Survey
* Your assessment is very important for improving the workof artificial intelligence, which forms the content of this project
* Your assessment is very important for improving the workof artificial intelligence, which forms the content of this project
1 Corporate Performance and Military Production in South Africa Peter Batchelor, Paul Dunne and Sepideh Parsa Centre for Conflict Resolution, University of Cape Town, South Africa and Middlesex University Business School, United Kingdom January 1999 Abstract With the end of the Cold War and apartheid, a process of demilitarisation and dramatic cuts in military spending has marked the transition to democracy in South Africa. Between 1989 and 1997 the South African defence budget was cut by more than 50% in real terms, with most of the cuts coming from the procurement budget, which was cut by nearly 70% in real terms during the same period. These cuts have had a significant impact on the country’s defence industrial base. However, there has been surprisingly little research on the changes to defence companies that have taken place since the late 1980s. This paper makes a start at rectifying that deficiency by providing an analysis of the restructuring of the major defence dependent companies over the period 1988-97. It uses a number of financial ratios and other measures of corporate performance to compare their experience with non-defence companies in the rest of the South African economy during the same period. 1 This paper is based on research currently being undertaken as part of a project on Defence Industrial Restructuring, Conversion and Economic Growth in South Africa, funded by the Leverhulme Trust whose support is gratefully acknowledged. A version was presented at the International Conference on Defence Economics and Security in Mediterranean and Sub-Saharan Africa, CesA/IDN, Lisbon, June 1998. We are grateful to participants, in particular Keith Hartley, and to Guy Liu for comments. 1. Introduction One of the most striking aspects of South Africa’s transition to democracy has been the marked decline in defence spending that has occurred since the late 1980s. The defence cuts, and in particular the cuts in procurement expenditure have led to a downsizing and restructuring of the country’s defence industrial base, which was built up during the presence of the UN arms embargo. These developments make South Africa an extremely valuable case study for understanding defence industrial restructuring in the face of reduced demand. The fact that South Africa has such a large and sophisticated defence industry for a country at its stage of development, plus fairly detailed and reliable company data have added to its interest for researchers. In addition, its mix of private and public ownership of defence production makes it possible to compare the performance of both private and public defence companies. One aspect of the process of defence industrial adjustment that has so far not been studied is the impact and response at company level. This paper provides a contribution to the debate by examining corporate restructuring and performance amongst defence companies compared with non-defence companies in South Africa during the period 1988-1997. Section 2 reviews the existing literature on defence industrial restructuring and firm performance, and considers the various hypotheses of the impact of defence purchasing on firm performance. Section 3 describes South Africa’s macroeconomic environment and the performance of the country’s manufacturing economy during the period 1989-1997 in order to provide a context for examining the restructuring and performance of the defence industry during this period. Section 4 describes the changing structure and size of South Africa’s defence market since the late 1980s. Section 5 compares the performance of both public and private sector defence companies using financial and economic data for Denel and South Africa’s 3 largest private sector defence companies: Reunert, Altech and Grintek. Section 6 examines firm performance in the private sector defence industry using a sample of defence and non-defence companies. Financial ratio analysis is used to compare performance in terms of profitability, asset utilisation, gearing and labour productivity. Finally, Section 7 provides some concluding remarks. 2. Defence Industrial Restructuring and Firm Performance Much of the existing literature on the restructuring of military industry has tended to focus at a relatively aggregate level and there has been little analysis of the individual companies. This is particularly true for developing countries where there is a dearth of relevant information. Brzoska & Lock (1992) and Wulf (1993) provide surveys. The defence industrial sector can be defined as a number of industries that have the economic, as well as the military, characteristics of strategic industries. The economic characteristics of defence companies include: decreasing costs reflecting scale and learning economies; high technology industries requiring large research and development (R&D) outlays and long development periods resulting in technical spin-offs; and imperfect competition based on domestic monopolies and oligopolies. Defence companies also have a high dependence on government both as a major (or often the only) buyer of their output and as a regulator (e.g. of profitability) (Martin, 1996: 325). This can also lead to inefficiencies and an inability to compete in civil markets, reflected in low capital investment, low productivity, low profitability and a relatively poor export performance (Levitt and Joyce, 1987). The often cosy relationship which exists between the MoD and defence dependent companies, and which is often characterised by monopoly markets, cost-plus and cost-based contracts, preferential purchasing and a culture of dependency may result in X-inefficiency. Dependence on government may, however, have positive effects, on a company's performance. It could improve competitiveness through the Ministry of Defence (MoD) acting as a competitive buyer opening up the domestic market; through its support for R&D and through government providing a larger home market leading to scale economies. Studies by Dunne (1995) and Dunne and Schofield (1997) discuss in detail the ways in which dependence on government impacts on the performance of defence companies. Overall, whether defence companies will perform less well than non-defence companies is an empirical question worthy of careful research. Also of interest is how these companies have coped with the marked reductions in domestic arms procurement and the increasing competitiveness of the international arms market since the end of the Cold War. To provide a more specific focus for our empirical analysis, we follow Martin et al (1996) in specifying a number of hypotheses with which we confront with the data: 1. Firms that are dependent upon the MoD for sales are likely to be more financially leveraged through borrowing, because their preferential position (as a result of cost-plus or cost-based contracts and protectionist policies) gives them a lower risk of bankruptcy. The possibility of government bailout for these firms is also higher than for non-defence firms. The financial managers of these defence firms realise that they face less business risk than other firms and thus seek to get pecuniary benefits through increased financial leverage. 