Trend Analysis GM and Toyota 2005—2008

Posted by PITHOCRATES - January 29th, 2013

History 101

GM’s Problems were caused by Franklin Delano Roosevelt and his Ceiling on Wages

The GM bailout is still controversial.  It was part of the 2012 campaign.  It was why we should reelect President Obama.  Because Osama bin Laden was dead.  And General Motors was alive.  But the bailout didn’t fix what was wrong with GM.  Why it went bankrupt in the first place.  The prevailing market price for cars was below their costs.  And what was driving their costs so high?  It was labor.  It was the UAW wage and benefit package that made it impossible for GM to sell a car profitably.

GM’s problems go back to Franklin Delano Roosevelt.  The country was suffering in the Great Depression with double-digit unemployment.  He wanted to get businesses to hire people.  To reduce unemployment.  And pull us out of the Great Depression.  So how do you get businesses to hire more people?  Hmmm, he thought.  Pay people less so businesses have more money to hire more people.  It was brilliant.  So FDR imposed a ceiling on wages.  Why did FDR do this?  Because he was from a rich family who didn’t understand business or basic economics.

Of course there was one major drawback to this.  How do you get the best talent to work for you if you can’t pay top dollar?  Normally the best talent can go to whoever pays the most.  But if everyone pays the same by law you might as well work at the place closest to your house.  Or across from the best bars.  No, if a business wanted the best workers they had to figure out how to get them to drive across town in rush hour traffic and sit in that traffic on the way home.  A real pain in the you-know-what.  So how to get workers to do that if you can’t pay them more?  You give them benefits.

Toyota doesn’t have the Legacy Costs that Bankrupted an Uncompetitive GM

And this was, is, the root of GM’s problems.  Those generous pension and health care benefits.  Things we once took care of ourselves.  Before our employers started providing these.  And the UAW really put the screws to GM.  Getting great pay, benefits and workplace rules.  For both active workers.  And retirees.  Even laid-off workers.  Such as the job bank.  Where GM paid workers who had no work to do.  It’s benefits like this that have bankrupted GM.  Especially the pensions and health care costs for retired workers.  Who outnumbered active workers.  Those people actually assembling the cars they sell.

It’s these legacy costs that have made GM uncompetitive.  Toyota, for example, didn’t suffer the FDR problem.  So their costs for retired workers don’t exceed their costs for active workers.  In fact let’s compare GM and Toyota for the four years just before GM’s government bailout (2005-2008).  We pulled financial numbers from their annual reports (see GM 2005 & 2006, GM 2007 & 2008, Toyota 2005 & 2006 and Toyota 2007 & 2008).  We’ve used some standard ratios and plotted some resulting trends.  Note that this is a crude analysis that provides a general overview of the information in their annual reports.  A proper analysis is far more involved and you should not construe that the following is an appropriate way to analyze financial statements.  We believe these results show general trends.  But we offer no investment advice or endorsements.

GM Toyota Current Ratio

We get the current ration by dividing current assets by current liabilities.  These are the assets/liabilities that will become cash or will have to be paid with cash within 12 months.  If this ratio is 1 it means current assets equals current liabilities.  Meaning that a business will have just enough cash to meet their cash needs in the next 12 months.  If the number is greater than 1 a business will have even a little extra cash.  If the number is less than 1 a business is in trouble.  As they won’t have the cash to meet their cash needs in the next 12 months.  Unless they borrow cash.  Toyota’s current ratio fell slightly during these 4 years but always remained above 1.  Falling as low as 1.01.  Whereas GM’s current ratio was never above 1 during these 4 years.  And only got worse after 2006.  Showing GM’s financial crash in 2008.

