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Article 28
Cash Flows, Ratio Analysis and the
W. T. Grant Company Bankruptcy
Although they surfaced as a gusher rather than a trickle, the problems that brought the
W. T. Grant Company into bankruptcy and, ultimately, liquidation, did not develop
overnight. Whereas traditional ratio analysis of Grants financial statements would not
have revealed the existence of many of the companys problems until 1970 or 1971,
careful analysis of the companys cash flows would have revealed impending doom as
much as a decade before the collapse.
Grants profitability, turnover and liquidity ratios had trended downward over the 10
years preceding bankruptcy. But the most striking characteristic of the company dur-
ing that decade was that it generated no cash internally. Although working capital pro-
vided by operations remained fairly stable through 1973, this figure (which constitutes
net income plus depreciation and is frequently referred to in the financial press as
cash flow) can be a very poor indicator of a companys ability to generate cash.
Through 1973, the W. T. Grant Companys operations were a net user, rather than pro-
vider, of cash.
Grants continuing inability to generate cash from operations should have provided in-
vestors with an early signal of problems. Yet, as recently as 1973, Grant stock was sell-
ing at nearly 20 times earnings. Investors placed a much higher value on Grants
prospects than an analysis of the companys cash flow from operations would have
warranted.
James A. Largay, III and Clyde P. Stickney
The W. T. Grant Company was the nations largest re-
tailer when it filed for protection of the Court under chap-
ter XI of the National Bankruptcy Act on October 2, 1975.
Only four months later, the creditors committee voted
for liquidation, and Grant ceased to exist. The collapse of
Grant is a business policy professors dreamambiguous
marketing strategy, personnel compensation based on
questionable incentive schemes, financially and adminis-
tratively unsound credit operations, centralization versus
decentralization issues and poorly conceived and poorly
executed long-range plans. Problems of this magnitude
do not develop overnight, although they often surface as
a gusher rather than a trickle.
As we will show, a traditional ratio analysis of Grants
financial statements would not have suggested the exist-
ence of many of these problems until approximately 1970
or 1971. As recently as 1973, Grant stock was selling at
nearly 20 times earnings. Perhaps investors believed that
Grant would continue to prosper despite many years of
consistent but lackluster performance; after all, the com-
pany had been in existence since the turn of the century,
paying dividends regularly from 1906 until August 27,
1974. But Grants demise should not have come as a sur-
prise to anyone following its fortunes closely; a careful
analysis of the companys cash flows would have re-
vealed the impending problems as much as a decade be-
fore the collapse.
Stock Prices and Ratio Analysis
Prior to 1971, Grants stock had tended to perform like
other variety store chain stocks. Beginning in June or July
of 1971, however, the stock price performance of Grant
and the other variety chains parted ways.
Exhibit I presents data on monthly closing prices and
various ratios from Grants financial statements for the 10
years preceding bankruptcy in 1975. The top panel shows
the December 31 closing price for Grants stock for each
year expressed as a ratio of the closing price on December
31, 1964 (i.e., the December 31, 1964 closing price equals
100). It also shows the values of the Standard & Poors Va-
riety Chain Stock Price Index and the Standard & Poors
ANNUAL EDITIONS
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Article 28. Cash Flows, Ratio Analysis and the W. T. Grant Company Bankruptcy
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500 Composite Stock Price Index at the end of each year,
each expressed as a ratio of its value on December 31,
1964.
The bottom four panels in Exhibit I shows the trends in
Grants profitability, turnover, liquidity and solvency ra-
tios over the fiscal periods between 1966 and 1975 (ending
January 31 of each year). The profitability, turnover and
liquidity ratios tended downward over this 10-year pe-
riod. The solvency ratios reflect increasing proportions of
liabilities in the capital structure. The most significant de-
terioration in these ratios, however, occurred during the
1970 and 1971 fiscal periods, leading the stock markets
recognition of Grants problems by approximately one
year.
Net Income and Cash Flows
The most striking characteristic of the Grant Company
during the decade before its bankruptcy was that it gen-
erated virtually no cash internally. The company simply
lost its ability to derive cash from operations. After ex-
hausting the possibilities of its liquid resources, it had to
tap external markets for funds. As the failure to generate
cash internally continued, the need for external financing
snowballed.
Most textbooks in corporate finance, investments and
financial statements analysis devote little attention to
computing or using cash flow from operations. Yet the
calculations are straightforward enough. One starts with
working capital provided by operations from the state-
ment of changes in financial position, adds changes in
current asset accounts (other than cash) that decreased
and current liability accounts that increased and subtracts
changes in current asset accounts (other than cash) that
increased and current liability accounts that decreased. In
accounting terms, the calculation is equivalent to adding
credit changes in working capital accounts and subtract-
ing debit changes. Exhibit II summarizes the process of
converting working capital provided by operations to
cash flow provided by operations.
Exhibit III graphs Grants net income, working capital
provided by operations and cash flow provided by oper-
ations for the 1966 to 1975 fiscal periods. Note how poorly
working capital provided by operations correlates with
cash flow from operations. The financial press frequently
refers to cash flow, defined as net income plus depreci-
ation. This measure of cash flow approximates working
capital provided by operations, which (as Exhibit III
shows) may prove a very poor surrogate for the cash flow
actually generated by operations.
While Grants net income was relatively steady
through the 1973 period, operations were a net user
rather than provider, of cash in all but two years (1968
and 1969). Even in these two years, operations provided
only insignificant amounts of cash. Grants continuing in-
ability to generate cash from operations should have pro-
vided investors with an early signal of problems.
Was the Market for Grant Stock Efficient?
In an efficient market, stock prices continually reflect all
publicly available information about a companys past
performance and future prospects. The evidence pre-
sented here, however, seems to suggest that W. T. Grant
Company was a counterexample to market efficiency.
Operations were a net user of cash in eight of Grants
last 10 years. Between January 31, 1966 and January 31,
1973, Grants sales nearly doubled, but its earnings and
ANNUAL EDITIONS
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earnings per share remained virtually unchanged. De-
spite its failure to translate vastly increased sales into ad-
ditional profits, Grants price-earnings ratio on January
31, 1973 was about twice what it had been on January 31,
1966.
We compared Grants price-earnings ratios with those
of similar variety chains (Kresge, McCrory, Murphy and
Woolworth) over the 196575 period. Until 1973, Grants
price-earnings multiple tended to exceed the multiples of
the other variety chains, with the exception of Kresge.
Traders in Grant stock during the companys last decade
placed a much higher value on Grants prospects than an
analysis of the companys cash flow from operations
would have warranted.
James Largay is Professor of Accounting at the college of Business and Econom-
ics, Lehigh University. This article was written while he was Coopers & Ly-
brand Visiting Associate Professor of Accounting at The Amos Tuck School of
Business Administration, Dartmouth College. Clyde Stickney is Associate Pro-
fessor of Accounting at The Amos Tuck School of Business Administration,
Darthmouth College.
The authors thank the Tuck Associates Program for its financial support.
From Financial Analysts Journal, July/August 1980, pp. 51-54. 1980 by the Financial Analysts Journal. Reprinted by permission.