IBM 2006 Annual Report Download - page 55

Liquidity and Capital Resources
Global Financing is a segment of the company and as such, is supported
by the company’s liquidity position and access to capital markets.
Cash generated from operations in 2006 was deployed to reduce
intercompany payables and pay dividends to the company in order to
maintain an appropriate debt-to-equity ratio.
RETURN ON EQUITY
(Dollars in millions)
AT DECEMBER 31: 2006 2005
Numerator:
Global Financing after tax income(a)* $  $,
Denominator:
Average Global Financing equity(b)** $, $,
Global Financing Return on Equity(a)/(b) .% .%
* Calculated based upon an estimated tax rate principally based on Global
Financing’s geographic mix of earnings as IBM’s provision for income taxes is
determined on a consolidated basis.
** Average of the ending equity for Global Financing for the last five quarters.
CRITICAL ACCOUNTING ESTIMATES
As discussed in the section, “Critical Accounting Estimates,” on
pages 45 to 47, the application of GAAP requires the company to
make estimates and assumptions about future events that directly
affect its reported financial condition and operating performance.
The accounting estimates and assumptions discussed in this section
are those that the company considers to be the most critical to Global
Financing. The company’s significant accounting policies are described
in note A, “Significant Accounting Policies,” on pages 62 to 71.
Financing Receivables Reserves
Global Financing reviews its financing receivables portfolio at least
quarterly in order to assess collectibility. A description of the meth-
ods used by management to estimate the amount of uncollectible
receivables is included on page 70. Factors that could result in actual
receivable losses that are materially different from the estimated
reserve include sharp changes in the economy or a significant change
in the economic health of a particular industry segment that repre-
sents a concentration in Global Financing’s receivables portfolio.
To the extent that actual collectibility differs from management’s
estimates by 5 percent, Global Financing after-tax income would be
higher or lower by an estimated $12 million (using 2006 data),
depending upon whether the actual collectibility was better or worse,
respectively, than the estimates.
Residual Value
Residual value represents the estimated fair value of equipment under
lease as of the end of the lease. Residual value estimates impact the
determination of whether a lease is classified as operating or sales type.
Global Financing estimates the future fair value of leased equipment
by using historical models, analyzing the current market for new and
used equipment and obtaining forward-looking product information
such as marketing plans and technological innovations. Residual value
estimates are periodically reviewed and “other than temporary”
declines in estimated future residual values are recognized upon
identification. Anticipated increases in future residual values are not
recognized until the equipment is remarketed. Factors that could
cause actual results to materially differ from the estimates include
severe changes in the used-equipment market brought on by unfore-
seen changes in technology innovations and any resulting changes in
the useful lives of used equipment.
To the extent that actual residual value recovery is lower than
management’s estimates by 5 percent, Global Financing’s after-tax
income would be lower by an estimated $19 million (using 2006 data).
If the actual residual value recovery is higher than management’s
estimates, the increase in after-tax income will be realized at the end
of lease when the equipment is remarketed.
MARKET RISK
See pages 47 and 48 for discussion of the company’s overall
market risk.
LOOKING FORWARD
Given Global Financing’s primary mission of supporting IBM’s
hardware, software and services businesses, originations for both
client and commercial financing businesses will be dependent upon
the overall demand for IT hardware, software and services, as well as
client participation rates.
As a result of the company divesting its Personal Computing
business to Lenovo, Global Financing is supporting Lenovo’s per-
sonal computer business through an exclusive, five-year agreement
covering all Global Financing lines of business effective since May 1,
2005. These participations with Lenovo are external revenue to
Global Financing.
Interest rates and the overall economy (including currency fluc-
tuations) 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 52), should
mitigate gross margin 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 discussed previously, Global Financing has historically been able
to manage residual value risk both through 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 client knowledge, should allow for the prudent management of
the business going forward, even during periods of uncertainty with
respect to the economy.
MANAGEMENT DISCUSSION
INTERNATIONAL BUSINESS MACHINES CORPORATION AND SUBSIDIARY COMPANIES
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