ANNUAl

REPORT

197~

FEdERAl

RESERVE

BANk

ofClEVElANd

SiXTY- FiRST ANNUALREPORT ANd STATEMENT

FEdERAL RESERVE BANk

of CLEVELANd

To the Member Banks in the Fourth Federal Reserve District:

We are pleased to present the 1975 Annual Report of the Federal Reserve Bank ofCleveland. This year's report examines the impact of the economic and financialchallenges of the early 1970's on the balance sheets and income statements of largemanufacturing firms in the Fourth District.

The Bank, in the exercise of its monetary policy and bank regulatoryresponsibilities within the Federal Reserve System, has among its goals the maintenanceof a strong and sound banking system in the Fourth District. The impact of monetarypolicy activities affects banks not only by influencing the flow of money and credit in theeconomy but also through its effects on financial decisions of households, nonfinancialfirms, and financial institutions. Thus, the Federal Reserve Bank of Cleveland and thebanking community have an interest in understanding how monetary policy interactswith financial decision-making of these groups. The long-standing importance ofmanufacturing activity in the District makes the interaction of monetary policy andcorporate decision-making of special interest, particularly because of the District's heavydependence on durable goods which in other periods contributed to more severerecessions and somewhat weaker recoveries here than in· the nation. Understandinghow national financial and economic conditions affect the District is vitally important.

The 1975 Annual Report highlights the financial behavior of major segments of thecorporate sector of the District during the first half of the decade. The inquiry in thisreport focuses on the liquidity, debt structure, and profitability of District manufacturingfirms between 1970 and 1974. It poses many questions about the financial performanceof firms in a period characterized by expansion and contraction in economic activity,sustained inflation, and rapid technological change. Answers to these questions wouldcontribute to an understanding of the interaction of monetary policy and corporatefinancial developments. We are concerned with these and other questions and will addressourselves to some of them in the year ahead.

Finally, we take this opportunity to thank the numerous people, especially memberbanks and directors, officers, and the staff of this Bank, who have helped us fulfill ourvaried responsibilities during 1975. We also ask them for their continued assistance in1976 in accomplishing the many complex tasks with which the Bank is charged.

1

Chairman of the Board President

A REViEW of CORPORATE BALANCE SItEETS

of FOURTIt Disrnicr MANUFACTURERS

1910-1914Corporate balance sheets and income statements

reflected a variety of volatile financial and economicconditions between 1970 and 1974. Some of the changesmade mirrored cyclical developments associated withbusiness expansion and contractions. The brief span of 5years covered a complete business cycle beginning withthe mild recession in 1970, followed by an expansionfrom 1971 to 1973, and ending with the worst recessionsince World War II. During this time, firms were alsosubjected to accelerating inflation, alternately tight andeasy credit market conditions, widely fluctuating stockprices, and wage-price controls. The resulting buildup indebt and erosion in liquidity handicapped manycorporations-bringing lower credit ratings for some firmsand near bankruptcy for others.

The Federal Reserve Bank of Cleveland is vitallyinterested in corporate financial developments because itsmonetary' policy responsibilities may be better carried outwith an understanding of how business firms adjust theirbalance sheets to money and credit conditions. Thesedevelopments are of particular interest in the FourthDistrict. Manufacturing accounts for about 31 percent oftotal employment in the District; but it also accounts formost of .the wide fluctuations in income and employmentin the District, because of the volatility of its large durablegoods component. How financial conditions affectcorporate balance sheets is also important to ban kersbecause banks are frequently a major source of funds forfirms.

This report analyzes balance sheets and incomestatements of firms in the heavily industrialized FourthFederal Reserve District to determine the nature of changesthat occurred between 1970 and 1974) Among the 110manufacturing firms headquartered in the District that are

Performance MeasuresThe financial aspects of firms in this study are

evaluated using liquidity ratios, debt ratios, andprofitability measures.

Liquidity, broadly defined, is the ability of a firm tomeet short-term obligations. How well a firm may do thiscan be measured several ways. Each approach provides asomewhat different perspective because each relates adifferent category of assets to current liabilities. Thecurrent ratio is one measure of liquidity used here, and itmeasures the ability of a firm to pay short-term obligationswith assets that are readily convertible to cash. It relates

the subject of this report, 54 are among the top 500 firmson the Fortune list of largest industrial firms in the UnitedStates and 16 are. among the 100 largest firms. Clevelandand Pittsburgh, the two largest metropolitan centers in theDistrict, rank third and seventh, respectively, in the numberof corporate headquarters for the largest industrial firms inthe U. S. Many of the firms are multinational, with plantsand subsidiaries throughout the world, and foreign sales ofseveral of the largest firms account for 20 to 30 percent oftheir total sales. These large firms represent a cross-sectionof industries that includes chemicals, petroleum, rubber andplastics, primary metals, fabricated metals, nonelectricalmachinery, electrical machinery and transportation, andthat accounted for over 70 percent of manufacturingemployment in the District last year.

