Undoing the Worrying Habit

Once acquired, the habit of worrying seems hard to stop. We're raised to worry and aren't considered "grown up" until we perfect the art. Teenagers are told: "you'd better start worrying about your future". If your worries aren't at least as frequent as your bowel movements, you're seen as irresponsible, childish, aimless. That's a "responsible adult" game rule.

To the extent that worrying is learned/conditioned behaviour, it can be undone. There are psychological gimmicks for undoing the worry habit. There are also obstacles.

Obstacle 1: Happiness Negation

Centuries-old cultural conditioning has given us a nasty neurosis: the belief that happiness must be "earned". It can be "earned" only by enduring unpleasantness (eg work, pain, misery). But how do you know if you've endured enough unpleasantness to deserve happiness? Another unspoken game rule: "responsible adults" can never endure enough unpleasantness to truly deserve happiness.

Laid on top of the first neurosis is the idea that spending money will make you happy. This is toffee coating on a bad puritan apple. If you spend enough money to give you the (advertised) conditions for happiness, the neurosis emerges in the form of apparently random worries, guilt, "feeling shitty", etc. Worrying is the easiest and most popular way to negate happiness. (See sidebar interlude).

So: we never stop working, we never stop spending money, we're never really happy – ideal conditions, coincidentally, for a certain type of slave economy.

Obstacle 2: The Idea that Worrying Serves a "Purpose"

You won't stop worrying if you think it serves you. So it's a good idea to distinguish the fight-or-flight response (a healthy bodily reaction to immediate danger) from worry (a psychological problem). By making this distinction, you're less likely to overrate the value of worrying.

The fight-or-flight response (FOF) is useful on rare occasions of real danger. In animals, the FOF responds to "external" stimuli; in humans it responds also to worries about imagined dangers, and to socially-conditioned psychological stimuli: "what will people think about me?", etc.

Worrying is never useful. It handicaps and diminishes us. The more it triggers the FOF with imagined threats, the more it prevents clear thinking (which is probably our greatest survival asset).
Rearranging the mental furniture

There's a useful gimmick to help stop worrying , you simply cultivate the habit of postponing worrying. Your mind becomes (re-)conditioned to not dwell on worries in the present.

The trick is that whenever you feel plagued by a worrying thought, note it down on a "worry sheet" (a piece of paper set aside for the purpose) – you can then forget about it, knowing that you plan to worry later.

This deceptively simple technique is effective because it bypasses the psychological obstacles mentioned above. Your mind is "fooled" into thinking that you haven't given up worrying. Meanwhile, you lose the habit of worrying in the present moment.

You can plan to revisit noted worries at a time when you're worry-free. Or you can postpone worries indefinitely. That might sound bizarre, but then so is the notion that you must experience endless unhappiness (eg worrying) before you're allowed to be happy.

More likely is that when using this technique you will simply forget your original worries – they will never have bothered you.

Accelerator-Brake analogy

What follows is slightly more esoteric than above. Feel free to ignore...

Strange as it may seem, you want what you worry about. Or at least that's what you inadvertently tell your brain when you worry. On one level, your brain can't process "negatives". If you tell it: "don't think about crashing the car", it can't help being "attracted" to the thought/image of crashing.

Consciously, worrying is about preventing/resisting/avoiding X. Subconsciously, it's a reinforcement of wanting X (at least to the extent of wanting the experience of X in your mind). Consciously, you're pressing on the brake; subconsciously you're pressing on the accelerator.

The difficulty is that your "feet" (to continue with the analogy) are tied together. So, to stop accelerating, you must also lift your foot from the brake. But you refuse to do this (which might be sensible in a car; but your brain isn't a car).

You somehow have to persuade (or con) your brain into thinking it's safe to lift both feet from the worry pedals. For serious anxiety disorders, phobias, etc, many people go into therapy. The end result, if successful, is equivalent to learning to lift both feet (ie to "let go" of the worry/fear).

For relatively "minor" worry problems, you can use psychological gimmicks to "con" your brain into letting go of the worry – eg the worry postponement and "focused punishment" techniques described above (both have the effect of getting you to "lift both feet" from the accelerator-brake).

Word of Inspiration

    “Just because something is easy to measure doesn't mean it's important.”

