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Analysis for
Financial Management
The McGraw-Hill Education Series in Finance,
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FINANCIAL MANAGEMENT Fundamentals of Corporate Finance INTERNATIONAL FINANCE

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Analysis for
Financial Management
Thirteenth Edition

ROBERT C. HIGGINS
Marguerite Reimers
   Emeritus Professor of Finance
The University of Washington
with

JENNIFER L. KOSKI
Associate Dean for Academic and
  Faculty Affairs
Kirby L. Cramer Endowed Chair
  in Finance
The University of Washington
and

TODD MITTON
Ned C. Hill Professor of Finance
Brigham Young University
 Final PDF to printer

ANALYSIS FOR FINANCIAL MANAGEMENT

Published by McGraw Hill LLC, 1325 Avenue of the Americas, New York, NY 10019. Copyright
©2023 by McGraw Hill LLC. All rights reserved. Printed in the United States of America. No part
of this publication may be reproduced or distributed in any form or by any means, or stored in a
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Some ancillaries, including electronic and print components, may not be available to customers
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1 2 3 4 5 6 7 8 9 LCR 27 26 25 24 23 22
ISBN 978-1-265-04263-9
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Cover Image: Dave Allen Photography/Shutterstock

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In memory of our sons
STEVEN HIGGINS
1970–2007
ALEXANDER MITTON
1997–2014
Brief Contents

Preface xii PART FOUR

Evaluating Investment Opportunities 235
PART ONE 7 Discounted Cash Flow
Assessing the Financial Techniques 237
Health of the Firm 1
8 Risk Analysis in Investment
1 Interpreting Financial Statements 3 Decisions 285
2 Evaluating Financial Performance 37 9 Business Valuation and Corporate
Restructuring 335
PART TWO
Planning Future Financial Performance 77 GLOSSARY 385
3 Financial Forecasting 79 SUGGESTED ANSWERS TO
4 Managing Growth 111 ODD-NUMBERED
PROBLEMS 397
PART THREE INDEX 429
Financing Operations 139
5 Financial Instruments and Markets 141
6 The Financing Decision 193
Contents

Preface xii The Value Problem 56

ROE or Market Price? 58
Ratio Analysis 60
PART ONE Using Ratios Effectively 61
ASSESSING THE FINANCIAL Ratio Analysis of Polaris Inc. 62
HEALTH OF THE FIRM 1 Summary 69
Additional Resources 70
Chapter 1 Problems 71
Interpreting Financial Statements 3
The Cash Flow Cycle 3 PART TWO
Overview of Financial Statements 6 PLANNING FUTURE FINANCIAL
The Balance Sheet 9 PERFORMANCE 77
Current Assets and Liabilities 10
Shareholders’ Equity 11 Chapter 3
The Income Statement 11 Financial Forecasting 79
Measuring Earnings 12
Sources and Uses Statements 16 Pro Forma Statements 79
The Two-Finger Approach 17 Percent-of-Sales Forecasting 80
The Cash Flow Statement 18 Interest Expense 86
Financial Statements and the Value Problem 22 Seasonality 86
Market Value vs. Book Value 22 Pro Forma Statements and Financial
Economic Income vs. Accounting Income 26 Planning 87
Imputed Costs 27 Forecasting with Spreadsheets 89
Summary 30 Coping with Uncertainty 92
Additional Resources 31 Sensitivity Analysis 92
Problems 32 Scenario Analysis 93
Simulation 93
Chapter 2 Cash Flow Forecasts 95
Evaluating Financial Performance 37 Cash Budgets 96
The Techniques Compared 100
The Levers of Financial Performance 37 Summary 101
Return on Equity 38 Additional Resources 102
The Three Determinants of ROE 38 Problems 103
The Profit Margin 40
Asset Turnover 42 Chapter 4
Financial Leverage 48
Managing Growth 111
Is ROE a Reliable Financial Yardstick? 53
The Timing Problem 54 Sustainable Growth 112
The Risk Problem 54 The Sustainable Growth Equation 112