2. Government dependence is likely to result in defence firms investing less in plant and equipment than other comparable firms. Capital investment is important for its contribution to factor productivity, for if defence firms invest less in capital equipment than other firms, then productivity growth is likely to be less than in civilian firms. 3. Defence dependence can have adverse effects on the level and growth of labour productivity. The nature of the defence market, low levels of capital investment, a culture of dependency on MoD purchases, local monopolies, preferential treatment and cost plus contracts tend to stifle innovation. Furthermore, the level and growth in productivity is likely to decrease as dependence on MoD purchases increases. 4. Defence dependent firms will have different levels of profitability to civil companies as measured by various ratios such as return on assets. Profitability might be the same if defence production is no riskier than other industrial activities. Profitability might be higher as a result of domestic monopolies or preferential purchasing in favour of national firms. Profitability might be lower as a result of the monopsony power of the MoD and export restrictions that reduce sales and increase unit production costs. These hypotheses are considered in Section 6 when the performance of a sample of nondefence companies and a sample of private sector defence dependent companies are compared. First we provide some background information on the South African economy and its recent development. 3. South Africa’s Macroeconomic Environment South Africa is Africa’s largest and most sophisticated economy. The country is richly endowed with national resources, and the economy was built up on the basis of mining and agriculture. However, in recent years, the secondary (i.e. manufacturing) and tertiary (e.g. transport, financial services) sectors have come to dominate the economy. The South African economy experienced its longest and most severe recession - since the depression of the 1930s- between 1989 and 1993. During this period GDP growth averaged less than 1% per annum in real terms, while GNP per capita declined every year in real terms. Total employment in the non-agricultural sectors of the economy declined by an average of 1% between 1989 and 1993 while Gross Domestic Fixed Investment (GDFI) declined by an average of more than 2% per annum. Inflation remained stubbornly high during this period, averaging 13.6% per annum. Exports also showed little positive growth during this period, largely because of the continued presence of trade and financial sanctions (see Table 1). Table 1: South Africa, Economic Indicators, 1989-1996 Figures are annual real growth rates. Year GDP 1989 1990 1991 1992 1993 1994 1995 1996 2.4 -0.3 -1 -2.2 1.3 2.7 3.4 3.1 GNP per capita -1.2 -3.8 -2.7 -4.5 -0.5 2.0 0.8 1.6 GDFI Exports Inflation Employment 6.5 -2.3 -7.4 -5.3 -2.8 8.7 10.3 6.8 5.4 1.7 -0.1 2.5 4.8 1.0 9.3 7.8 14.7 14.4 15.3 13.9 9.7 9.0 8.7 7.4 0.9 -0.3 -1.7 -2.0 -2.1 -0.6 0.7 -1.5 Average 1989-93 0.0 -2.5 -2.3 2.9 1993-96 2.6 1.0 5.8 5.7 1989-96 1.2 -1.0 1.8 4.1 Source: South African Reserve Bank, Quarterly Bulletin, various issues. 13.6 8.7 11.6 -1.0 -0.9 -0.8 Since 1993, however, the South African economy has experienced positive GDP growth for four consecutive years. GDP growth averaged 2.6% between 1993 and 1996 while GNP per capita also witnessed positive growth, averaging 1% per annum. Gross Domestic Fixed Investment recovered quite dramatically and experienced average growth of nearly 6% per annum between 1993 and 1996. Exports also experienced positive growth, largely as a result of the lifting of trade sanctions, which accompanied the ending of apartheid. Inflation was brought under control, largely as a result of tighter monetary policies, and averaged less than 9% for the period 1993-1996. In 1996 inflation was 7.4%, the lowest rate since 1972. The only disappointing economic indicator since 1993 has been the trend in formal employment. Total employment in the non-agricultural sectors of the economy continued to decline between 1993 and 1996 despite the sustained growth in economy activity, thus constituting a situation of ‘jobless growth’. Despite the dramatic improvement in economic activity since 1993, the South African economy remains beset by a number of structural problems (e.g. shortage of skilled labour, low foreign exchange reserves), which are largely a function of the legacy of apartheid. In terms of income distribution, the country has one of the highest levels of income inequality in the world. The country has also experienced very high levels of crime and violence in the last few years. The performance of South Africa’s manufacturing sector since the late 1980s has also been particularly disappointing, reflecting the severity of the recession. The value and volume of manufacturing sales grew by less than 1% per annum between 1989 and 1996. Both indicators declined after 1989, bottomed out in 1993, and then started to improve after 1994. Manufacturing employment declined by more than 1% per annum between 1989 and 1996, and by 1996 total employment was nearly 10% less than in 1989. In fact manufacturing employment declined faster per annum than total employment in the South African economy between 1989 and 1996. Manufacturing output grew by an average of 0.02% per annum between 1989 and 1996. This was considerably slower than the average growth of GDP (1.2% per annum) during the same period. Thus the performance of the manufacturing sector between 1989 and 1996 was even worse than the performance of the macroeconomy (see Table 2). Table 2. South Africa Manufacturing Sector Performance, 1989-1996 Figures in italics are in percentages. Year (1) 1989 100.5 1990 100 -0.5 100 -0.4 1581 1991 96.5 -3.5 96.4 -3.6 1992 92.6 -4.0 93.5 1993 91.9 -0.8 1994 94.1 2.4 1995 100.8 1996 101.9 Avg: 89-96 Change: 89Notes:96 % change (2) 64813 % change -0.1 63064 -2.7 1546 -2.2 60183 -4.6 -3.0 1504 -2.7 58209 -3.3 93.3 -0.2 1477 -1.8 58316 0.2 95.8 2.7 1480 0.2 59791 2.5 7.1 103 7.5 1493 0.9 64351 7.6 1.1 103.3 0.3 1437 -3.8 64581 0.4 100.4 0.3 1.4 % change (3) % change 1583 0.5 2.9 (4) -1.4 -9.2 0.02 -0.4 (1) Value of Manufacturing Sales (1990=100) (2) Volume of Manufacturing Sales (1990=100) (3) Manufacturing Employment (‘000) (4) Value of Manufacturing Output (1990 Rand Million) Source: South African Reserve Bank, Quarterly Bulletin, various issues. 