The analysis shows that manufacturing firms in theDistrict did well despite adverse economic and financialconditions between 1970 and 1974. Problems that dosurface involve individual firms rather than the aggregatebalance sheet for manufacturers. When viewed against somecommonly accepted measures, reduction in liquidity waspartly a cyclical phenomenon. Moreover, the buildup ofdebt was matched by growth in equity, and manufacturerswere able to improve profit margins.

iBalance sheet data for 1975 are not yet available to indicate howwell manufacturing firms in the Fourth District restructured balancesheets and how well they were able to maintain profitability.Financial data used in this report are based on balance sheet andincome statement data collected by Investors Management Sciences,Inc., a subsidiary of Standard and Poor's Corporation. Data covered110 manufacturing firms that had sales of $50 million or more in1972.

current assets, including cash, marketable securrtres,receivables, and inventories, to current liabilities, includingaccou nts payable, short-term notes payable, maturinglong-term obligations, and other miscellaneous liabilities. Acurrent ratio of 2:1 has long been considered the standardfor an acceptable level of liquidity. Another ratio used here,the quick ratio, relates the most liquid assets, cash andGovernment securities, to current liabilities. Accountsreceivable and inventories are excluded from this ratiobecause neither is necessarily convertible into cash on shortnotice without losses.

3

Debt ratios measure a firm's leverage, i.e., the amountof firm financing through debt. Increased leverage can makea firm more susceptible to financial risks during bothrecessions and tight credit market conditions. A highlyleveraged firm may have difficulty covering interest costsand other fixed charges when earnings decline. A highdebt-equity ratio during tight credit market conditions maymake it difficult for a firm to increase borrowing until morecapital is provided through equity markets or retainedearnings. A firm that does not have access to debt marketsor decides not to add more debt for investment may decideto lease property or equipment. This alternative to debtfinancing allows the firm to acquire assets withoutnecessarily adding to its debt structure. Therefore,debt-equity ratios for firms that use leasing could be higherthan reported if leases were capitalized in the same manneras an investment in fixed assets. Under most leases, a firmneither adds to fixed investment nor to long-term debt, andcan allocate its limited resources more fully to workingcapital needs.

Although analysts have expressed .concern overbusiness liquidity in recent years, investors tend toemphasize profitability when measuring how well a firm ismanaged. Therefore, profitability is used in this report toevaluate overall firm performance from 1970 to 1974. Thetwo measures used are return on sales (net profit after taxesas a percent of sales) and return on net worth (net profit

after taxes as a percent of net worth). Rates of return onsales and net worth are the product of many factors,inc Iud i n g management goals, market structure of anindustry, growth and stability of sales, and cost-pricerelationships. As a result, they differ widely among firmswithin an industry as well as between industries.

This report analyzes the financial aspects not only ofthe group of 110 manufacturing firms as a whole, but alsoof these manufacturers by industry, by size, and by salesgrowth rates. These three factors can cause an individualfirm's liquidity ratios and debt structure to vary fromoverall manufacturing averages for several reasons. Forexample, one firm may require larger amounts of financingthan another if it is in a more capital intensive industrythan the other. If the firm is in a fast growing industry, itmay be able to rely more on internal financing than if it isin a slow growing, cyclical industry. If it is a large firm withhigh earnings, it may have greater access to money, capital,and equity markets than if it is a small firm. If the firm hasfast growing sales, it may have greater needs for financingfor expansion than if it is a slow growing firm, but it alsomay be better able to attract investors willing to pay apremium for its stock because of its growth and earningspotential. Thus, analysis of firms in different industries, ofdifferent sizes, and with different growth rates can helpdetermine the pervasiveness of financial changes and differ-ences in financial characteristics among various groups.

Developments in Balance Sheets and EarningsCo rporate finance between 1970 and 1974 was

marked by two major developments:

• The period opened with the liquidity positionof manufacturers already eroded by heavyshort-term financing and the consequent needto restructure debt and rebuild liquid assets.The period closed with liquidity anddebt-equity relationships under pressure as aresult of heavy debt financing to meet soaringdemands for capital equipment and inventoryinvestment.

