Chapter 5. The financing of non-financial corporations1

Non-financial corporations’ role as producers of goods and services

The sum of non-financial corporations’ production is referred to as their output. It is what results from the production of goods and services by combining labour, capital, and intermediate goods and services. Non-financial corporations are the source of much of the world’s output and employment. In most countries, non-financial corporations account for over 60% of total output, as can be seen from Table 5.1. This share is fairly consistent from one country to the next. The average share for the OECD countries in the table is almost 70%.

Non-financial corporations’ role in investment

Investment plays a key role in any economy, ensuring that capital used in the production process to meet the demand for goods and services is in place. In order for non-financial corporations to remain viable, they need to invest in productive assets. Therefore, investment, or gross fixed capital formation (GFCF) as it is called in national accounts terminology, is crucial to non-financial corporations’ current and future production. In many economies, non-financial corporations account for the overwhelming share of such investment in non-financial assets. Table 5.2 shows the share of investment of non-financial corporations to total investment for selected OECD countries.

Non-financial corporations’ role as an investment vehicle: net borrowing and net lending

Non-financial investment, that is, investments in assets like buildings, machinery and equipment, and software, are the link between the non-financial corporations’ “real” accounts (or real activity) and financial accounts (or financial activity). If non-financial corporations are able to generate saving in excess of their non-financial investment needs in a given accounting period, they are known as net lenders or net financial investors. If non-financial corporations are unable to generate saving that match their investment needs in a given accounting period, they are net (financial) borrowers. The relevant balancing item is the net lending/net borrowing position, and is recorded in the capital account. Non-financial investments can be financed in one of two ways, through the use of internal funds (current or retained earnings), or by borrowing funds from other sectors of the economy.

In the event that non-financial corporations require external funds, other sectors must be willing to provide them with funds. This highlights the third important role non-financial corporations play in the economy – an investment vehicle for investors from other sectors. Non-financial corporations offer investors a stake in their earnings (in the form of dividends on equity held) or interest payments on debt. The end result is that claims on non-financial corporations can be found on the balance sheets of other sectors in the economy, such as households, financial corporations and non-residents. The reverse is also true: in the event that non-financial corporations have excess funds they become financial investors and supply these funds to other institutional sectors. In recent years, the latter has been the situation in Canada, the US, and some other countries as well. See also Box 5.1.

Box 5.1. Non-financial corporations’ net lending and investment trends in Canada

In Canada, as well as in some other OECD countries, the non-financial corporations’ sector moved from a net borrowing position to a net lending position around the turn of the 21st century. This structural change fundamentally altered the balance sheets of non-financial corporations, and is an excellent example of the link between the “real” accounts of non‐financial corporations and their corresponding financial accounts.

In Canada, corporations began generating large net lending positions since 2000. Corporate earnings have been on a strong upward trend since about 1997 (except for a few interruptions – the high-tech bust in 2001, and the financial crisis in 2008-09). This earnings growth was led by consumer demand and, in many industries, foreign demand (see Figure 5.1).

Clearly, earnings growth has had a major impact on the financial position of non-financial corporations. However, a second significant factor has been lower capital expenditure relative to net operating surplus over the last 17 years (see Figure 5.2).

The above developments suggest a number of things. First, Canadian non-financial corporations have benefitted from generally high commodity prices over the period under consideration – creating a growing gap between the supply of internal funds and the funds required for investment. This has led to a modification in corporate investment behaviour – a shift towards financial investment as a growing use of funds. Notable acquisitions of financial instruments have included both portfolio and inter-company investment. Some of the latter has been directed outside of the country via foreign direct investment, suggesting the increased influence of global production among Canadian multinational enterprises.

Figure 5.1. Net lending/net borrowing and net operating surplus of non-financial corporations, Canada

Millions of CAD

Source: Statistics Canada (2016), Table 380-0076 – Current and capital accounts – Corporations, quarterly (CAD) (database), www5.statcan.gc.ca/cansim/a26?lang=eng&id=3800076.

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Figure 5.2. Net operating surplus and non-financial investments of non-financial corporations, Canada

Millions of CAD

Source: Statistics Canada (2016), Table 380-0076 – Current and capital accounts – Corporations, quarterly (CAD) (database), www5.statcan.gc.ca/cansim/a26?lang=eng&id=3800076.

 https://doi.org/10.1787/888933588516

Major flows of financial investment have been directed to liquid assets and other portfolio investments since 2000. In particular, currency and bank deposits (domestic and foreign) and various other types of portfolio investments have trended upward since the late 1990s. This development has substantially improved the liquidity position of non‐financial corporations. In policy circles, these investments in liquid assets have often been referred to as “dead money” of the non-financial corporations’ sector, or funds that could be used for capital expenditure.

Not surprisingly, similar patterns for non-financial corporations have been observed in a number of countries. In the US, this development has been sometimes referred to as the “financialisation” of non-financial corporations – a rise in investment in financial assets along with a decline in accumulation of tangible non-financial assets (see, for example, Davis (2013) and Fano and Trovato [2013]).

The associated issue of “dead money” will be explored in more detail below.

The financial behaviour of non-financial corporations

Thus far it has been established that the national accounts record the role of non-financial corporations as producers of goods and services, investors and net lenders/net borrowers. If the national accounts stopped here, users of macroeconomic statistics would be left with a cliff-hanger, as important questions remain unanswered:

• Where do firms obtain their funds if they need to borrow?

• Where do firms invest their excess funds?

• What tools (or instruments) do firms use to raise funds?

• How do firms raise funds over economic cycles?

These questions are answered by examining the financial accounts and balance sheets of non-financial corporations.

Uses of funds by non-financial corporations

Financial uses of funds

A second and increasingly important use of funds for non-financial corporations is in the form of financial investments. This is primarily investment in financial assets but it can also relate to liability transactions, such as paying down debt or the buy-back of own shares.