viii

Too Much Growth 114
Balanced Growth 115
DLH Holdings’ Sustainable Growth Rate 116
“What If” Questions 118
What to Do When Actual Growth Exceeds
Sustainable Growth 118
Sell New Equity 119
Increase Leverage 121
Reduce the Payout Ratio 121
Profitable Pruning 122
Outsourcing 122
Pricing 123
Is Merger the Answer? 123
Too Little Growth 123
What to Do When Sustainable Growth Exceeds
Actual Growth 124
Ignore the Problem 125
Return the Money to Shareholders 126
Buy Growth 127
Sustainable Growth and Pro Forma
Forecasts 127
New Equity Financing 128
Why Don’t U.S. Corporations Issue
More Equity? 131
Summary 132
Additional Resources 133
Problems 134
PART THREE
FINANCING OPERATIONS
Chapter 5
Financial Instruments and
Markets 141
Financial Instruments 142
Bonds 143
Common Stock 149
Preferred Stock 153
Financial Markets 155
Venture Capital Financing 155
Private Equity 157
Initial Public Offerings 158
Seasoned Issues 160
Issue Costs 164
Contents ix
Efficient Markets 166
What Is an Efficient Market? 166
Implications of Efficiency 169
Appendix
Using Derivatives to Manage Risks 170
Forward Markets 172
Hedging with Forward Contracts 172
Hedging with Futures Contracts 173
Types of Forwards and Futures 174
Hedging with Swaps 175
Interest Rate Swaps 176
Currency Swaps 177
Hedging with Options 178
Limitations of Financial Market Hedging 181
Valuing Options 182
Summary 185
Additional Resources 187
Problems 188
Chapter 6
The Financing Decision 193
Financial Leverage 195
Measuring the Effects of Leverage on a
Business 199
Leverage and Risk 201
Leverage and Earnings 203
How Much to Borrow 206
Irrelevance 206
Tax Benefits 208
139 Distress Costs 208
Flexibility 213
Market Signaling 216
Management Incentives 219
The Financing Decision and
Growth 219
Selecting a Maturity Structure 222
Inflation and Financing Strategy 223
Appendix
The Irrelevance Proposition 223
No Taxes 224
Taxes 226
Summary 227
Additional Resources 228
Problems 230
x Contents
PART FOUR
EVALUATING INVESTMENT
OPPORTUNITIES 235
Chapter 7
Discounted Cash Flow Techniques
Figures of Merit 238
The Payback Period and the Accounting
Rate of Return 239
The Time Value of Money 240
Equivalence 245
The Net Present Value 246
The Benefit-Cost Ratio 248
The Internal Rate of Return 248
Uneven Cash Flows 252
A Few Applications and Extensions 253
Mutually Exclusive Alternatives and
Capital Rationing 256
The IRR in Perspective 257
Determining the Relevant Cash Flows
Depreciation 260
Working Capital and Spontaneous
Sources 262
Sunk Costs 263
Allocated Costs 264
Cannibalization 265
Excess Capacity 266
Financing Costs 267
Appendix
Mutually Exclusive Alternatives and
Capital Rationing 269
What Happened to the Other $578,000? 270
Unequal Lives 271
Capital Rationing 274
The Problem of Future Opportunities 275
A Decision Tree 276
Summary 277
Additional Resources 278
Problems 278
Chapter 8
Risk Analysis in Investment Decisions 285
Risk Defined 287
Risk and Diversification 289
Estimating Investment Risk 291
Three Techniques for Estimating
Investment Risk 292
Including Risk in Investment
Evaluation 293
237 Risk-Adjusted Discount Rates 293
The Cost of Capital 294
The Cost of Capital Defined 295
The Cost of Capital for Polaris 296
The Cost of Capital in Investment
Appraisal 304
Multiple Hurdle Rates 304
Four Pitfalls in the Use of Discounted
Cash Flow Techniques 307
The Enterprise Perspective vs. the Equity
Perspective 307
Inflation 310
Real Options 311
Excessive Risk Adjustment 316
258 A Cautionary Note 318
Appendix
Asset Beta and Adjusted Present
Value 318
Calculating Asset Beta 319
Using Asset Beta to Estimate Equity
Beta 320
Asset Beta and Adjusted Present Value 321
Summary 325
Additional Resources 326
Problems 327
Chapter 9
Business Valuation and Corporate
Restructuring 335
Valuing a Business 337
Assets or Equity? 338
Dead or Alive? 338
Minority Interest or Control? 340
Discounted Cash Flow Valuation 341
Free Cash Flow 342
The Terminal Value 343
A Numerical Example 346
Problems with Present Value
Approaches to Valuation 348
 Contents xi

Valuation Based on Comparable Trades 349 The Venture Capital Method—Multiple Financing
Lack of Marketability 353 Rounds 372
The Market for Control 354 Why Do Venture Capitalists Demand Such High
The Premium for Control 354 Returns? 374
Financial Reasons for Restructuring 357 Summary 375
The Empirical Evidence 364 Additional Resources 376
The LinkedIn Buyout 366 Problems 378
Appendix
Glossary 385
The Venture Capital Method of
Valuation 368 Suggested Answers to
The Venture Capital Method—One Financing Odd-Numbered Problems 397
Round 369 Index 429
Preface