• Manufacturers generally maintained profitmargins and raised rates of return on equitythrough the period, but at a slightly lower levelthan in the prior 5 years. Return on equity andon sales averaged 11.0 percent and 4.8 percent,respectively, between 1970 and 1974;compared to an average of 11.9 percentand 6.2percent, respectively, between 1965 and 1969.However, profits and retained earnings werenot generated fast enough to support workingcapital needs as the expansion accelerated in1973. Heavy debt-service charges, illusoryprofits from inventories and inadequate

4

depreciation charges constrained internallygenerated funds and forced firms into anotherwave of debt financing in 1974.

Liquidity

Liquidity ratios fluctuate with the business cycle.When an economic expansion begins, liquidity is rebuilt asprofits increase and current assets, especially cash andsecurities, expand more rapidly than short-term debt andother current liabilities. As the expansion progresses, liquidassets rise slowly or are run down as demands strengthen tofinance receivables, inventories and fixed assets. Short-termdebt builds rapidly after the expansion is well underway.Liquidity weakens in the latter stages of expansion andcontinues to slide until late in a recession. In addition tothis cyclical behavior, liquidity ratios have followed along-term declining trend, as businesses have learned tomanage cash balances more efficiently and to resort toshort-term financing to provide funds.

Behavior of liquidity ratios for manufacturing firmsin the District from 1970 to 1974 roughly paralleled boththe cyclical pattern and the long-term trend. During therecession in 1970, current assets exceeded current liabilitiessomewhat more than the 2:1 norm. Nevertheless, thecurrent ratio was at a low, reflecting both cyclical and

Selected Financial Ratios of Fourth District Manufacturing Firms1970-1974

Current Ratio

2.3 r---::;;::::::=:--------,2.2

2.1

2.0

1.9

1.8

1970 '71 '74'72 '73

Quick Ratio0.4 ,-------------------.....,

0.3

0.2~~--------

0.1

1970 '74'71 '72 '73

Source: Federal Reserve Bank of Cleveland andInvestors Management Science, Inc.

long-term influences. During 1971 and 1972, the District'seconomy was recovering from the recession andmanufacturers rebuilt liquidity. Treasurers built theircurrent assets, especially cash and liquid assets, morerapidly than short-term debt. At yearend 1972, liquiditymeasures were well above the low 2 years earlier. In 1973and 1974, liquidity was squeezed as liquid assets were rundown and short term credit expanded to finance soaringdemand for inventories and capital spending. Corporatetreasurers financed the bulk of their needs with short-termfunds, mainly bank loans and commercial paper, expectingrecord borrowing rates to decline. Equity financing was notan attractive source of funds because of depressed stockprices. Also, long-term debt financing, especially in thebond market, was hindered because investors preferredthe highest quality securities and because businesses werereluctant to issue debt when interest rates were high. At theend of 1974, the current ratio was well below the previouslow in 1970, although the quick ratio holdings of liquidassets relative to current liabilities was higher than in 1970(see charts on page 5).

Long-Term Debt/EquityPercent

53 r--------------------.....,52

51

50

49

48

01970 '71

Return on EquityPercent14

13

12

11

10

9-s-

01970 '71

Profit MarginsPercent6

5

4

01970 '71 '73 '74

'72 '73 '74

'72 '73 '74

'72

Debt Structure

Business firms have become increasingly dependenton borrowed funds in recent years, making huge demandson capital markets. Debt financing reflected inadequateprofits and internal cash flows relative to capital investmentand inventory investment program requirements.

5

Inadequate internal funds partly reflected the rampantinflation in the cost of doing business that drainedcorporate liquidity in recent years, especially in 1973 and1974. In addition, inflation tended to overstate corporateprofits which boosted taxes at a time when higher costs ofnew facilities increased the volume of funds needed forreplacement. With equity prices at unattractive levels andtax advantages from debt financing, business firms rei iedheavily on debt financing. The sharp buildup in debt alsostrained the liquidity of many firms because much of theborrowing was concentrated in short-term markets.

As a result, manufacturing firms in the FourthDistrict acquired large amounts of debt between 1970 and1974, but long-term debt relative to equity was at the sameproportion at the end of 1974 as it was at the end of 1970.Apparently, manufacturers refunded some· portion of theshort-term debt acquired in 1970, reduced the proportionof debt to equity in 1972 and 1973, and then added debtmore rapidly than equity in 1974. Looking at individualfirms rather than aggregate data, 13 manufacturers hadmore long-term debt than equity in both 1970 and 1974.

Profitability

Manufacturers in the District successfully improvedprofit margins between 1972 and 1974 and considerablyimproved return on equity during the 5-year period. Returnon equity improved from 9.2 percent in 1970 to 14 percentin 1974, as net income of Fourth District firms nearlydoubled in response to a higher volume of sales and higherprices.

