
(i) Estimated amount of contracts remaining
to be executed on capital account (net of 1,569 1,636
advances) and not provided for
(ii) Contingent liabilities:
a) Bills receivable discounted and not
87,400 373,889
matured
b) Letter of credit 217,779 29,060
c) Bank guarantees including 189,559 150,805
commitments
d) Claims against the Company not
acknowledged as debts (including
interest and penalty demanded)
- Customs duty
430
2007, POME, Gautam_Koppala, All Rights Reserved
- Sales tax 6,970 208,065
- Central Excise 19,500 29,496
- Service tax 3,130 -
- Income tax (additionally refer to 70,000 -
note (g),(h) and (i) below)
741,488 12,450
- Others
21,946 11,194
e) Sundry debtors factored with recourse
/ put option for the buyer outstanding
1,000,000 1,000,000
at the year end (additionally refer to
note (j) below)
f) Potential liability of provident fund
payable on leave encashment for the
period October 1994 to April 2005 2,881 -
which is pending final decision by
appropriate authorities
g) Also, the notices in the previous years including an interest component from
the Income Tax Authorities relating to the assessment year to be checked.
h) Even, a Notice of Demand for the amount towards tax and interest from the
Income Tax Authorities relating to that assessment year The demand towards
tax comprising amount, on account of transfer pricing adjustment and also the
other amount on account of denial of tax holiday benefit and other
adjustments.
i) The Company factors its receivables with the banks. As per the factoring
agreement, the bank shall have the right to immediate recourse upon
happening of the following events:
i. If there is a shortfall, due to non-payment by the customer, which will
trigger the exercise of the “PUT” option by the bank and shall be exercised
by debit to the Company’s bank account; and
431
2007, POME, Gautam_Koppala, All Rights Reserved
ii. Upon termination of this agreement.
Further, the factored debtors have been adequately provided for.
2. Legal and professional fees include auditors’ remuneration (POME Sample)
31 March 31 March 2005
2006
Rs ‘000 Rs ‘000
Statutory audit fees 2,836 2,350
Tax audit fees 135 126
Out-of-pocket expenses 85 86
_____ _____
2,562
3,056
3. Leases
Finance leases ( POME Sample):
The Company taken vehicles, computers and office equipment under finance lease. Future minimum
lease payments under finance lease obligations as at 31 March 2006 is:
Rs ‘000
Minimum lease Future Present value of
Period
payments interest minimum lease
Not later than 1
year 54,120 5,928 48,191
Later than 1 year
and not later than 5 57,234 3,456 53,778
432
2007, POME, Gautam_Koppala, All Rights Reserved
years
111,354 9,384 101,969
Operating leases
The Company leasing office and housing facilities under cancellable operating lease agreements. The
Company if intends to renew such leases in the normal course of business. Total rental expenses, sub-
lease income incurred also to be incorporated for the assessed year.
Deferred taxation ( POME Sample)
Deferred taxes included in the balance sheet comprise the following:
31 March 31 March
2006 2005
Rs ‘000 Rs ‘000
Deferred tax assets
Inventories 53,346 48,859
Sundry debtors 82,218 140,623
Loans and advances 129,282 130,526
Current liabilities 76,175 50,146
Provisions 11,882 14,953
Unabsorbed depreciation and carry forward - 62,487
losses
Total deferred tax assets 352,903 447,594
Deferred tax liability
Fixed assets (82,903) (102,594)
Total deferred tax liabilities (82,903) (102,594)
433
2007, POME, Gautam_Koppala, All Rights Reserved
Deferred tax asset, net 270,000 345,000
“Virtual certainty”--the Company has reassessed the carrying value of the deferred tax asset arising
from unabsorbed depreciation, carry forward business losses and other timing differences and has
accordingly reduced the deferred tax asset from Rs 345,000,000 as at 31 March 2005 to Rs
270,000,000 as at 31 March 2006.
The Board of Directors believe that based on business circumstances as at 31 March 2006, the
Company would be able to realise the carrying value of the deferred tax asset of Rs 270,000,000
through generation of sufficient taxable profits in the future years based on the profits arising from the
Company’s software business with the parent company and the profits arising from the export of
certain ultra sound equipment manufactured by the Company, for distribution to other others. The
software profits that were exempt from tax under section 10A of the Income Tax Act 1961 became
taxable from the year ended 31 March 2004. Based on current business circumstances, the Company
expects to realize sufficient future taxable profit to recover the carrying value of the deferred tax asset
at 31 March 2006. The deferred tax balance is periodically evaluated for the appropriateness of its
carrying value in light of business circumstances at the evaluation date.