The financial accounts and balance sheets provide a picture of the non-financial corporations’ evolving portfolio of financial investments, measuring transactions in financial assets and liabilities by type of instrument. For example, the very different investment patterns over time in the Canadian non-financial corporations’ sector are evident from analysing the financial accounts; this is summarised in Table 5.5, with a period of recession in the fourth quarter of 2008 up to the second quarter of 2009.

Table 5.5. Selected financial asset transactions, Canadian non-financial corporations
Billions of CAD
	4Q06	1Q07	2Q07	3Q07	4Q07	1Q08	2Q08	3Q08	4Q08	1Q09	2Q09	3Q09	4Q09	…	2Q13	3Q13
Total financial assets	48.6	90.2	48.7	41.0	40.6	58.3	60.2	33.3	25.7	-18.0	0.4	54.3	41.0	…	38.3	22.2
Currency and deposits	10.4	7.2	12.2	16.4	3.5	-21.7	31.2	-5.4	5.4	-9.1	12.3	7.1	8.1	…	10.2	12.8
Short-term paper	-3.3	14.5	-17.0	13.0	-4.9	20.5	-26.7	6.0	5.1	-28.5	0.6	12.4	-5.8	…	1.2	0.6
Bonds and debentures	3.4	4.3	4.1	0	0.5	0.5	0.3	2.0	1.0	-3.6	0.5	-1.0	-.1		1.7	0.6
Inter-corporate loans	1.6	5.4	2.2	-0.7	0.8	-.0.4	1.8	2.7	3.8	.2	-.6	-.5	9.5		1.3	8.0
Corporate equity	-6.0	66.0	6.5	.9	37.5	30.7	26.3	39.1	19.6	26.6	12.5	16.2	15.1		2.7	9.4
Trade accounts receivable	4.3	5.4	0.3	3.0	-.8	7.6	12.1	2.8	-1.8	-18.1	-7.3	0.7	1.8		0.6	3.1
Source: Statistics Canada (2017), Table 378-0121 – National Balance Sheet Accounts, quarterly (CAD) (database), www5.statcan.gc.ca/cansim/pick-choisir?lang=eng&p2=33&id=3780121; Statistics Canada (2017), Table 378-0119 – Financial Flow Accounts, quarterly (CAD) (database), www5.statcan.gc.ca/cansim/a26?lang=eng&retrLang=eng&id=3780119&&pattern=&stByVal=1&p1=1&p2=31&tabMode= dataTable&csid=.
https://doi.org/10.1787/888933589998

In 2008, the sector invested heavily in corporate equity, including inter-company investment. This reflected the surging markets that lasted up to the outset of the global financial crisis. In 2009, investment in equity and investment fund shares decelerated, while investment in currency and deposits increased. In 2013, investment in currency and deposits was again significant, and investment in equity and investment fund shares continued to decline. Clearly, non-financial corporations manage their financial asset portfolio in concert with changes in economic and financial conditions.

More generally, the financial accounts and balance sheets record the financial investment preferences of non-financial corporations, in relation to current economic events, such as earnings, financial market fluctuations and business cycles. Disregarding the settlement of liabilities, they specifically reveal non-financial corporations’ choices with respect to the type of financial assets they would like to hold. This is essential in understanding investment patterns and potential risks of non-financial corporations, shedding light on issues such as preferences for short-term versus long-term investment and firms’ projections of future demand. Non-financial corporations will invest where the financial return is the highest. For example, if they feel that investing in a machine or a building will bring a significant return to their owners, they will focus on the acquisition of non-financial assets. Conversely, if their expectations about the demand for their goods and services are weak or declining, they may decide that they can earn a higher return (at least temporarily) by directing funds towards financial assets rather than non-financial assets.

In addition to providing insight into the sector’s expectations about future growth, the financial account investment flows and balance sheet holdings also provide insight into preferences with respect to the type of financial investments and associated risk. If, in a certain period, non-financial corporations invest heavily in very liquid assets, this provides an indication of their need to access funds in the near term, either due to internal reasons or as a reaction to financial market fluctuations. On the other hand, if non-financial corporations invest primarily in bonds, this provides an indication of their willingness to “tie up” their funds for a longer period of time and their expectations about financial markets. If this investment is focussed in central government securities, corporations are seeking a safe haven for investment, and this detail thus provides information about their current assessment and preferences with respect to risk in their sector, the domestic economy, and the global economy. Needless to say, the “what” non-financial corporations invest in provides a significant amount of information about their assessment of risk, their reactions to current economic events and their predictions of future economic conditions. In recent years, non-financial corporations in many countries have increased their investment flows and holdings in liquid assets. When funds are increasingly used to invest in such financial assets, this investment is often referred to as “dead money” – reflecting a perception by some analysts that such funds could be better put to use (see Box 5.2).

In most economies, a notable feature of non-financial corporations is investment in associated corporations. This is accomplished by transferring some of the funds that a non-financial corporation has available in one part of the enterprise group to another part of the enterprise group, either through equity investments or loans and advances. These types of investments can be reflected in the financial accounts (and balance sheets) as an additional breakdown in the equity and investment funds category, as is the case in Canada, where these are called “corporate claims”. This detail is important as intercompany investment transactions can be indicative of fixed capital formation in the same industry, in upstream or downstream industries of the enterprise group, and of corporate re-structuring going on in the economy as well as in other economies through foreign direct investment. These flows can often signal times of consolidation through mergers and acquisitions, and expansion through investment in start-ups or affiliates.

Box 5.2. Dead money in Canada, the US and elsewhere

In recent years there have been concerns expressed about the large stockpile of liquid assets held by non-financial corporations, sometimes referred to as “dead money”. In 2012, the Governor of the Bank of Canada took note of the significant liquidity position of Canadian corporations. He noted that while this reflected prudence on the part of the corporate sector after the financial crisis and recession, the liquidity position also represented funds that could be invested in non-financial assets in order to spur current and future economic growth. More specifically, he noted that “the level of caution could be viewed as excessive ... their job is to put money to work”.

