Health Care Reform Vote - A Historic Date

Today, the House of Representatives will be voting on whether to pass what is being referred to as Health Care Reform. There has been much controversy surrounding this bill from the rules and procedures used to pass the bill to the claim that this bill will give government control over 1/6 of the country's economy.

I heard something on C-Span for the first time that I found personally disturbing and that I hope millions of Americans would equally find disturbing. In the bill the IRS would be the in control of determining what is an acceptable health insurance plan, tracking and punishing those who don't have coverage, subsidizing individual insurance plans with tax credits, and enforcing the rules on those who attempt to opt out, break the rules, or game the system.

The IRS would require individuals to attest that they have adequate coverage on their 1040 and that would be matched against 1099's that insurers would be required to submit to the IRS. Imagine the additional cost to your plan through this additional requirement. An individual who does not have health insurance for any part of the year will be penalized on a pro rata basis. So if your insurance lapsed and you went three months without insurance you would pay three twelfths of the penalty. The IRS could also offset your refund by this penalty. Think of the amount of time that the IRS and private employers will spend on validating employee coverage. The Congressional Accounting Budget office estimates this will increase the IRS budget by $10 BILLION to oversee health care. Can we really call something health care reform that involves a greater degree of intrusion by our government (IRS). I say no.

Just recently Caterpillar sent a letter to House Speaker Nancy Pelosi and House Minority Leader John Boehner urging them not to pass health care reform. Caterpillar estimates that this biil will drive up health costs by more than 20% or $100 MILLION - in the first year alone. Caterpillar said that while it supports health care reform this bill is not in the best interests of its 150,000 employees, retirees, and dependents they cover.

Caterpillar said the single biggest problem with the bill is that it would tax Medicare Part D. That cost of itself would put at risk the coverage that its current employees and retirees receive. Caterpillar spokesperson Bridget Young says that taxing Medicare Part D "would be a big enough disadvantage that it would likely cause some companies to change the way they provide prescription drug coverage for their retirees".

It seems that when two parties are so adamantly divided on a bill such as this and when so many backroom deals have been made to get votes, that what will get passed has a small chance of improving American lives.

TIME VALUE OF MONEY

Last week I talked about financial ratios and their application depending on who was using them. This week I want to cover the time value of money and how that can be useful in everyday decision making. The most common types of time money calculations that consumers use are auto loans and home mortgages.

When you go to buy an automobile one of the first questions they ask is how much you want your monthly payment to be. Before you buy a vehicle you need to decide what you can afford for a monthly payment, but more importantly you need to shop for the best rate and calculate the present value of those payments over the life of the loan. Then compare the present value to what you believe is a fair purchase price. Never buy a vehicle based just on the payment amount. That gives the dealership the flexibility to play with the price and financing.

The monthly payments over the length of the loan discounted at the interest rate on the loan equal the loan amount or present value. Another way of looking at it is if you were to put the loan amount in a savings account paying the same rate as your auto loan you would be able to make monthly withdrawals equal to your loan payment over the term of the loan. At the end of the term your savings account would have a zero balance.

The other type of present value is Net Present Value (NPV) which is the internal rate of return that a business would generate in order to discount a series of future (monthly, yearly) cash flows that would equal the cost of the investment. Suppose a printing business was fully utilizing all equipment, business was expanding, and needed to buy an additional printer to prevent a back log on orders. What do they need to know in order to make a wise investment? First, the company needs to know the cost of the printing equipment that is necessary to meet demand. Then they would need to know their estimated monthly gross margin which is revenue minus variable costs. Next calculate the interest cost to finance the equipment that you wouldn’t otherwise have to pay. Lastly, there is depreciation which is an expense, but not a cash outlay. If the corporate tax rate is 33%, depreciation only costs the company 67%. Most corporations have a targeted return or payback period that they require before they will make a capital investment. Therefore, if the equipment costs X and I were to invest the projected cash flows at the required rate of return how long would I have to receive those monthly cash flows before the discounted value equals the cost of the investment. If it takes eight years and the company requires a 5 year payback then they would not buy this piece of equipment.

Financial Ratios

In Bus501 and Bus502 we have been learning about financial ratios. There are five categories of financial ratios that tell a story about the companies financial position, management of assets, use of debt to finance assets, profitability and returns, and market value. Keep in mind that users of financial statements look at different ratios depending on their purpose. Each ratio by itself means something, but investors will look at all the ratios to use as one piece of their decision making process. Creditors may only be interested in a companies liquidity for short-term financing, and shareholders likely want to know what is my rate of return and dividend payout. Also, ratios are usually measured against that company's industry standard. In the absence of an industry standard one would compare the ratios against several companies within the same industry.

The first group of ratios is the liquidity ratios which are the current asset, quick, and cash ratio. The current and quick ratios are two of the most commonly referred to with the quick ratio measuring how many dollars of current assets per dollar of current liabilities. The quick ratio subtracts inventory from current assets since inventory isn't readily convertible to cash. The most liquid asset is cash and so a cash ratio of 1:1 says that the company can pay off all their current liabilities with just cash.