Seth Godin

    “Never doubt that a small group of thoughtful,

citizens can change the world. Indeed, It is the only thing that ever has.”

Margaret Mead

    “People are, if anything, more touchy about being thought silly than they are about being thought unjust.”

E. B. White

    “Selling to people who actually want to hear from you is more effective than interrupting strangers who don't.”

Seth Godin

    “Take away my people, but leave my factories, and soon grass will grow on the factory floors. Take away my factories, but leave my people, and soon we will have a new and better factory.”

Andrew Carnegie 

Writing Skills

Getting Your Written Message Across Clearly

A colleague has just sent you an email relating to a meeting you're having in one hour's time. The email is supposed to contain key information that you need to present, as part of the business case for an important project.

But there's a problem: The email is so badly written that you can't find the data you need. There are misspellings and incomplete sentences, and the paragraphs are so long and confusing that it takes you three times more than it should to find the information you want.

As a result, you're under-prepared for the meeting, and it doesn't go as well as you want it to.

Have you ever faced a situation similar to this? In today's information overload world, it's vital to communicate clearly, concisely and effectively. People don't have time to read book-length emails, and they don't have the patience to scour badly-constructed emails for "buried" points.

The better your writing skills are, the better the impression you'll make on the people around you – including your boss, your colleagues, and your clients. You never know how far these good impressions will take you!

In this article, we'll look at how you can improve your writing skills and avoid common mistakes.

Audience and Format

The first step to writing clearly is choosing the appropriate format. Do you need to send an informal email? Write a detailed report? Create advertising copy? Or write a formal letter?

The format, as well as your audience, will define your "writing voice" – that is, how formal or relaxed the tone should be. For instance, if you write an email to a prospective client, should it have the same tone as an email to a friend?
 
Definitely not.
 
Start by identifying who will read your message. Is it targeted at senior managers, the entire human resources team, or a small group of engineers? With everything you write, your readers, or recipients, should define your tone as well as aspects of the content.


Composition and Style

Once you know what you're writing, and for whom you're writing, you actually have to start writing.

A blank, white computer screen is often intimidating. And it's easy to get stuck because you don't know how to start. Try these tips for composing and styling your document:

• Start with your audience – Remember, your readers may know nothing about what you're telling them. What do they need to know first?
• Create an outline – This is especially helpful if you're writing a longer document such as a report, presentation, or speech. Outlines help you identify which steps to take in which order, and they help you break the task up into manageable pieces of information.
• Use AIDA – If you're writing something that must inspire action in the reader, follow the Attention-Interest-Desire-Action (AIDA) formula. These four steps can help guide you through the writing process.
• Try some empathy – For instance, if you're writing a sales letter for prospective clients, why should they care about your product or sales pitch? What's the benefit for them? Remember your audience's needs at all times.
• Use the Rhetorical Triangle – If you're trying to persuade someone to do something, make sure that you communicate why people should listen to you, pitch your message in a way that engages your audience, and present information rationally and coherently. Our article on the Rhetorical Triangle can help you make your case in the most effective way.
• Identify your main theme – If you're having trouble defining the main theme of your message, pretend that you have 15 seconds to explain your position. What do you say? This is likely to be your main theme.
• Use simple language – Unless you're writing a scholarly article, it's usually best to use simple, direct language. Don't use long words just to impress people.

Structure

Your document should be as "reader friendly" as possible. Use headings, subheadings, bullet points, and numbering whenever possible to break up the text.

After all, what's easier to read – a page full of long paragraphs, or a page that's broken up into short paragraphs, with section headings and bullet points? A document that's easy to scan will get read more often than a document with long, dense paragraphs of text.

Headers should grab the reader's attention. Using questions is often a good idea, especially in advertising copy or reports, because questions help keep the reader engaged and curious.

In emails and proposals, use short, factual headings and subheadings, like the ones in this article.

Adding graphs and charts is also a smart way to break up your text. These visual aids not only keep the reader's eye engaged, but they can communicate important information much more quickly than text.



Grammatical Errors

You probably don't need us to tell you that errors in your document will make you look unprofessional. It's essential to learn grammar properly, and to avoid common mistakes that your spell checker won't find.