Provisions, Contingent Liabilities and Contingent Assets
a. Provision for warranty (POME Sample)
Warranty provision is utilised to make good the amount spent on spares, labor, and all other related
expenses on the event of failure of equipment. All the amounts are expected to be utilized in the
ensuing year. Outflows are expected to maintain the same trend as that of past years. No amount is
expected as a reimbursement towards this cost.
31 March 2006 31 March 2005
Particulars Rs ‘000 Rs ‘000
Opening balance 149,244 104,439
Add: Provision 245,223 225,718
Less: Utilisation 168,161 180,913
434
2007, POME, Gautam_Koppala, All Rights Reserved
Closing balance 226,306 149,244
b. Provision for legal cases (POME Sample)
The provision for legal cases is utilised to make good any amount payable in the event of any adverse
judgement on the Company. The provision is based on informed advice obtained by the Company.
The Company, however, could not estimate with reasonable certainty the period of utilization of the
same.
31 March 2006 31 March 2005
Particulars Rs ‘000 Rs ‘000
Opening balance 2,400 2,250
Add: Provision 3,675 150
Less: Utilisation - -
Closing balance 6,075 2,400
Expenditure and earnings in foreign currency (POME Sample)
31 March 2006 31 March 2005
Rs ‘000 Rs ‘000
(a) Expenditure in foreign currency
Royalty (Gross of TDS) 157,059 89,005
Travel (including daily allowances) 22,927 18,470
Communication 7,702 13,789
Personnel costs 52,767 45,245
Others 34,885 28,253
275,340 194,762
435
2007, POME, Gautam_Koppala, All Rights Reserved
(b) Earnings in foreign currency
FOB value of export of goods and 4,265,386 3,618,726
services
Software 521,060 443,859
Commission on sales 64,251 53,808
Scrap sale 132,586 75,383
4,983,283 4,191,776
Value of imports on C.I.F. basis (POME Sample)
Raw materials and components 2,012,909 1,806,881
Traded goods 2,895,124 2,504,077
Capital goods 33,988 67,740
4,942,021 4,378,698
a) The following is the summary of significant transactions with related
parties by the Company; (POME Sample)
Particulars For the year ended 31 March 2006
For the year ended 31 March 2005
Rs ‘000
Holding Fellow
Shareholder
company subsidiaries
Rs Rs Rs
Sale of goods, 462,174 3,970,787 Nil
436
2007, POME, Gautam_Koppala, All Rights Reserved
services and scrap
347,728 3,353,240 Nil
Purchase of goods & 146,719 3,646,176 115,620
services
114,588 2,747,888 96,943
Expenses reimbursed 3,675 47,391 Nil
by GG ORG
535 231,420 Nil
Expenses reimbursed 4,778 107,500 Nil
to GG ORG
14,532 135,748 Nil
Purchase of fixed Nil Nil Nil
assets
16,927 5,478 Nil
Inter –corporate Nil 560,000 Nil
deposits given
Nil Nil Nil
Rent received Nil Nil Nil
Nil 2,649 Nil
Rent paid Nil 4,802 Nil
Nil 25,696 Nil
Commission on sales Nil 64,251 Nil
Nil 53,809 Nil
Royalty 59,615 97,444 61,999
Nil 89,005 Nil
b) Salary to key managerial personnel (POME Sample)
Personnel cost includes salary paid to Managing Director:
Particulars For the year For the year
ended 31 March ended 31 March
437
2007, POME, Gautam_Koppala, All Rights Reserved
2006 2005
Salary including ESOP cost 7,916 9,940
Company’s contribution to 422 -
provident fund and family pension
fund
Total 8,338 9,940
c) Transactions entered with GG INC, Bangladesh – Subsidiary (POME
Sample)
Particulars For the year ended 31
March 2006
For the year ended 31 March
2005
Rs ‘000
Trade advances 26,653
6,829
d) The balances receivable from and payable to related parties are as follows
(POME Sample)
Particulars For the year ended 31 March 2006
For the year ended 31 March 2005
Rs ‘000
Holding Fellow Shareholder
company subsidiaries
438
2007, POME, Gautam_Koppala, All Rights Reserved
Sundry debtors 109,008 365,481 Nil
Nil 60,535 Nil
Advances/Inter Nil 560,000 Nil
corporate deposits
Nil 8,411 Nil
Sundry creditors 22,446 755,358 14,985
25,278 550,575 13,688
Amount receivable from or invested in GG INC, Bangladesh - Subsidiary
(POME Sample)
Particulars For the year ended 31 March
2006
For the year ended 31 March
2005
Rs ‘000
Trade advances 71,191
44,538
Provision for 32,795
advances
22,618
Investments 211
211
439
2007, POME, Gautam_Koppala, All Rights Reserved
Segment reporting (POME Sample)
If the primary segments of the GG ORG Company are its business segments as follows:
a) Equipment segment – includes manufacture and trading in diagnostic ultrasound systems,
computer tomography systems, medical electronic diagnostic imaging products, high
power x-ray including image intensifier TV Systems and medical electronic diagnostic
equipments and accessories.