Similar questions were raised in the US around the same time. As early as 2005, the Governor of the Federal Reserve Board noted: “Although capital investment has been advancing at a reasonably good pace, it has nonetheless lagged the exceptional rise in profits and internal cash flow”. In 2013, the Federal Reserve Bank of St Louis emphasised that “US corporations are holding record-high amounts of cash”.

Figure 5.3. Liquid assets of Canadian non-financial corporations

Percentage of total financial assets

Source: OECD (2017), “Financial Balance Sheets, SNA 2008 (or SNA 1993): Non-consolidated stocks, annual”, OECD National Accounts Statistics (database), https://doi.org/10.1787/data-00720-en.

 https://doi.org/10.1787/888933588535

The IMF has recently demonstrated that this increased corporate saving and net lending was the case in a number of G7 and OECD countries (2015). This research into the liquidity of corporations suggested “... that the emergence of the corporate saving glut may be more related to a perceived paucity of profitable (domestic) investment opportunities”.

While the inter-company financial investment flows can provide insight into trends over time, there are a number of important questions these data do not address. The first is with whom is this investment being made, and does it represent a vertical investment (supply chain) or a horizontal investment (concentration)? In order to address these questions, users often request that the non-financial corporations’ sector financial accounts and balance sheets be sub-sectored into more granular groups, and that these granular groups take the form of a traditional industry-based classification so that they are able to better understand the vertical (within industry) and horizontal (outside of the industry) investment. However, such detail is generally missing from most financial accounts and balance sheets. Furthermore, users are also increasingly interested in whether the inter-company investments are between residents and non-residents. Given the increasingly global nature of enterprises there is a substantial amount of cross-border financial investment taking place, often related to supply chain management. These international flows are specifically captured in the financial accounts with the rest of the world, but also reflected (implicitly, at least) in the financial transactions of the non-financial corporations’ sector.

Another use of funds is tied to actively reducing debt loads. In 1981-82, with nominal interest rates at historical highs and in the midst of a six-quarter recession, non-financial corporations in many countries paid off significant portions of both short-term and long-term debt. The interest charges associated with their debt levels were becoming unmanageable and, therefore, firms found it more important to reduce their liabilities than to invest in financial assets or non-financial assets. This use of funds contributed significantly to a substantial restructuring of corporations’ financial positions, setting the stage for the economic recovery that followed.

Sources of funds for non-financial corporations

As noted earlier in this chapter, non-financial corporations are responsible for a large share of total output, non-financial investments and employment in most economies. As such, they need access to funds in order to finance new initiatives as well as react to changing economic conditions. In developed economies, especially for large corporations, funds are accessed through the capital market (debt and equity), the money market and the business loans market. A key focus of the non-financial corporations’ financial accounts and balance sheets is to present the sources of funds available to non-financial corporations. An analysis of these sources of funds reveals a great deal about the overall strategy of firms, as well as how they are reacting to current financial market conditions.

The sources of funds available to non-financial corporations can be illustrated in a number of ways. They can be presented in such a way as to distinguish between internally generated or externally raised funds. In the case of external funds, the accounts reveal whether or not corporations chose to finance their funding needs through borrowing or through the issuance of shares. With respect to debt, the accounts typically articulate whether corporations are issuing short-term or long-term debt. They can also indicate whether the source of funds is domestic or foreign.

External sources of funds

In many countries and in most time periods, the internally generated saving of the non-financial corporations’ sector are not sufficient to meet non-financial corporations’ investment needs; or corporations may decide to divert some of the saving into financial assets. In other words, non-financial corporations generally have a need to raise funds via equity or debt on a regular basis. As such, non-financial corporations must turn to other sectors of the economy in order to secure their required funds for a given accounting period. The ratio of the sources of internal funds (represented by corporate saving, again disregarding the impact of capital transfers), with the total demand for funds on financial markets for Germany and the United States is presented in Figure 5.4. It is clear that, in general, non-financial corporations require more funds than what is internally generated through saving. However, the difference between the two countries presented, Germany and the United States, is quite striking. While the United States’ reliance on external funding has been somewhat volatile over the period presented, Germany has been more reliant on internal funding, certainly since 2000.

Figure 5.4. Internal sources (gross saving) and external sources (change in liabilities) of funds of non-financial corporations in Germany and the United States

Percentage of gross value added of non-financial corporations

Source: OECD (2017), “Detailed National Accounts, SNA 2008 (or SNA 1993): Non-financial accounts by sectors, annual”, OECD National Accounts Statistics (database), https://doi.org/10.1787/data-00034-en; and “Financial Accounts, SNA 2008 (or SNA 1993): Non-consolidated flows, annual”, OECD National Accounts Statistics (database), https://doi.org/10.1787/data-00718-en.

 https://doi.org/10.1787/888933588554

More generally, non-financial corporations have different means to raise external funds. Typically, they borrow from financial corporations, issue debt securities or issue new shares of equity. Their choices provide significant insight into the expectations, behaviour and structure of the corporations. For example, economies where a relatively large proportion of firms are publicly held may engage in more equity financing than in economies where privately held firms are more dominant. This is one material difference between Canada and the US, with the latter having a much higher share of listed firms.