Here are some examples of commonly misused words:

• Affect/effect

1. "Affect" is a verb meaning to influence. (Example: The economic forecast will affect our projected income.)
2. "Effect" is a noun meaning the result or outcome. (Example: What is the effect of the proposal?)

• Then/than

1. "Then" is typically an adverb indicating a sequence in time. (Example: We went to dinner, then we saw a movie.)
2. "Than" is a conjunction used for comparison. (Example: The dinner was more expensive than the movie.)

• Your/you're

1. "Your" is a possessive. (Example: Is that your file?)
2. You're" is a contraction of "you are." (Example: You're the new manager.)
3. Note: Also watch out for other common homophones (words that sound alike but have different spellings and meanings) – such as their/they're/there, to/too/two, and so on.

•  Its/it's

1.  "Its" is a possessive. (Example: Is that its motor?)
2.  "It's" is a contraction of "It is." (Example: It's often that heavy.) (Yes, it is this way around!)

• Company's/companies (and other possessives versus plurals)

1. "Company's" indicates possession. (Example: The company's trucks hadn't been maintained properly.)
2. "Companies" is plural. (Example: The companies in this industry are suffering.)

Tip:
Some of your readers – arguably an increasing number – won't be perfect at spelling and grammar. They may not notice if you make these errors. But don't use this as an excuse: there will usually be people, senior managers in particular, who WILL notice!
Because of this, everything you write should be of a quality that every reader will find acceptable.




Proofing

The enemy of good proofreading is speed. Many people rush through their documents, but this is how you miss mistakes. Follow these guidelines to check what you've written:

• Proof your headers and subheaders – People often skip these and focus on the text alone. Just because headers are big and bold doesn't mean they're error free!
• Read the document out loud – This forces you to go more slowly, so that you're more likely to catch mistakes.
• Use your finger to follow text as you read – This is another trick that helps you slow down.
• Start at the end of your document – Proofread one sentence at a time, working your way from the end to the beginning. This helps you focus on errors, not on content.

Key Points

More than ever, it's important to know how to communicate your point quickly and professionally. Many people spend a lot of time writing and reading, so the better you are at this form of communication, the more successful you're likely to be.

Identify your audience before you start creating your document. And if you feel that there's too much information to include, create an outline to help organize your thoughts. Learning grammatical and stylistic techniques will also help you write more clearly; and be sure to proof the final document. Like most things, the more you write, the better you're going to be!

12 Essential Trading Tips

This isn’t some self-help rubbish list that’s meant to inspire. This is a down and dirty, harsh and truthful list.

1. Learn the Basics 

Yes this is a simple one but it has to be said. A man in my position has the pleasure of talking to scores of newbie traders on a daily basis. If there is one thing I have learned it’s that most newbies forego the basic training and jump straight into the warzone. This is of course a fatal error, on their part, so if you’re a newbie LEARN THE DAMN BASICS!


2. You Won’t Get Rich Quick, Experience Makes You Rich
If you’re here to get rich quick you’re just a clueless tourist. Don’t be naive. Trading is all about experience. As is the case with any career, the longer you do it the more efficient you become. I am often asked “Nick, how did you make 90 pips when I only made 70 pips on the same trade?” It is all about experience. I have been trading for 5 years so I am an efficient trader. I see things that newbie’s don’t because I have the experience. The journey to becoming a trader is a long one so be prepared to stick it out for 1-3 years before you’re consistently profitable.

3. Experts Are a Joke 

Listening to expert opinions is great right? Of course it is!
The problem with financial markets is that every newbie who’s had a good week thinks they are an expert. The other, more pathetic, type of expert is the 30-60 year old guy/girl, in a suit, who claims to be a professional trader yet begs you to buy their book. These people are usually failed traders who make money teaching other traders how to fail. Self-proclaimed experts tend to:

1. Regurgitate generic old information that just doesn’t work.
2. Say they’re rich full time traders yet try to sell you books.
3. Make outrageous claims like they turned $1k into $1mil in a month or some such rubbish.
4. Try to prove they are profitable traders by posting pics of photoshopped account statements.
5. Cleverly use maths to make themselves appear more successful than they are e.g. double counting wins and single counting losses.

So most ‘trading experts’ are a joke. Take what they say with a pinch of salt.

