Case of the Unidentified Industries

Objective: To develop an understanding of the influence of a firm’s

operating/technological and competitive characteristics on

 the firm’s investment in various types of assets (the investment decision),

 the riskiness of these investments (business risk), and

 the financial structure of the firm’s balance sheet (financial risk).

It has become harder and harder to identify firms suitable for a case like this case. Why?

 Fewer firms operate within a homogeneous industry,

 The complexities of financial reporting create difficulties in the comparability of data

across firms and industries.

Matching the Industry to the Financial Statement/Ratio Characteristics

Note: I had some problems matching these firms to their appropriate industry, much as
some of you did. I provide the Harvard suggested answers below.

Please don’t worry too much about your answers. The main point of this case is to
illustrate how asset structures imposed by the technological requirements of various
industries and the business risk of the cash flows generated by these assets influences
financial structure.

Why is the matching of these firms to their respective industry important?

This matching exercise highlights the natural structural ratio differences across industries.
It should be obvious why, when benchmarking, we must compare firms only to firms
within their respective industries. This objective is often easier said than done.
 Electric Utility [B]

 Assets largely plant and equipment

 Capital intensity is reflected in the Sales/Total Assets ratio
 Collection period is a reasonable 48 days
 Inventory turnover seems low (at least to me), but utilities do hold fuel oil, gas,
coal, and uranium in inventory

 Japanese Trading Company [D]

 Low fixed assets – the firm doesn’t manufacture anything

 Long collection period – international trade
 High inventory turnover
 Low profit margin

 Aerospace Manufacturer [E]

 Low inventory turnover – long production process (work-in-progress)

 Low Sales/Total Asset ratio
 High current liabilities – reflects customer advanced payments
 High accounts payable – reflects high level of purchased components

 Automobile Manufacturer [A]

 Long correction period –reflects captive finance subsidiary consolidation

 Inventory turnover distinguishes this industry from aerospace manufacturing
 Large investment in plant and equipment

 Supermarket Chain [C]

 High Sales/Total Asset ratio

 Negligible accounts receivable
 Low profit margin
 Negligible collection period