The upward movement in profitability paralleled butfell somewhat short of the gains experienced by allmanufacturing corporations in the U. 5.2 Moreover, a large

part of the reported gains in earnings in recent years wereillusory because high rates of inflation overstated profitsfrom inventories. Many manufacturers in the District used afirst-in/first-out method of accounting that includescost-of-goods-sold at historic costs instead of replacementcosts; therefore, large profits from inventories were realizedduring this period of sharp increases in costs and prices.These profit gains were illusory because inventories had tobe replaced at current higher costs. In 1974, for example,nearly 37 percent of total reported profits of nonfinancialcorporations in the U. S. were inventory gains. If earningsof manufacturers in the District were adjusted for inventoryprofits in the same proportion as for nonfinancialcorporations in the U.S., net income of the 110manufacturers in 1974 would have fallen 3 percent fromthe previous year rather than increased by 23 percent. For1970 to 1974, net income would have risen 22.5 percentafter allowance for inventory gains, rather than nearlydoubling.

Similarly, depreciation allowances in an inflationaryperiod tend to overstate profits. Charges for depreciationare inadequate because of higher replacement costs, wh ichare only partly compensated for by accelerateddepreciation allowances.

In summary, relatively slow growth in earnings afterinventory profits from 1970 to 1974, and an outrightdecline in 1974, squeezed liquidity and fostered reliance onexternal sources of funds to finance soaring demands forcurrent and fixed assets.

2For all manufacturing corporations in the United States, profitmargins averaged 4 cents per dollar of sales in 1970 and 5.5 cents in1974. Return on equity amounted to 9.3 percent and 14.9 percent,respectively.

Industry Differences and BehaviorLiquidity ratios and debt structure within an industry

may vary widely from the overall developments reportedabove. These variances reflect differences in product,market structure, growth and stability of sales, and theability to raise financing in the money, capital and equity. markets. For instance, firms more capital intensive thanothers may require larger amounts of financing from bothinternal and external sources. Firms with fast growing salesand high returns on investment can depend more heavily oninternal financing. Other firms with slower growing salesand- insufficient depreciation allowances to meet their needsfor fixed assets may depend more on external financing.The stability and growth of sales within an industry alsoaffect its means of financing. Firms whose sales andearnings are highly cyclical and slow growing, such as steelfirms, may have difficulty interesting investors in equityfinancing. Firms with stable and rapidly growing sales, suchas chemical firms, can rely more on equity markets forfinancing expanding needs.

To help determine the pervasiveness of financialchanges as well as differences in financial characteristics

6

among various industries, eight groups of manufacturersare considered, including chemicals, petroleum, rubberand plastics, primary metals, fabricated metals, machinery,electrical machinery and equipment, and transportationequipment. Firms in these industries account for 71 percentof the firms included in this report and for about the sameproportion of employment in manufacturing in the Districtlast year.

All industries, except electrical machinery andequipment, had lower current ratios in 1974 than in 1970,and most industries had more debt relative to equity in1974 than in 1970. Firms in the chemical industry had thelowest debt relative to equity and the best returns on salesand equity. Firms in the machinery industry were thelowest earners and had the highest debt to equity of anyindustry (see charts on page 7).

Liquidity

The cyclical nature of liquidity is suggested by thebehavior of liquidity ratios for the various industries during

Current Ratio3.0

2.0

1.0

o'70 '74 '70 '74 '70 '74 '70 '74 '70 '74 '70 '74 '70 '74 '70 '74 0.2

12345678

Selected Financial Ratios of Fourth DistrictManufacturing Firms by Major Industries

Industry

1. Chemicals and Allied Products2. Petroleum3. Rubber and Plastics4. Primary Metals5. Fabricated Metals6. Nonelectrical Machinery7. Electrical Machinery8. Transportation

No. of Firms

Quick Ratio0.7 -------------------------------------------

0.6

0.5

0.4

0.3

0.1

o'70 '74 '70 '74 '70 '74 '70 '74 '70 '74 '70 '74 '70 '74 '70 '74.1 2 3 4 5 6 7 8

868145158

14

Long-Term Debt/EquityPercent70----------------~-----------------------

Source: Federal ReserveBank of Clevelandand 40 -----Investors Management Science, Inc.

Return on EquityPercent18-------------------------------------------

16

14

12

10

8

6

4

.-;/o'70 '74 '70 '74 '70 '74 '70 '74 '70 '74 '70 '74 '70 '74 '70 '74

12345678

30.-;/o'70 '74 '70 '74 '70 '74 '70 '74 '70 '74 '70 '74 '70 '74 '70 '74

2345678

Profit MarginsPercent9-------------------------------------------

6

5

4

3

2

o '70 '74 '70 '74 '70 '74 '70 '74 '70 '74 '70 '74 '70 '74 '70 '7412345678

7

the period. From lows, generally in 1970, liquidity ratiosrose in 1971 and 1972 and then fell to new lows in 1974.