4. South Africa’s Defence Market The size and structure of South Africa’s defence market has changed quite dramatically since the late 1980s (Batchelor & Willett, 1998). Between 1989 and 1996 South Africa’s defence budget was cut by 50% in real terms, while procurement expenditure declined by nearly 70% during the same period. While the overall defence market declined by nearly 70% between 1989 and 1996 (average of 15% per annum), the domestic market only declined by 53% (average of 10% per annum) during the same period (see table 3). Before 1992 the state-owned company Armscor acted as the procurement agency for the South African Defence Force (SADF). It also owned a number of arms production subsidiary companies, and was the major domestic producer of armaments. In 1992 Armscor was split into Denel, a new state-owned industrial company, which inherited all of Armscor’s former arms production and research facilities; and Armscor, which retained responsibility for procurement for the SADF (Batchelor & Willett, 1998). Table 3. South African Defence Market, 1989-1996 Figures are in Rand million in constant 1990 prices. Figures in italics are in percentages. Year Total Market* 6236 5126 3931 3242 3162 2427 2167 1984 % change Domestic Market + 3618 2973 3123 2696 2625 2093 1808 1707 % change Domestic/ Total (%) 58 58 79 83 83 86 83 86 77 1989 1990 -17.8 -17.8 1991 -23.3 5.1 1992 -17.5 -13.7 1993 -2.5 -2.6 1994 -23.2 -20.3 1995 -10.7 -13.6 1996 -8.4 -5.6 Average -14.8 -9.8 89-96 Notes * Based on total value of Armscor Acquisition Spending for Departments of Defence, Safety and Security (Police) and Correctional Services (Prisons). + Value of Domestic Acquisition Spending Source: Armscor; Armscor Annual Report (various years) Apart from the creation of Denel, there has been a marked change in the structure of the supply side of the market. This has resulted from South Africa’s re-admittance into the international community and the lifting of the United Nations mandatory arms embargo in May 1994, which has allowed South Africa to purchase armaments from foreign suppliers for the first time since 1977. The value of arms imports has declined since the late 1980s, largely as a result of lower levels of procurement spending, while the share of imports in total procurement spending has remained relatively constant since the early 1990s. Between 1992 and 1996, the share of imports in the overall defence market fluctuated between 17% and 14% (average of 16%). Denel’s share fluctuated between 34% and 44% (average of 40%) between 1992 and 1996, while the private sector’s share has fluctuated between 40% and 49% (average 44%) during the same period (see Table 4). Table 4. Structure of South African Defence Market, 1992-96 Figures are percentages. Year 1992 1993 1994 1995 1996 Average 1992-96 Imports 17 17 14 17 14 16 Denel 43 34 38 42 44 40 Private Sector 40 49 48 42 42 44 Total 100 100 100 100 100 100 Sources: Armscor Annual Report (various years); Denel Annual Report (various years). The structure of the domestic defence market has also changed in the last few years. Denel has continued to dominate the domestic defence market, averaging 48% of the domestic market since 1992, while the private sector’s share has averaged 52%. However, Denel’s current share of the domestic market is significantly lower than in the 1980s, when the former Armscor subsidiary companies (now part of Denel) accounted for nearly 70% of the domestic market (Batchelor & Willett, 1998). In addition to its 48% aggregate share of the domestic defence market, Denel continues to dominate most of the seven major sectors of the domestic defence market, particularly aerospace, ammunition (small, medium and large calibre), weapons systems (including infantry weapons, cannons, artillery systems and missiles) and military vehicles. The other major sectors of the domestic defence market, namely electronics, maritime and support equipment are dominated by the three largest private sector defence firms, namely Reunert, Altech and Grintek. Denel also dominates many of the sub-sectors of the domestic defence market such as information technology, and testing. The three largest private sector defence firms (Reunert, Grintek and Altech) completely dominate the private sector’s share of the domestic defence market. In 1996, the three firms accounted for over 80% of the private sector’s share of the domestic defence market. Since the early 1990s these three firms have acquired many small and medium sized private defence firms in an attempt to consolidate their positions in the domestic market. These firms, like Denel, have also attempted to vertically integrate, by outsourcing far less of their defence business than in the past. This process of vertical integration has had a very negative impact on the hundreds of smaller defence firms, particularly those that act as suppliers and sub-contractors for the larger defence firms. In the last few years many small and medium-sized private defence firms have exited the defence market, merged with, or been acquired by, larger defence firms (e.g. Reunert acquired the armoured car division of TFM in early 1997). As a result, the domestic defence market (excluding imports) has become increasingly concentrated. In 1996 Denel and the three largest private sector defence firms accounted for over 90% of total domestic acquisition spending. Although Denel dominates a number of sectors of the domestic defence market, the private sector defence industry is still extremely important. In 1996, Denel was smaller than Reunert in terms of turnover (see Table 5), but larger than Altech and Grintek. By 1996, according to interviews with company officials, none of the private sector companies had defence taking up more than 20% of turnover. Denel is clearly much more dependent on arms production and exports than the private sector companies, and in 1996 Denel’s defence sales, including exports, accounted for 64% of turnover (Denel Annual Report, 1996/97). 5. Firm Performance in South Africa’s Public and Private Sector Defence Industry The dramatic cuts in defence spending, and particularly procurement spending, have had a significant impact on the performance of South Africa’s public and private sector defence industry. Denel’s financial performance since its establishment in 1992 has not been particularly impressive. Over the period 1992-96 its turnover declined by an average of nearly 6% per annum in real terms, while the three largest private sector companies, Reunert, Altech and Grintek, witnessed positive average annual increases in turnover during the same period. The average annual growth in Denel’s net profit between 1992 and 1996 was better than Altech and Grintek but worse than Reunert. It is striking that Denel has a much higher level of total assets relative to turnover than the private sector companies, suggesting it retains poorly performing assets. The relatively high value of Denel’s total assets relative to the private sector companies is largely a result of the fact that Denel’s assets are valued at book value rather than market value. Denel’s total employment declined by nearly 9 percent between 1992 and 1996, and by an average of 2 percent per annum (see Table 5). During the same period Reunert's employment declined by slightly less than Denel's. Both Altech and Grintek witnessed declines in total employment by over 20%. Table 5. Denel and Private Sector Defence Firms, 1992-1996 Figures are in 1996 Rand Million. Figures in italics are in percentages. Year 1992 1993 1994 1995 1996 3839 3507 3376 3506 3013 -9 -4 4 -14 2906 3933 4890 4915 -6 35 24 1 1147 1206 1379 1593 -5 5 14 15 1687 1887 2106 2230 0 12 12 6 294 348 390 82 -8 18 12 -79 134 181 195 203 8 36 7 4 110 68 66 5 -12 -38 -3 -92 36 46 53 7 -33 29 15 -87 5771 4562 4520 4253 -6 -21 -1 -6 1687 2452 2689 2532 0 45 10 -6 1053 1024 1001 1048 15 -3 -2 5 791 920 1071 1598 7 16 16 49 13895 13826 14150 14200 -11 0 2 0 13251 15323 15938 12733 -4 16 4 -20 3966 3641 3730 3494 -12 -8 2 -6 3201 2827 3009 2319 -3 -12 6 -23 Avg: 92-96 Turnover Denel % change Reunert 3104 % change Altech 1214 % change Grintek 1683 % change -5.8 13.5 7.4 7.4 Net Profit Denel 320 % change Reunert 124 % change Altech 125 % change Grintek 53 % change -14.2 13.8 -36.5 -19.0 Total Assets Denel 6166 % change Reunert 1683 % change Altech 916 % change Grintek 740 % change