Page 65 - Bruce Ellig - The Complete Guide to Executive Compensation (2007)

Chapter 2. Performance Measurements and Standards 51

3. Those pushing stock options all the way down in the organization will use more shares
than those who do not.
4. When the company stock has not shown any appreciable gains for a long period of time,
there will be a greater number of unexercised stock options than if there were appreciable
appreciation.
5. If reloads and repriced stock options (Chapter 8) are not returned to the pool for reuse
as new grants, the shares available for use will more quickly be depleted. The same is true
for forfeited shares unless returned for use.
6. If all shares used are from shareholder-approved plans, the overhang will be greater
than if stock used had been purchased from the open market, as the latter reduces the
denominator in the calculation.

The balance sheet is typically understated in terms of the fair market value of such things
as property, which is reported on a cost basis. The problem with fair value accounting,
favored by some to replace the historical cost basis, is that it is virtually impossible to deter-
mine the “fair value.” Is it based on a tax assessor’s amount? Or on what similar property sold
for recently? If the latter, to what extent are conditions (e.g., exact locations, space, interest
rates, and lapsed time) the same? For such reasons, historical cost remains the financial model
for recording noncurrent assets.
Definitions and Formulas Following is a listing of various financial definitions and
measurements used in executive pay plans.
• Accounts receivable turnover This is sales divided by receivables. In our example,
this is $101,546,400 (Table 2-1) divided by $18,678,600 (Table 2-6), a ratio of 5.4 to 1.
• Acid test ratio This is quick assets (cash and those assets quickly converted to cash)
divided by current liabilities. In the example, this is $18,738,200 $14,833,800
$4,559,400 $18,678,600 for a total of $56,810,000 (Table 2-6) divided by $23,683,100
(Table 2-7), indicating that quick assets equal a ratio of 2.4 of current liabilities.
• Amortization This is the cost allocation to the income statement of a nontangible,
noncurrent asset such as franchise fees, patents, and goodwill (resulting from an
acquisition at more than fair value) on the balance sheet. The amount is determined
annually in accordance with GAAP and reported on the income statement. In Table
2-1, an amount of $2,624,800 is shown. Tax regulations may differ from GAAP.

• Asset turnover This is net sales divided by total assets. In the example, this is
$101,546,400 (Table 2-1) divided by $330,997,900 (Table 2-6), or a ratio of 0.31 to 1.
• Book value This is the shareholder equity ($137,077,400 in Table 2-8) and is some-
times called the breakup value of the company.
• Book value to earnings ratio This is the book value per share divided by the earn-
ings per share (see Book value share price). In Table 2-1, with book value at $8.99 per
share and an EPS (earnings per share) of 63¢, this would result in a ratio of 14.3 to 1.
• Book value increase Book value at the end of the business year divided by the book
value at the end of the previous year equals the percentage change; book value at the
end of the year minus book value at the end of the previous year equals the dollar
change. This formula is typically used by privately held companies that have no