The fears of a jobless recovery may be receding but the US economy has a long way to go before pre-recession employment levels are achieved. As we stated previously the economy needs to create over 200,000 jobs per month for 48 consecutive months to achieve pre-recession employment levels. The six month average of 63,000 is still well below the required rate of job creation for a robust recovery to occur.  The Unemployment Rate still exceeds 9%.

The February report is encouraging because it points to an accelerating pace of job creation. The post Christmas season employment surge represents a 30,000 job gain over January’s strong report that triples the six month moving average. The service sector accounted for over 200,000 of the job gains. The manufacturing and goods producing sector combined to create 35,000 jobs. Construction continues to mirror the moribund housing market shedding an additional 9,000 jobs during the month. The construction industry has lost over 2.1 million jobs since its peak in 2008.

The robust recovery in the service sector is welcomed but sustainable economic growth can only be achieved by a robust turn around in the goods producing and manufacturing sectors. Service sector jobs offer lower wages, tend to be highly correlated to retail consumer spending and positions are often transient in nature. Small and Mid-Sized Enterprises (SME) is where the highest concentration of service jobs are created and the employment figures bear that out with SMEs accounting for over 204,000 jobs created during the month of February.

Large businesses added 13,000 jobs during the month of February. The balance sheets of large corporations are strong. The great recession provided large corporates an opportunity to rationalize their business franchise with layoffs, consolidations and prudent cost management. Benign inflation, global presence, outsourcing, low cost of capital and strong equity markets created ideal conditions for profitability and an improved capital structure. The balance sheets of large corporations are flush with $1 trillion in cash and it appears that the large corporates are deploying this capital resource into non-job creating initiatives.

The restructuring of the economy continues. The Federal stimulus program directed massive funds to support fiscally troubled state and local government budgets. The Federal Stimulus Program was a critical factor that help to stabilize local government workforce levels. The expiration of the Federal stimulus program is forcing state and local governments into draconian measures to balance budgets. Government employment levels are being dramatically pared back to maintain fiscal stability. Public service workers unions are under severe pressure to defend employment, compensation and benefits of workers in an increasingly conservative political climate that insists on fiscal conservatism and is highly adverse to any tax increase.

The elimination of government jobs, the expiration of unemployment funds coupled with rising interest rates, energy and commodity prices will drain significant buying power from the economy and create additional headwinds for the recovery.

Macroeconomic Factors

The principal macroeconomic factors confronting the economy are the continued high unemployment rate, weakness in the housing market, tax policy and deepening fiscal crisis of state, local and federal governments. The Tea Party tax rebellion has returned congress to Republican control and will encourage the federal government to pursue fiscally conservative policies that will dramatically cut federal spending and taxes for the small businesses and the middle class. In the short term, spending cuts in federal programs will result in layoffs, and cuts in entitlement programs will remove purchasing power from the demand side of the market. It is believed that the tax cuts to businesses will provide the necessary incentive for SME’s to invest capital surpluses back into the company to stimulate job creation.

The growing uncertainty in the Middle East and North Africa is a significant political risk factor. The expansion of political instability in the Gulf Region particularly Iran, Egypt and Saudi Arabia; a protracted civil war in Libya or a reignited regional conflict involving Israel would have a dramatic impact on oil markets; sparking a rise in commodity prices and interest rates placing additional stress on economic recovery.

Political uncertainty tends to heighten risk aversion in credit markets. The financial rescue of banks with generous capital infusions and accommodating monetary policies from sovereign governments has buttressed the profitability and capital position of banks. Regulatory uncertainty of Basel III, Dodd-Frank, and the continued rationalization of the commercial banking system and continued concern about the quality of credit portfolios continue to curtail availability of credit for SME lending. Governments are encouraging banks to lend more aggressively but banks continue to exercise extreme caution in making loans to financially stressed and capital starved SMEs.

Highlights of the ADP Report for February include:

Private sector employment increased by 217,000

Employment in the service-providing sector rose 202,000

Employment in the goods-producing sector declined 15,000

Employment in the manufacturing sector declined 20,000

Construction employment declined 9,000

Large businesses with 500 or more workers declined 2,000

Medium-size businesses, defined as those with between 50 and 499 workers increased 24,000

Employment among small-size businesses with fewer than 50 workers, increased 21,000

Overview of Numbers

The 202,000 jobs created by the SME sectors represents over 90% of new job creation. Large businesses comprise approximately 20% of the private sector employment and continues to underperform SMEs in post recession job creation. The strong growth of service sector though welcomed continues to mask the under performance of the manufacturing sector. The 11 million manufacturing jobs comprise approximately 10% of the private sector US workforce. The 20 thousand jobs created during February accounted for 10% of new jobs. Considering the severely distressed condition and capacity utilization of the sector and the favorable conditions for export markets and cost of capital the job growth of the sector appears extremely weak. The US economy is still in search of a driver. The automotive manufacturers have returned to profitability due to global sales in Latin America and China with a large portion of the manufacturing done in local oversea markets.