Employment (numbers) Denel 15572 % change Reunert 13863 % change Altech 4514 % change Grintek % change 3299 Sources: Company Annual Reports, various years. -8.5 12.4 3.7 22.2 -2.1 -1.2 -6.1 -7.8 Although Denel has managed to remain profitable for the first few years of its corporate existence, the company’s financial performance relative to the large private sector defence groups has not been particularly impressive (see Table 6). Denel’s net profit margin (net profit/turnover) was on average higher than the private sector companies for the period 1992-96. However its return on assets (net profit/ total assets) was on average lower than the private sector companies, except for Grintek. Denel's relatively poor return on assets was due to the capital-intensive and non-performing nature of many of its assets. It was also a function of the fact that the company’s assets were valued at book value rather than market value. Denel’s return on assets improved slightly after 1993, as a result of the fact that the company’s assets were revalued through a capital reduction of R700 million during 1994/95 as a result of the termination of the space program at Houwteq. Denel’s economic performance between 1992 and 1996 relative to the 3 major private sector defence groups was also mixed (see table 6). Denel’s labour productivity, as measured by turnover per employee was lower on average than the 3 private sector companies. However, the company's labour efficiency (net profit per employee) was higher on average than the private sector companies. Table 6. Denel and Private Sector Firms, Corporate Performance, 1992-96 Figures are in Rand in 1996 prices. Figures in italics are in percentages. Year 1992 1993 1994 1995 1996 Avg: 1992-96 Net Profit Margin(1) Denel 8.3 8.4 10.3 11.1 2.7 8.2 Reunert 4.0 4.6 4.6 4.0 4.1 4.3 Altech 10.3 9.6 5.7 4.8 0.3 6.1 Grintek 3.2 2.1 2.4 2.5 0.3 2.1 Return on Assets (2) Denel 5.2 5.1 7.6 8.6 1.9 5.7 Reunert 7.4 7.9 7.4 7.2 8.0 7.6 Altech 13.7 10.5 6.7 6.6 0.5 7.6 Grintek 7.2 4.5 5.0 4.9 0.4 4.4 Labour Productivity (3) Denel 246532 252393 244178 247774 212183 240612 Reunert 223872 219268 256661 306794 386005 278520 Altech 268918 289269 331241 369807 455924 343032 Grintek 510022 527059 667456 699962 961621 673224 Labour Efficiency (4) Denel 20550 21159 25170 27562 5775 20043 Reunert 8943 10093 11839 12225 15943 11809 Altech 27767 27844 18761 17689 1431 18698 Grintek 16106 11116 16241 17473 3019 12791 Notes: (1) Net Profit/Turnover (2) Net Profit/Total Assets (3) Turnover/Employment (4) Net Profit/Employment Sources: Company Annual Reports, various years. 6. Defence and Non-defence Company Performance It is clear that the defence sector and its constituent companies have undergone considerable changes since the start of the transition to democracy. To better understand the influence of their dependence on defence procurement it is important to be able to compare their performance with that of other non-defence companies. This section uses various financial ratios to undertake such a comparison. Appendix 1 discusses the methodology of constructing the samples used. There are 7 companies in the sample of defence companies - Reunert, Altech, Grintek, Logtek, Spescom, Dorbyl and Plessey. All of the companies except Dorbyl are listed in the electronics sector of the Johannesburg Stock Exchange (JSE). The sample of 33 nondefence companies represents a range of firms in various industries such as beverages and hotels; building and construction; chemicals and oils; electronics; engineering; food; paper and packaging; retail; steel allied and transport. For each sample the mean values of six financial variables (total assets, market capitalisation, equity funds, net profit, turnover and employment) were computed. In addition the growth between the first and last year of the sample period (1988 and 1997) was computed for each sample. As Table 7 shows, a simple comparison of the growth rates for various size indicators for each sample suggests that the performance of non-defence companies has been better than defence companies during the sample period. Between 1988 and 1997, the turnover of the defence sample grew by almost 124%, while that of the non-defence sample grew by more then double that, 314%. Across all of the other measures total assets, market capitalisation, equity funds, net profit and employment the non-defence companies have outperformed the defence ones by a considerable margin. To evaluate the relative performance of the two samples, various aspects of firm performance for both defence and non-defence companies were analysed using various financial ratios. Appendix 1 provides definitions of all the financial ratios used in the following section and Table 8 gives the computed values. Table 7. Financial Information, 1988-1997 Figures are mean values in current Rand Million. Figures in italics are in percentages. 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 785.3 587.8 530.2 548.9 618.01 697.93 844.3 849.4 1117.2 1211.3 -25.1 -9.8 3.5 12.6 12.9 21.0 0.6 31.5 8.4 543.5 370.7 400.9 502.5 478.55 792.5 1177.4 1131.6 757.7 9.9 -31.8 8.1 25.3 -4.8 65.6 48.6 -3.9 -33.0 315.7 243.6 276.5 294.6 325.63 378.1 410.3 515.9 598.4 -9.0 -22.8 13.5 6.5 10.5 16.1 8.5 25.7 16.0 Defence Companies Total Assets 1988-97 % change Market Capitalisation 494.6 % change Equity Funds 346.9 % change Net Profit 49.4 57.7 45.7 49 46.2 31.97 38.1 56.6 68.3 67.6 16.8 -20.8 7.2 -5.7 -30.8 19.2 48.6 20.7 -1.0 921.4 862.8 973.9 1104.3 1092 1381.1 1482.5 1862.9 2053.1 0.5 -6.4 12.9 13.4 -1.1 26.5 7.3 25.7 10.2 14060 10956 9594.8 9323.8 8011.3 8195 6773.2 5405.3 5170.8 2.1 -22.1 -12.4 -2.8 -14.1 2.3 -17.3 -20.2 -4.3 1173.6 1670.4 1902.4 2225.1 2585.3 2887.5 3212 3900.3 4481.3 5193.9 42.3 13.9 17.0 16.2 11.7 11.2 21.4 14.9 15.9 763.3 1146 1267.4 1682.3 1671 2207.3 3552.8 3602 3761.5 3621.1 50.1 10.6 32.7 -0.7 32.1 61.0 1.4 4.4 -3.7 839.9 964 1069.4 1225.9 1325.9 1477.3 1754.5 1979.8 2344 59.8 14.8 10.9 14.6 8.2 11.4 18.8 12.8 18.4 159.4 170 148.8 143.7 144.5 165.4 254.8 265.2 278.5 80.9 6.6 -12.5 -3.4 0.6 14.5 54.1 4.1 5.0 1912.6 2226.1 2499.6 2813.2 3141.2 3532.3 4217.3 4866.4 5832.7 35.8 16.4 12.3 12.5 11.7 12.5 19.4 15.4 19.9 15482 15970.5 15319.5 15440.6 14978.6 14575.3 14645.4 13565.3 13965.2 14.3 3.2 -4.1 0.8 -3.0 -2.7 0.5 -7.4 2.9 % change Turnover 916.8 % change Employment % Growth 13775.7 % change 54.2 53.2 72.5 36.8 123.9 -62.5 Non-Defence Companies Total Assets % change Market Capitalisation % change Equity Funds 525.5 % change Net Profit 88.1 % change Turnover 1408.9 % change Employment % change 13541.3 342.6 374.4 346.1 216.1 314.0 3.1 Table 8. Financial Ratios, 1988-1997 Figures are in percentages based on mean values in current Rand Million. Year 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 Defence Companies Asset Turnover 1988-97 116.7 % change Return on Equity 14.2 % change Return on Assets 6.3 % change Net Profit Margin 5.4 % change Labour Productivity 6.7 % change Labour Efficiency 0.4 % change Gearing 29.9 % change Capital Turnover % Growth 185.4 % change 156.8 162.7 177.4 178.7 156.5 163.6 174.5 166.8 169.5 34.4 3.8 9.0 0.7 -12.4 4.5 6.7 -4.4 1.6 18.3 18.8 17.7 15.7 9.8 10.1 13.8 13.2 11.3 28.9 2.7 -5.9 -11.3 -37.6 3.1 36.6 -4.3 -14.4 9.8 8.6 8.9 7.5 4.6 4.5 6.7 6.1 5.6 55.6 -12.2 3.5 -15.7 -38.7 -2.2 48.9 -9.0 -8.2 6.3 5.3 5 4.2 2.9 2.8 3.8 3.7 3.3 16.7 -15.9 -5.7 -16.0 -31.0 -3.4 35.7 -2.6 -10.8 6.6 7.9 10.2 11.8 13.6 