The GM Bailout did not address the Cause of their Bankruptcy—UAW Pensions and Health Care Benefits

There are two basic ways to finance a business.  With debt.  And equity.  Equity comes from outside investors (when a business issues new stock).  Or from profitable business operations.  Which typically accounts for the majority of equity.  Profitable business operations are the whole point of running a business.  And it’s what raises stock prices.  To see which is providing the financing of a business (debt or equity) we calculate the debt ratio.  We do this by dividing total liabilities by total assets.  If this number equals 1 then total assets equal total liabilities.  Meaning that 100% of a business’ assets are financed with debt.  And 0% with equity.  Lenders do not like seeing this.  And will be very reluctant to loan money to you if your business operations cannot generate enough profits to build up some equity.  And that was the problem GM had.  Their business operations could not generate any profits.  So GM had to keep borrowing.

GM Toyota Debt Ratio

GM went from bad to worse after 2005.  Their debt ratio went from 1.02 in 2006.  To 1.24 in 2007.  And to 1.94 in 2008.  Indicating massive borrowings to offset massive operating losses.   And how big were those losses?  They lost $17.806 billion in 2005.  $5.823 billion in 2006.  $4.309 billion in 2007.  And in the year of their crash (2008) they lost $21.284 billion.  Meanwhile Toyota kept their debt ratio fluctuating between 0.61 and 0.62.  Very respectable.  And where lenders like to see it.  As they will be more willing to loan money to a company that can generate almost half of their financing needs from profitable business operations.  So why can’t GM?  Because of those legacy costs.  Which increases their cost of sales.

GM Toyota Cost of Sales

GM’s cost of sales was close to 100% of automotive sales revenue these 4 years.  Even exceeding 100% in 2008.  And it’s this cost of sales that sent GM into bankruptcy.  Toyota’s was close to 80% through these 4 years.  Leaving about 20% of sales to pay their other costs.  Like selling, general and administrative (S,G&A).  Whereas GM was already losing money before they started paying these expenses.  Thanks to generous UAW pay and benefit packages.  The job bank.  And the even greater costs of pensions and health care for their retirees.  It’s not CEO compensation that bankrupted GM.  It was the UAW.  As CEO compensation comes out of S,G&A.  Which was less than 10% of sales in 2007 and 2008.  Which was even less than Toyota’s.

GM Toyota S G and A

GM’s costs kept rising.  But they couldn’t pass it on to the consumer.  For if they did the people would just buy a less expensive Toyota.  So GM kept building cars even though they couldn’t sell them competitively.  And sold them at steep discounts.  Just to make room for more new cars.  So the UAW could keep building cars.  Incurring massive losses.  Hoping they could make it up in volume.  But that volume never came.

GM Toyota Automotive Sales as percent of 2005

Toyota continued to increase sales revenue year after year.  But GM’s sales grew at a flatter rate.  Even falling in 2008.  It was just too much.  GM was such a train wreck that it would have required a massive reorganization in a bankruptcy.  Specifically dealing with the uncompetitive UAW labor.  Especially those pensions and health care benefits for retirees.  Which the government bailout did not address.  At all.  The white collar workforce lost their pensions.  But not the UAW.  In fact, the government bailout went to bolster those pension and health care plans.  So the underlying problems are still there.  And another bankruptcy is likely around the corner.

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Statement of Cash Flows

Posted by PITHOCRATES - December 18th, 2012

Economics 101

No Business will be able to Repay any Loan unless their Business Operations can Generate Cash

In business cash is king.  As it is in life.  We need cash to buy food to survive.  Just as a business needs cash to pay its bills to survive.  Cash is so important to a business that there is a special financial statement to summarize cash flows in a business.  It looks something like this.

The above are made up numbers that could be similar to any statement of cash flows.  It shows the three sources of cash for a business.  Operating activities.  Investing activities.  And financing activities.  Every last dollar a business has came from one of these three sources.  And we can determine the health of the business just by seeing where its cash came from.

Not all business owners use a statement of cash flows.  Most small business owners probably don’t.  Having some other method to see where their cash is coming from.  And going to.  But if they plan on borrowing money from a bank they’re going to need one.  As bankers want to see a business’ ability to generate cash from their business operations.  For no business will be able to repay any loan unless their business operations can generate cash.

