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Video 7.4: 3M Company: Long-Term Debt and Leases

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Video 7.4: 3M Company: Long-Term Debt and Leases

We move to the right-hand side of the Balance Sheet this week with a look at Liabilities. We will start by covering time-value of money, which is the idea that $1 today is not worth the same as $1 in the future. Almost all liabilities involve a consideration of the time-value of money, so this will be an important foundation piece for you to understand. Then, we will cover accounting for bank debt, mortgages, and bonds. Next, we will move into the topic of "off-balance-sheet" liabilities with a discussion of Leases.

The course builds on my Introduction to Financial Accounting course, which you should complete first. In this course, you will learn how to read, understand, and analyze most of the information provided by companies in their financial statements. These skills will help you make more informed decisions using financial information.

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Financial Accounting, Financial Statement, Accounting, Generally Accepted Accounting Principles, Accounting Terminology

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Brian J Bushee
The Geoffrey T. Boisi Professor

脚本

Hello I'm Professor Brian Welcome back, we're going to close out the week by

taking a look at the long term debt and the leases of the 3M company.

Let's get started.

K so I'll start our look on the balance sheet for 3M, and

if we go into liabilities we can see long term debt about five billion.

There's short term borrowings and current portion of long term debt.

Which is another billion or so.

So, if you add this together, that's, five,

about six billion of debt, either long term or short term.

Which is not that high compared to the stockholder's equity of 3M.

So 3M has about 18 billion of stockholders equity.

So you're looking at a long term debt to a equity ratio of about a third,

which is fairly low, which again indicates sort of the fact that 3M's in a pretty

good financial state, fairly conservative in how they're managing their business.

They're not taking on a lot of debt.

Now in terms of the leases, we're not going to see any of the operating leases

here, because, of course, those are going to be off balance sheet.

But we will see some evidence of capital leases in a little bit.

Next ,we could take a look at 3M's statement of cash flows and

to see the action with debt, long-term debt,

we would go down to cash Cash from Financing Activities.

So we have change in short term debt, which is a pretty small number, and then

here is repayment of debt, and proceeds of debt, maturity greater than 90 days.

So these would be the long term debt instruments that 3M has.

And as what you can, what you can see is for most the cases we have here.

Three was actually paying more debt than they're borrowing.

Only in the most recent year,

2012, do we see that they borrowed more than they pay back.

So again, some evidence that they're not relying a lot on debt financing recently

most of how, how they've been financing their obser, operation.

Operations, as we saw earlier in the course was this

tremendously high $5 billion of cash they generate from operating the company.

So this is probably debt related to specific long-term projects,

because by and large they can mostly finance their business with the cash from

operating activities.

So we go to foot note nine, where 3M details its long term debt, and

short term borrowings.

They have a table where they have all of their major debt issuances listed.

All the smaller ones are combined into other borrowings.

So their biggest one is a Euro bond with a principe amount of 70, 775 Euros.

So it tells you the currency is Euro.

Fixed interest rate.

The effective rate so that was the interest rate in play when it was issued.

The maturity date, so it's two years, and the balance.

Now, the balance is bigger than the principal, in this case.

'because the principal's in Euros, and it's translated into dollars.

So let's look at one that's in dollars.

There's a medium term note with a one billion dollar principal amount.

So a note is sort of like a bond.

Still plays.

Pays coupon payments, but, but not at long term.

US dollar, fixed interest rate means the interest rate doesn't change over

the life of the bond.

We've got the affective rate, and notice that the balance.

Is increasing between 2011 and 2012, and it's at a point where

it's below the principal amount.

So what that tells is that this note was issued at a discount.

So was issued where the effect interest rate,

the market rate was above the coupon rate.

And so the market paid less than $1 billion.

The proceeds were a discount, so what's been happening is every year this, balance

has been increasing towards one billion, which is where it's going to get in 2016.

And we can see that with this medium term note that's 850 million.

That and the balance is increased up to 850 million and

sure enough it's due in 2013.

So the discount has been eliminated through that interest expense and

cash journal entry that we do where we plug bonds payable.

And so now we're getting to the point where it's maturing, and

the balance is at 850 which is the principal amount.

So you can go down and

look at the different debt issuances that are summarized here.

All the long term debt that comes due in

the next year is summarized in the current portion of long term debt.

And then the rest of it will go into the long-term debt

section of the balance sheet.

And then down below there's some more interest more information on

short-term borrowings, weighted average borrowing weight, rates.

So it's about 3.9 1% short term, 3.16% long term.

Maturity so debt is coming due in the next few years.

How much are they going to have to pay, and

then various other information on their.

Debt portfolio.

So I'll be honest with you here.

I typically do not spend a lot of time looking at this footnote.

The information here is a lot more relevant to corporate finance issues.

So how the company is managing its capital structure through borrowing activities,

and my bias is always trying to use accounting information to

assess managers' performance and operating the company.

Not in financing it.

But if you are interested in those issues, I would strongly suggest our

Coursera course on corporate finance, An Introduction to Corporate Finance, where

you can dig into these issues more than I can, as someone who's not a finance guy.

And not terribly interested in debt financing.

Sorry.

so to find information on operating leases we need to

go to a footnote called commitment and contingencies.

And this is where you would find it in any an report.

There's always a note.

On contingencies these are things that are sort of like liabilities.

They're, they're contractual obligations but they haven't met the definition of

a liability and so they're not on the balance sheet, and so

here's where 3M reports their operating leases.

