Case 3.3: W. T. Grant Company
I. Case Objectives
A. Demonstrate the importance of analyzing cash flow from operations in assessing the impact of operations on liquidity.
B. Demonstrate the impact of changes in accounting principles and misstatements of accounting data on the analysis and interpretation of financial statements.
C. Demonstrate how inadequate financial controls can get a decentralized organization into trouble.
II. Class Discussion
Begin by placing the following chart on the board:
1966 1967 1968 1969 1970 1971 1972 1973 1974 1975 1976
A. Slowly move the plain sheet of paper to the right. Most students agree that the major deterioration in the ratios occurred in the fiscal year ending January 31, 1970, or January 31, 1971. Write these dates on the time line on the board, noting that the financial statements signaled Grant's problems approximately one year before the stock market reaction.
Next, place the following two column headings on the board:
"Major Contributing Factors" and "Questionable Policies"
Ask the class to identify the major factors that contributed to Grant's collapse. As students identify each factor, try to discuss it fully before moving on to the next factor. Ask the student who offered each factor how he or she would identify the problem using financial statement ratios. Following are the major factors and related issues that you should try to elicit from the discussion.
A. Credit Extension and Collection Policies—Grant operated with a decentralized organizational philosophy. Each store manager had authority to extend credit. There was no minimum on the amount that customers could charge. There were extremely liberal policies with respect to the amount and timing of repayment. The manager's compensation, based on a percentage of sales, induced store managers to extend credit at will. With appropriate centralized financial controls, a decentralized organizational structure can have positive motivational effects on employees. The absence of such controls, however, can hurt the organization as a whole. The problems with the credit system began showing up in a decreasing accounts receivable turnover in the late sixties and early seventies.
At this point, bring up three items affecting the accounts receivable data. First, ask what impact consolidation of the finance subsidiary in 1970 had on the accounts receivable turnover ratio. Consolidation did not affect sales in the numerator, but it substantially increased accounts receivable in the denominator. Thus, the receivables turnover ratio decreased as a result of consolidation. Ask students this question: Can you see any reason for Grant to select the year ending January 31, 1970, as the time to switch? One hypothesis is that Grant saw its receivables turnover decreasing because of its poor credit policies and figured it might confuse the market by changing its consolidation policy at the same time. In this way, it would not be clear how much of the decrease was due to consolidation and how much was due to the credit problems.
Next, ask what impact the front-end loading of interest on installment receivables had on the accounts receivable turnover ratio. A comparison of Exhibits 3.39 and 3.41 in the case suggests that Grant netted interest revenue against selling, general, and administrative expenses. Thus, the front-end loading increased the denominator of the accounts receivable turnover ratio and decreased the overall turnover ratio. The practice of front-end loading...