b) Services segment – includes annual maintenance contracts.
c) Software segment – includes development of software for medical equipments.
The accounting policies consistently used in the preparation of the financial statements are also applied
to record revenue and expenditure in individual segments.
Revenue and direct expenses in relation to segments are categorised based on items that are
individually identifiable to that segment, while other costs, wherever allocable, are apportioned to the
segments on an appropriate basis. Certain expenses are not specifically allocable to individual
segments as the underlying services are used interchangeably. The Company therefore believes that
it is not practicable to provide segment disclosures relating to such expenses and accordingly such
expenses are separately disclosed as ‘unallocated’ and directly charged against total income.
Assets and liabilities in relation to segments are categorised based on items that are individually
identifiable to that segment. Certain assets and liabilities are not specifically allocable to individual
segments as these are used interchangeably. The Company therefore believes that it is not
practicable to provide segment disclosures relating to such assets and liabilities and accordingly these
are separately disclosed as ‘unallocated’.
Rs ‘000
31 March 31 March
Primary segment information
2006 2005
Segment revenue
440
2007, POME, Gautam_Koppala, All Rights Reserved
Equipment, net of excise duty 7,494,775 6,529,982
Services 1,239,175 1,115,158
Software 521,060 443,859
9,255,010 8,088,999
Segment profit
Equipment 337,802 341,686
Services 246,170 146,504
Software 156,182 126,077
740,154 614,267
Other unallocable expenditure, net of
unallocable income
(290,427)
(215,690)
Profit/(loss) before tax 524,464 323,840
Income taxes (98,106) (66,316)
Profit/(Loss) after taxation 426,358 257,524
Segment assets
Equipment 1,723,614 1,268,646
Services 599,803 372,880
Software 263,660 155,730
2,587,077 1797,256
Corporate – Unallocated 2,675,560 1,757,997
5,262,637 3,555,253
Segment liabilities
Equipment 702,735 1,396,845
Services 75,068 691,350
Software 33,203 4,973
441
2007, POME, Gautam_Koppala, All Rights Reserved
811,006 2,093,168
Corporate – Unallocated 2,987,494 424,459
3,798,500 2,517,627
Capital expenditure (capitalised during
the year)
52,951
Equipment
27,511
1,215
Services
2,263
37,958
Software
22,742
35,239
Unallocable
61,448
127,363
113,964
Depreciation
Equipment 107,159 105,821
Services 3,162 6,602
Software 28,574 31,587
Unallocable 44,142 26,050
183,036 170,061
Secondary segmental reporting is performed on the basis of the geographical location of customers. The
geographical segments include:
a) Domestic
b) Exports
Rs ‘000
442
2007, POME, Gautam_Koppala, All Rights Reserved
31 March 31 March
Secondary segment information
2006 2005
Segment revenue
Domestic 4,026,354 4,483,554
Exports 5,228,656 3,605,445
9,255,010 8,088,999
Segment assets
Domestic 4,280,195 2,737,922
Exports 982,442 817,331
5,262,637 3,555,253
The names of small-scale industrial undertaking and others to whom the Company owes a sum, which is
outstanding for a period of more than 30 days, alos to be included in the schedule of accounts.