4. Do Your Own Analysis 

Continuing from the last tip, blindly following others will make you blind. Your goal should be to become a successful trader, not a pigeon following others around for scraps of information.
As a trader you need to pick a method and learn to analyse the market. Being able to do your own analysis will bring you closer to being a pro trader. Doing your own analysis allows you to:

1. Be self reliant.
2. Actually learn to trade.

If you choose to blindly follow some self-proclaimed guru all you are is a pigeon. How will you make the money when the guru stops giving tips or the tips stop working? Will you even understand why they worked in the first place and why they no longer work?

5. The Demo Myth
If I wanted to be a professional boxer then I would go out and buy a boxing game for my PlayStation 3 and start my boxing training. Would that make any sense?? Well it makes just as much sense as trading demos in the hopes of becoming a successful trader.
Demo trading for 3 months does not work for 2 reasons:-

1. Demos give new traders false confidence and cause them to learn bad habits.
2. Demo account performance is often superior to a brokers live account performance. This includes execution speed, stop hunting, and several other factors.

The best solution is to use a demo to learn the basics and test out, or find, a trading method. When it comes to actually trading you should only trade a live account. These days you can open an account with pocket change ($10) so there are no reasons not to trade live.
Oh and if you cannot afford to lose $10 you should not be trading anyway….

6. Kill Losing Streaks Early
This is by far the most important rule I have ever put to action in my own trading. Had I not stringently stuck to this rule I truly believe I would not be a successful trader today.
If you lose 3 trades in a row STEP AWAY from your charts. Take a few days off trading and come back with a clear head. Losing streaks are very dangerous and falling into one can lead to very big losses.
I cannot stress this tip enough.

7. Following the Pack
Have you heard that 90% of new traders fail? Like most statistics that one is probably bull. However it is fair to say that the majority of newbie’s coming into this market fail.
I believe the secret is to break away from the pack and do your own thing. That doesn’t mean you should segregate yourself from the trading community. It just means you should rely on yourself. Get enough knowledge/experience to be independent and not simply a follower.
Think about this one logically:-

1. The vast majority of new traders fail.
2. If I follow the majority I become part of the majority.
3. If I am part of the majority I am likely to fail with them.

Become independent DO NOT remain a follower.

8. Stick to Your Method
Every trading method has its ups and downs. No trading system, method or style will be 100% profitable, all year round. My method, for example, has on average an 80% success rate. Some periods of the year I will win only 6 in 10 trades (60%). Other periods in the year I win 100% of trades for a month or two.
I know each year, I will have some bad periods in which case I lose more trades than normal. I do not lose faith though. I stick it out and keep on trading. The problem with most newbie’s is they will give up on a method after its first bad week.
Don’t abandon your method when times are tough.

9. Keep It Simple
This is an easy one. Keep it simple!
There is no reason to complicate trading. For example, my trading method is extremely simple yet extremely effective. I spend 2-5 hours per week trading and the rest of the week enjoying life.
Your method does not have to be incredibly complex to work. Keeping it simple will allows you to:

1. Work much more efficiently
2. Work less
3. Speed up your learning (KISS)

If you remember nothing else from this article, remember this…..
Keep it simple, stupid!

10. Trade Only One Pair
The key to making that transition from newbie to pro is keeping your trading simple.
One of the easiest ways to keep trading simple is to trade only a single currency pair at a time. This is so damn obvious I am surprised more people do not do it. Trading one pair helps because it allows you to concentrate all your efforts on learning that pair, therefore allowing you to understand how it moves.
If you try and trade 5 pairs at the same time, learning to trade becomes much harder. You will have to learn the unique characteristics of all those different pairs and each pair is unique. Each currency pair:

1. Reacts differently to news.
2. Moves at different rates, some fast some slow.
3. Moves more rapidly at different times of the day.
4. Has to be managed differently when holding an open position.

As a newbie, jumping into the deep end with multiple pairs adds a lot more stress and slows the learning process.
So start off with a single pair. Once you’re profitable you can add as many pairs as you think you can handle.