16.9 21.9 34.5 39.7 -1.5 19.7 29.1 15.7 15.3 24.3 29.6 57.5 15.1 0.4 0.4 0.5 0.5 0.4 0.5 0.8 1.3 1.3 0.0 0.0 25.0 0.0 -20.0 25.0 60.0 62.5 0.0 41.9 34.3 31 41.4 32 52.3 65.2 54.4 21 40.1 -18.1 -9.6 33.5 -22.7 63.4 24.7 -16.6 -61.4 169.5 232.7 243 219.7 228.2 174.3 125.9 164.6 271 -8.6 37.3 4.4 -9.6 3.9 -23.6 -27.8 30.7 64.6 114.5 117 112.3 108.8 108.8 110 108.1 108.6 112.3 162.3 14.3 6.9 4.3 17.0 0.7 40.3 201.4 Non-Defence Companies Asset Turnover 120.1 % change Return on Equity 16.8 % change Return on Assets 7.5 % change Net Profit Margin 6.3 % change Labour Productivity 10.4 % change Labour Efficiency 0.7 % change Gearing 31.2 % change Capital Turnover 184.6 -4.7 2.2 -4.0 -3.1 0.0 1.1 -1.7 0.5 3.4 19 17.6 13.9 11.7 10.9 11.2 14.5 13.4 11.9 13.1 -7.4 -21.0 -15.8 -6.8 2.8 29.5 -7.6 -11.2 9.5 8.9 6.7 5.6 5 5.1 6.5 5.9 5.4 26.7 -6.3 -24.7 -16.4 -10.7 2.0 27.5 -9.2 -8.5 8.3 7.6 6 5.1 4.6 4.7 6 5.4 4.8 31.7 -8.4 -21.1 -15.0 -9.8 2.2 27.7 -10.0 -11.1 12.4 13.9 16.3 18.2 21 24.2 28.8 35.9 41.8 19.2 12.1 17.3 11.7 15.4 15.2 19.0 24.7 16.4 1 1.1 1 0.9 1 1.1 1.7 2 2 42.9 10.0 -9.1 -10.0 11.1 10.0 54.5 17.6 0.0 26.7 23.9 36.4 26.6 39.9 58.4 51.3 47.4 35.3 -14.4 -10.5 52.3 -26.9 50.0 46.4 -12.2 -7.6 -25.5 166.9 175.6 148.6 168.4 142.3 99.4 117.1 129.4 161.1 112.1 14.1 6.6 5.9 22.3 1.3 37.7 149.3 % change 01:24, 1/22/00 -9.6 5.2 -15.4 13.3 -15.5 -30.1 19 17.8 10.5 24.5 6.1 Profitability Martin et al (1996) suggest that defence dependent firms will have different levels of profitability to civil ones. There are a number of debates surrounding the most appropriate measure of profitability. Therefore, three measures of profitability were used: • Return on Equity = (Net Profit)/Equity • Return on Assets = (Net Profit)/(Total Assets) • Net Profit Margin = (Net Profit)/Turnover The values for return on equity in Table 8 do not support their hypothesis and suggest that the average level of return on equity for both defence and non-defence companies was fairly similar (around 14%) for the period between 1988 and 1997. As Graph 1 illustrates between 1990 and 1993 the defence companies were generally more profitable by this measure, but after 1993 their profitability was lower than the non-defence companies. This pattern might be explained by the fact that after 1993 the severity of the cuts in procurement spending began to impact more significantly on the profitability of defence companies. The return on assets ratios show a similar pattern in Graph 2. While defence companies had a higher return on assets than non-defence companies in two distinct periods: 1991-92 and 1995-97, the general trend over the entire period is fairly similar for both. The findings for return on equity and return on assets are in line with the results of a 1995 study in the UK (Review Board, 1995). In contrast, Graph 3 shows that if the net profit margin ratio is used as a measure of profitability (net profit relative to changes in the price of output, i.e. turnover), defence companies had lower average profit margins than the non-defence companies for the entire period 1988-1997. This is consistent with the hypothesis of Martin et al (1996), but does suggest that any higher profit margins that defence companies may have received through the use of cost plus contracts have been adversely effected by the severity of the defence cuts, and the increasingly competitive domestic defence market. The monopsony power of the Defence Ministry in awarding contracts, export restrictions (which reduce sales and limit economies of scale), and the highly competitive nature of the defence market (which forces defence contractors to charge unrealistically low prices in order to win contracts) could all have influenced the relatively low profitability of the defence companies. Gansler (1989) discusses this for US defence firms. 6.2. Gearing The Gearing ratio is commonly used to evaluate the level of corporate borrowing or a firm’s leverage. It is also used to determine the liquidity of a company, especially during either recession or financial crisis. • 2 Gearing Ratio = 1 - [(Equity Funds)/(Market Capitalisation Value)] Martin et al (1996) suggest that firms dependent on defence procurement are likely to be more financially leveraged, because their preferential position gives them a lower risk of bankruptcy. The values in Table 8 suggest that the average gearing ratio was indeed higher amongst defence companies than non-defence companies. As Graph 4 shows, however, there were considerable fluctuations in the trends in gearing ratios for both defence and nondefence companies. Generally, the level of gearing by defence companies showed a rising trend after 1990 a steep fall in 1995. The cuts in defence spending which occurred after 1989 probably forced defence companies to look for alternative sources of finance, and so increase their levels of gearing There may be specific reasons for the relatively higher gearing ratios of defence companies in 1992, 1995 and 1996. Defence companies may have used higher gearing as a means of raising finance from government sources. In 1992, for instance, when the government established Denel as a new state-owned armaments company, many private defence companies may have considered this development as 2 Note this is the same as Debt/(Debt + Equity) 01:24, 1/22/00 21 a competitive threat. As a result, private defence companies may have raised their gearing ratios to obtain more financing from the government and to secure their overall financial positions. The same was repeated in 1995. After the lifting of the United Nations mandatory arms embargo in May 1994, many private defence companies once again raised their gearing ratios, perhaps in response to the prospect of a more competitive domestic defence market and the entry of international suppliers. 6.3. Asset Utilisation As mentioned above, changes in the level of gearing can be used by defence companies as a means of raising finance from government sources. Managers who skilfully change their gearing ratios are also expected to be able to control their financial resources efficiently. To evaluate how efficiently defence companies use their financial resources, we examine the capital turnover ratio: • Capital Turnover = (Turnover)/(Market Capitalisation) This indicates the efficiency of use of shareholders’ funds in generating sales. Graph 5 suggests that defence companies had a higher average capital turnover ratio for most of the period. These results may be due to more efficient management of financial resources in defence companies, or the considerably lower market value of defence companies coupled with considerably higher unit prices for defence products. The sharp rise in defence companies’ capital turnover ratio in 1996 and 1997 was due to sharp drops in the market capitalisation of defence companies (4% in 1996 and 33% in 1997) which were accompanied by increases in turnover (26% in 1996 and 10% in 1997). 