An Increase in Accounts Receivable indicates a Business’ Customers are Paying them Slower

A business generates cash from operating activities.  Which comes from sales.  Of course business have to spend a lot of money to create those sales.  So the net cash generated is basically net income with a few adjustments.  In accrual accounting we expense a portion of what we spent on an asset as a depreciation expense each accounting period.  Because although we pay for an asset in one year we may use that asset for the next 5 years.  Or more.   So we expense a portion of that asset each accounting period.  But we don’t have to write a check to pay for depreciation.  It is a non-cash transaction.  So to adjust net income to show net cash generated we have to add back this depreciation expense.

An increase in accounts payable indicates a business is paying their bills slower.  And when you pay your bills slower you free up cash for other things.  Becoming a source of cash.  With each payroll a business has to withhold taxes from their employees’ paychecks.    Social Security, Medicare, unemployment insurance, the employee’s federal and state withholding taxes.  With each payroll these liabilities accrue and are payable to the various government agencies.  You  can free up some cash by paying these taxes late.  But it is not recommended.  For the penalties for doing so can be severe.

An increase in accounts receivable indicates their customers are paying them slower.  An increase in inventory indicates they’re buying more into inventory than they’re selling from inventory.  Prepayments will conserve cash in the future by paying for things now.  But they will leave you with less cash now.  A decrease in accrued liabilities indicates they’re catching up on paying some of their accrued expenses.  Like those payroll taxes.  (In the ideal world if you add up the increase and decrease in accrued liabilities they should net out. Indicating you’re paying your accrued expenses on time.  In this example the business has a balance of $3,000 they’re paying late.)  Increases in all of these items consume cash, leaving the business with less cash for other things.

When the Owner has to put in More of their Own Cash into the Business Things are not going Well

Cash flows from investing activities can include financial investments a business buys and sells with the excess cash they have.  In this example the only investment activities is the buying and selling of some plant assets.  Perhaps selling some old equipment that is costly to maintain and replacing it with new equipment.  Even replacing a vital piece of production equipment that breaks down.  Putting a business out of business.  Thus requiring a cash purchase to replace it as quickly as possible.  Short-term borrowing may be advances on their credit line while the settlement on short-term debt may be the repaying of some of those advances.  Proceeds from long-term debt may be a new bank loan.  While payments to settle long-term debt may be repaying a previous loan.  Finally, paid-in capital is money from the business owner.  Such as cashing in a 401(k) or getting a second mortgage on their house so they can put it into their business to make up for a cash shortage.

So what does all of this mean?  Is this business doing well?  Or are they having problems?  Well, the good news is that they are meeting their cash needs.  The bad news is that it’s not because of their operating activities.  They’re meeting their cash needs by paying their vendors slower.  In fact, if they didn’t they may have had a net loss of cash for the year.  Which means had they not paid their bills late they may have gone bankrupt.  And their cash problems are evident elsewhere.   For not only are they paying their vendors slower their customers are paying them slower.  Making them wait longer to get the cash from their sales.  And with more money going into inventory than coming out of inventory it indicates that sales are down.  Leaving them with less revenue to convert into cash.  And what’s particularly troubling is that increase in accrued liabilities.  Which could mean they’re paying their payroll taxes slower.  Accessing their credit line also indicates a cash problem.  Also, having to borrow $50,000 to help repay a $100,000 loan coming due is another sign of cash problems.  Finally, when the owner has to put in more of their own cash into the business things are not going well.

These are things a business owner has to deal with.  And things a loan officer will note when reviewing the statement of cash flows.  Some people may think a net increase in cash of $18,000 is a good thing.  But it’s not that good.  Considering they had to get that cash by paying their vendors slower, paying the government slower, borrowing money as well as investing more of their personal savings into the business.  Worse, despite having all of these cash problems the government is taxing away of lot of their cash.  Because their net income passing through to their personal income tax return is $235,000.  Putting them in the top 5% of income earners.  And into the crosshairs of those looking to raise tax rates on those who can afford to pay a little more.  To make sure they pay their ‘fair’ share.

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