VideoProfessor Jablonsky also cautions that all models that require numerous calculations and adjustments create opportunities for manipulation. At Caterpillar and Nucor, subjects of research projects by Jablonsky for the Financial Executives Research Foundation (the research arm of the Financial Executives Institute), methodology takes a backseat to clarity. "Performance information is widely shared," Jablonsky says, "and it's tied to compensation, so people take an interest in the numbers."
From an operating standpoint, managers may not need to know how well they are utilizing capital from day to day, according to Dale Flesher, Arthur Andersen professor of accounting at the University of Mississippi, Oxford. "Under the traditional measure, managers can't know whether they've created value for the firm, not without knowing the cost of capital," Flesher observes. "The question is, Do they care?" Without control over the company's cost of capital, he argues, a divisional manager may need to know only that the hurdle is 15 percent, for example, leaving the rest of the calculations to the corporate level.
This issue spawns sharp disagreement with proponents of cost-of-capital-based metrics, however. "One of the beauties of EVA is that the message is easily communicated to all levels of the business," says Kenneth Stephens, general auditor at Harnischfeger Industries Inc., a capital goods manufacturer based in Milwaukee. "With EVA, you are trying to make prudent business decisions to maximize your financial returns while minimizing the assets employed to achieve that. So you can talk to a salesperson about why you want to put consignment inventory in place, or ask a foreman whether he really needs a machine tool."
MIX 'N MATCH
The DuPont model falls short, say some critics, because it is not a great tool for predicting the future or for tracking costs. "It is designed to give you a picture of where you've put your resources," says Jack Kreischer, president of the Pennsylvania Institute of CPAs and managing director of Kreischer, Miller & Co., a public accounting firm in Horsham, Pennsylvania. A DuPont model can tell you, for example, the extent to which you've invested in machinery to build widgets, but it offers little insight into growth prospects or costs along the way, Kreischer says. By the same token, DuPont lacks the means to include increasingly prominent intangible assets in its return calculations.
Flexibility, a hallmark of the expandable DuPont model, can enable finance executives to combine return on investment with measures that do incorporate growth prospects. "DuPont can be hooked up to a variety of value-based measures," says Eric Olsen, vice president of The Boston Consulting Group Inc., which has developed cash flow metrics of its own, including cash flow return on investment, or CFROI.
Some securities analysts routinely use DuPont in their state-of-the-art environment. "The DuPont method has the advantage of being much easier to use than other forms of analysis that depend on information buried in footnotes," says analyst Jim Stoeffel of Salomon Smith Barney, in New York.
Nucor's decision to stick with DuPont reflects a pragmatic view of metrics. "I don't say it's the best way," Siegel concedes. "All I say is that it has worked for us."
Robin Goldwyn Blumenthal, a former reporter for the Wall Street Journal, writes frequently about business.
THE FIRST REENGINEER
------------------------------------------------------------------------ ------------ The DuPont model of financial analysis was dreamed up by F. Donaldson Brown, an electrical engineer who joined the giant chemical company's treasury department in 1914. A few years later, DuPont bought 23 percent of the stock of General Motors Corp. and gave Brown the task of cleaning up the carmaker's tangled finances--in effect, America's first large-scale reengineering effort. Much of the credit for GM's ascension afterward belongs to Brown's systems of planning and control, according to no less an expert than Alfred Sloan, GM's legendary chairman. Ensuing success launched the DuPont model to prominence in major U.S. corporations. It remained the dominant form of financial analysis until the 1970s. --R.G.B.
Reader Comments» Post a comment