Details of raw materials and components consumed
31 March 2006 31 March 2005
Class of goods * Rs ‘000 Rs ‘000
Raw materials and components for
computer tomography / ultrasound /
high power X-ray including image 2,916,353 2,692,489
intensifier TV Systems and medical
electronic diagnostic equipments
* There has been no item consumed during the year whose individual value is higher
than 10% of the total consumption value.
Details of imported and indigenous raw materials and components consumed
443
2007, POME, Gautam_Koppala, All Rights Reserved
Particulars 31 March 2006 31 March 2005
% Value % Value
Rs ‘000 Rs ‘000
Imported 61 1,778,975 60 1,615,493
Indigenous 39 1,137,378 40 1,076,996
100 2,916,353 100 2,692,489
Details of traded goods
31 March 2006 31 March 2005
Class of goods Quantity Value Quantity Value
Nos. Rs ‘000 Nos. Rs ‘000
Diagnostic ultrasound
systems, equipment and
accessories
Opening stock 1,380 141,634 1,276 313,410
Purchases 9,529 1,174,235 6,373 683,206
Closing stock 2,143 168,742 1,380 141,634
Sales 8,766 1,395,874 6,269 1,236,669
Computer tomography
systems, equipment and
accessories
Opening stock * - 67,241 - 90,899
Purchases 1,189 765,947 66 385,848
Closing stock 917 44,587 - 67,241
Sales 1,332 954,145 66 622,783
444
2007, POME, Gautam_Koppala, All Rights Reserved
Medical electronic
diagnostic imaging
products
Opening stock 4,608 418,758 3,518 277,261
Purchases 14,024 2,362,118 16,163 2,274,809
Closing stock 2,932 534,551 4,608 418,758
Sales 15,700 2,863,023 15,073 2,216,621
Notes:
1. Quantities stated above are exclusive of stores and spares, as these do not constitute
individually more than 10% of the respective categories. However, the values of
stores and spares have been included in the above figures.
2. Sales include sales of stores and spares, which is a part of ‘income from annual
maintenance contracts’.
3. * The quantities were not presented since, it is not determinable by management
Capacity and production
Class of Goods Installed Capacity * Production
31 March 31 31 March 31 March
2006 March 2006 2005
2005
Nos. Nos. Nos. Nos.
Diagnostic
ultrasound
systems, 23,500 30,000 15,552 27,326
equipment and
accessories
Computed
100 100 - -
tomography
445
2007, POME, Gautam_Koppala, All Rights Reserved
systems,
equipment and
accessories
Medical electronic
diagnostic 22,800 22,800 21,724 21,711
imaging products
Notes:
1. Company products are not covered under licence and are accordingly not disclosed.
2. * Installed capacities and production are as certified by the management and have not
been verified by the auditors as this is a technical matter.
Details of turnover of manufactured items
Class of goods 31 March 2006 31 March 2005
Quantity Value Quantity Value
Nos. Rs ‘000 Nos. Rs ‘000
Diagnostic
ultrasound systems,
14,840 1,854,071 27,422 1,469,879
equipment and
accessories
Medical electronic
diagnostic imaging 21,434 1,666,837 21,770 1,674,132
products
3,520,908 3,144,011
Details of opening inventories of manufactured items
446
2007, POME, Gautam_Koppala, All Rights Reserved
Class of goods 1 April 2005 1 April 2004
Quantity Value Quantity Value
Nos. Rs ‘000 Nos. Rs ‘000
Diagnostic
ultrasound systems,
9 205 105 7,374
equipment and
accessories
Computed
tomography
- - 1 5,848
systems, equipment
and accessories
Medical electronic
diagnostic imaging 42 11,609 101 11,002
products
11,814 24,224
Details of closing inventories of manufactured items
Class of goods 31 March 2006 31 March 2005
Quantity Value Quantity Value
Nos. Rs ‘000 Nos. Rs ‘000
Diagnostic
ultrasound systems,
721 15,228 9 205
equipment and
accessories
Medical electronic
332 18,917 42 11,609
diagnostic imaging
447
2007, POME, Gautam_Koppala, All Rights Reserved
products
34,145 11,814
Royalty
Royalty which pertains amounts accrued in excess of the prescribed limits under the relevant rules.