The stock market continues to perform well. The Fed is optimistic that the QE2 initiative will allay bankers credit risk concerns and ease lending restrictions to SMEs. A projected GDP growth rate of 3% appears to be an achievable goal. The danger of a double dip recession is receding but severe geopolitical risk factors continue to keep the possibility alive.

Interest rates have been at historic lows for two years and will begin to notch upward as central bankers continue to manage growth with a mix of inflation and higher costs of capital. The stability of the euro and the EU’s sovereign debt crisis will remain a concern and put upward pressure on interest rates and the dollar.

As the price of commodities and food spikes higher the potential of civil unrest and political instability in emerging markets of Southeast Asia, Africa and Latin America grows. Some even suggest this instability may touch China.

The balance sheets of large corporate entities remain flush with cash. The availability of distressed assets and volatile markets will encourage corporate treasurers to put that capital to work to capitalize on emerging opportunities. The day of the lazy corporate balance sheet is over.

Solutions from Sum2

Credit Redi offers SMEs tools to manage financial health and improve corporate credit rating to attract and minimize the cost of capital. Credit Redi helps SMEs improve credit standing and demonstrate to bankers that you are a good credit risk.

For information on the construction and use of the ADP Report, please visit the methodology section of the ADP National Employment Report website.

You Tube Video: John Handy, Hard Work

Risk: unemployment, recession, recovery, SME, political

The Small Business Lending Fund (SBLF) a $30 billion program established by the Treasury Department to encourage Community Banks to step up lending to SMEs is still trying to get some traction in the marketplace.  The SBLF injects capital into community banks that demonstrate an active SME lending  program will take another quarter to determine its effectiveness.

Community Banks are still transitioning its small business lending focus from an over dependency on real estate development.  SMEs seeking loans for capital improvements, fund operations or business expansion must provide lenders some added assurances about the financial health of the business.

SMEs can take steps to improve their credit standing and get approvals from lenders for loans and expansion for credit.  SMEs must demonstrate they have an excellent understanding of the condition of their firm’s financial health, what they must do to improve profitability and how they will use the credit extended by lenders to produce an acceptable return.

Credit Redi helps SME’s demonstrate the condition of the firms financial health, the risks and opportunities that SMEs must address to improve the firms financial health and identify the initiatives that need to be  funded to achieve desired profitability and growth.  These are the keys bankers look for on applications for loans.  Being able to demonstrate credit worthiness with an industry standard rating methodology determines weather a lender will grant you a loan, what rates you will pay and how much lending institutions will lend.

Since 2002, Sum2 has been helping SME’s manage risk and seize opportunities to grow and prosper under the most competitive market conditions.  Credit Redit is the latest addition to Sum2′s series of SME risk management products.

To determine the condition of your company’s financial health click here: 

Risk: credit, SME, capital allocation, credit rating

Credit Redi is designed for small businesses to quickly spot customer credit risk.  Small businesses typically don’t have access to information that provides transparency about customer credit worthiness.  Credit Redi is a credit risk management tool for small and mid-sized businesses.   It only takes one or two bad receivables to damage an SME’s  financial health.  Market conditions quickly change and its critical to have some type of business insight into the businesses SME’s work with.

Credit Redi is also an excellent tool to determine the financial health of critical suppliers.  A key supplier going out of business could have disastrous consequences for SMEs.  Credit Redi  monitors the financial health of existing suppliers and help managers make wiser choices in supply chain and business partner decisions.

Get Credit Redi here: 

Risk: SME, credit risk, supply chain, partnerships, customers, receivables

The Blog-Health-o-Meter™ reads Fresher than ever.

Crunchy numbers

A Boeing 747-400 passenger jet can hold 416 passengers. This blog was viewed about 12,000 times in 2010. That’s about 29 full 747s.

In 2010, there were 18 new posts, growing the total archive of this blog to 102 posts. There were 18 pictures uploaded, taking up a total of 6mb. That’s about 2 pictures per month.

The busiest day of the year was January 6th with 155 views. The most popular post that day was Prognostications and Expostulations for 2010.

Where did they come from?

The top referring sites in 2010 were linkedin.com, stumbleupon.com, bigextracash.com, en.wordpress.com, and sum2.com.

Some visitors came searching, mostly for maginot line, drywall, irs, risk management, and prison jumpsuit.