11. Trade Only One Time frame
As above, picking a single time frame keeps things simple.
Looking at a single time frame has several benefits:

1. Allows you to concentrate on learning one time frame, therefore removing a lot of the confusion that comes with learning multiple time frames.
2. Gives you less charts to look at and allows you to concentrate more energy on analysing a single chart, therefore improving efficiency and the quality of your analysis.
3. Stops you from overanalysing your pair. Looking at too many time frames can give you conflicting signals.
4. It just makes your life easier.

Remember it’s all about keeping it simple. If you have a single timeframe and a single pair it means you’re looking at a single chart. As a newbie you do not want to juggle multiple charts. Stick with one chart, until you become consistently profitable.

12. Clean Charts
Most newbies pile as many indicators as possible onto a chart, when they first start trading. Indicators help with your trading (apparently) so the more the better, right? Wrong!
As traders gain more experience they start figuring out that less is more. The more indicators you have on your chart the more confusion you will have. Every extra indicator:-

1. Adds to the clutter making your charts harder to read.
2. Gives you more to think about therefore clouding your judgment.
3. Increases the possibility of giving you conflicting signals.
4. Looks pretty damn ugly…

Indicators are not essential. I personally trade with no indicators and have an 80% success rate. I am not saying you need to remove all indicators but limit it to a max of 2 at a time on your chart.
I trade with no indicators, simply a few support and resistance lines and candlestick patterns.

Six ways to make people like you

1. Become genuinely interested in other people.
2. Smile. 
3. Remember that a person's name is to that person the sweetest and most important sound in any language.
4. Be a good listener. Encourage others to talk about themselves.
5. Talk in terms of the other person's interests. 
6. Make the other person feel important - and do it sincerely. 

Zen Stories IV

Transient

A famous spiritual teacher came to the front door of the King's palace. None of the guards tried to stop him as he entered and made his way to where the King himself was sitting on his throne.
"What do you want?" asked the King, immediately recognizing the visitor.
"I would like a place to sleep in this inn,"
replied the teacher.
"But this is not an inn," said the King,
"It is my palace."
"May I ask who owned this palace before you?"
"My father. He is dead."
"And who owned it before him?"
"My grandfather. He too is dead."
"And this place where people live for a short time and then move on - did I hear you say that it is NOT an inn?"

Without Fear

During the civil wars in feudal Japan, an invading army would quickly sweep into a town and take control. In one particular village, everyone fled just before the army arrived - everyone except the Zen master.
Curious about this old fellow, the general went to the temple to see for himself what kind of man this master was.
When he wasn't treated with the deference and submissiveness to which he was accustomed, the general burst into anger.
"You fool," he shouted as he reached for his sword, "don't you realize you are standing before a man who could run you through without blinking an eye!"
But despite the threat, the master seemed unmoved.
"And do you realize," the master replied calmly, "that you are standing before a man who can be run through without blinking an eye?"

Surprising the Master

The students in the monastery were in total awe of the elder monk, not because he was strict, but because nothing ever seemed to upset or ruffle him. So they found him a bit unearthly and even frightening.
One day they decided to put him to a test. A bunch of them very quietly hid in a dark corner of one of the hallways, and waited for the monk to walk by. Within moments, the old man appeared, carrying a cup of hot tea. Just as he passed by, the students all rushed out at him screaming as loud as they could.
But the monk showed no reaction whatsoever. He peacefully made his way to a small table at the end of the hall, gently placed the cup down, and then, leaning against the wall, cried out with shock, "Ohhhhh!"

Knowing Fish

One day Chuang Tzu and a friend were walking by a river.
"Look at the fish swimming about," said Chuang Tzu, "They are really enjoying themselves."
"You are not a fish," replied the friend, "So you can't truly know that they are enjoying themselves."
"You are not me," said Chuang Tzu. "So how do you know that I do not know that the fish are enjoying themselves?"



Also Read
Zen Stories I
Zen Stories II
Zen Stories III

Book Summary: First, Break All The Rules

This article is based on the following book:
First, Break All The Rules
‘What The World’s Greatest Managers Do Differently’
By Marcus Buckingham & Curt Coffman

Based on a mammoth research study conducted by the Gallup Organization involving 80,000 managers across different industries, this book explores the challenge of many companies - attaining, keeping and measuring employee satisfaction. Discover how great managers attract, hire, focus, and keep their most talented employees!