6.4 Labour Productivity A company’s performance can also be assessed relative to its labour resources, evaluating the efficiency of labour in generating turnover and profits. This can be measured by examining labour productivity or labour efficiency: • Labour Productivity = (Turnover)/(Total Number of Employees) 01:24, 1/22/00 22 • Labour Efficiency = (Net Profit)/(Total Number of Employees) Martin et al (1996) suggested that government dependence was likely to have adverse effects on labour productivity and Graph 6 would appear to support this. Non-defence companies tended to have a higher average level of labour productivity than defence companies during the period 1988-97. Labour productivity for both samples increased by similar rates for most of the period, but labour productivity amongst defence companies seemed to improve slightly faster in 1996 and 1997 (see Table 8). This could have been the result of large retrenchments accompanied by significant increases in the value of total assets (investment) and turnover (sales). The results in Graph 7 show that non-defence companies had a higher average level of labour efficiency than defence companies between 1988 and 1997. The difference between the two samples was also relatively constant over the period, with both experiencing significant increases in labour efficiency after 1994, largely as a result of retrenchments. In general, the improvements in labour productivity appear to have occurred for all South African companies over the period between 1988 and 1997. Certainly, the ending of apartheid and the coming to power of the ANC (in alliance with COSATU) has helped to reduce the number of work days lost to strikes and industrial action, which in turn has had a positive impact on labour productivity. Significant investments in capital and technology after 1994 (reflected in increases in total assets), and a positive macroeconomic climate (reflected in increases in turnover and net profit), together with significant retrenchments also contributed to the improvements in labour productivity and labour utilisation (see Table 9). Table 9. Growth Rates in Turnover, Total Assets, Net Profit and Employment 1988-97 Figures are in percentages, based on changes in current prices. 01:24, 1/22/00 23 Turnover Total Assets Net Profit Employment Growth: 1988-1997 Defence Non-defence 123.9 314.0 54.2 342.6 36.8 216.1 -62.5 3.1 Average Annual Growth: 1988-97 Defence Non-defence 9.9 17.3 6.2 18.3 6.0 16.7 -9.9 0.5 Source: Calculated from Tables 7 and 8. 7. Conclusions This paper has provided an analysis of the changes in performance of defence companies in South Africa during the period of military expenditure cuts and defence industry downsizing which has occurred since the late 1980s. Despite the process of restructuring, the industry remains dominated by one large state owned industrial company, Denel, and three large private sector defence companies - Reunert, Altech and Grintek. Since its inception in 1992 Denel has pursued a policy of downsizing and diversification in order to fit the more limited domestic defence market. At the same time, the large private sector defence firms have also had to adjust to the changed market environment. However, the fact that these companies’ dependence on defence sales is less than 20% of turnover means that their problems are not as severe as Denel’s. Both Denel and the large private sector defence companies have engaged in policies of vertical integration, diversification and the acquisition of small and medium sized defence firms. This has led to increasing concentration and monopolisation in the domestic defence market and has threatened the viability of many smaller defence firms. Comparing the performance of the seven main private sector defence companies to a sample of non-defence companies for the period 1988-97 produces some interesting results. An analysis of the growth rates in turnover, total assets and net profit amongst defence companies suggested relatively slow growth and significant fluctuations compared to non-defence companies. During the sample period the defence companies experienced significant negative growth in employment, as a result of the dramatic cuts in defence spending, while non-defence companies experienced marginal positive growth in 01:24, 1/22/00 24 employment. Using financial ratio analysis it was evident that private sector defence companies in South Africa have a lower net profit margin than non-defence companies, but a similar return on assets and return on equity. Gearing was generally higher for defence companies, suggesting higher levels of financial leverage, but there were considerable variations during the last few years. As expected, defence companies were found to have a higher capital turnover ratio than non-defence companies, suggesting that they were managing their financial resources more efficiently than non-defence companies. Labour productivity and labour efficiency was considerably lower for defence companies, indicating that they utilised their labour resources less efficiently. These results are generally consistent with the findings of other studies for countries with large defence industries (Gansler, 1989, Martin et al, 1996). The defence companies performed as well as the non-defence companies over the period 1988-97 when financial ratios are considered, but they have performed much worse in terms of growth. This would suggest a “hollowing out” of the companies with marked reductions in the relative size and capacity of the defence companies. It is also important to bear in mind the nature of the industry in South Africa. All of the main private defence contractors are part of larger more diversified industrial conglomerates who could make up declines in defence business through expansion in non-defence divisions. Thus the full impact of the cuts on the defence divisions is likely to have been much greater. In addition, the impact of the cuts is likely to have been more pronounced for small and medium sized privately owned companies that had high levels of dependence on defence work, but for whom financial data is not readily available. Overall, the results suggest that the private sector defence companies have been relatively successful in downsizing their defence production without compromising their financial performance relative to non-defence companies. 01:24, 1/22/00 25 References Archer, S., (1989), ‘Defence Expenditure and Arms Procurement in South Africa’ in Cock, J., and Nathan, L., eds., War and Society: The Militarisation of South Africa, David Philip, Cape Town. Armscor (various years), Annual Report, Armscor, Pretoria. Armscor (various issues), Armscor Acquisition Bulletin, Armscor, Pretoria. Armscor (various years), South African Defence Industry Directory, Armscor, Pretoria. Batchelor, P., (1996), Militarisation, Disarmament and Defence Industrial Adjustment: The Case of South Africa, Unpublished PhD Dissertation. University of Cambridge. Batchelor, P., and Willett, S., (1998), Disarmament and Defence Industrial Adjustment in South Africa, Stockholm International Peace Research Institute and Oxford University Press, Oxford. Bowlin, F., (1995), ‘A note on the financial condition of defence contractors’, Defence and Peace Economics, 6, 4, 295-304. Brzoska, M., (1986), ‘South Africa: Evading the Embargo’, in Brzoska, M., and Ohlson,T., eds., Arms Production in the Third World, Taylor and Francis, London. Brzoska, M., (1991), ‘Arming South Africa in the Shadow of the UN Arms Embargo’, Defence Analysis, 7, 1, 21-38. Brzoska, M., and Lock, P., eds., (1992), Restructuring of Arms Production in Western Europe, Stockholm International Peace Research Institute and Oxford University Press, Oxford. Buys, A., (1992), ‘The Future of the South African Armaments Industry’, South African Defence Review, 7, 5-9. Cilliers, J., (1994), ‘The Future of the South African Defence industry’, in