Like its predecessors, the thirteenth edition of Analysis for Financial Management
is for nonfinancial executives and business students interested in the practice of
financial management. It introduces standard techniques and recent advances
in a practical, intuitive way. The book assumes no prior background beyond a
rudimentary and perhaps rusty familiarity with financial statements—although
a healthy curiosity about what makes business tick is also useful. Emphasis
throughout is on the managerial implications of financial analysis.
Analysis for Financial Management should prove valuable to individuals
interested in sharpening their managerial skills and to executive program partic-
ipants. The book has also found a home in university classrooms as the sole text
in Executive MBA and applied finance courses, as a companion text in case-
oriented courses, and as supplementary reading in more theoretical courses.
Analysis for Financial Management is our attempt to translate into another
medium the enjoyment and stimulation we have received over many years
working with executives and college students. This experience has convinced
us that financial techniques and concepts need not be abstract or obtuse; that
significant advances in the field, such as agency theory, market signaling,
market efficiency, capital asset pricing, and real options analysis, are impor-
tant to practitioners; and that finance has much to say about the broader
aspects of company management. We are also convinced that any activity in
which so much money changes hands so quickly cannot fail to be interesting.
Part One looks at the management of existing resources, including the use of
financial statements and ratio analysis to assess a company’s financial health,
its strengths, weaknesses, recent performance, and future prospects. Emphasis
throughout is on the ties between a company’s operating activities and its finan-
cial performance. A recurring theme is that a business must be viewed as an
integrated whole and that effective financial management is possible only within
the context of a company’s broader operating characteristics and strategies.
The rest of the book deals with the acquisition and management of new
resources. Part Two examines financial forecasting and planning, with par-
ticular emphasis on managing growth and decline. Part Three considers the
financing of company operations, including a review of the principal security
types, the markets in which they trade, and the proper choice of security type
by the issuing company. The latter requires a close look at financial leverage
and its effects on the firm and its shareholders.
Part Four addresses the use of discounted cash flow techniques, such as
the net present value and the internal rate of return, to evaluate investment
opportunities. It also deals with the difficult task of incorporating risk into
xii
 Preface xiii

investment appraisal. The book concludes with an examination of business

valuation and company restructuring within the context of the ongoing debate
over the proper roles of shareholders, boards of directors, and incumbent
managers in governing America’s public corporations.
An extensive glossary of financial terms and suggested answers to odd-
numbered, end-of-chapter problems follow the last chapter.

Changes in the Thirteenth Edition

Noteworthy changes and refinements in the thirteenth edition include:
∙ Updated discussions of adjusted earnings and International Financial
Reporting Standards in Chapter 1.
∙ Application in Chapter 3 of Argo, a new, free Excel add-in for implementing
simulation analyses to financial forecasting.
∙ Inclusion of a discussion of Special Purpose Acquisition Companies
(SPACs) in Chapter 5, in the context of trends in raising capital.
∙ Expanded discussion of the underinvestment problem for corporate invest-
ments and its consequences for the capital structure decision in Chapter 6.
∙ Updated discussions of tax inversions, EPS dilution, and research on
merger performance in Chapter 9.
∙ Use of Polaris, Inc., a leading producer of snowmobiles, all-terrain vehi-
cles, motorcycles, and boats, as an extended example throughout the book.
A word of caution: Analysis for Financial Management emphasizes the appli-
cation and interpretation of analytic techniques in decision making. These tech-
niques have proved useful for putting financial problems into perspective and for
helping managers anticipate the consequences of their actions. However, tech-
niques can never substitute for thought. Even with the best technique, it is still
necessary to define and prioritize issues, to modify analysis to fit specific cir-
cumstances, to strike the proper balance between quantitative analysis and more
qualitative considerations, and to evaluate alternatives insightfully and creatively.
Mastery of technique is only the necessary first step toward effective management.
The ability to access current Compustat data continues to be a great help
in providing timely examples of current practice. We also owe a large thank
you to the following people for their insightful reviews of the twelfth edition
and their constructive advice. They did an excellent job. Any remaining short-
comings are ours, not theirs.
Buleny Aybar, Southern New Hampshire University
Janet L. Bartholow, Limestone University
Dennis Burke, Coker University
Deanne Butchey, Florida International University
xiv Preface

Steven Droll, Bethel University

Steven Wei Ho, Columbia University
Leon Hutton, University of Maryland Global Campus
David Ikenberry, University of Colorado Boulder
Jaemin Kim, San Diego State University
Jonathan Newman, Bryan College
Thanh Nguyen, University of South Carolina-Upstate
Patrice Nybro, American Intercontinental University
Christopher Palmer, MIT
Micki Pitcher, Davenport University
Wenbin Tang, Shenandoah University
Arthur Wilson, George Washington University
Jack Wolf, Clemson University
Nikhil Varaiya, San Diego State University
Stephanie Yates, University of Alabama at Birmingham
Lili Zhu, Shenandoah University

We appreciate the exceptional direction provided by Barb Hari, Chuck

Synovec, Michele Janicek, and Harvey Yep of McGraw-Hill on the develop-
ment, design, and editing of the book. We thank Paige Nelson for her thor-
ough review of the end-of-chapter problems for this edition. David Beim,
Dave Dubofsky, George Parker, Megan Partch, and Alan Shapiro have our
continuing gratitude for their insightful help and support throughout the
book’s evolution. Finally, we want to express our appreciation to students
and colleagues at the University of Washington, Brigham Young University,
Stanford University, IMD, The Darden School, The Pacific Coast Banking
School, The Koblenz Graduate School of Management, The Gordon Institute
of Business Science, Boeing, and Microsoft, among others, for stimulating
our continuing interest in the practice and teaching of financial management.
We envy you learning this material for the first time. It’s a stimulating
intellectual adventure.

