Management Application: Operating Improvement versus Financial...

Management Application: Operating Improvement versus Financial Engineering

Assume that you are the CEO of a small publicly traded company. The operating performance of your

company has fallen below market expectations, which is reflected in a depressed stock price. At your

direction, your CFO provides you with the following recommendations that are designed to increase

your company's return on net operating assets (RNOA) and your operating cash flows, both of which

will, presumably, result in improved financial performance and an increased stock price.

1. To improve net cash flow from operating activities, the CFO recommends that your company reduce

inventories (raw material, work-in-progress, and finished goods) and receivables (through selective

credit granting and increased emphasis on collection of past due accounts).

2. The CFO recommends that your company lengthen the time taken to pay accounts payable (lean on

the trade) to increase net cash flows from operating activities

3. Because your company's operating performance is already depressed, the CFO recommends that you

take a "big bath;" that is, write off all assets deemed to be impaired and accrue excessive liabilities for

future contingencies. The higher current period expense will, then, result in higher future period income

as the assets written off will not be depreciated and your company will have a liability account available

to absorb future cash payments rather than recording them as expenses.

4. The CFO recommends that your company increase its estimate of expected return on pension investments. This will reduce pension expense and increase operating profit, a component of net operating

profit after tax (NOPAT) and, thus, of RNOA.

5. The CFO recommends that your company share ownership of its outbound logistics (trucking division)

with another company in a joint venture. This would have the effect of increasing throughput, thus spreading overhead over a larger volume base, and would remove the assets from your company's balance sheet

since the joint venture would be accounted for as an equity method investment.

Evaluate each of the CFO's recommendations. In your evaluation, consider whether each recommendation will positively impact the operating performance of your company or whether it is cosmetic in

nature.