The choice of debt or equity may also be related to the business cycle. In times where stock market prices are low and economic confidence is building – such as just prior to or the early part of an upturn in a business cycle, when share values typically start to trend up – investors may be more willing to invest in equity than in corporate bonds, and equity financing becomes more attractive to firms. This equity-business cycle relationship can be seen when economic growth is plotted against the net issuance of new equity, with stock markets tending to lead economic growth; see Figure 5.5. On the other hand, in the later stages of a business cycle when share prices are also typically peaking, there may be more of a tendency to increasingly rely on debt as a source of funds, which can lead to financial stability concerns. Generally speaking, in the context of debt issues, a corporation should have enough confidence in the economic conditions so as to not compromise their ability to meet future obligations (including the payment of interest as well as the repayment of debt). In any case, the choice between equity and debt is an important one for non-financial corporations, which is governed by the availability of funds on the financial markets, changes in the financial position, and future prospects, and the choice has varied considerably over time.

Figure 5.5. Net equity issuance and growth in real GDP, Canadian non-financial corporations

Equity issuance in percentage of total debt and equity issuance

Source: Statistics Canada (2017), Table 378-0119 – Financial Flow Accounts, quarterly (CAD) (database), www5.statcan.gc.ca/cansim/a26?lang=eng&retrLang=eng&id=3780119&&pattern=&stByVal=1&p1=1&p2=31&tabMode=dataTable&csid=; Statistics Canada (2017), Table 380-0064 – Gross domestic product, expenditure-based, quarterly, www5.statcan.gc.ca/cansim/a26?lang= eng&id=3800064.

 https://doi.org/10.1787/888933588573

With respect to debt financing, non-financial corporations also have the choice of short-term or long-term debt. Short-term debt is defined as any debt with a maturity of less than one year at the time of issue, while long-term debt is defined as any debt with a maturity of more than one year. Furthermore, in many economies, only larger firms may have access to the bond market and, especially, the money market. Smaller firms have to rely more heavily on loans from financial corporations to raise funds. The term structure of borrowing in any given period again may reveal a great deal about corporations’ expectations regarding future growth and financial conditions such as interest rates. Enterprises tend to issue short-term debt if interest rates are highly volatile, or they expect that interest rates will fall in the near future. Enterprises would tend towards long-term debt when they feel interest rates are stable at an acceptably sustainable level, or if they sense that interest rates may increase in the future. While Canadian corporations’ borrowing on money and capital markets trailed off during the last recession, their issues of long-term debt advanced as interest rates reached historic lows after the 2007-09 economic and financial crisis. This is demonstrated in Table 5.6.

Table 5.6. Debt raised on money and capital markets, Canadian non-financial corporations
Billions of CAD
	4Q06	1Q07	2Q07	3Q07	4Q07	1Q08	2Q08	3Q08	4Q08	1Q09	2Q09	3Q09	4Q09	…	2Q13	3Q13
Total raised	14.4	8.4	3.7	8.1	1.8	9.4	5.9	3.7	-3.9	3.8	9.4	6.8	-0.3	…	16.0	10.1
Short-term paper	5.5	3.0	-.9	2.9	-0.2	6.9	-1.7	-1.5	-1.9	0	-4.9	-2.1	-7.3	…	4.5	-1.3
Bonds and debentures	8.9	5.4	2.8	5.2	2.0	2.5	7.6	5.2	-2.0	3.8	14.3	8.9	7.0	…	11.5	11.4
Source: Statistics Canada (2017), Table 378-0121 – National Balance Sheet Accounts, quarterly (CAD) (database), www5.statcan.gc.ca/cansim/pick-choisir?lang=eng&p2=33&id=3780121; Statistics Canada (2017), Table 378-0119 – Financial Flow Accounts, quarterly (CAD) (database), www5.statcan.gc.ca/cansim/a26?lang=eng&retrLang=eng&id=3780119&&pattern=&stByVal=1&p1=1&p2=31&tabMode=data Table&csid=.
https://doi.org/10.1787/888933590017

Short-term versus long-term debt may vary considerably across OECD countries and over time. In Figure 5.6 a striking feature is the strong reliance on short-term debt in some European economies. This situation contrasts with patterns in other European countries such as Finland, Sweden and the United Kingdom, where corporations almost entirely rely on long-term debt.

As with financial investments, information about non-financial corporations’ liabilities can also show from whom (at least in part) non-financial corporations receive their funding. An emphasis on from-whom-to-whom information is also a feature of the G-20 Data Gaps Initiative (see Chapter 10). Traditionally, the financial accounts and balance sheets have provided details on the type of financing received by non-financial corporations, but the focus has mainly been on the instruments – debt or equity, long-term or short-term. Increasingly, users are demanding that an additional dimension be added to the financial accounts: “from whom”, i.e. from whom are non-financial corporations receiving their funds; from domestic sectors or from foreign sectors; and if funds are from domestic sectors, are the funds coming from other non-financial corporations, banks, institutional investors or other financial corporations. This “from whom” dimension provides additional insight into the economy-wide risk associated with sectoral inter-connectedness.

Figure 5.6. Loans and debt securities, short-term versus long-term, 2014

Percentage of total loans and debt securities

Source: OECD (2017), “Financial Balance Sheets, SNA 2008 (or SNA 1993): Non-consolidated stocks, annual”, OECD National Accounts Statistics (database), https://doi.org/10.1787/data-00720-en.

 https://doi.org/10.1787/888933588592

Box 5.3. Data sources and methodology for non-financial corporations

Data sources for the non-financial corporations’ sector vary considerably across countries. The source data are used to estimate financial accounts and balance sheets, as well as other changes in assets accounts. Data quality and asset-liability details may vary across countries, but there are four basic data sources: publicly available corporate balance sheets, survey statistics, tax data, and counterpart information (e.g. banks’ deposit liabilities or loan assets) or indirect data (e.g. securities’ databases). These are not mutually exclusive sources and most compilers leverage as much information as they can, often using two or more data sources. Integrating these data sources is a further methodological complication as each of these data sources has its own characteristics.