Robert C. (Rocky) Higgins Todd Mitton

Marguerite Reimers Emeritus Professor of Finance Ned C. Hill Professor of Finance
Foster School of Business Marriott School of Business
University of Washington Brigham Young University
rhiggins@uw.edu todd.mitton@byu.edu
Jennifer L. Koski
Associate Dean for Academic and Faculty Affairs
Kirby L. Cramer Endowed Chair in Finance
Foster School of Business
University of Washington
jkoski@uw.edu
 Final PDF to printer

Preface xv

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 Preface xvii

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P A R T O N E

Assessing the Financial

Health of the Firm
C H A P T E R O N E

Interpreting Financial
Statements

Financial statements are like fine perfume; to be sniffed but not

swallowed.
Abraham Briloff

Accounting is the scorecard of business. It translates a company’s diverse

activities into a set of objective numbers that provide information about the
firm’s performance, problems, and prospects. Finance involves the interpre-
tation of these accounting numbers for assessing performance and planning
future actions.
The skills of financial analysis are important to a wide range of people,
including investors, creditors, and regulators. But nowhere are they more
important than within the company. Regardless of functional specialty or
company size, managers who possess these skills are able to diagnose their
firm’s ills, prescribe useful remedies, and anticipate the financial conse-
quences of their actions. Like a ballplayer who cannot keep score, an operat-
ing manager who does not fully understand accounting and finance works
under an unnecessary handicap.
This and the following chapter look at the use of accounting information
to assess financial health. We begin with an overview of the accounting prin-
ciples governing financial statements and a discussion of one of the most
abused and confusing notions in finance: cash flow. Two recurring themes
will be that defining and measuring profits is more challenging than one
might expect, and that profitability alone does not guarantee success, or even
survival. In Chapter 2, we look at measures of financial performance and
ratio analysis.

The Cash Flow Cycle

Finance can seem arcane and complex to the uninitiated. However, a com-
paratively few basic principles should guide your thinking. One is that a
company’s finances and operations are integrally connected. A company’s
4 Part One Assessing the Financial Health of the Firm

FIGURE 1.1 The Cash Flow–Production Cycle

es
y iti
quit iabil
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si si
n ge nge es rest iden
h a ha ax nte iv
C C T I D

Coll
Cash ecti
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en of
c
stm r
n

ed
tio
ve

Ca

it
In

uc

sal
sh
od

sa
Pr

es
le
s
Accounts
Fixed assets
receivable
De

les
pr

iat
ec

it

sa
ion
ed
Inventory Cr

activities, method of operation, and competitive strategy all fundamentally

shape the firm’s financial structure. The reverse is also true: Decisions that
appear to be primarily financial in nature can significantly affect company
operations. For example, the way a company finances its assets can affect the
nature of the investments it is able to undertake in future years.
The cash flow–production cycle shown in Figure 1.1 illustrates the close
interplay between company operations and finances. For simplicity, suppose
the company shown is a new one that has raised money from owners and
creditors, has purchased productive assets, and is now ready to begin opera-
tions. To do so, the company uses cash to purchase raw materials and hire
workers; with these inputs, it makes the product and stores it temporarily in
inventory. Thus, what began as cash is now physical inventory. When the
company sells an item, the physical inventory changes back into cash. If the
sale is for cash, this occurs immediately; otherwise, cash is not realized until
some later time when the account receivable is collected. This simple move-
ment of cash to inventory, to accounts receivable, and back to cash is the
firm’s operating, or working capital, cycle.
Another ongoing activity represented in Figure 1.1 is investment. Over a
period of time, the company’s fixed assets are consumed, or worn out, in the
 Chapter 1 Interpreting Financial Statements   5

