IBM 2002 Annual Report Download - page 65

debt
at december 31: 2002 2001
Debt to equity ratio 6.9x 6.8x
Global Financing funds its operations primarily through bor-
rowings using a debt-to-equity ratio of approximately 7 to 1.
The following table illustrates the correlation between
Global Financing assets and Global Financing debt. Both
assets and debt are presented in the Global Financing balance
sheet on page 61.
global financing assets and debt
(dollars in millions)
■global financing assets ■global financing debt
The company’s Global Financing business provides funding
predominantly for the company’s external customers but also
provides intercompany financing for the company (internal),
as described in the “Description of Business” on page 60. As
previously stated, IBM manages and measures Global Financing
as if it were a standalone entity and accordingly, interest
expense relating to debt supporting Global Financing’s exter-
nal customer and internal business is included in the “Global
Financing Results of Operations” on page 60 and in note x,
“Segment Information,” on pages 100 to 104.
In the company’s Consolidated Statement of Earnings on
page 64, however, the interest expense supporting Global
Financing’s internal financing to the company is reclassified
from Cost of financing to Interest expense.
liquidity
Global Financing is a segment of IBM and as such is supported
by IBM’s liquidity position and access to capital markets.
Global Financing generated cash in 2002, which was primarily
driven by net income and a decline in assets. Cash was
deployed to reduce debt and pay dividends in order to main-
tain an appropriate debt to equity ratio.
Critical Accounting Estimates
As discussed in note a, “Significant Accounting Policies,” on
pages 70 to 75, the application of GAAP involves the exercise of
varying degrees of judgment. The following areas require more
judgment relative to the others and relate to Global Financing:
financing receivables reserves
The company reviews its financing receivables portfolio at
least quarterly in order to assess collectibility. A description
of the methods used by management to estimate the amount
of uncollectible receivables is included on pages 73 and 74.
Factors that could result in actual receivable losses that are
materially different from the estimated reserve include sharp
changes in the economy, or a large change in the health of a
particular industry segment that represents a concentration
in the company’s receivables portfolio.
residual value
Residual value represents the estimated fair value of equip-
ment under lease as of the end of the lease. The company
estimates the future fair value of residual values by using his-
torical models, the current market for used equipment and
forward-looking product information such as marketing plans
and technological innovations. These estimates are periodically
reviewed and any other-than-temporary declines in estimated
future residual values are recognized upon identification.
Anticipated increases in future residual value are not recognized
until the equipment is remarketed. Factors that could cause
actual results that materially differ from the estimates include
severe changes in the used equipment market brought on by
unforeseen changes in technology innovations and any result-
ing changes in the useful lives of used equipment. Previous
writedowns of residual values have not been material.
Market Risk
See pages 58 and 59 for discussion of the company’s overall
market risk.
Looking Forward
Given Global Financing’s mission of supporting IBM’s hard-
ware, software and services, originations for both customer
and commercial finance businesses will be dependent upon
the overall demand for IT equipment.
Interest rates and the overall economy (including currency
fluctuations) will have an effect on both revenue and gross
profit. The company’s interest rate risk management policy,
however, combined with the Global Financing funding strategy
(see page 60), should mitigate gross profit erosion due to
changes in interest rates. The company’s policy of matching
asset and liability positions in foreign currencies will limit the
impacts of currency fluctuations.
The economy could impact the credit quality of the
Global Financing receivables portfolio and therefore the level
of provision for bad debts. Global Financing will continue to
apply rigorous credit policies in both the origination of new
business and the evaluation of the existing portfolio.
As seen above, Global Financing has historically been able
to manage residual value risk through both insight into the
product cycles as well as through its remarketing business.
Global Financing has policies in place to manage each of
the key risks involved in financing. These policies, combined
with product and customer knowledge, should allow for the
prudent management of the business going forward, even
with the uncertainty of the current economy.
Management Discussion
63international business machines corporation and Subsidiary Companies
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