Attractions in 2010

These are the posts and pages that got the most views in 2010.

Prognostications and Expostulations for 2010 January 2010

SRZ’s Maginot Line January 2009

Politicians Get Wind of Contaminated Drywall May 2009

IRS Audit Risk Survey for Hedge Funds (Interim Update 2) March 2009

Using the Z Score to Manage Corporate Financial Health July 2010

You Tube Music Video: Pink Floyd, Money

Risk: commerce

The October report arrests the September decline in job growth that reversed  seven consecutive months of positive job creation.  During that time the economy averaged employment gains of 34,000 new private sector jobs per month. This rate of job creation does little to reduce the negative overhang  a 10% unemployment rate is having on economic  growth.   A stabilized and expanding labor market is a key ingredient for a sustained economic recovery. Over the past three years the economy lost over 9 million jobs. For a robust recovery to occur the economy needs to create 200,000 jobs per month for the next four years to return the job market to its pre-recession levels.

As we reported last month the expiration of the Federal stimulus program will force state and local governments to layoff  workers.  Sluggish job creation continues to pressure depleted unemployment funds and the expiration of benefits for many of the unemployed is draining buying power from the economy.

Soft consumer demand  threatens retailers and leisure industry segments and has a spillover effect  on the housing market.  Joblessness is a principal factor in mortgage defaults and contributes to the growing inventory of foreclosed properties held by banks.  The ADP report indicates that during October the US economy shed an additional 23,000 construction jobs. It is estimated that it will take 24 months for the housing market to absorb the existing inventory of foreclosed properties. A  healthy turnaround in the construction  industry will  move in step with the improvement in the housing market conditions.

A sustained recovery will require sector leadership by Small and Mid-Size Enterprises (SME)  as principal drivers of job creation.   SME’s  sector strength has traditionally been in the construction, specialty retail, leisure and service sectors.  Among these segments  only the services sector continues to be a consistent driver for job creation.

Macroeconomic Factors

The principal macroeconomic factors impairing recovery are the continued high unemployment rate, weakness in the housing market, tax policy and deepening fiscal crisis of state, local and federal governments.   The results of this weeks mid-term election and the return of congress to Republican control will encourage the federal government to pursue fiscally conservative policies that will dramatically cut spending and taxes for the small businesses and the middle class.  In the short term spending cuts in federal programs will result in layoffs and cuts in entitlement programs will remove purchasing power from the demand side of the market.  It is believed that the tax cuts to businesses will provide the necessary incentive for SME’s to invest capital surpluses back into the company to stimulate job creation.

Highlights of the ADP Report for October include:

Private sector employment increased by 43,000

Employment in the service-providing sector rose 77,000

Employment in the goods-producing sector declined 34,000

Employment in the manufacturing sector declined 12,000

Construction employment declined 23,000

Large businesses with 500 or more workers declined 2,000

Medium-size businesses, defined as those with between 50 and 499 workers increased 24,000

Employment among small-size businesses with fewer than 50 workers, increased 21,000

Overview of Numbers

The 45,000 jobs created by the SME sectors reverses a decline from September and offsets the 2,000 job cuts by large companies.  The strong growth of service sector  jobs is a positive development.  However the continued softness of goods producing segments and manufacturing continues to indicate the continued decline of  US industrial capacity.  The strong rebound in services  may be the result of the expanding practice of companies utilizing outside contractors to fill human capital requirements.  These types of jobs may mask an underemployed and  transient labor pool forced to accept work at  lower wage scales.

The stock market continues to perform well.  Yesterdays QE2 initiative by the Fed to pump $600 billion into the banking system may allay bankers credit risk concerns and ease lending restrictions to capital starved SME’s.  Despite a projected GDP growth rate of 2%, ADP’s employment figures indicates that the economy continues to dwell at the bottom of an extreme down economic cycle. The danger of a double dip recession still lurks as a remote possibility.  Interest rates remain at historic lows and inflation continues to be benign but its danger grows as a weak dollar continues to flounder forcing oil prices to climb while government debt levels continue to spiral upward.  The balance sheets of large corporate entities remain flush with cash.  Analysts estimate that over $1 Trillion in cash swells corporate treasuries remaining underemployed on lazy corporate balance sheets.  The low interest rate environment  has allowed companies to pursue  deleveraging strategies  considerably strengthening the capital structure of corporate America.  To the dismay of politicians and the unemployed,  economists speculate that deployment of this cash is still a few quarters away from finding its way into the real economy.

Solutions from Sum2

Sum2 offers SME’s the Profit|Optimizer to help them manage risk, devise recovery strategies and make better informed capital allocation decisions.

