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French companies earnings

Friday 20 January 2012, by Romain Sautard

In a previous study on equity capital of French companies, we have shown that, compared to British companies, French firms are undercapitalized. One of the potential reasons of this difference is that French companies earn fewer profits than British ones.

Indeed, during a company life cycle, the main funding source for investments comes from the profits earned during the year. This is called self-financing. National accounting of non-financial companies shows that this kind of companies has generated almost five times lower retained earnings in France than in the UK over the period 2007-2008, constraining the self financing capacity of French companies. Moreover, French companies have a funding requirement of almost 50 billion Euros while, during the same time, British companies have a financing capacity of 50 billion Euros.

A more detailed analysis of national accounting highlights that the difference observed between the two countries mainly comes from the amount of social contributions and taxes on production, paid by companies, but also from the level of net savings of companies (meaning that French companies invest relatively more than British ones).

Profits and self-financing of companies

We know that companies’ growth is driven by investments. These investments can be financed from two sources: external financing (from banks, capital markets, etc) or internal financing. This internal financing – called self-financing – mainly comes from profits that are retained [1]. Thus, higher companies profits are, higher retained earnings and self-financing will be.

National accounts of non-financial corporations in France and United Kingdom give the following results [2]:

These graphs show that, even if global turnover of non financial corporations are the same in both countries (graph 1), UK companies generate about 55% more profits, on average, than French companies (graph 2). Regarding retained earnings, the gap is even more dramatic: French companies generated 5 times less retained earnings than UK companies (graph 3). This constrained all the more the capacity of French companies of increasing their equity capital and, thus, their self financing capacity.

These differences have also a direct impact on the global financing capacity of the non financial corporations. Indeed, whereas French companies have a negative disposable income of about 50 billion Euros, UK companies have a positive disposable income of 50 billion Euros.

Rationale of these differences

How to explain these differences? Are French companies less competitive than UK companies? Focusing on the different lines of the national accounts, we can highlight three main differences:

  • The first one comes from financial transfers to Governments, including production taxes and social contributions paid by companies: In 2008, UK non financial corporations paid 115 billion Euros of taxes and French companies paid 210 billion Euros taxes, 80% more than UK companies. All things being equal, this difference explains the gap in profits between the two countries;
  • The other item, explaining the gap between profits and retained earnings, is the level is the profits reinvested of Foreign Direct Investments (FDI). These later are the profits of MNEs’ subsidiaries that are not distributed through dividends to headquarters and that are reinvested in the subsidiary. In France, the net balance of such item if about 7 billion Euros (average 2007-2008) against 52 billion Euros in United Kingdom. This shows that FDI level is much higher in the UK, allowing companies to have more cash;
  • Finally, we can also observe a huge gap in net saving of non financial corporations in both countries. This explains why retained profits of UK companies are higher than retained profits of French companies. French companies do not save money (and some years have negative savings) whereas UK companies have global net savings of 100 billion Euros a year (on average). However, this difference could be explained by the fact that UK companies invest less than French companies [3].

Conclusion

In this study, we have shown that the strength of companies could be measured by the global amount of equity capital. Thus, it is important that, in a crisis such as today, companies have sufficient equity capital to survive. A previous study showed that French companies are undercapitalized compared to UK companies and, thus, face a higher risk. Analyzing the national accounts of both countries, we can see that under capitalization of French companies mainly comes from the fact that they generate fewer profits than UK companies and thus can not raise their equity capital.

Whereas the global turnover of the non financial corporations in both countries is almost the same, even higher for French companies, the profits gap is dramatic. Almost all this gap is explained by the difference in taxes on production and social contributions paid by French and UK companies.

However, not all is dark because, first, French companies do not seem to be less competitive than UK companies and investments of French non financial corporations are sensitively higher that investments of UK companies. This could explain that, despite a better financial health of its companies, United Kingdom faces a low GDP growth since the last 5 years.

Footnotes

[1Retained profits are total profits less distributed profits (that includes dividends, interests paid to banks, profits/losses on property and land valuation, etc)

[2€ / £ exchange rate used : 0.684 in 2007 and 0.796 in 2008 (yearly average)

[3While the difference in net savings is about 115 billion Euros a year between the two countries, the difference is about 80 billion Euros in gross savings (net savings + amortizations). However, French companies may need to invest more due to poor investment quality or lower returns.

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