The decline in both current and quick ratios was mostpronounced in the chemical, fabricated metals, andnonelectrical machinery industries. Several firms in theseindustries held fewer liquid assets in 1974 than in 1970 and1971. They has also added substantially to short-term debtto finance soaring demand for inventories and capitalequipment.

Primary metals producers, especially steel, held ahigher proportion of liquid assets to current liabilities in1973 and 1974 as a result of high earnings in those years.Nevertheless, some deterioration in their current ratiooccurred as working capital and fixed capital needs rosesharply.

Debt Structure

Five of the eight industries held more debt relative toequity in 1974 than in 1970. Two capital intensiveindustries, petroleum and primary metals, reduced theirlong-term debt relative to equity. Most primary metalproducers reduced the proportion of debt to equitybetween 1970 and 1974. Steel companies improved theirdebt-equity relationship as a result of improved earnings

Size Differences and BehaviorDifferent size firms may also have liquidity ratios and

debt structures that vary widely from the overalldevelopments discussed earlier. These variances reflectfirms' different financial needs and abilities to finance thoseneeds. For instance, smaller firms are typically moreconservatively managed and may have less access to debtand equity markets than larger firms. Larger firms generatestronger cash flows but frequently not enough to permitmodernization and expansion of capacity. Thus, largerfirms typically need external financing, particularly forfixed assets. Working capital needs also vary among smallerand larger firms. Smaller firms depend heavily on currentasset management, and trade credit is an important sourceof external financing for them. Larger firms with higherearnings have access to a variety of debt and equity sourcesand resort to external financing to meet both workingcapital and fixed asset needs.

To determine how changes in financial marketsaffected different size firms, the 110 manufacturing firmsare classified into four groups based on 1970 sales. Theseclassifications are: firms from $50-$100 million in sales;firms from $100-$500 million; firms from $500 million to$1 billion; and firms with sales of more than $1 billion.

Balance sheet and income performance between 1970and 1974 was substantially different for large and smallfirms. In 1974, the largest firms in the District ($1 billionand over) held lower current ratios, higher debt-equityratios, and higher returns on sales and equity than the

8

from a high volume of steel operations and substantial priceincreases following wage-price decontrol in April 1974.They also stepped up modernization and expansion offacilities in 1973 and 1974. Producers of chemicals andallied products, another capital intensive industry, held thelowest amount of debt relative to equity of any of the eightindustries.

Profitability

Manufacturers generally were able to improve their,return on equity between 1970 and 1974, but not allimproved their profit margins. Profit margins generallypeaked in 1973 but then dropped as a result of lower salesvolume and higher costs that were not recoverable in someindustries, such as rubber and automotive, because of weakmarket conditions.

Ra tes of return on sales and on equity variedconsiderably between the highest and lowest earners. In1974, profit margins ranged from a low of 2.6 cents perdollar of sales in electrical machinery to a high of 6.7 centsper dollar in chemical and allied products and from a low of8.8 percent return on equity in fabricated metals to a highof 17.7 percent in chemicals. Return on equity in 1974 washigher than in 1970 for all industries except fabricatedmetals and electrical equipment.

smallest firms ($100 million or less). Firms with salesbetween $500 million and $1 billion were the mostprofitable (see charts on page 9).

LiquidityBoth liquidity measures followed the cyclical pattern

described earlier. Both ratios peaked in 1971 and slidgradually to lows in 1974. Firms in all size classes reducedholdings of current assets relative to current liabilitiesbetween 1970 and 1974, but the largest reduction occurredfor firms in size classes $100/$500 million and $1 billionand over. Firms in the smallest size group were the mostliquid, and the largest firms the least liquid.

Debt StructureSmallest firms held the lowest proportion of debt to

equity of any of the four groups. Firms in the $500million/$1 billion size class were the only group thatconsistently added more debt than equity between 1970 to1974, and they were also the group with the highestproportion of debt to equity. For other size classes, debt toequ ity was generally lower in 1974 than in 1970.

ProfitabilityManufacturers in all size classes earned a higher return

on equity in 1974 than in 1970, and a return on sales thatwas nearly the same or better in 1974 than in 1970.

