emphasis is being placed on the slower (0-5%) growth rate segment than on the faster (5-10%) segment.

If one could safely assume that segmented earnings contribution growth rates of the firm's various "basic activities" will continue at the same approximate level, then a reasonable expectation would be that segments with higher growth rates would also command relatively greater amounts of the firm's investment in the future. This is obviously not the case for the hypothetical company in our illustration.

Recognizing that growth rates are based exclusively upon historical performance measurements, the investor may see disparities between growth rate experience and resource allocation as an indication that management believes that future periods will see "basic activities" redistributed differently among the growth rate segments. The disparity may be in some cases explained by different levels of investment required to sustain various types of activities. In yet other cases, the investor, on the basis of his analysis, may believe that management is indeed making significant judgmental errors in its resource allocation plan. The important point is that in any event the proposed funds statements provide the investor some guidance as to the future direction and emphasis of the firm.

Question 2-Which segments are sources and which are users of funds?

A closely related aspect of the company's resource allocation activity is the deployment of intra-company cash transfers. These cash transfers may be viewed as a residual account. That is, cash transfers are the net result of the magnitude of funds provided by operations less the sum of capital expenditures and required expansion of working capital. Note that in the illustration, the slowest and fastest growth rate segments were net users, while the 5-10% growth rate segment was a modest provider of funds. An analysis of intra-company cash transfers, therefore, provides the investor some initial idea of whether cash flows generated by established activities can be relied upon to finance the unusual growth opportunities likely to provide significant earnings contributions in the years ahead.

Question 3 The productivity of capital

The precise rate of return on investment that is earned in different segments cannot be determined directly from the income and flow of funds statements. However, an investor can estimate the productivity of capital in the various segments by comparing the financial statements of a firm through time.

Suppose an investor finds that for over a period of several years the company continues to invest substantial sums in a low growth area. Suppose further that the number of basic activities in the segment remains constant and the level of profits does not rise by an amount comparable to the increase in investment. An obvious inference can then be drawn about the returns in that sector.

A calculation such as that outlined above cannot be made with the traditional statements that are now furnished by firms in their annual reports. The reason for this is that the present statements aggregate all of the corporation's present activities. No indication is given on the performance of the component parts of the firm.*

Questions 4 and 5-Will the company require additional financing in the future, and will dividend payments be increased?

Exhibit 5-1, like the traditional sources and uses of funds statement provides guidance for assessing the future financing requirements of the firm. No financial statement by itself, however, can provide enough information for the investor to form a definitive assessment in this area. The reason for this limitation of financial statements is that the extent of financing necessary for business acquisitions cannot be estimated without some understanding of the company's basic plans in the acquisition area. Nor can the extent of financing required for the various growth rate segments be determined without data on plans for future expansion of facilities.

An examination of Exhibit 5-1, like traditional sources and uses of funds statements, however, does provide enough data to let the investor determine whether the funds generated from operations are sufficient to support the dividends being paid. The hypothetical company whose data make up Exhibit 5-1 did not generate sufficient funds to cover the $100,000 outlays for dividends. A specific analysis of this situation is shown at the top of the next page.

Exhibit 5-1 shows that funds to support business acquisitions, capital expenditures and increased working capital during the year were obtained via increases in long term debt and common shares. It is for each investor to estimate the extent to which these financing sources will be utilized in the years to come.

The analysis of the company's requirements for and sources of financing also allows the investor a basis for estimating probable changes *For an approach to calculating the productivity of capital of corporate segments See Alfred Rappaport, "A Capital Budgeting Approach to Divisional Planning and Control," Financial Executive, October, 1968.

in dividend rates. Dividends in large measure depend upon earnings, cash generated by operations, capital expenditure levels, business acquisition plans, choice among alternative financing plans, and management's dividend policy.

Summary

A segmented sources and uses of funds statement is an important financial statement to an investor interested in forecasting the future growth of a diversified firm. Such a statement clearly shows whether the diversified company is making investment commitments in highor low-growth areas, as well as whether the high or low growth areas are suppliers or users of funds. Moreover, by comparing these statements over time, estimates can be developed on the productivity of capital in various sectors. Based upon these data, investors may be able to generate better estimates of future growth rates than is now possible.