For information on the construction and use of the ADP Report, please visit the methodology section of the ADP National Employment Report website.

You Tube Video: Theme from Teenage Mutant Ninja Turtles

Risk: unemployment, recession, recovery, SME

A stabilized labor market is a key ingredient to a sustained economic recovery. Over the past three years the economy lost over 9 million jobs. For a robust recovery to occur the economy needs to create 200,000 jobs per month for the next four years to return the job market to its pre-recession levels.

The Federal stimulus program that directed funds to state and local governments to help stem layoffs has now expired. This will result in further belt tightening by local government agencies and will result in layoffs of employees to meet the fiscal restraint imposed by the poor economy.  This will exacerbate the unemployment problem and further impede the buying power and tax revenues.  This will continue to hurt the retail industry and local governments sales tax receipts.

The reduction in the government work force is symptomatic of the reconfiguration of the economy. During the past decade government employment increased dramatically. Its pairing down will put added pressure on the private sector to incubate new industries to drive the recovery. Manufacturing and the growth industries of the past decade will be hard pressed to create the level of job creation a robust recovery requires.

The ADP report indicates that since its peak in January of 2007, construction employment has lost 2,297,000 jobs. Construction trades along with credit marketing, retailing, community banking and services supporting these sectors have been dramatically weakened and downsized in the wake of the recession. The private sector led by small and mid-size enterprises (SME) will need to incubate growth industries to create jobs and lead the country out of the doldrums of the flailing economic recovery.

Macroeconomic Factors

The principal macroeconomic factors impairing recovery are the continued high unemployment rate, continued weakness in the housing market, persistent deflation concerns, tax policy and deepening fiscal crisis of state, local and federal governments.  The economic impact of the Gulf oil spill was immediate and dramatic to the local aqua-cultural industries, fishing and regional tourist industries. The long term effects of the spill on the ecological communities of the Gulf is yet to be determined.  The geopolitical uncertainty of the wars in Afghanistan and Iraq, persistent worries about Iran’s nuclear program and the sovereign debt crisis of the weaker EU member states are persistent concerns weighing on capital market participants.

Highlights of the ADP Report for September include:

Estimates non-farm private employment in the service-providing sector decreased by 39,000.

Employment in the goods-producing sector declined 45,000

Employment in the manufacturing sector declined 17,000

Construction employment declined 28,000

Employment in the services sector rose 6,000.

Large businesses with 500 or more workers declined 11,000

Medium-size businesses, defined as those with between 50 and 499 workers declined 14,000

Employment among small-size businesses with fewer than 50 workers, declined 14,000

Overview of Numbers

Job loss in the SME sector is troubling. SMEs are the backbone of the construction and retail industries and the continued weakness of these sectors weighs on their ability to become a driver of consistent job growth. The continued deterioration of the financial health of SMEs and their ability to marshal resources from depleted balance sheets and limited credit lines may be impairing the ability to mount an effective response to the dire economic conditions.

Despite the backdrop of the stock markets stellar performance during September, ADP’s employment figures indicates that the economy continues to dwell at the bottom of an extreme down economic cycle. The danger of a double dip recession still lurks as a possibility.  The balance sheets of large corporate entities are flush with cash.  Some analysts estimate that over $1 Trillion in cash swells corporate coffers.  Some economists speculate that deployment this cash is critical to the economic upturn and still a few quarters away from finding its way into the real economy.

Solutions from Sum2

Sum2 offers SME’s the Profit|Optimizer to help them manage risk, devise recovery strategies and make better informed capital allocation decisions.

For information on the construction and use of the ADP Report, please visit the methodology section of the ADP National Employment Report website.

You Tube Video: Van Halen, Ice Cream Man

Risk: unemployment, recession, recovery, SME

The EU’s social democratic economic models embody the best and worst aspects of these issues. The social democratic state attempt to combine entrepreneurial impulses of capitalism with the management and administration of social welfare for all its citizens. Democratically “elected administrators” use the apparatus of the state to facilitate and manage the competing interests of capital and labor, free markets and regulation while seeking to balance an entrepreneurship friendly culture with long term sustainability.

Yesterday a toxic tsunami of aluminum sludge coated 16 square miles of pristine Hungarian countryside. It is a telling example of a severe risk event that confronts modern life. A lassiaz-faire approach to the event is not viable and offers no solace to those harmed by this assault.  Communities cannot be asked to suffer a market response that promises to correct the problem of the next instance of this event.  The construction of better berms and the implementation redundant protection devises to safeguard against this risk  for the future is little compensation to those who were killed, injured and lost property or livelihoods as a result of MAL Zrt poor risk management practices.