The next set of ratios tell the story about how a company manages their assets which would be inventory, accounts receivable, and total assets. All three of these assets are measured against sales. The inventory ratio tells how fast they are turning over their inventory. A company with a low turnover ratio in comparison may indicate stagnant inventory which may have to be written down. The accounts receivable ratio measures how quickly the company collects from their customers. It is measured by taking accounts receivable and dividing it by the average daily sales. A high receivables turnover ratio in comparison would likely indicate that the company was ineffective in managing the collection of accounts receivable. The ineffective management of accounts receivable and inventory would lead to higher working capital and the need for increasing short-term debt. The total asset turnover ratio measures the effectiveness of asset utilization in generating sales. The ratio measures the amount of sales generated for each dollar of assets.

Another area that a company is evaluated on is long-term debt. Long-term debt is a necessary source of funds to finance the purchase of long-term assets which will be used to generate sales and profit. There needs to be a balance between debt and equity. A company that is highly leveraged which means they are principally using debt to finance their assets is susceptible to the negative impact of high interest costs especially so when the company goes through a recession or cyclical downturn. The long-term debt ratio measures how many dollars of debt for each dollar of assets. This ratio should not be over one and should probably be around 50%.

The next set of ratios measure a company's profitability. Profit margin, return on assets, and return on equity are three of the more common ratios used to measure a company's profitability. Return on assets (ROA) measures the percent of profit for each dollar of assets. Corporations are often interested in this statistic which is referred to as RONA (Return on net assets)which is slightly different than ROA. Companies that are considering an acquisition or major capital expenditure will calculate a payback or return on investment that must meet the companies required rate of return before they will consider the investment. Shareholders will additionally want to look at profit margin and return on equity. Profit margin is especially meaningful because it tells what percent of sales is net income which is used to calculate earnings per share. A quarterly upward trend in profit margin is a strong indicator that a company is improving their gross margin and controlling their SG&A expenses. Return on equity tells an investor what their rate of return is on their investment. ROE measures the rate of return generated by the shareholders' net worth which is assets minus liabilities.

The last set of ratios is market value ratios. These ratios often tell how a company is perceived by investors. Several profitability ratios would be Price Earnings (PE), PEG (Price Earnings Growth), and cash flow. The PE ratio measures how many dollars of the market price for each dollar of earnings an investor is willing to pay. Corporations forecasting strong growth in revenue and earnings will demand a higher earnings per share price than a mature company with stable earnings but low growth. The PEG measures the ratio of the price (trading price) an investor is willing to pay for each dollar of earnings for each percent of sales growth. A high PEG ratio can be a good indicator for companies perceived to be growing quickly. A low PEG ratio of one or below could indicate that investors have overlooked the value of the company or they aren't very positive about the company's future growth prospects.

This was a good exercise for me to see how much I have learned about financial ratios, and hopefully it was helpful to those who read this.

Toyota Loses Focus of Customer Satisfaction

Rivals beware. What happened to Toyota should be a warning to all auto manufacturers. According to an article in the Economist there is not one auto manufacturer who has not patterned its manufacturing and supply-chain management after Toyota. Mr. Toyoda gave testimony to the House oversight committee on February 24th, and acknowledged that Toyota stretched its lean philosophy to the breaking point and lost focus on what made their company great: putting customer satisfaction above everything else and their ability to stop, think, and improve.

James Womack one of the authors of "The Machine that Changed the World", a book about Toyota's innovations in manufacturing believes that the company's misfortunes date back to 2002, when the firm set a goal to expand its market share from 11% to 15%. According to Mr. Womack the rapid expansion was not connected to customer satisfaction and was driven by ego. When customer recalls started mounting in the middle of the decade, Toyota's president asked that there be a renewed focus on quality. However, nothing was allowed to get in the way of another goal which was to overtake GM as the biggest car maker in the world.

The article goes on to say that Toyota's problems were not in their factories, but those of their suppliers. As they adopted an aggressive expansion strategy they started using a lot of unfamiliar suppliers. In the auto manufacturing world you have the car makers referred to as OEM's. Then you have tier-one, tier-two, and tier-three suppliers. Tier-one suppliers are responsible for making the big integrated systems, tier-two suppliers make and ship components to tier-one suppliers, and tier-three suppliers may make a single component for tier-two suppliers. The supplier who made the faulty gas pedals is a tier-two supplier.

Before Toyota's expansion efforts, they had designated certain suppliers as the sole provider of certain components leading to a close and long-term relationship and a sense of mutual benefit. However, as the company rapidly expanded their production capacity they became more dependent on suppliers outside of Japan with whom they did not have years of working experience. Also, Toyota did not have enough senior engineers to keep track of how new suppliers were doing. Toyota continued to trust in its sole-sourcing method, and gained economies of scale not seen before by contracting single suppliers for entire ranges of its cars across multiple markets.

A senior executive at one of the tier-one suppliers stresses that Toyota's single supplier source philosophy was taken to risky extremes especially when mixed with the company's highly centralised decision-making in Japan. There was not close enough monitoring. They didn't have transparency with their supplier base.

So the industry faces a question. Is sole-sourcing the way to go. Should you put all your eggs in one basket. The article suggest that perhaps by having multiple suppliers for big components they could benchmark each other.