Garba, J., ed., Towards Sustainable Peace and Stability in Southern Africa, Institute of International Education, New York. Cobbett,W., (1989), ‘Apartheid's Army and Arms Embargo’, in Cock,J., and Nathan, L., eds., War and Society: The Militarisation of South Africa, David Philip, Cape Town. De Waal,T., (1993), ‘Commercialisation of the Defence Industry: Issues Faced in the Procurement of Arms’, South African Defence Review, 11, 7-10. De Wet,G., Jonkergouw, E., Koekemoer, R., Schoeman, N., Steyn, F., and Truu, M., (1996), ‘The Peace Dividend in South Africa’, in Gleditsch, N., Bjerkholt, O., Cappelen, 01:24, 1/22/00 26 A., Smith, R., and Dunne, P., eds. (1996), The Peace Dividend, Elsevier Science B.V., Amsterdam. Dunne, P., (1993), ‘The Changing Military industrial Complex in the UK’, Defence Economics, 4,2, 1-12. Dunne, P., (1995), ‘The Defence Industrial Base’ in Hartley,K., and Sandler,T., Handbook of Defence Economics, North Holland, Amsterdam. Dunne, P., and Schofield, S., "Contracts, Competition and Performance in the British Defence Industry", Discussion Paper No. 16, School of Economics, Middlesex University, December 1995. Financial Mail (various years), Top Companies Survey, Financial Mail, Johannesburg. Fine,B., and Rustomjee,Z., (1996), The Political Economy of South Africa: From Minerals-Energy Complex to Industrialisation, Hurst and Company, London. Hartley,K., and Sandler,T., (1995), Handbook of Defence Economics, North Holland, Amsterdam. Hartley,K., and Sandler,T., (1995), The Economics of Defence, Cambridge University Press, Cambridge. Heitman, H., (1992), ‘South Africa's Defence Industry: Challenges and Prospects’, South African Defence Review, 2, 26-34. Heitman, H., (1992), ‘The South African Defence Industry: Present and Future Prospects’, South African Defence Review, 7, 15-25. Gansler, J., (1980), The Defense Industry, MIT Press, London. Gansler,J., (1989), Affording Defense, MIT Press, London. Geroski,P. (1990), ‘Procurement policy as a part of industrial policy’, International Review of Applied Economics, June, 182-198. Joffe, A., Kaplan, D., Kaplinsky, R., and Lewis, D., (1995), Improving Manufacturing Performance in South Africa: Report of the Industrial Strategy Project, University of Cape Town Press, Cape Town. Landgren, S., (1989), Embargo Disimplemented: South Africa's Military Industry, Stockholm International Peace Research Institute and Oxford University Press, Oxford. Levitt, M., and Joyce, M., (1987), The Growth and Efficiency of Public Spending, Cambridge University Press, Cambridge. 01:24, 1/22/00 27 Martin, S., White,R., and Hartley,K., (1996), ‘Defence and Firm Performance In the UK’, Defence and Peace Economics, 7, 325-337. Matthews, R., (1988), ‘The Development of the South African Military Industrial Complex’, Defence Analysis, 4, 1, 7-24. McMillan, S., (1992), ‘Economic Growth and Military Spending in South Africa’ International Interactions, 18, 1, 35-50. Michie, J., and Padayachee, V., eds. (1997), The Political Economy of South Africa’s Transition: Policy Perspectives in the Late 1990s, Dryden Press, London. Nattrass, N., and Ardington, E., eds (1990), The Political Economy of South Africa, Oxford University Press, Cape Town. Rogerson, C., (1990), ‘Defending apartheid: Armscor and the Geography of Military Production in South Africa’, GeoJournal, 22, 3, 241-250. Rogerson, C., (1995), ‘The Question of Defence Conversion in South Africa: Issues from the International Experience’, Africa Insight, 25, 3, 154-162. Roux, A., (1994), ‘Defence, Human Capital and Economic Development in South Africa’, South African Defence Review, 19, 14-22. Schrire, R., ed. (1990), Critical Choices for South Africa: An Agenda for the 1990s, Oxford University Press, Cape Town. Schrire, R., ed. (1992), Wealth or Poverty? Critical Choices for South Africa, Oxford University Press, Cape Town. Simkins, C., (1994), ‘The South African Economy: Problems and Prospects’, in Spence, J., ed., Change in South Africa, Pinter, London. Simpson, G., (1989), ‘The Politics and Economics of the Armaments Industry in South Africa’, in Cock, J., and Nathan,L. (eds), War and Society: The Militarisation of South Africa, David Philip, Cape Town. Singh, R., and Wezeman, P., (1995), ‘South Africa’s Arms Production and Exports’, in SIPRI Yearbook 1995: Armaments, Disarmament and International Security, Oxford University Press, Oxford. Todd, D., (1988), Defence Industries: A Global Perspective, Routledge, London. Trevino,R., and Higgs,R., (1992), ‘Profits of US defense contractors’, Defence Economics, 3, 211-218. Wulf,H., ed., (1993), Arms Industry Limited, Stockholm International Peace Research Institute and Oxford University Press, Oxford. 01:24, 1/22/00 28 01:24, 1/22/00 29 APPENDIX 1. Sources and Methods There are considerable problems in obtaining detailed disaggregated financial information on defence companies, as Martin et al (1996) discuss. There is no clear definition of the South Africa defence industrial base. Some definitions focus on the products (e.g. aircraft, missiles, tanks) which are produced by firms in the country’s industrial base. Other definitions attempt to include the supply chain and all manufacturing firms which act as contractors, subcontractors or suppliers to Armscor, the Ministry of Defence’s procurement agency. No official South African government source provides data on the domestic defence industry. In addition, South African national economic data also does not have a separate International Standard Industrial Classification (ISIC) category for defence production. In the absence of official information, information on defence companies was obtained from a number of sources: 1) Armscor’s Acquisition Bulletin; 2) the South African Aerospace, Maritime and Defence Industry Association (AMD) and 3) the South African Defence Industry Directory, which is published bi-annually. From these sources it was possible to construct a fairly complete list of the names of defence companies in South Africa. However, none of these sources collect detailed disaggregated financial data for the various defence companies. For the purposes of this paper ‘defence companies’ are defined as those companies which are directly and indirectly involved in some aspect of armaments production. Disaggregated financial data for South African industrial companies is readily available. The Top Companies Survey, which is published annually by the Financial Mail, includes detailed financial information (total assets, market capitalisation, net profit, net equity, turnover and total employment) on South Africa’s top 300 private sector industrial companies. A sample of defence and non-defence companies was selected for the purposes of this paper, utilising the constructed list of defence companies (as described above) and the financial data contained in the annual Top Companies Survey. Additional information on defence and non-defence companies was obtained from other sources, including McGregors Who Owns Whom in order to verify and cross check the information obtained from the Top Companies Survey. Financial data was collected for 7 defence and 33 nondefence companies for the sample period 1988-1997. The sample period was chosen to capture the effects of the dramatic cuts in defence spending, which have take place since the late 1980s, on firm performance. All of the companies in the defence and non-defence sample are publicly quoted companies on