So we can see their rent expense was about 300 million in 2012.

Just to give you a sense for how much of their.

Incoming cash flows is going towards renting property plant and equipment.

But what, what we're really interested in is trying to figure out

how big these operating leases would be if they would be on the balance sheet.

And we can see down here is a disclosure of all of the expected cash payments

they're going to make on these leases from 2013 going to 2017 and beyond.

And notice the operating leases,

the cash flow payments are much bigger than the capital leases.

I don't know if you remember this the last time we

looked at property plan equipment but.

capital leases for 3M are not that big, I think it's about $100 million or

so that they have on the balance sheet, but operating leases, it's a lot more that

they're keeping off balance sheet, and this is something where last week we were

speculating, part of the reason why 3M didn't seem to have a lot of.

Property plant equipment, or

a lot of depreciation could be these operating leases.

So, what we're going to try now is to estimate how big these operating leases

would be, if they were actually put on the balance sheet as assets and liabilities.

'Kay, so I'm going to pop into Excel.

And we're going to try and

figure out the present value of these operating lease cash flows.

because the present value of this cash flows is one way that we can estimate what

the liability would be if these were on the balance sheet.

So I've copied over the future cash flows into these Excel cells.

These cells in Excel, and we just are going to take the present value.

Now one issue we have is we've got this after 2017,

and it's hard to take the present value of something that's that amorphous.

So we're going to have to make an assumption.

So what we're going to do is carry over these payments, but for

the after 2017, I'm going to split it up into two payments after that,

just to make the present value easier.

So I'm going to assume that this is,

the way the trend is going that there's going to be two more payments, one of 60.

And one of 59 you could split it into three if you wanted,

do it more complicated, but you're going to get sort of the same answer.

Now that we have the payment stream, what we can do is go ahead and

calculate the present values.

And so what I've done here, is I've set up a formula for

each, and up here I've got an interest rate of three and a half percent.

I got that from if you remember a few minutes ago we saw the weighted average

effective interest rate was about three and a half percent, so

that's what I'm going to use for these leases, and then I created a formula,

let me bring up what it looks like, where I linked to that cell, so

it puts in the interest rate, of course I could have just typed it in as well.

For the number of periods that we're discounting the cash flow back,

I've taken the year, so 2013, minus 2012, so I'm discounting back one year.

There's no payment, but instead we're just discounting back this future

cash flow of 194 to present value terms, and it would be 187.

Then I do the formula for the next year which is

the same except now it's D13, so it's discounting this payment back two years.

So we're discounting 158 back two years, and so forth.

So if you go all the way to 2019.

The way the formula looks is we use this interest rate of 3.5%,

we discount it back seven years, 2019 minus 2012, this,

this payment seven years from now of $59, in present value terms that's 46.

Then I can add that up, and I would see that the present value is 6.62.

So that's one estimate of what the liability would be if

this was on the balance sheet.,

and then the cool thing about setting up the formula is I could play around with

the rate.

So one thing I noticed is, 3M recently took out a medium term note with

about this maturity and the interest rate that they got was one and half percent.

And so I could type that in and it would change the present value up to 735.

Now the other way I said you could do this is you could do this is you could take 8

times Rent Expense.

So we saw in the Scotia the rent expense was 300.

If we take 8 times that we get twen, $2.4 billion.

So what's the liability going to be?

Somewhere between 735 million and $2.4 billion.

So a good question is how can something like eight times rent expense be even

close to as accurate as doing the present value of all these future lease payments?

because something like the 8*Rent Expense assumes that it's

about three percent over eight years, so it's a very course estimate, but

the problem with the present value calculation that we did,

is if you look at the payments, they start at 194 and then they drop substantially.

Meanwhile, 3M has been paying about 300 or so a year in rent expense.

So, what's missing from this present value, or from the table of payments is,

is that these leases are expiring and so the payments go away.

But if 3M still needs the equipment, they still need the buildings,

they're going to have to renew the leases.

So, really,.

This is a bit misleading because it's showing these leases go away.

When in fact, 3M would probably have to renew these leases going forward.

And that's why something like an 8 times rent expense,

which assumes a constant payment, may actually give you

a better guesstimate of the amount than the present value approach.

Although we can look at both and split the difference.

So, anyway let's just split the difference and say that there's about

1.5 billion of both assets and liabilities that [INAUDIBLE]

keeps off the balance sheet through it's use of operating leases.

So, how big of a deal is this.

Well, if we remember from the balance sheet, or, at least I remember from

the balance sheet, net property plant equipment was about 8 billion dollars.

And long term debt was about 6 billion dollars.

So if we added what we see here for the operating leases,

net property plant in equivalent would increase to $9.5 billion and

long term debt would increase to $7.5 billion.

Now it's still relative to stockholders equity of.

Of 18 billion, this would not dramatically increase the leverage ratio,

but it does increase it, and it's a pretty sizable number.

So, if I was going to compare 3M to other companies, what I might want to do is some

kind of quick and dirty adjustment to get these operating leases.

Back on the balance sheet so I could get an apples-to-apples comparison to

the other, companies, if I was going to do any kind of ratios.

So, you know, it's not as.

It's not as enormous as these operating leases can be for some companies.

But it is still a big deal that's kept off the balance sheet for 3m.

>> And that wraps up our look at time valued money, long term debt and leases.

Thanks for sticking with me through a lot of minutes of video this week.

Don't worry, next week we're going to move on to a lighter, happier topic.

Taxes. I'll see you then.

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