creation of products. It is as though every item passing through the business

takes with it a small portion of the value of fixed assets. The accountant recog-
nizes this process by continually reducing the accounting value of fixed assets
and increasing the value of merchandise flowing into inventory by an amount
known as depreciation. To maintain productive capacity and to finance addi-
tional growth, the company must invest part of its newly received cash in new
fixed assets. The object of this whole exercise, of course, is to ensure that
the cash returning from the working capital cycle and the ­investment cycle
exceeds the amount that started the journey.
We could complicate Figure 1.1 further by including accounts payable and
expanding on the use of debt and equity to generate cash, but the figure already
demonstrates two basic principles. First, financial statements are an impor-
tant window on reality. A company’s operating policies, production tech-
niques, and inventory and credit-control systems fundamentally determine
the firm’s financial profile. If, for example, a company requires payment on
credit sales to be more prompt, its financial statements will reveal a reduced
investment in accounts receivable and possibly a change in its revenues and
profits. This linkage between a company’s operations and its finances is our
rationale for studying financial statements. We seek to understand company
operations and predict the financial consequences of changing them.
The second principle illustrated in Figure 1.1 is that profits do not equal
cash flow. Cash—and the timely conversion of cash into inventories, accounts
receivable, and back into cash—is the lifeblood of any company. If this cash
flow is severed or significantly interrupted, insolvency can occur. Yet the
fact that a company is profitable is no assurance that its cash flow will be
sufficient to maintain solvency. To illustrate, suppose a company loses con-
trol of its accounts receivable by allowing customers more and more time to
pay, or suppose the company consistently makes more merchandise than it
sells. Then, even though the company is selling merchandise at a profit in the
eyes of an accountant, its sales may not be generating sufficient cash soon
enough to replenish the cash outflows required for production and invest-
ment. When a company has insufficient cash to pay its maturing obligations,
it is insolvent. As another example, suppose the company is managing its
inventory and receivables carefully, but rapid sales growth is necessitating
an ever-larger investment in these assets. Then, even though the company is
profitable, it may have too little cash to meet its obligations. The company
will literally be “growing broke.” These brief examples illustrate why a man-
ager must be concerned at least as much with cash flows as with profits.
To explore these themes in more detail and to sharpen your skills in using
accounting information to assess performance, we need to review the basics
of financial statements. If this is your first look at financial accounting, buckle
up because we will be moving quickly. If the pace is too quick, take a look at
one of the accounting texts recommended at the end of the chapter.
6 Part One Assessing the Financial Health of the Firm

Overview of Financial Statements

The most important source of information for evaluating the financial health
of a company is its set of financial statements, consisting principally of a bal-
ance sheet, an income statement, and a cash flow statement. Although these
statements can appear complex at times, they all rest on a very simple founda-
tion. To understand this foundation and to see the ties among the three state-
ments, let us look briefly at each.
A balance sheet is a financial snapshot, taken at a point in time, of all the
assets the company owns and all the claims against those assets. The basic
relationship, and indeed the foundation for all of accounting, is
​Assets = Liabilities + Shareholders’ equity​
It is as if a herd (flock? column?) of accountants runs through the business on
the appointed day, making a list of everything the company owns, and assign-
ing each item a value. After tabulating the firm’s assets, the accountants list
all outstanding company liabilities, where a liability is simply an obligation to
deliver something of value in the future—or more colloquially, some form of
an “IOU.” Having thus totaled up what the company owns and what it owes,
the accountants call the difference between the two shareholders’ equity.
Shareholders’ equity is the accountant’s estimate of the value of the share-
holders’ investment in the firm, just as the value of a homeowners’ equity is
the value of the home (the asset), less the mortgage outstanding against it (the
liability). Shareholders’ equity is also known variously as ­owners’ equity,
stockholders’ equity, net worth, or simply equity.
It is important to realize that the basic accounting equation holds for indi-
vidual transactions, as well as for the firm as a whole. When a firm pays $1
million in wages, cash declines $1 million and shareholders’ equity falls by
the same amount. Similarly, when a company borrows $100,000, cash rises
$100,000, as does a liability named something like loans outstanding. And
when a company receives a $10,000 payment from a customer, cash rises
while another asset, accounts receivable, falls by the same figure. In each
instance, the double-entry nature of accounting guarantees that the basic
accounting equation holds for each transaction, and when summed across all
transactions, it holds for the company as a whole.
To see how the repeated application of this single formula underlies the cre-
ation of company financial statements, consider Worldwide Sports (WWS),
a newly founded retailer of value-priced sporting goods. In J­anuary 2021,
the founder invested $150,000 of his personal savings and added another
$100,000 borrowed from relatives to start the business. After buying furniture
and display fixtures for $60,000 and merchandise for $80,000, WWS was
ready to open its doors.
 Chapter 1 Interpreting Financial Statements   7

The following six transactions summarize WWS’s activities over the

course of its first year.
∙ Sold $900,000 of sports equipment, receiving $875,000 in cash, with
$25,000 still to be paid.
∙ Paid $190,000 in wages, including the owners’ salary.
∙ Purchased $380,000 of merchandise at wholesale, with $20,000 still owed to
suppliers, and $30,000 worth of product still in WWS’s inventory at year-end.
∙ Spent $210,000 on other expenses, such as utilities and rent.
∙ Depreciated furniture and fixtures by $15,000.
∙ Paid $10,000 interest on WWS’s loan from relatives and another $40,000
in income taxes to the government.
Table 1.1 shows how an accountant would record these transactions.
WWS’s beginning balance, the first line in the table, shows cash of $250,000,
a loan of $100,000, and equity of $150,000. But these numbers change
quickly as the company buys fixtures and an initial inventory of merchandise.
And they change further as each of the listed transactions occurs.
Abstracting from the accounting details, there are two important things to
note here. First, the basic accounting equation holds for each transaction. For
every line in the table, assets equal liabilities plus owners’ equity. Second,
WWS’s year-end balance sheet across the bottom of the table is just its begin-
ning balance sheet plus the cumulative effect of the individual transactions.
For example, ending cash on December 31, 2021 is the beginning cash of

TABLE 1.1 Worldwide Sports Financial Transactions 2021 ($ thousands)