Key Ideas:

1. The best managers reject conventional wisdom.
2. The best managers treat every employee as an individual.
3. The best managers never try to fix weaknesses instead they focus on strengths and talent.
4. The best managers know they are on stage everyday. They know their people are watching every move they make.
5. Measuring employee satisfaction is vital information for your investors.
6. People leave their immediate managers, not the companies they work for.
7. The best managers are those that build a work environment where the employees answer positively to these 12 Questions:

• Do I know what is expected of me at work?
• Do I have the materials and equipment I need to do my work right?
• At work, do I have the opportunity to do what I do best everyday?
• In the last seven days, have I received recognition or praise for doing good work?
• Does my supervisor or someone at work seem to care about me as a person?
• Is there someone at work who encourages my development?
• At work, do my opinions seem to count?
• Does the mission/purpose of my company make me feel my job is important?
• Are my co-workers committed to doing quality work?
• Do I have a best friend at work?
• In the last six months, has someone at work talked to me about my progress?
• This last year, have I had the opportunity at work to learn and grow?

The Gallup study showed that those companies that reflected positive responses to the 12 questions profited more, were more productive as business units, retained more employees
per year, and satisfied more customers.

Without satisfying an employee’s basic needs first, a manager can never expect the employee to give stellar performance. The basic needs are: knowing what is expected of the employee
at work, giving her the equipment and support to do her work right, and answering her basic questions of self-worth and self-esteem by giving praise for good work and caring about
her development as a person.

The great manager mantra is don’t try to put in what was left out instead draw out what was left in. You must hire for talent, and hone that talent into outstanding performance.

More wisdom in a nutshell from First, Break All the Rules:

1. Know what can be taught, and what requires a natural talent.
2. Set the right outcomes, not steps. Standardize the end but not the means. As long as the means are within the company’s legal boundaries and industry standards,let the employee use his own style to deliver the result or outcome you want.
3. Motivate by focusing on strengths, not weaknesses.
4. Casting is important, if an employee is not performing at excellence, maybe she is not cast in the right role.
5. Every role is noble, respect it enough to hire for talent to match.
6. A manager must excel in the art of the interview. See if the candidate’s recurring patterns of behavior match the role he is to fulfill. Ask open-ended questions and let him talk. Listen for specifics.
7. Find ways to measure, count, and reward outcomes.
8. Spend time with your best people. Give constant feedback. If you can’t spend an hour every quarter talking to an employee, then you shouldn’t be a manager.
9. There are many ways of alleviating a problem or non-talent. Devise a support system, find a complementary partner for him, or an alternative role.
10. Do not promote someone until he reaches his level of incompetence simply offer bigger rewards within the same range of his work. It is better to have an excellent highly paid waitress or bartender on your team than promote him or her to a poor starting-level bar manager.
11. Some homework to do: Study the best managers in the company and revise training to incorporate what they know. Send your talented people to learn new skills or knowledge. Change recruiting practices to hire for talent, revise employee job descriptions and qualifications.

Financial analysis with the DuPont ratio: A useful compass

Financial Analysis and the Changing Role of Credit Professionals

In today's dynamic business environment, it is important for credit professionals to be prepared to apply their skills both within and outside the specific credit management function. Credit executives may be called upon to provide insights regarding issues such as strategic financial planning, measuring the success of a business strategy or determining the viability of an acquisition candidate. Even so, the normal duties involved in credit assessment and management call for the credit manager to be equipped to conduct financial analysis in a rapid and meaningful way.


Financial statement analysis is employed for a variety of reasons. Outside investors are seeking information as to the long run viability of a business and its prospects for providing an adequate return in consideration of the risks being taken. Creditors desire to know whether a potential borrower or customer can service loans being made. Internal analysts and management utilize financial statement analysis as a means to monitor the outcome of policy decisions, predict future performance targets, develop investment strategies, and assess capital needs. As the role of the credit manager is expanded cross-functionally, he or she may be required to answer the call to conduct financial statement analysis under any of these circumstances. The DuPont ratio is a useful tool in providing both an overview and a focus for such analysis.