An issue in the compilation of financial accounts and balance sheets concerns the level of consolidation of national accounts data on financial assets and liabilities for non-financial corporations. Depending on the source data, this consolidation can vary considerably across countries. Enterprise-based survey sources tend to present data that are generally consolidated at the enterprise level, i.e., borrowing and lending among related entities would be eliminated. Legal entity-based source data, however, tend to present assets and liabilities in which the borrowing and lending between legal entities belonging to the same enterprise (group) are not cancelled out. As a consequence, total assets and liabilities will be larger in the latter case than in the former, and may compromise international comparability. Needless to say, it is important to consult any available country metadata in order to properly interpret the financial accounts and balance sheets data for non-financial corporations.

Table 5.7. Basic sources of data to construct the non-financial corporations’ sector
Data source/general characteristics	Publicly available financial information	Tax data	Survey statistics	Counterpart or indirect data
Frequency	Typically annual although, with the increase in private sector databases, sub-annual information is becoming more common	Annual	Can be designed to be quarterly	Typically quarterly, or higher frequency for some items (securities databases)
Timeliness	Varying lags, from short lags (partial information) to medium and long lags (in excess of one year) for complete financial information; however, with the increase in private sector databases, select information is becoming more timely	Long lag (often in excess of 1-2 years)	Can be designed to have an adequate lag for timely quarterly releases	Typically a short lag
Details	Aggregated, such that limited detailed information may be available	Aggregated, such that limited detailed information may be available	Can be detailed by design	Instrument-specific details
Consolidation	Largely global consolidation for complex MNEs; domestic consolidation for other enterprises (in the case of enterprises consisting of several legal entities possibly only unconsolidated data available). Lack of clearly defined statistical unit	Domestic consolidation, based on legal entities’ statistical units	Domestically consolidated enterprises for enterprises consisting of several legal entities; domestic legal entities for simple firms	Reflection of domestically consolidated entities
Coverage	Typically no, as the focus is on relatively large firms	Yes, for legal entities’ statistical units	No, is restricted to survey sample	Typically yes for instrument specific details
Cost	Relatively low cost	Relatively low cost, if available	Relatively high cost; concerns about response burden	Relatively low cost

In relation to borrowing from non-residents, there is an additional important dimension: the currency composition of foreign debt, as foreign investors are sometimes unwilling to assume the additional risk (and potential reward) of an appreciation or depreciation of the currency, with respect to the holdings of non-financial corporations’ debt. In order to guard against currency fluctuations, non-financial corporations therefore often seek or are required to issue debt in a common currency such as the Euro or the US dollar. For example, in Canada the majority of private corporation bonds held by non-residents have been issued in US dollars, to “protect” foreign investors against large depreciations of the local currency. As a result, non-financial corporations are exposed to currency risks when raising funds in foreign currency. Specifically, they will have to pay interest and reimburse the principal at whatever exchange rate prevails when these obligations come due. This may lead to increased foreign currency hedging activity on the part of borrowers. It is thus becoming increasingly important that financial accounts provide detail on the currency composition of debt.

Non-financial assets

For non-financial corporations, non-financial assets typically account for a significant share of total assets. When examining the non-financial assets section of the balance sheet account of the non-financial corporations sector, it is important to consider three aspects: coverage, ownership and valuation. In this respect, it could be argued that ensuring complete coverage is the most important consideration in constructing a balance sheet. In many ways, the stock of non-financial assets – or capital base – explains how non-financial corporations go about producing goods and services and generating income for their owners. Produced assets (e.g. structures, machinery and equipment) comprise the principal non-financial assets for the non-financial corporations’ sector, followed by land and inventories. If non-financial assets are not fully articulated on the balance sheet, then there is a disconnect between the production of goods and services, the generation of income, and the assets that are used by the sector to produce these goods and services and contribute to net worth changes. This potential disconnect is best illustrated using a few examples.

Currently “branding” does not fall within the asset boundary of national accounts. This means that the development and use of a brand does not find its way onto the national accounts’ balance sheets for non-financial corporations. It is widely accepted however, that firms invest in the development of a brand and then use that brand to sell goods and services and earn a return on their investment. Excluding this asset is likely to attribute too much return to other assets that are recorded on the balance sheets. As a result, it is difficult to have a proper understanding of the assets that were used to produce the goods and services of the non-financial corporations sector.

Another asset that is often missing from the balance sheet accounts concerns natural resources. Non-financial corporations in many economies are often granted (for a price) the explicit right to extract natural resources by governments. This right to extract is an asset they acquire in order to produce goods and services. For many non-financial corporations, this is one of the most important assets that they own and exert ownership rights over (i.e. they can sell the asset). However, this asset is often not reflected in the balance sheet of national accounts, mainly because measurement issues related to the delineation and estimation of the reserves (e.g. proven reserves versus probable reserves) and the future income that can be derived from extracting these reserves. The exclusion of natural resources is a significant data gap in some countries that leads to an underestimation of the sector’s assets. As a result, the relevance of these accounts and the international comparability of wealth data may be adversely impacted.

The second important aspect that needs to be considered when examining non-financial assets in the balance sheets is the establishment of the owner to which the assets is to be attributed. The purpose of the balance sheets is to provide a current representation of the sector’s assets, liabilities, and the balance of these two categories, net worth. Ownership of assets is an important characteristic that needs to be taken into consideration when analysing the balance sheets of non-financial corporations. National accounts distinguish between legal ownership and economic ownership, with a preference for the latter – that is, national accounts allocate assets to the sector of the user (for example, in the case of financial leasing). Therefore, within the balance sheets assets are recorded in the sector that has economic ownership of the asset. In the case of financial leases, a liability (and a corresponding financial asset in the legal owner’s sector) is recorded to reflect the “borrowing” of this asset from the legal owner. This approach links the goods and services produced by non-financial corporations and the assets that are used to produce the goods and services.