Assets = Liabilities + Equity
Accounts Fixed Accounts Loan from Owners’
Cash Receivable Inventory Assets = Payable Relatives Equity
Beginning Balance 1/1/21 $ 250 = $100 $ 150
Initial purchases (140) 80 60 =
Sales 875 25 = 900
Wages (190) = (190)
Merchandise purchases (360) 30 = 20 (350)
Other expenses (210) = (210)
Depreciation (15) = (15)
Interest payment (10) = (10)
Income tax payment (40) = (40)
Ending Balance 12/31/21 $ 175 $25 $110 $ 45 = $20 $100 $ 235
8 Part One Assessing the Financial Health of the Firm

$250,000 plus or minus the cash involved in each transaction. Incidentally,

WWS’s first year appears to have been a decent one: Owners’ equity is up
$85,000 over the year, on top of whatever the owner paid himself in salary.
To further convince you that the bottom row of Table 1.1 really is a bal-
ance sheet, the following table presents the same information in a more con-
ventional format.
Worldwide Sports Balance Sheet, December 31, 2021 ($ thousands)
Cash $175 Accounts payable $ 20
Accounts receivable 25 Total current liabilities 20
Inventory 110 Loan from relatives 100
Total current assets 310 Equity 235
Fixed assets 45 Total liabilities and
Total assets $355 Owners’ equity $355

If a balance sheet is a snapshot in time, the income statement and the cash
flow statement are videos, highlighting changes in two especially important
balance sheet accounts over time. Business owners are naturally interested
in how company operations have affected the value of their investment. The
income statement addresses this question by partitioning the recorded changes
in owners’ equity into revenues and expenses, where revenues increase
­owners’ equity and expenses reduce it. The difference between revenues and
expenses is earnings, or net income.
Looking at the right-most column in Table 1.1, WWS’s 2021 income state-
ment looks like this. Note that the $85,000 net income appearing at the bot-
tom of the statement equals the change in owners’ equity over the year.
Worldwide Sports Income Statement, 2021 ($ thousands)
Sales $900
Wages 190
Merchandise purchases 350
Depreciation 15
Gross profit $345
Other expenses 210
Interest expense 10
Income before tax $125
Income taxes 40
Net income $ 85

The focus of the cash flow statement is solvency, having enough cash in the
bank to pay bills as they come due. The cash flow statement provides a detailed
look at changes in the company’s cash balance over time. As an organizing
principle, the statement segregates changes in cash into three broad categories:
cash provided (or consumed) by operating activities, by investing activities,
and by financing activities. Figure 1.2 is a simple schematic diagram showing
the close conceptual ties among the three principal financial statements.
 Chapter 1 Interpreting Financial Statements   9

FIGURE 1.2 Ties among Financial Statements

Assets at beginning = Liabilities at beginning + Equity at beginning
Cash Shareholders' Equity