A comprehensive financial statement analysis will provide insights as to a firm's performance and/or standing in the areas of liquidity, leverage, operating efficiency and profitability. A complete analysis will involve both time series and cross-sectional perspectives. Time series analysis will examine trends using the firm's own performance as a benchmark. Cross sectional analysis will augment the process by using external performance benchmarks for comparison purposes. Every meaningful analysis will begin with a qualitative inquiry as to the strategy and policies of the subject company, creating a context for the investigation. Next, goals and objectives of the analysis will be established, providing a basis for interpreting the results. The DuPont ratio can be used as a compass in this process by directing the analyst toward significant areas of strength and weakness evident in the financial statements.

ROE = (Net Income/Sales) X (Sales/Average Assets) X (Average Assets/Average Equity) (1)

The ratio provides measures in three of the four key areas of analysis, each representing a compass bearing, pointing the way to the next stage of the investigation.

The DuPont Ratio Decomposition

The DuPont ratio is a good place to begin a financial statement analysis because it measures the return on equity (ROE). A for-profit business exists to create wealth for its owner(s). ROE is, therefore, arguably the most important of the key ratios, since it indicates the rate at which owner wealth is increasing. While the DuPont analysis is not an adequate replacement for detailed financial analysis, it provides an excellent snapshot and starting point, as will be seen below.

The three components of the DuPont ratio, as represented in equation (1), cover the areas of profitability, operating efficiency and leverage (liquidity analysis needs to be conducted separately). In the following paragraphs, we examine the meaning of each of these components by calculating and comparing the DuPont ratio using the financial statements and industry standards for Atlantic Aquatic Equipment, Inc. (Exhibits 1, 2, and 3), a retailer of water sporting goods.

Profitability: Net Profit Margin (NPM: Net Income/Sales)

Profitability ratios measure the rate at which either sales or capital is converted into profits at different levels of the operation. The most common are gross, operating and net profitability, which describe performance at different activity levels. Of the three, net profitability is the most comprehensive since it uses the bottom line net income in its measure.

The net profitability for Atlantic Aquatic Equipment in 1996 is:

Net Profit Margin = Net Income/Sales = $70,530/$5,782,000 = 1.22%. (2)

A proper analysis of this ratio would include at least three to five years of trend and cross-sectional comparison data. The cross sectional comparison can be drawn from a variety of sources. Most common are the Dun & Bradstreet Index of Key Flnancial Ratios and the Robert Morris Associates (RMA) Annual Statement Studies. Each of these volumes provide key ratios estimated for business establishments grouped according to industry (i.e., SIC codes). More will be discussed in regard to comparisons as our example is continued below.

Operating Ficiency or Asset U tion: Total Asset Turnover (TAT: Sales/Average Assets)

Turnover or efficiency ratios are important because they indicate how well the assets of a firm are used to generate sales and/or cash. While profitability is important, it doesn't always provide the complete picture of how well a company provides a product or service. A company can be very profitable, but not too efficient. Profitability is based upon accounting measures of sales revenue and costs. Such measures are generated using the matching principle of accounting, which records revenue when earned and expenses when incurred. Hence, the gross profit margin measures the difference between sales revenue and the cost of goods actually sold during the accounting period. The goods sold may be entirely different from the goods produced during that same period. Goods produced but not sold will show up as inventory assets at the end of the year. A firm with abnormally large inventory balances is not performing effectively, and the purpose of efficiency ratios is to reveal that fact.

The total asset turnover (TAI) ratio measures the degree to which a firm generates sales with its total asset base. As in the case of net profitability, the most comprehensive measure of performance in this particular area is being employed in the DuPont ratio (other measures being fixed asset turnover, working capital turnover, inventory and receivables turnover). It is important to use average assets in the denominator to eliminate bias in the ratio calculation.

Financial ratio bias is commonly present when combining items from both the balance sheet and income statement. For example, TAT uses income statement sales in its numerator and balance sheet assets in the denominator. Income statement items are flow variables measured over a time interval, while balance sheet items are measured at a fixed point in time. In cases where the firm has been involved in major change, such as an expansion project, balance sheet measures taken at the end of the year may misrepresent the amount of assets available and/or in use over the course of the year. Taking a simple average for balance sheet items (i.e., ((beginning ending)/2)) will control for at least some of this bias and provide a more accurate and meaningful ratio. The limiting assumption is that the change in the balance sheet occurred evenly over the course of the year, which may not always be the case.