A final aspect to be considered is the valuation of non-financial assets. As many non-financial assets are not regularly traded on second-hand markets, it is difficult to find appropriate market values for the assets which are in use for a certain period of time. The 2008 SNA therefore uses an alternative method, called the “perpetual inventory method” or the “current replacement cost method” for produced capital assets, which is based on the past accumulation of assets, adjusted for depreciation and price changes. Non-produced assets should be similarly valued at some approximation to market value. More details on this, and other issues concerning the measurement of non-financial assets, are discussed in Chapter 8.

Financial assets

For non-financial corporations, the largest assets tend to be deposits, accounts receivable (mostly intra-sectoral) and inter-company investment. The latter item, which may consist of equity as well as loans, is not separately recorded in standard national accounts presentations, but included under the relevant instruments (equity or loans). It is increasingly important to be able to separate inter-company investment from the individual instruments, especially given the significant growth in recent times of direct investment in subsidiary companies abroad. This is further discussed in the context of globalisation later in this chapter. Furthermore, portfolio investment has also grown in recent years in some western economies, as the growth of companies’ earnings has been increasingly directed into liquid assets such as deposits, tradeable shares and debt securities (see Box 5.1) with growing shares in foreign securities. The above factors have, in turn, led to an increase in the share of financial assets to total assets of non-financial corporations in many economies in recent years. This is evident in Table 5.8 with Canadian financial assets gaining ground over Canadian non-financial assets steadily since 2000, growing from 42% to 53% of total assets, interrupted only by the effect of the drop in the value of equity assets in the fourth quarter of 2008. As a result, it has become important to analyse the financial assets of non-financial corporations in terms of instruments held. Table 5.8 also shows the shares of deposits in total financial assets for non-financial corporations for Canada. As can be seen, the share of liquid deposit assetshas doubled from 8% to 16% of total financial assets in the 25 years since 1990, with a cyclical increase in liquidity evident in the financial crisis period.

It is also interesting to analyse the financial assets of non-financial corporations by counterparty, relating investors and borrowers. Increasingly, statistics are becoming available on the counterparty sectors in which the sectors of the economy invest, or from which they borrow, as per the G-20 Data Gaps Initiative (see Box 5.4). The power of the latter detail on “from-whom-to-whom” (FWTW) information for non-financial corporations is best demonstrated using an example. Assume that users are informed that the non-financial corporations’ sector holds USD 100 million in financial assets. That single number does not reveal anything about non-financial corporations’ risk or their assessment of current economic conditions. Now assume that users are told more specifically that non-financial corporations hold the USD 100 million in currency and deposits. This provides additional information regarding risk (in this case, minimal risk) and indicates that non-financial corporations are probably looking to invest these funds elsewhere in the short to medium term, since they are likely earning a relatively low return. Now assume that users are also told that non-financial corporations hold the currency and deposits, denominated in US Dollars, with a bank in the United States. This information regarding non-financial corporations’ financial assets – how much (the value), what type (the instrument) and with whom (the counterparty sector) provides a complete picture that assists in the assessment of the risk and investment patterns of this sector.

Liabilities

Liabilities of non-financial corporations tend to outsize financial assets by a significant margin. The largest liability of non-financial corporations normally consists of equity held by others, though its importance fluctuates over time. This fluctuation reflects changes in the market valuation of equity over time, as well as time-dependent preferences for the use of debt versus equity. Loans, marketable debt instruments (bonds and short-term paper issues outstanding) and accounts payable also tend to be relatively large proportions of total liabilities.

The use of debt securities varies considerably across OECD countries. Figure 5.8 presents the use of debt securities and loans by non-financial corporations for a number of different countries. It shows that the US has the highest proportion of debt securities, which can partially be explained by US non-financial corporations’ access to debt markets.

At the same time, the liquidity of non-financial corporations in Canada has also improved in concert with the growth in financial investments in liquid assets. A broad measure related to liquidity looks at liquid assets relative to short-term liabilities and provides a measure of non-financial corporations’ ability to meet their short-term debt commitments. Figure 5.9 demonstrates that, in Canada, this ratio fluctuates over time, but the increase in deposits and portfolio investment suggests that liquidity is not currently an issue of concern for the non-financial corporations sector.

Leverage is another measure of the financial health of non-financial corporations. The debt-to-equity ratio is a measure of the non-financial corporations’ leverage. Leverage has been on a slight downward trend in Canada, the United States and other OECD countries over the last 25 years, further underlining the general health of the balance sheets of the enterprises in this sector. Notably, the leverage ratio based on national accounts data is calculated at market value. This makes the ratio sensitive to stock market swings. Therefore, it is also useful to compile a measure of leverage based on book values or historical cost. Figure 5.10 shows both ratios for Canada. Despite the larger volatility of the national accounts-based ratio, both indicators generally move in concert.

Figure 5.8. Loans versus debt securities of non-financial corporations, 2015

Percentage of total loans and debt securities

Source: OECD (2017), “Financial Balance Sheets, SNA 2008 (or SNA 1993): Non-consolidated stocks, annual”, OECD National Accounts Statistics (database), https://doi.org/10.1787/data-00720-en.

 https://doi.org/10.1787/888933588630

Figure 5.9. Non-financial corporations’ liquidity ratio, Canada

Percentage of liquid assets to short-term liabilities

Source: Statistics Canada (2017), Table 378-0121 – National Balance Sheet Accounts, quarterly (CAD) (database), www5.statcan.gc.ca/cansim/pick-choisir?lang=eng&p2=33&id=3780121; Statistics Canada (2017), Table 378-0119 – Financial Flow Accounts, quarterly (CAD) (database), www5.statcan.gc.ca/cansim/a26?lang=eng&retrLang=eng&id=3780119&&pattern= &stByVal=1&p1=1&p2=31&tabMode=dataTable&csid=.