Cash flow Income

statement statement

Financing
Operating

Revenues

Expenses
Investing
Balance
sheets

Assets at end = Liabilities at end + Equity at end

The Balance Sheet

See polaris.com. Follow
Company > Investors >
Financials & Filings for
financial statements.
We will now take a more in-depth look at each of the key financial statements
in turn, beginning with the balance sheet. To illustrate the techniques and
concepts presented throughout the book, I will refer whenever possible to
Polaris Inc., the self-styled “Global leader in Powersports” including snow-
mobiles, all-terrain vehicles (ATVs), motorcycles, and boats. In addition to
the United States, Polaris has manufacturing operations in China, France,
Mexico, and Poland. It has offices in 14 countries and sells its products in
over 100 countries, although 80 percent of sales originate in the United States.
The ­company’s focus, as embodied in its marketing tagline “Think Outside”
is to create products that enhance the experience of outdoor enthusiasts.
Headquartered in Medina, Minnesota, a small town outside of Minne-
apolis, Polaris has $7 billion in annual sales, and its stock trades on the
New York Stock Exchange. The firm was founded in 1954 as one of the
pioneers of the snowmobile industry. In the 1980s, Polaris diversified into
off-road vehicles when they produced the first American-made ATVs. In
2011, Polaris extended its reach into on-road vehicles with its acquisition
of the legendary Indian Motorcycle company. Between 2018 and 2019, two
more acquisitions added three well-known boat brands to Polaris’s prod-
uct portfolio. Polaris’s recent ventures include forays into electric ATVs,
electric motorcycles, and special-purpose electric automobiles. In 2020,
64 ­percent of Polaris’s sales came from snowmobiles and off-road vehi-
cles, with 9 ­percent coming from boats, 8 percent from motorcycles, and
19 ­percent from other products and services.
Table 1.2 presents Polaris’s balance sheets for 2019 and 2020. If the precise
meaning of every asset and liability category in Table 1.2 is not immediately
apparent, be patient. We will discuss many of them in the following text. In addi-
tion, all of the accounting terms used appear in the glossary at the end of the book.
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Her lips moved. A moment later she opened her big grey eyes and
asked me in a whisper:
“Where am I?”
“You are safe,” I assured her, holding her in my arms. “Don’t worry.
We’ll be out of this very soon.”
“But where are we?” she asked gazing around upon the snowy
surroundings. “Where is John? Tell me!”
I told her briefly what had happened.
“But where is John?” she queried. “I hope he is all right. It was very
foolish for us to venture up here after the warm Foehn of yesterday,
—wasn’t it?”
“I expect John is all right,” I said. “He warned us, and no doubt took
precautions.” Guides in the Alps seldom fail.
With difficulty we wriggled out of the snow and stood up. Even in our
shaken condition we could not but admire the panorama of the Eiger,
the Jungfrau and the Wetterhorn, across the darkening valley before
us. But haste was imperative: the light was fading quickly and we
were a long way from Mürren.
I had lost one of my skis, which had been torn from its strong
Huitfeldt binding in our fall. Mrs. Audley’s, however, were intact, and
we started to descend. She soon recovered in the keen Alpine air,
and was able to help me, lame dog that I was. Repeatedly we gave
the six shouts recognized as the regular Alpine distress call, but
there was no reply.
It was quite dark when we struggled back, to find that our guide,
having happily escaped, had arrived before us and sent out a
search-party. By shouts and flashing signals, this was soon recalled.
At the hotel they put Thelma to bed at once, while after the Swiss
doctor had seen to my head, I sat in the bar recounting my
experience and drinking a strong whiskey and soda.
Dr. Feng and Humphreys were both most eager to know the details
of our adventure. But later the doctor said—
“I think you are very foolish, Yelverton! You ought never to have had
anything to do with the bride, she will only bring trouble upon you.
Humphreys agrees with me. You’re a young fool!”
“Probably I am,” I replied laughing! “I very nearly lost my life over it
today.”
“You are a regular Don Quixote,” he said. “Well, I admire you after
all. You would be a fine young fellow, if you were just a little more
cautious.”
“Cautious!” I laughed, facing the old doctor, “I’m young. You are old.
You weren’t cautious when you were my age, were you?”
“No,” he answered. “I suppose not—I suppose not.”
The night-mail train from Boulogne arrives at the little station at
Lauterbrunnen each evening about five o’clock. The next afternoon
therefore Mrs. Audley, who had quite recovered from her accident on
the previous day, accompanied me down into the valley by the cable
railway. She was all excitement, for her husband, before his
departure, had promised to return by that train, and had, indeed,
booked his sleeping-berth by it.
At last the train came slowly in from Interlaken, where the change is
made from the wagon-lit. A number of hurrying English visitors
descended but Stanley Audley was not among them.
Bitter disappointment was written upon the girl’s face.
“He must have missed the train at Victoria,” she declared.
“Well,” I said, “There is not another through train until tomorrow—
unless he travels by Paris and Bâle.”
The station master, however, informed us that the service from Paris
would not arrive till early next morning, so that we were compelled to
reascend to Mürren.
Audley’s failure to telegraph or write to his wife, struck me as
uncommonly strange.
While we were in the narrow little compartment of the cable railway, I
ventured to put several questions to her concerning him. But she
would give only evasive replies.
Next day she went to the little wood-built post office alone and
despatched several telegrams to various addresses, but the replies
she received gave no news of her husband. Evening came again,
but Stanley Audley was not among the arrivals from London, though
I was with Thelma on the arrival of the mountain train at Mürren
station.
“I cannot make it out,” she said as we sped back to the hotel on our
skis. “Surely he must be delayed. Perhaps he has telegraphed to me
and the message has gone astray!”
“That may be,” I agreed in order to reassure her, but personally I felt
much mystified.
Next day I telegraphed to the managing director of Gordon & Austin,
the electrical engineers in George Street, Westminster, asking for
news of Stanley Audley, and in response about five o’clock in the
evening came a reply which read: “Stanley Audley is not employed
by us and is unknown to us.”
I said nothing to Thelma, but finding Dr. Feng alone, showed him the
telegram.
The old doctor grunted with dissatisfaction.
“Something wrong somewhere,” he remarked. “One should always
be very careful of hotel acquaintances. I warned you at the time that
you were indiscreet to offer to look after the bride of a man you don’t
know.”
“I admit that! But the whole affair is very mysterious. He told me a
deliberate lie when he said he was employed by Gordon & Austin.”
“Yes. He’s a mystery, and evidently not what he pretended to be.
What does his wife think?”
“I haven’t shown her the telegram.”
“Don’t. Try and discover what you can from her.”
“You don’t seem to like her, Doctor,” I said bluntly.
“No. I don’t like either of them,” the old man admitted. “There’s too
much mystery about the pair. I was discussing them with Humphreys
this morning, and he agrees.”
“It is not Thelma’s fault,” I said.
“It may be. She evidently knows more about her husband than what
she has told you.”
“Well, she’s told me nothing,” I replied.
“There you are! She is concealing the truth. Go and find out all you
can. And don’t be indiscreet. Your present position is dangerous.
Perhaps he’s left her deliberately and palmed her off upon you,
hoping that you will both fall in love, and he can free himself of her at
your expense. Such things are not unknown, remember!”
“I don’t believe it,” I declared. “I undertook a trust—foolishly if you
like—and it is up to me to carry it out to the best of my ability.”
“Ah! my dear boy, your eyes are closed very often,” the old doctor
said. “The lookers-on see most of the game, and I’ve seen one or
two little things which show that your temporary bride is not adverse
to a little secret flirtation.”
“How?” I asked quickly.
“Well, she’s on quite friendly terms with that young fellow, Harold
Ruthen.”
“Ruthen!” I echoed. “I didn’t know they were acquainted. I’ve never
seen them speak.”
“No, not when you are about,” replied the old man laughing. “But I’ve
often seen them chatting together.”
This surprised me. Harold Ruthen was a rather foppish, fair-haired
man about my own age, whose airs were of the superior type. His
interest in Thelma had not escaped me, but I had never seen them
speaking together. He was, I understood, an ex-officer, and he was a
very good skater. But at first sight I had taken an instinctive dislike to
him and, that he should have made Thelma’s acquaintance in secret,
greatly annoyed me.
I felt myself responsible to Stanley Audley, even if he had deceived
me.
Now I found myself in a difficulty. Only at that moment I recollected
how, on the morning before Thelma’s husband had announced his
forced return to London, I had seen Ruthen walking with the doctor
up a narrow path with high snow-banks close to the hotel. They were
deep in conversation, and old Feng seemed to be impressing some
point upon Ruthen while he listened very attentively.
Did Dr. Feng know more than he admitted?
I must say that I did not like his hostile attitude towards the newly
wedded pair, an attitude which now seemed to be shared by old Mr.
Humphreys.
That night, when Thelma came to table, she was wearing a charming
gown of almond green, that we had not seen before. Though she
looked beautiful, her face was more serious than usual, and I
suspected that I saw traces of tears.
As we sat together I fell to wondering who was Stanley Audley? Why
had he deceived his young wife, and then deserted her, leaving her
in my charge?
Had I fallen into a clever trap?
 CHAPTER IV
WHISPERS OF WOMEN