APPENDIX A

Background of Events and Issues for Financial Reporting by Diversified Companies

THE

HE IDEA THAT DIVERSIfied firms should report their operating results on some segmented basis only recently received widespread attention. Early in 1965 the Subcommittee on Anti-Trust and Monopoly of the Senate Committee on the Judiciary held hearings on "Mergers and other Factors Affecting Industry Concentration." During the course of the hearings, Professor Joel Dirlam of Rhode Island University suggested disclosure of "the relative profitability of different divisions and product lines" as essential to the investor and antitrust authorities alike.2 Senator Hart, Chairman of the Subcommittee, subsequently requested that Chairman Manuel F. Cohen of the Securities and Exchange Commission comment on the Dirlam proposal. Cohen's response was to the effect that the Commission did in fact have the authority to require additional disclosure by diversified firms, but had refrained from exercising this authority to date.3

After the hearings were over, Cohen made a series of speeches in which he urged that the financial community give serious thought to potential "change(s) in financial reporting requirements to provide the kind of information needed to evaluate the experience and pros1 For a comprehensive review of this and other events from 1965 through 1967 see A. A. Sommer, Jr., "Conglomerate Disclosure: Friend or Foe?" in Alfred Rappaport, Peter A. Firmin, and Stephen A. Zeff, Public Reporting by Conglomerates: The Issues, the Problems, and Some Possible Solutions, Englewood Cliffs, N. J.: PrenticeHall, Inc., 1968, pp. 1-16.

2 Hearings before the Subcommittee on Anti-Trust and Monopoly, Committee on the Judiciary, United States Senate, Eighty-Ninth Congress, First Session, p. 769. 3 Ibid., pp. 1069-1071.

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pects of conglomerate companies." A similar plea was made before the Annual Meeting of the American Institute of Certified Public Accountants in October, 1966.

In 1964, NAA initiated a study entitled Financial Reporting for Security Investment and Credit Decisions to test the hypothesis that the kinds of financial information relevant to investors' and creditors' purposes can be ascertained by studying how these groups make decisions and that such knowledge can be a useful guide to financial reporting practice. During the study, 72 financial analysts and an equal number of commercial bankers were interviewed. The need for information about operating results for major segments of diversified companies was raised in almost all of these interviews.5

As a result of the concern expressed by SEC officials over reporting practices of diversified firms, the Financial Executives Research Foundation sponsored a study "lest authoritative bodies issue requirements for additional reporting by conglomerates without adequate study of the need for and limitations of such reporting." In addition, the Ameri can Institute of Certified Public Accountants, through its Committee on Relations with Securities and Exchange Commission and Stock Exchanges, began to study the problem from the standpoint of the role of accountants in solving it.

As segmented reporting emerged as a significant and controversial issue during 1966 and 1967 among corporate executives, a number of key concerns were voiced about the potentially adverse effects of new reporting requirements. Some of these concerns are summarized below:"

1. Additional disclosure may penalize reporting companies, because it may be helpful to competitors, labor unions, suppliers, and certain regulatory agencies of government.

4 Address before the Nineteenth Annual Conference of the Financial Analysts Federation, New York, May 24, 1966, p. 6.

5 See Morton Backer and Walter B. McFarland, External Reporting for Segments of a Business, NAA Research Studies in Management Reporting No. 1, April 1968. Findings from the study concerning other aspects of financial reporting will be pub lished by NAA in late 1969.

R. K. Mautz, Financial Reporting by Diversified Companies, New York: Financial Executives Research Foundation, 1968, p. v.

7 The interested reader will find additional detail for arguments opposing segmented reporting in Morton Backer and Walter B. McFarland, External Reporting for Segments of a Business, New York: National Association of Accountants, 1968, pp. 77-97; Top Management Looks at Product-Line Reporting, Washington, DC: Machinery and Allied Products Institute, 1967; Joe J. Cramer, Jr., "Income Reporting by Conglomerates-Views of American Businessmen," Abacus, Winter 1968. pp. 17-26; "Profit Reporting By Divisions?" Dun's Review, May 1967; Letters the Editor of the Financial Executive, June and October, 1966, and June 1967.