 https://doi.org/10.1787/888933588649

Figure 5.10. Non-financial corporations’ leverage, Canada

Percentage of debt to equity

Source: Statistics Canada (2017), Table 378-0124 – National Balance Sheet Accounts, financial indicators, corporations, quarterly (per cent) (database),0 www5.statcan.gc.ca/cansim/a26?lang=eng&retrLang=eng&id=3780124&&pattern=&stByVal=1&p1=1 &p2=31&tabMode=dataTable&csid=.

 https://doi.org/10.1787/888933588459

Equity and net worth: a key difference between national and corporate accounting

Apart from the valuation and the definition of assets, one of the major differences between the SNA and business accounting relates to the treatment of equity. Differences between national accounts and business accounts are discussed in detail in Box 5.5. Here, we address the differences in defining net worth, net asset value and owners’ equity. The basic accounting identity used in business accounting is:

Total assets = Total debt liabilities + Owners’ equity

In the system of national accounts, the equity of a corporation, in the sense of shares and other equity valued at market prices, is treated as a liability, hence the accounting identity becomes:

Total assets = Total liabilities (including outstanding equity at market prices) + Net worth (i.e. any remaining residual)

Note that when total assets are equal to total liabilities in the SNA, there is no residual net worth of the non-financial corporations’ sector. Furthermore, if stock market prices are particularly high, in view of investors’ future profit expectations, then residual net worth may even become negative. This leads to the following three questions:

• Why is equity treated as a liability in national accounts? The market value of corporate equity is treated as a liability in the balance sheets (and the financial accounts), because all corporate shares have an external owner. For example, assume that a mutual fund invests in the shares of a non‐financial corporation. This investment is a financial asset owned by the mutual fund sector. If the mutual fund holds a financial asset, then there must be a corresponding liability in another sector – in this case, in the non-financial corporations’ sector. However, one can also think of the market value of corporate equity (on the liability side of the corporation) as a measure of corporate net worth belonging to shareholders when analysing the non-financial corporations’ sector in isolation.

• Can owners’ equity be derived as the net asset value in the system of national accounts? Yes, it can and some countries (including Canada) release such a supplementary national accounts measure – sometimes referred to as the net asset measure or current value measure of the corporation. It is calculated as total assets minus total debt liabilities (i.e. excluding the market value of corporate equity). One would expect that this value is equal or at least close to the market value of the corporate equity liability. However, this is rarely the case, because one amount is based on the value of the shares on the stock market, while the other is based on the intrinsic value of the corporation, i.e. the difference between the assets and the debt liabilities on the balance sheets. The net asset value may also be quite different from the owners’ equity according to business accounting. One reason is the divergent valuation practices. For example, in business accounting, non-financial assets are usually valued at historical cost, while the 2008 SNA applies the current replacement cost method. It may also differ due to coverage. For example, some assets are recognised in the national accounts which are not recorded as such in business accounting, such as intellectual property products. On the other hand, in the case of business accounts some provisions for future expenses may be deducted from the owners’ equity.

• Why is there residual corporate net worth in the system of national accounts? Residual corporate net worth is that part of corporate net worth which is not assigned to another sector as an asset. It can be the result of the methodology employed in recording assets and liabilities in the balance sheets, or it can be related to measurement errors. Measurement errors can arise due to missing or misvalued assets and debt liabilities in the net asset measure of the intrinsic value of the corporation, or any mismeasurement in the calculation of the market value of the outstanding shares (listed and unlisted) in the corporate equity liability measure. In addition, residual corporate net worth may arise due to a “market expectation gap”. More specifically, the share prices of corporations reflect the investors’ perception about the future earning potential and value of the enterprise. If they are “pricing” the shares higher than the net asset value, it may be an indication of i) excess speculative activity; ii) investors’ assessment of assets that are not recorded on the balance sheets; or iii) investors’ expectations about future profits which are not reflected in the assets. The reverse can also be the case.

For instance, assume that the non-financial corporations sector’s assets for a given country are USD 100 000 and its debt liabilities are USD 90 000. The net asset value of the firm is therefore USD 10 000 (USD 100 000 in assets less USD 90 000 in debt liabilities). Assume that the sector has 1 000 shares outstanding and the current market value (stock market price) of these shares is USD 15 per share. The market value of the firm’s equity is USD 15 000 (1 000 shares × USD 15 per share). In national accounts, the difference between the USD 10 000 net asset value (or current value) and the USD 15 000 equity is referred to as the sector’s (residual) corporate net worth. In this case, net worth according to national accounts is equal to minus USD 5 000. Figure 5.11 shows these different measures, the net asset value (or current value) and the market value of equity, for non-financial corporations in Canada. While these measures track each other well over time, they are rarely equal, with the difference representing residual corporate net worth.

Figure 5.11. Net asset value versus equity (market value) for non-financial corporations in Canada

Millions of CAD

Source: Statistics Canada (2017), Table 378-0121 – National Balance Sheet Accounts, quarterly (CAD) (database), www5.statcan.gc.ca/cansim/pick-choisir?lang=eng&p2=33&id=3780121; Statistics Canada (2017), Table 378-0119 – Financial Flow Accounts, quarterly (CAD) (database), www5.statcan.gc.ca/cansim/a26?lang=eng&retrLang=eng&id=3780119&&pattern= &stByVal=1&p1=1&p2=31&tabMode=dataTable&csid=.

 https://doi.org/10.1787/888933588478

In economic theory, putting measurement issues aside, the relationship between the market value of equity to a corporation’s net asset value (at current replacement costs) is often referred to as Tobin’s q. Tobin’s q suggests that the market value of an enterprise should be equal, or close, to its intrinsic value at current values. If Tobin’s q is greater than 1 it is reflective of the fact that investors are assigning a premium to something, likely valuing some unmeasured or unrecorded asset of the company, or expecting larger future profits not reflected in the assets. As can be derived from Figure 5.12, the Tobin’s q measure for the non-financial corporations’ sector in Canada is quite volatile, with peaks in the dotcom bubble around 2000, and around the Great Recession.