Better to suffer a regulatory initiative that is based on an understanding of an economic ecosystem as complex and inhabited by competing interests of diverse stakeholders.  The ecosystem including the shareholders of MAL Zrt, residents of the surrounding communities, plant workers (also community residents), small businesses (SME) and down stream farmers making a living on arable land and access to clean water all have a stake,  albeit competing,  in the safe operation of the plant. The possibility that the toxic sludge may find its way into the Danube poses a threat to the water supply of other eastern European nations.  This elevates this catastrophic event to other EU jurisdictions. The inter-dependencies and interconnectedness of the pan-regional and larger global economy requires vigorous regulatory safeguards, mitigation initiatives and enforcement response.

The true cost of this event is potentially staggering. It supersedes the narrow interest and economic value of shareholders rights and capital invested in MAL Zrt.  Bad economic behavior exemplified by BP’s Horizon Deepwater failure to install redundant protective devises to keep production costs to a minimum, ended up costing BP shareholders and Gulf Coast stakeholders dearly.

State intervention in markets and the reemergence of managed economies is a reality of the global economy. The “managed economy” of the Peoples Republic of China places western style “free market” economies at a disadvantage. The managers of the PRC efficiently deploy and manage capital, effect trade and market protections and scrupulously manage currency valuation. It has created enormous social wealth for China and has contributed to its rapid rise as a preeminent world power.  China’s rise requires better coordination of private capital and government to marshal a competitive market response to the challenges posed by managed economies to free and open markets of western democracies. The massive pools of capital deployed by sovereign wealth funds of oil producing regencies and the growing insurgency and power of underground economic activity also pose significant challenges to the viability of unregulated markets.

America’s free market model that eschewed regulation since the 1980′s evolved into a mercantile economy with a weakened economic base. The outsourcing of manufacturing infrastructure loosened free market impulses that left in its place a debtor nation whose warped economy depended on housing/commercial real estate construction (collateral creation/securitization), credit marketing, retailing and a service sector that was designed to support the new economic paradigm. It is a model that has proven itself to be wasteful, costly and unsustainable.

Deregulation has led to the dislocation of the capital markets from the real economy. It has contributed to the massive disparities in social wealth and a crumbling infrastructure.  Milton Friedman’s mistaken belief that free market impulses would preserve infrastructure investment has been proven incorrect. Ironically this has added to the government’s burden to provide social assistance to segments of the population disenfranchised from economic participation. Some believe that the basis for the prosecution of the wars in Iraq and Afghanistan are economic stimulus programs designed to keep the economy going due to the vacuum created by the loss of manufacturing.

China’s example nor the resurrection of the soviet socialist model is not a desirable alternative for western democratic capitalist societies. Centralized control and state economic planning is rife with inefficiencies. State run economies threatens liberty, stifles innovation and encumbers economic dynamism. The virtues of capitalism (innovation, dynamism, liberty) needs to be encouraged and blended into the new economic reality of a highly dependent and interconnected world that requires cooperation, coexistence, sustainability, fair asset valuation, and the equitable sharing of resource and responsibility. SME’s are at the forefront of innovation, value creation and dynamism and will play a leading role in the creation of new social-political values as sources of sustainable growth and wealth in the emerging economic paradigm.

You Tube Music Video: Chevy Chase and Mike Myers: I’m Looking Over a Four Leaf Clover

Risk: regulatory, capitalism, sustainability

The Z Score provides a quantitative measurement into a company’s financial health. The Z Score highlights factors contributing to a company’s financial health and uncovers emerging trends that indicate improvements or deterioration in financial condition.

The Z Score is a critical tool business managers use to assess financial health. It helps managers align business strategies with capital allocation decisions and provide transparency of financial condition to lenders and equity capital providers. Business managers use the Z Score to raise capital and secure credit. The Z Score is an effective tool to demonstrate credit worthiness to bankers and soundness of business model to investors.

The Z Score is based on actual financial information derived from the operating performance of the business enterprise. It avoids biases of subjective assessments, conflicts of interest, brand and large company bias. The Z Score employs no theoretical assumptions or market inputs external to the company’s financial statements. This provides users of the Z Score with a consistent view and understanding of a company’s true financial health.

Background

The Z Score was first developed by NYU Professor Edward Altman. The Z Score methodology was developed to provide a more effective financial assessment tool for credit risk analysts and lenders. It is employed by credit professionals to mitigate risk in debt portfolios and by lenders to extend loans. It is widely utilized because it uses multiple variables to measure the financial health and credit worthiness of a borrower. The Z Score is an open system. This allows users of the Z Score to understand the variables employed in the algorithm. All the mysteries and added cost of “proprietary black box” systems are avoided empowering users to enjoy the benefits of a proven credit decision tool based solely on solid financial analysis.