The measure of total asset turnover for Atlantic Aquatic Equipment is:

TAT = Sales/Average Assets= $5,782,000/(($2,203,200 $2,476,200)/2)= 2.47. (3)

In this case, total assets did not substantially change over the course of the year, and therefore, potential bias caused by using the ending asset amount would not be substantial. Regardless, it is a good idea to get into the habit of using averages for all balance sheet items when conducting this type of analysis.

Leverage: The Leverage Multiplier (Average Assets/Average Equity)

Leverage ratios measure the extent to which a company relies on debt financing in its capital structure. Debt is both beneficial and costly to a firm. The cost of debt is lower than the cost of equity, an effect which is enhanced by the tax deductibility of interest payments in contrast to taxable dividend payments and stock repurchases. If debt proceeds are invested in projects which return more than the cost of debt, owners keep the residual, and hence, the return on equity is "leveraged up." The debt sword, however, cuts both ways. Adding debt creates a fixed payment required of the firm whether or not it is earning an operating profit, and therefore, payments may cut into the equity base. Further, the risk of the equity position is increased by the presence of debt holders having a superior claim to the assets of the firm.

The leverage multiplier employed in the DuPont ratio is directly related to the proportion of debt in the firm's capital structure. The measure, which divides average assets by average equity, can be restated in two ways, as follows:

Average Assets/Average Equity = 1/(1 -(Average Debt/Average Assets)), or
Average Assets/Average Equity = 1 (Average Debt/Average Equity =1 (Average DebtlAvernge Equity). (S)

Equation (4) employs a simple debt/asset ratio, while equation (5) uses the well known debt/equity ratio. Once again, averages are used to control for potential bias caused by the end-of-year values. The leverage multiplier for Atlantic Aquatic Equipment is:

Average Assets/Average Equity = $2,339,700/(($995,652 $1,025,982)/2) = 2.31.(6)

Combination and Analysis of the Results

Once the three components have been calculated, they can be combined to form the ROE, as follows:

(Net Income/Sales)X(Sales/Average Assets)X(Average Assets)X(Average Assets/Average Equity) = ROE

1.22% X 2.47 X 2.31 = 6.96%. (7)

While additional measures for prior years would provide the basis for a necessary trend analysis, this result is not meaningful until it is compared to an industry or best practices benchmark. The DuPont ratio for the industry (Exhibit 4) is:

3.60% X 2.60 X 2.00 = 18.72% (8)

As can be seen, problems in Atlantic Aquatic Equipment are immediately evident in the comparison of equations (7) and (8). The company appears to have a significant weaknesses in profitability, while total asset turnover and leverage seem to be roughly in line with the industry. The analyst can now focus on the company's profitability. A quick analysis of profitability yields the following result:

As can be seen, the inventory turnover is significantly lower than the industry average, which means that the problem is more likely due to poor location or inventory quality rather than the inventory management processes. The next step in the analysis would most likely be a qualitative study of the composition of the inventory as well as the retail facility itself.

Concluding Remarks

Sound financial statement analysis is an integral part of the management process for any organization. The DuPont ratio, while not the end in itself, is an excellent way to get a quick snapshot view of the overall performance of a firm in three of the four critical areas of ratio analysis, profitability, operating efficiency and leverage. By identifying strengths and/or weaknesses in any of the three areas, the DuPont analysis enables the analyst to quickly focus his or her detailed study on a particular spot, making the subsequent inquiry both easier and more meaningful. Some caveats, however, are to be noted.

The DuPont ratio consists of very general measures, drawing from the broadest values on the balance sheets and income statements (e.g., total assets is the most broad of asset measures). A DuPont study is not a replacement for detailed, comprehensive analysis. Further, there may be problems that the DuPont decomposition does not readily identify. For example, an average outcome for net profitability may mask the existence of a low gross margin combined with an abnormally high operating margin. Without looking at the two detailed measures, understanding of the true performance of the firm would be lost.

The DuPont ratio can also be broken into more components, depending upon the needs of the analyst. In any case, the DuPont can add value, even "on the fly," to understand and solving a broad variety of business problems.