the Johannesburg Stock Exchange (JSE). Therefore detailed financial information on the companies is also publicly available through annual reports, shareholder meetings etc. The total sample contains 40 companies. It is divided into two subsamples: 1) 7 defence companies, and 2) 33 non-defence companies. Each sample covers differences in the size (measured by turnover, assets and employment), ownership structure, products and services, industrial sector and geographical location of companies. All 7 companies in the defence sample are directly or indirectly involved in some aspect of armaments production, but in none of companies is defence dependence (defence sales as a share of turnover) amount to more than 20%. The sample of 33 non-defence companies covers 10 major 01:24, 1/22/00 30 sectors of the industrial economy: • beverages and hotels (313) • building and construction • chemicals and oils (351/352) • electronics (383) • engineering (382) • food (311/312) • paper and packaging (341) • retail • steel allied (371) • transport (385) These 10 sectors correspond with most of the major ISIC categories of the manufacturing sector (ISIC 3 digit categories in brackets). Companies included in the sample are: Defence Companies Company Sector 1. 2. 3. 4. 5. 6. 7. Electronics Electronics Electronics Electronics Electronics Engineering Electronics Reunert Altech Grintek Logtek Spescom Dorbyl Plessey Non-defence Companies Company Sector 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17. 18. 19. SA Breweries Alpha PPC Group 5 Boumat Sasol AECI Sentrachem Powertech ED L Bate Metkor Afrox Haggie NEI Africa Tiger Oats ICS Rainbow Tongaat-Hulett Sappi 01:24, 1/22/00 Beverages & Hotels Building & Construction Building & Construction Building & Construction Building & Construction Chemicals & Oils Chemicals & Oils Chemicals & Oils Electronics Engineering Engineering Engineering Engineering Engineering Food Food Food Food Paper and Packaging 31 20. 21. 22. 23. 24. 25. 26. 27. 28. 29. 30. 31. 32. 33. Nampak Consol Metcash Pick n Pay Pep Wooltru Waltons Pepkor Iscor Hiveld USKO Trencor Putco Toyota Paper and Packaging Paper and Packaging Retail Retail Retail Retail Retail Retail Steel Allied Steel Allied Steel Allied Transport Transport Transport 2. Definitions of Company Information In order to make comparisons between the performance of defence and non-defence companies it is necessary to have basic financial information on each company. The following 6 categories of financial information (with definitions) for all companies in the sample was obtained from the annual Top Companies Survey, published by the Financial Mail. The definitions for the 6 categories of financial information are: Fixed Assets Fixed as well as current assets are included. Investments are at market price or directors' valuation, at latest balance sheet date. Other assets, such as land and buildings, are at book value. Where revaluations were not taken into the balance sheet, these were ignored. Where cash balances were netted off against bank overdraft, the cash balances were added back. Tax paid in advance was netted off against tax payable, and only the gross amount included. Cost of control and intangible assets, such as goodwill, patents and licences were not included; mining assets were, however, included. Where amounts invoiced on contracts in progress exceeded the value of contracts in progress, the difference was included with retained income; or, if the amounts received consisted of deposits received, the difference was included with creditors. If stock was valued using Lifo, it was adjusted to reflect the Fifo or average value if this was disclosed. Market Capitalisation The market value of all fully paid and issued ordinary shares calculated in the closing price of the last trading day of each year. Issued capital and closing prices were obtained from the JSE's December Monthly Bulletin. Equity Funds Net assets attributable to ordinary shareholders were adjusted for the same items as total assets. Provisions included with credit balance such as warranty provisions, provisions for self-insurance and provisions for maintenance were included with distributable reserves. Deferred tax was regarded as retained profit. 01:24, 1/22/00 32 Net Profit Taxed profit attributable to ordinary shareholders, after excluding extraordinary items where appropriate. Deferred tax and amounts transferred to provisions and reserves were regarded as retained profit, thus increasing taxed profit disclosed. Also excluded are items such as cost of control written off, prospecting expenditure, provisions against investments and adjustments for prior year tax. The pre-tax difference in profit between Lifo and Fifo or average stock values was added to net profit. Share of associated companies' retained profits was also included. Turnover The total value of sales of goods and services. Employment The total number of employees, including contract and part time employees. 3. Definitions of Financial Ratios Several aspects of financial performance can be analysed using different financial ratios. Financial aspects to be compared are: profitability, asset utilisation, gearing and labour utilisation. Profitability There are different measures of profitability. In this paper the three most commonly used ratios are used. • Return on Equity This ratio measures the return on the investment made by the investors and was calculated as follows: Return on Equity = (Net Profit)/Equity • Return on Assets Another measure of profitability is return on assets ratio and was calculated as follows: Return on Assets = (Net Profit)/(Total Assets) • Net Profit Margin Net profit margin ratio is another measure of profitability commonly used to assess profitability by considering price changes of output, i.e. turnover. A high profit margin can be achieved by charging higher prices on output but higher prices could be followed by a decrease in demand and therefore lower turnover. Net profit margin was calculated as follows: Net Profit Margin = (Net Profit)/Turnover Asset Utilisation • Capital Turnover Capital turnover refers to the return on shareholders’ equity which is represented here as market Capitalisation. This ratio indicates the efficient use of shareholders’ funds in generating profit by relating it to net profit. Capital turnover was calculated using the following ratio: Capital Turnover = (Turnover)/(Market Capitalisation) 01:24, 1/22/00 33 Gearing/Financial Leverage • Gearing Ratio The gearing ratio is commonly used to evaluate the level of corporate borrowing in a company’s capital structure. This is significant in determining the liquidity of a company especially during either recession or financial crisis. The gearing ratio was calculated as follows: Gearing Ratio = 1 - [(Equity Funds)/(Market Capitalisation Value)] Labour Productivity Labour productivity deals with the efficient use of labour in generating turnover and profit. Two ratios were used. • Labour Productivity Labour productivity ratio is a measure of turnover generated relative to the number of employees. This ratio was calculated as follows: Labour Productivity = (Turnover)/(Total Number of Employees) • Labour Efficiency The other measure of labour productivity is labour efficiency which is calculated as a measure of net profit to the total number of employees. Labour Productivity = (Net Profit)/(Total Number of Employees) 01:24, 1/22/00 34