The Z Score is also an effective tool to analyze the financial health and credit worthiness of private companies. It has gained wide acceptance from auditors, management accountants, courts, and database systems used for loan evaluation. The formula’s approach has been used in a variety of contexts and countries. Forty years of public scrutiny speaks highly of its validity.

Z Score Formula

The Z Score method examines liquidity, profitability, reinvested earnings and leverage which are integrated into a single composite score. It can be used with past, current or projected data as it requires no external inputs such as GDP or Market Price.

The Z Score uses a series of data points from a company’s balance sheet. It uses the data points to create and score ratios. These ratios are weighted and aggregated to compile a Z Score.

Z Score = 3.25 + 6.56(X1) + 3.26(X2) + 6.72(X3) + 1.05(X4) where

X1 = Working Capital / Total Assets
X2 = Retained Earnings / Total Assets
X3 = Earnings Before Interest & Tax / Total Assets
X4 = Total Book Equity /Total Liabilities

If you divide 1 by X4 then add 1 the result is the company’s total leverage.

The higher the score the more financially sound the company.

Z Score Ratings cutoff scores used in classifications:

AAA     8.15             AA        7.30

A          6.65              BBB     5.85

BB        4.95             B            4.15

CCC     3.20             D           3.19

Credit Worthiness and Cost Of Capital

Lenders and credit analysts use Z Scores because they are effective indicators and predictors of loan defaults. it is an important risk mitigation tool and helps them to better price credit products based on borrowers credit worthiness.

Utilizing a 10 year corporate mortality table demonstrates how Z Score ratings correlate to defaults. Those with a rating of A or better have a 10 year failure rate that ranges from .03% to .082%. The failure rate for those with a BBB rating jumps to 9.63%. BB, B and CCC failure rates are 19.69%, 37.26% and 58.63% respectively. These tables will differ slightly as each producer uses different criteria but overall they are quite similar.

Borrowers with higher Z Scores ratings will have a better chance of obtaining financing and secure a lower cost of capital and preferred interest rates because lenders will have greater confidence in being paid back their principal and interest. Financial wellness is an indication of strong company management and that effective governance controls are in place.

Managing Business Decisions to Improve Financial Health

The Z Score is also a critical business tool managers utilize to make informed business decisions to improve the financial health of the business. The Z Score helps managers assess the factors contributing to poor financial health. Z Score factors that contribute to under-performance; working capital, earnings retention, profitability and leverage can be isolated. This enables managers to initiate actions to improve the score of these factors contributing to financial distress. Targeting actions to specific under-performing stress factors allows managers to make capital allocation decisions that mitigate principal risk factors and produce optimal returns.

Focus areas for managers to improve Z Score are transactions that effect earnings/(losses), capital expenditures, equity and debt transactions.

The most common transactions include:

1. Earnings (Net Earnings) increases working capital and equity.
2. Adjust EBIT by adding back interest expense.
3. Adjust EBIT by adding back income tax expense.
4. Depreciation and amortization expense is already included in the earnings number so it won’t have an additional effect on earnings or equity but it will increase working capital as noncash items previously deducted.
5. Capital Expenditures (fixed asset purchases) decrease working capital as cash is used to pay for them (whether the source is existing cash or new cash acquired from debt).
6. Short term debt transactions have no effect on working capital as there are offsetting changes in both current assets and liabilities but does change total liabilities and total assets.
7. Acquiring new long term debt increases working capital, total liabilities and total assets.
8. Typical equity transactions (other than earnings, which we have already accounted for) are dividends paid to stockholders resulting in decreases to working capital and equity.
9. New contributed capital increases working capital and equity.

Scenario Analysis

Using the Z Score financial managers can actively manage their balance sheet by considering transactions and initiatives designed to impact financial wellness. Considerable attention needs to be placed on how losses, sale of fixed assets and long term debt payments effect financial condition.

In the above we included the basic transactions that would likely occur but you can do the same for any scenario by applying the same concept. It may take a little practice to think in these groupings but you’ll shortly find yourself with the ability to project any event. The effects can be measured and revised as necessary by adjusting the contemplated transactions. Remember that several variables exist and that a combination of choices might be necessary to keep your financial strength at the desired level.

Any projection should include the calculation and comparison of key metrics to historical results to ensure that assumptions have been correctly calculated. Significant deviations from prior results should have adequate explanations. Maintaining a strong working capital position can offset the negative effects from increased debt, increased assets and minor earning declines.