The Company has made an application to appropriate authorities seeking approval for the payment of
the same.
Employee stock options
If certain employees of the Company have received some restricted stocks from the parent company.
The exercise price of these restricted stocks is nil. These restricted stocks will vest in four equal
installments through continued employment certain years. The intrinsic value method debiting
personnel cost with a corresponding credit to “General reserve” account. The proforma disclosures
have not been presented as the intrinsic value approximates fair value.
448
2007, POME, Gautam_Koppala, All Rights Reserved
The Balance-Sheet Model of the Project
Total Value of Project Total Project Value to Investors:
Assets:
Current
Current Liabilities
Assets
Long-Term
Debt
Fixed Assets
1 Tangible Shareholders’
2 Intangible Equity
449
2007, POME, Gautam_Koppala, All Rights Reserved
POME BALANCE SHEET SAMPLE:
GG ORG
As at As at
Rs '000 Rs '000
SOURCES OF FUNDS
Shareholders' funds
1,464,137 1,037,626
Loan funds
450
APPLICATION OF FUNDS
Fixed assets
707,977 751,633
451
4,284,449 2,458,409
3,693,905 2,450,409
452
1,568,732 1,104,844
(0)
for POME
Chartered Accountants
GG ORG
453
9,597,156 8,354,982
EXPENDITURE
Personnel costs
454
9,072,692 8,031,142
Income taxes
455
GG ORG
As at As at
456
Authorised
paid up
[Of the above 5,100,000 (31 March 2005 : 5,100,000) equity shares
of Rs.10
General reserve
457
1,364,137 937,626
4 Secured loans
104,595 67,218
1 Cash credit from banks are secured by hypothecation, a pari passu charge, of stock and book debts, both present
. and future.
458
As at As at
Rs '000 Rs '000
6 Investments
25,000 (31 March 2005 : 25,000) equity shares of Bangladesh Taka 10 211 211
7 Inventories
459
1,061,181 920,860
899,909 775,446
8 Sundry debtors
Unsecured
Other debts
- considered good
460
1,648,895 707,357
1,176,661 295,896
Cash in hand 11 1
- Current account with M&I Marshall & Ilsley Bank, Milwaukee,USA - 427
461
970,815 903,708
Maximum balance at any time during the year with non-scheduled banks was as follows:
Unsecured
Considered good
Advance tax and tax deducted at sources, net of provision for tax of
462
Considered doubtful
1,600,439 874,156
Less: Provision for doubtful advances ( net of write offs ) (363,375) (390,797)
1,237,064 483,359
463
11 Current liabilities
Sundry creditors
Other liabilities
464
3,403,118 2,254,263
* Includes liability in respect of provident fund of Rs 4,118 thousands ( 31 March 2005 : Rs 2,481 thousands )
GG ORG
5. Fixed Assets
Rs’000
Gross block
As at As at
Deletions /
Particulars Additions 31 March
(Adjustement)
1 April 2005 2006
A. Intangible Assets
465
B. Tangible Assets
1. Owned Assets
466
2. Leased Assets
Accumulated depreciation
467
A. Intangible Assets
B. Tangible Assets
1. Owned Assets
Freehold land - -
468
Net block
As at As at
Particulars
31 March 2006 31 March 2005
A. Intangible Assets
B. Tangible Assets
469
Vehicles - -
2. Leased Assets
470
GG ORG
Rs '000 Rs '000
13 Revenues
9,265,088 8,119,459
14 Other income
Commission on sales
471
342,146 265,983
472
15 Materials cost
4,036,011 3,397,801
6,929,795 6,108,865
16 Personnel costs
473
600,575 538,593
GG ORG
Rs '000 Rs '000
17 Other expenses
474
475
476
18 Finance expense
133,848 89,336
GG ORG
477
I Registration details
State code 08
478
Unsecured loans -
Investments 211
479
Miscellaneous expenditure -
480
For GG ORG
GG ORG
Workings for cash flow statement for the year ended 31 March 2006
Sl.
No. Particulars 31st March 2006 31st March 2005 NET CY
481
482
483
44,540
58,395
484
Opening 67,218
Additions 61,450
Closing (101,969)
51,279
485
44,540
486