'74 '70 '74 '70 '74 '70 '74

Selected Financial Ratios of Fourth District 2 3 4

Manufacturing Firms by Size

Size No. of Firms Long-Term Debt/EquityPercent

1. $50 Million to $100 Million 40 702. $100 Million to $500 Million 433. $500 Million to $1 Billion 11 604. $1 Billion and Over 16

50

Source: Federal Reserve Bank of Cleveland andInvestors Management Science, Inc. 40

30.c;::-O'70 '74 '70 '74 '70 '74 '70 '74

Return on Equity 2 3 4

Percent17

15 Profit Margi nsPercent6

13

5

11

.Current Ratio3.0------------------------------------------

2.0

1.0

o'70 '74 '70 '74 '70 '74 '70 '74

2 3 4

9

7

5.c;::-

O '70 '74 '70 '74 '70'74 '70 '742 43

Quick Ratio0.4 ---------------------

'70 '74 '70 '74'74 '70'74 '702 3 4

9

Nevertheless, margins in 1974 were lower than in 1973 forfirms in all size classes except in the $500 million/$l billiongroup. Firms in the largest size class consistently earned the

highest return per dollar of sales, but firms in the $500million/$l billion class earned the highest return on equity(1972-1974).

Growth Differences and BehaviorLiquidity ratios and debt structures will also vary

from the overall developments discussed at the beginning ofthis report among firms with different rates of growth insales. On the one hand, faster growing firms are likely tohave larger working capital needs and maintain lowerliquidity than slower growing firms. This reflects the fastergrowing firms' needs to meet expanding receivables,inventories and capacity. Heavier demands for workingcapital may cause cash flow problems for faster growingfirms. On the other hand, faster growing firms may havegreater access to both equity and debt financing thanslower growing firms. Faster growing firms attract investorswho are willing to pay some premium for their stockbecause of its growth and earnings potential.

To analyze these differences, the 110 firms areclassified according to their growth rates in sales. Growthhere is defined as a compound annual rate of change in netsales from 1970 to 1974. Manufacturers are classified intofive groups according to their growth: percentage growthin sales of 0-5 precent; 5-10 percent; 10-15 percent; 15- 20percent; and 20 percent or higher. Growth rates forindividual firms ranged from a low of 4 percent to a high of43 percent. Fastest growth rates were frequently associatedwith firms in the petroleum industry (whose sales wereinflated by the sharp increase in oil prices) and firms thatmerged or acquired other firms. Firms with the fastestgrowth rates tend to be least liquid, have higher returnson sales and equity, and lower debt to equity (see chartson page 11).

Concluding CommentThis analysis shows that financial performance of

manufacturing firms in the aggregate was better than mightbe expected in view of highly volatile conditions during theearly 1970's. However, the broad analysis conceals someindividual problems. For some firms, liquidity was strainedmore seriously and servicing debt was more difficult thanindicated for manufacturers generally. Nevertheless,analysis of manufacturing firms by industry, size, or growthrates did not surface any special problem areas in a periodthat might be classified as one of the most traumatic sinceWorld War II.

This overview shows how business managers adjustedtheir balance sheets during the recent volatile financial

10

LiquidityAll classes of firms but those with the slowest growth

rates (0-5 percent and 5-10 percent) had lower liquidityratios at the end of 1974 than at the end of 1970. Firmswith the fastest growth rates accounted for a good part ofthe decline in the current ratio for total manufacturingindustries between 1970 and 1974 but also held a steadilylarger proportion of their current assets in cash andsecurities than other groups. Slowest growth firmsimproved their liquidity between 1970 and 1974.

Debt StructureAll classes of firms except the 10-15 percent growth

class held less debt relative to equity in 1974 than in 1970.The proportion of debt held among the five classes differedwidely, with the lowest proportion held by firms in theslowest growth class and the highest proportion held in1973 and 1974 by the 5-10 percent growth class.

ProfitabilityAll growth classes of firms but the 5-10 percent class

reported higher rates of return on equity in 1974 than in1970. Also, all classes of firms reported higher returns onsales in 1974 than in 1970, again with the exception offirms with growth rates of 5-10 percent. ,

Fastest growth companies showed the highest returnson equity in 1973 and 1974, and were the second highestearners in previous years.

market conditions, but it leaves unanswered manyquestions concerning what factors these business managersconsidered in making these adjustments. For instance, whatis the relationship between cash flow and fixed investmentdecisions? What is the relationship between highly leveragedfirms, earnings and the business cycle? What are thetrade-offs between liquidity and soundness of firms? Inwhat ways do small firms seek to finance their needs duringtight credit conditions? Will banks be willing and able tofinance assets, given liquidity and leverage trends of recentyears? These are among the questions this Bank willinvestigate in future research projects.

j. j. Erceg

'74 '70 '74 '70 '74 '70 '74 '70 '74

Selected Financial Ratios of Fourth District 2 3 4 5

Manufacturing Firms by Sales Growth

Average Annual Sales Growth No. of FirmsLong-Term Debt/Equity

1. 0-5 Percent 6 Percent

2. 5-10 Percent 25 70

3. 10-15 Percent 404. 15-20 Percent 22 505. 20 Percent and Over 17

30Source: Federal Reserve Bank of Cleveland andInvestors Managernen ( Science, Inc.