Sum2′s Profit|Optimizer

Sum2 publishes the Profit|Optimizer.  The Profit|Optimizer is a risk assessment and opportunity discovery tool for small and mid-sized businesses.  It assists managers to identify and manage risk factors confronting their business. The goal of the Profit|Optimizer is to help business mangers demonstrate creditworthiness to lenders and make make informed capital allocation decisions.

Sum2 boasts a worldwide clientele of small and mid-sized business managers, bankers, CPA’s and risk management consultants that utilize the Profit|Optimizer to help their clients raise capital with effective risk governance.

Cautions

Financial models are not infallible and should be used in conjunction with common sense and with an awareness of market conditions. It is important to understand your model so that other considerations can be incorporated when necessary. Note that most models (Z score included) use a proxy (working capital) for liquidity which works well until there are severe disruptions in credit markets as recently encountered. Use caution with all models. Use extreme caution when using a proprietary black box system where you can’t understand all the components. Are these users aware or ignorant of possible issues?

Trust but verify seems like a prudent policy.

Conclusions

The Z Score is a valuable management tool to proactively assess the financial condition of the company’s balance sheet, uncover factors that are stressing the balance sheet and initiate actions to improve the financial wellness and credit worthiness of the firm. All business decisions and actions are ultimately revealed in the company’s balance sheet. The Z Score measures the effectiveness of business decisions. It empowers managers to anticipate changes occurring in credit worthiness and proactively manage changes in financial condition.

Armed with a tool to calculate future financial positions managers have the latitude to better manage outstanding receivables, improve liquidity and lower their cost of capital. Calls for capital, negotiations for funding or decisions in setting credit policy can now be made from a knowledgeable position with a set of supporting facts.

The Z Score gives business managers an important negotiating tool to defend their credit rating during capital raises when excess leverage or deficient levels of working capital and equity are present.

This post was authored by CreditAides.

This post was edited by Sum2llc

Risk: small business lending, credit risk, commercial lending, SME

]]> http://sum2llc.wordpress.com/2010/07/22/using-the-z-score-to-manage-corporate-financial-health/feed/ 3 riskrapper z-score http://sum2llc.wordpress.com/2010/06/09/small-business-optimism-improves/ http://sum2llc.wordpress.com/2010/06/09/small-business-optimism-improves/#comments Wed, 09 Jun 2010 14:58:28 +0000 riskrapper http://sum2llc.wordpress.com/?p=1114 ]]> The National Federation of Independent Business (NFIB) has just released the Small Business Economic Trends Report for June 2010. The report published since 1973 measures small business sentiment on numerous economic and business factors that confront small businesses.

This months report indicates that small business optimism continues to improve.  The NFIB index rose 1.6 points to 92.2 recording the highest level of the index since September of 2008.

During the month seven of the 10 index components rose, with job creation and capital expenditure plans recording minuscule increases.  The Index rose above the 90 level for the first time in 21 months ending the longest period of negative sentiment in the four decade history of the index.

Though seven of the ten index components rose, small business job creation remains weak.  The  hemorrhaging  of job losses has abated employment opportunities with small businesses is not materializing.  Employment is a critical component of the Index and is understood as an important sign of economic recovery.  During the month small businesses continued to layoff workers registering a negative .5 per respondent.   This records the weakest reading for small business employment for the past three months.  The NFIB Index corroborates employment trends recently reported by ADP’s National Employment Report and the Department of Labor.  The small business sector is not contributing to private sector employment growth.  This is a troubling concern because it is widely understood that small businesses need to be a leading driver for job creation to sustain economic recovery.  As we stated last month, historically small businesses have been the major driver in job creation following recessions.  The poor job creation reading by the index  continues to be a  contra indicator of economic recovery. Small business owners are by nature and temperament optimistic and the report indicates that small businesses are still very cautious about allocation capital for jobs to meet improving business conditions.

Highlights of the Report:

• Jobs:   9% percent of respondents reported unfilled job openings. Over the next three months, 7 % plan to reduce employment and 14 % plan to create new jobs.

• Credit:  32% of respondents looking for financing report difficulties in arranging credit.  13% reported loans harder to get than in their last attempt. Overall, 92% of the owners reported all their credit needs met.

• Profits: 17%of respondents reported higher earnings while 49% of respondents reported a decline in profits.

• Prices:   14% reported raising average selling prices, and 28% reported average price reductions.

• Capital Spending:  A net 20% of respondents planned to make a capital expenditure within the next three months, 5% planned a facilities expansion and a net 8% expect business conditions to improve over the next six months.

• Sales: 23% of all owners reported higher sales while 38% reported lower sales.

Overview of the Report

The NFIB Optimism Index records that small business sentiment and business conditions are improving  but hint that small businesses are not fully participating in a vibrant economic recovery story.  The survey indicates that small businesses remain reluctant to create new jobs.  Until this improves, demand in the larger economy and stimulation drivers for small business growth will remain weak.

