Policy DecisionDoubling Assets
For example, using the starting balance sheet, let’s double our starting assets and apply the constraints outlined. The company’s financial structure will look something like this:
| ASSETS | LIABILITIES & OWNER'S EQUITY | |||
| Cash | $8,000 | Accounts Payable | $14,000 | 7.0% |
| Accounts Receivable | $18,000 | Current Debt | $12,000 | 6.0% |
| Inventory | $22,000 | Long Term Debt | $80,000 | 40.0% |
| Total Current Assets | $48,000 | Total Liabilities | $106,000 | 53.0% |
| Plant and equipment | $201,000 | Common Stock | $50,000 | 25.0% |
| Accum. Depreciation | ($49,000) | Retained Earnings | $44,000 | 22.0% |
| Total Fixed Assets | $152,000 | Total Equity | $94,000 | 47.0% |
| Total Assets | $200,000 | Total Liab. & O. E. | $200,000 | 100.0% |
To grow its assets, the company has kept all of its profits and issued all the stock it could—$15 million profits plus $29 million stock for total new equity of $44 million. It leveraged the new equity with $43 million of new long term debt. Presumably the $87 million of plant improvements expanded the product line and/or improved the plant efficiencies.
In short, management’s top priority was to identify opportunities to accumulate efficient assets. When identified, managers raised the money first with equity (retained profits and stock issues) , and then with as much long term debt as needed (up to its credit limits) .
Note the trade-offs with other performance measures. We are increasing assets, equity and leverage. Dividends are zero. Stock is diluted.
The implications for other performance measures include:
- ROE: Likely falls in the short run, may climb in the long run
- ROA: Likely falls in the short run, may climb in the long run.
- Asset turnover: Likely stays neutral or falls slightly
- Stock price: Since dividends fall to zero as shares are diluted, likely falls.
- Market cap: Stays neutral. More shares, but at a lower price.
- ROS: Probably goes up.
- Market share: Goes up.
Of course, the team hopes that profit growth will outpace balance sheet growth, and if it does, all of these measures will swing positive in the long run.
If the board of directors imposes other performance measures, management will feel torn. That can be a good thing. While cumulative profits is, perhaps, the most important individual measure, it does not take into consideration all of the stakeholders interests, particularly stockholders.