10

0'70 '70 '74'70 '74 '70 '74 '70 '74 '74

Return on Equity 2 3 4 5

Percent

17

15 Profit MarginsPercent

13 8

7

116

9 5

7 4

5 3

23

Current Ratio3.0---------------------

2.0

1.0

'74 '70 '74 '70 '74 '70 '74 '70 '742 3 4 5

'74 '70 '74 '70 '74 '70 '74 '70 '742 3 4 5

Quick Ratio0.4-----------------------------

0.2

0.1

o

11

COMPARATivE STATEMENTof CONdiTioN

ASSETSGold Certificate Reserves .Special Drawing Rights Certificates .Federal Reserve Notes of Other Banks .Other Cash .

Loans to Member Banks .Federal Agency Obligations - Bought Outright .U. S. Government Securities:

Bills .Notes .Bonds .

Total U.S. Government Securities .

Total Loans and Securities .

Cash Items in Process of Collection .Bank Premises .Operating Equipment .Interdistrict Settlement Account 1 .Other Assets .

Total Assets

LIABILITIESFederal Reserve NotesDeposits:

Member Bank - Reserve Accounts .U.S. Treasurer - General Account .Foreign .Other Deposits .

Total Deposits .

Deferred Availability Cash Items .Other Liabilities .

Total Liabilities .

CAPITAL ACCOUNTSCapital Paid in .Surplus .

Total Liabilities and Capital Accounts .Contingent Liability on Acceptances Purchased for ForeignCorrespondents .

1 Prior to 1975 this amount was iricluded in Gold Certificate Reserves.

12

Dec. 31, 1975 Dec. 31, 1974

$ 888,341,331 $ 661,606,70743,000,000 33,000,000121,257,590 90,672,83844,629,033 30,605,087

100,000 300,000479,750,000 398,634,000

2,939,681,000 3,116,800,0003,475,489,000 3,391,864,000436,259,000 278,356,000

6,851,429,000 6,787,020,000

7,331,279,000 7,185,954,000

558,094,757 527,729,75525,335,174 26,335,214

697,574 -0-654,068,671 -0-103,121,178 79,903,681

$9,769,824,308 $8,635,807,282

$6,770,159,378 $6,233,786,708

1,689,907,719 1,269,243,074597,027 ,539 376,618,25322,846,200 25,520,00018,263,605 41,980,972

2,328,045,063 1,713,362,299

413,832,654 440,514,97396,517,013 92,300,702

$9,608,554,108 $8,479,964,682

80,635,10080,635,100

$9,769,824,308

77,921,30077,921,300

$8,635,807,282

$ -0- $ 86,486,400

COMPARisON of EARNiNGS ANd EXPENSES

Total Current Earnings .Net Expenses .

Current Net Earnings .

Additions to Current Net Earnings:

Profit on Sales of U. S. Government Securities (Net) .All Other .

Total Additions .

Deductions from Current Net Earnings:

Loss on Foreign Exchange Transactions (Net) .All Other .

Total Deductions .

Net Deductions .Net Additions .

Net Earnings before Payments to U.S. Treasury .

Dividends Paid .Payments to U.S. Treasury (Interest on F.R. Notes) .Transferred to Surplus .

Total .

1975$483,991,23938,663,613

1974$468,639,82336,217,420

445,327,626 432,422,408

3,012,563138,099

(3,165,278)673,549

3,150,662 {2,491 ,729)

21,035,480 2,988,89961,300 435,266

21,096,780 3,424,165

17,946,118 5,915,894-0- -0-

$427,381,508 $426,506,514

$ 4,790,394 $ 4,631,401419,877,314 418,281,863

2,713,800 3,593,250

$427,381,508 $426,506,514

Disposition of Gross Earnings

---- To u.s. Treasury

---- Dividends---- Operating Expenses

---- Surplus

90.1%1.0

8.3

0.6

13

As of March 7, 7976

DIRECTORSChairman

HORACE A. SHEPARDChairman of the Board and Chief Executive Officer

TRW Inc.Cleveland, Ohio

Deputy ChairmanROBERT E. KIRBY

Chairman and Chief Executive OfficerWestinghouse Electric Corporation

Pittsburgh, Pennsylvania

EDWARD W. BARKERChairman of the BoardFirst National Bank of MiddletownMiddletown, Ohio

MERLE E. GILLIANDChairman of the Board and Chief Executive OfficerPittsburgh National BankPittsburgh, Pennsylvania