Earnings and capital expenditures tend to correlate in the absence of  subdued credit channels.  More businesses are required to self fund expansion initiatives and capital expenditures.  With earnings down small businesses spending will remain weak creating yet another headwind to market demand for goods and services.

As government stimulus programs come to a close it is crucial that small and mid-sized businesses (SME) become a lead driver in the recovery.   Though the NFIB index indicates that business conditions and sentiment is improving the financial health and overall psychology of the sector seems ambivalent to its critical role in economic recovery scenarios.

About the NFIB Index

Components of the Optimism Index include: Labor Markets, Capital Spending, Inventory and Sales, Inflation, Profits and Wages and Credit Markets.  This months survey recorded the responses of 823 NFIB members and concluded May 31.

The NFIB Research Foundation has collected Small Business Economic Trends Data with Quarterly surveys since 1973 and monthly surveys since1986. The sample is drawn from the membership files of the NFIB.

The NFIB Report can be downloaded from the Sum2 website. NFIB Optimism Index

Solutions from Sum2

Sum2 offers risk management and opportunity discovery tools to SME’s.  The Profit|Optimizer helps SME’s manage risk, devise recovery strategies and make better informed capital allocation decisions.

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Risk: SME, small business, economic recovery, NFIB

A stabilized labor market is a key ingredient to a sustained economic recovery.  The economy lost over 9 million jobs during the recession and recovery will require the creation of 200,000 new jobs per month for the next 4 years to get back to pre-recession employment levels.  Last years massive Federal stimulus programs directed funds to state and local governments to help stem layoffs. The expiration of those programs will force fiscally challenged local governments to resort to austerity measures that will require the public sector to trim jobs.

Macroeconomic factors continue to be challenging the economic recovery.  The sovereign fiscal crisis in Europe, slowing growth in China, tepid credit markets and political uncertainty counterbalance the positive effects of a stabilizing housing market, low interest rates and benign  inflation.

The economic impact of the Gulf oil spill will not be confined to the region. The local aqua-cultural industries, fishing and tourism to the region has been immediately impacted by the spill.  A prolonged duration of the event will have a profound impact on the economies of the entire Caribbean. The economies and fiscal stability of American cities such as Pensacola, Mobile, Tampa,  New Orleans and Key West are directly threatened by the unfolding events.  Cities and regions along the Texas Coast and Mexico also remain remain at risk and share the unfortunate distinction of being in the probability cross hairs of suffering extreme toxic damage as a result of a hurricane.  Shipping lanes and the closure of ports due to oil contamination could impact America’s vital agricultural industry.  The moratorium on deep water drilling has placed pressure on the oils services sector and may impact the industries long term financial health.   The impact on the price of oil and refined petroleum products remains to be seen.

Highlights of the ADP  report include:

Estimates non-farm private employment in the service-providing sector increased by 55,000.

Employment in the goods-producing sector declined 23,000

Employment in the manufacturing sector rose 15,000

Employment in the services sector rose 78,000.

Large businesses with 500 or more workers  added 3,000 jobs

Medium-size businesses, defined as those with between 50 and 499 workers increased by 39,000

Employment among small-size businesses with fewer than 50 workers, increased by 13,000

Overview of Numbers

The net gain of 52,000 jobs in the small and mid-sized enterprise (SME) sector, compared to the creation of 3,000 jobs in large enterprises is a telling statistic about the changing topology of the US job market.   During the past decade, a large proportion of job growth occurred in the public and small mid-size enterprises (SME) sector.  Large businesses have led the way in implementing lean enterprises and have outsourced and off shored many jobs and business functions to accomplish this. Job creation by SME’s during the past month represented over 90% of new job creation.  America’s reinvention and economic renaissance must be led by the SME sector.  It is vital that capital formation initiatives and credit availability is positioned to foster the growth and development of the SME sector.

This months ADP report is an indication that the US economy continues at the bottom of an extreme down economic cycle.  The danger of a double dip recession unfortunately still lurks as a possibility.  The oil spill in the Gulf of Mexico, the potential of market contagion from EU credit distress, China’s slowdown and the anemic rate of job creation in the wake of massive government expenditures and budget deficits presents continuing challenges to a sustained and robust recovery in the United States.

Solutions from Sum2

Sum2 offers SME’s the Profit|Optimizer to help them manage risk, devise recovery strategies and make better informed capital allocation decisions.

For information on the construction and use of the ADP Report, please visit the methodology section of the ADP National Employment Report website.

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Risk: unemployment, recession, recovery, SME