Figure 5.12. Tobin’s q for the non-financial corporations’ sector in Canada

Source: Statistics Canada (2017), Table 378-0121 – National Balance Sheet Accounts, quarterly (CAD) (database), www5.statcan.gc.ca/cansim/pick-choisir?lang=eng&p2=33&id=3780121; Statistics Canada (2017), Table 378-0119 – Financial Flow Accounts, quarterly (CAD) (database), www5.statcan.gc.ca/cansim/a26?lang=eng&retrLang=eng&id=3780119&&pattern= &stByVal=1&p1=1&p2=31&tabMode=dataTable&csid=.

 https://doi.org/10.1787/888933588497

National accounting and business financial accounting

There are many similarities between what is presented in national accounts and what is included in business financial reports. This is convenient, as national accounts are largely derived from business financial statements. There are also some important differences.

Presentation

In general the non-financial corporation financial accounts and balance sheets are structurally similar to what you would find in a set of business accounts. Both have an income account, or profit and loss account, but national accounting segments income more finely than business accounting. Similarly, both national accounts and business accounts have an account that relates to capital expenditure. Moreover, the SNA financial account is the equivalent to the business accounting statement of change in financial position. However, the latter also includes revaluations and other changes that are treated as separate accounts in national accounting. The balance sheet is the statement with the largest resemblance between the two bases of accounting. However, even in the balance sheet there remain important differences, especially with respect to the classification and valuation of assets and liabilities.

Valuation of assets and liabilities

At the outset, it should be recognised that, with respect to valuation, business accounting is moving closer to national accounting. The traditional trend in business accounting to rely on book value measures (acquisition cost for assets and issue price for liabilities) and the principle of market valuation in national accounting have resulted in significant differences. The relatively new international business accounting guidelines for corporations, known as the International Financial Reporting Standards (IFRS), recommend more current value accounting for financial instruments as compared to some previous accounting regimes (along with a more comprehensive measure of income). However, this is both a benefit and a challenge for compilers of financial statistics, as companies in the non-financial corporations’ sector evolve towards IFRS.

In national accounting, non-financial assets will generally be valued differently from what would be found on a typical non-financial corporation’s balance sheet. Estimates of the stocks of non-financial assets themselves along with their depreciation could be substantially different, since the national accounts reflect economic depreciation (rather than tax allowable rates), and use a valuation at current prices (instead of book value, based on historic costs). Even in cases where financial statements move from a book value basis to a more current value basis, the prices and methodology used to determine the current values of both non-financial and financial assets could be quite different from national accounting.

In terms of liabilities, while corporations are moving towards more current valuation for tradeable financial assets, this is not the case for liabilities. This is directly contradictory to national accounting, which applies a market price valuation for tradeable liabilities. The SNA recommends this, because its main purpose is to measure aggregates in industries, sectors and the economy as a whole. In this context, consistency of valuation on both sides of the balance sheet and across all sectors is a requirement related to both the accuracy and relevance of the statistics.

Adjustments to assets-liabilities: provisions

In business accounting charges (expenses) are made against current income for a variety of provisions (e.g. potential asset impairment, deferred income tax, as well as certain environmental liabilities and employee pension obligations). Provisions are amounts set aside for probable but uncertain future asset value losses or future liabilities of an enterprise. The use of provisions is consistent with the principle of accrual accounting, where financial events are recorded on a timely and ongoing basis instead of when the event may be subject to a cash settlement or otherwise final impact on the financial statements. Provisions also give rise to corresponding adjustments on the business balance sheet account: either an asset is reduced in value or a new liability is created, and there are matching appropriations from retained earnings in the equity account such that assets remain equal to liabilities plus equity. In the case of non-performing loans or trade receivables, new provisions are one of the entries (along with recoveries and write-offs) in the allowance for doubtful accounts which is netted against the asset account.

In national accounts provisions, being due to exogenous events with a likely future impact on the business, are not part of income arising from current economic production, and are thus excluded from operating surplus/mixed income (and therefore, saving). Similarly, any provisions based changes to the value of assets or liabilities are not part of transactions in the financial account; rather, to the extent that provisions are known, they should be treated as other changes in the volume of assets. These volume changes would then impact the relevant stocks on the balance sheets, including net worth. However, related to data availability issues, national accountants may or may not record adjustments for these items, as a consequence of which international comparability may be hampered. On the one hand, the allowance for doubtful accounts is typically deducted in relation to impaired loans and accounts receivable (based on the treatment in source data), with the flow (new provisions) accounted for as other changes in the volume of assets. Furthermore, changes in pension obligations on defined benefit plans, due to actuarial revaluations may give rise to changes in the relevant liabilities on the balance sheets. On the other hand, certain environmental liabilities do not necessarily have a counterpart asset in the economy (a 2008 SNA requirement), and are ignored in national accounts. Similarly, deferred income taxes are not treated as liabilities.

Equity and net worth

The different treatment of equity and net worth in business accounting and national accounts has already been discussed earlier in this chapter, at the end of Indicator 4.

Coverage and classification

The national accounts typically have a more complete coverage of assets. Research and development, and other intellectual property products, such as software and databases, mineral exploration, and entertainment, literary and artistic originals, are all recognised and recorded as assets in the system of national accounts, whereas in business accounting expenditures on these categories are often treated as current expenditures, certainly when produced in-house.

There may also be some (usually minor) differences in the way instruments are classified. Instruments such as bonds in business accounts may be classified as currency and deposits in the financial accounts. As another example, corporate financial reports show the components of intercompany investment as separate asset, as opposed to allocating these components with other equity and debt assets on the SNA balance sheet.