CHARLES Y. LAZARUSChairmanThe F. & R. Lazarus Co.Columbus, Ohio

DONALD E. NOBLEChairman of the Board and Chief Executive OfficerRubbermaid IncorporatedWooster, Ohio

RICHARD P. RAISHPresidentThe First National BankBellevue, Ohio

OTIS A. SINGLETARYPresidentUniversity of KentuckyLexington, Kentucky

MEMBER, FEDERAL ADVISORY COUNCILM. BROCK WEI R, President and Chief Executive

The Cleveland Trust CompanyCleveland, Ohio

OFFICERSWILLIS J. WINN, President

WALTER H. MacDONALD, First Vice President

ROBERT D. DUGGAN, Senior Vice PresidentWI LLiAM H. HENDRICKS, Senior Vice PresidentDONALD G. BENJAMIN, Vice PresidentJOHN E. BIRKY, Vice PresidentGEORG E E. BOOTH, JR., Vice President and CashierPAUL BREIDENBACH, Vice President

and General CounselR. JOSEPH GINNANE, Vice PresidentWI LLiAM J. HOCTER, Vice President and EconomistHARRY W. HUNI NG, Vice PresidentR. THOMAS KI NG, Vice PresidentELFER B. MI LLER, General AuditorTHOMAS E. ORMISTON, JR., Vice PresidentLESTER M. SELBY, Vice President and SecretaryROBERT E. SHOWALTER, Vice PresidentHAROLD J. SWART, Vice PresidentDONALD G. VINCEL, Vice President

14

OSCAR H. BEACH, JR., Assistant Vice PresidentMARGRET A. BEEKEL, Assistant Vice PresidentTHOMAS J. CALLAHAN, Assistant Vice President

and Assistant SecretaryGEORGE E. COE, Assistant Vice PresidentPATRICK V. COST, Assistant General AuditorROBE RT G. COU RY, Assistant General CounselJOHN J. ERCEG, Assistant Vice President

and EconomistAN N E J. ERSTE, Assistant Vice PresidentROBERT J. GORIUS, Assistant Vice PresidentJAMES W. KNAUF, Assistant Vice PresidentBU RTON G. SHUT ACK, Assistant Vice PresidentROBERT D. SYMONDS, Assistant Vice PresidentDAVID A. TRUBICA, Assistant Vice PresidentROBERT VAN VALKENBURG, Assistant Vice

President

As of March 7, 1976

CiNCiNNATi BRANCit

JOE D. BLOUNT, PresidentThe National Bank of CynthianaCynthiana, Kentucky

MARTIN B. FRI EDMAN, PresidentFormica Corp.Cincinnati, Ohio

LAWRENCE C. HAWKINS, Vice PresidentUniversity of CincinnatiCincinnati, Ohio

DIRECTORSChairman

LAWRENCE H. ROGERS, IIPresident

Taft Broadcasting CompanyCincinnati, Ohio

ROBERT A. KERR, Chairman and PresidentWinters National Bank and Trust CompanyDayton, Ohio

JOSEPH F. RIPPE, PresidentThe Provident BankCincinnati, Ohio

CLAIR F. VOUGH, ChairmanProductivity Research International, Inc.Lexington, Kentucky

OFFICERSROBERT E. SHOWALTER, Vice President

CHARLES A. CERINO, Vice President and Cashier DAVID F. WEISBROD, Assistant Vice PresidentROSCOE E. HARRISON, Assistant Vice President JERRY S. WILSON, Assistant Vice President

RICHARD D. EDWARDS, PresidentThe Union National Bank of PittsburghPittsburgh, Pennsylvania

R. BURT GOOKIN, Vice President andChief Executive OfficerH. j. Heinz Co.Pittsburgh, Pennsylvania

WILLIAM H. KNOELL, PresidentCyclops CorporationPittsburgh, Pennsylvania

DIRECTORSChairman

G. J. TANKERSLEYPresident

Consolidated Natural Gas CompanyPittsburgh, Pennsylvania

MALCOLM E. LAMBING, JR., President andChief Executive OfficerThe First National Bank of PennsylvaniaErie, Pennsylvania

WILLIAM E. MIDKIFF, III, Chairman of the BoardFirst Steuben Bancorp, Inc.Toronto, Ohio

ARNOLD R. WEBER, DeanGraduate School of Industrial AdministrationCarnegie-Mellon UniversityPittsburgh, Pennsylvania

OFFICERSROBERT D. DUGGAN, Senior Vice President

SAMU EL G. CAMPBELL, Vice President and Cashier CHARLES A. POWELL, Assistant Vice PresidentPAUL E. ANDERSON, Assistant Vice President WILLIAM R. TAGGART, Assistant Vice President

15