Two days passed, yet Stanley Audley did not return.

On the afternoon of the second day, old Mr. Humphreys spoke to me
in confidence while we sat at tea, which is almost a religious
ceremony in Mürren.
“Funny about that young fellow Audley,” he said. “Have you
discovered anything further?”
“No,” I replied, “the fact is I don’t like to be too inquisitive.”
“Of course, but the girl is left in your charge, and you certainly have a
right to know the truth,” declared the old invalid. “Personally, I don’t
like the situation at all. I shall go back to London in a few days, but
do let me know how you get on, for I am interested. You can always
write to me, care of the Ottoman Bank in London.”
I promised, and finding Thelma, who had just come in from the rink,
where there had been an ice-hockey match, I greeted her in the hall
as she went downstairs to tea.
Later we went for a stroll together and as we passed out into the
grey twilight, young Ruthen held open the door for us, bowing, but
not speaking. Before me the pair posed as strangers.
“I don’t like that fellow!” I remarked, as we walked along the snowy
road out of the village.
“Neither do I,” was her quick response.
“But, if I’m not mistaken, Mrs. Audley, you are acquainted with him,” I
remarked.
“Well—yes—and no,” she said. “It is true that he thrusts himself upon
me whenever he has the chance, and your back is turned. I’ve
snubbed him a dozen times, but he is always lurking about.”
“Then you are not friendly with him?”
“On the contrary. I confess I don’t like him,” she answered quite
frankly. Whereupon I resolved to try and catch him speaking with her
and tell him what I thought of him.
“He’s a cad!” I declared. “He pretends to be a gentleman, but he
does not behave like one.”
“You speak as though you are annoyed, Mr. Yelverton,” and she
laughed lightly.
“I am. You are left in my care, Mrs. Audley. Your husband would be
very angry if he knew that the fellow pestered you with his unwanted
attentions, would he not?”
“I suppose he would,” she faltered.
“I wonder why we hear nothing from Stanley?” I said. “It is all very
mysterious. Do you know that he is not employed by that electrical
firm in Westminster? They know nothing of him!”
She halted, held her breath and stared at me.
“What!” she cried. “But surely he is at Gordon & Austin’s? I left him at
their offices one day just before our marriage and he went in there.”
“They know nothing of him,” I assured her, telling her of their reply to
my inquiry.
“I really can’t believe it,” she said in a voice of despair. “Stanley could
not have lied to me like that.”
“Have you ever met his parents?”
“No. They are in India—at Lucknow.”
“But what do you know about him? Where did he live before you
married him?”
“He had rooms in Half Moon Street. I went there once or twice,” and
she told me the number.
“How long had you known him before you married?” I inquired.
“About six months, but he was mostly away in Paris, on business for
his firm.”
“That is the story he told you, but it is now proved to be incorrect.
The firm have no knowledge of him.”
“There must be some mistake,” she said, much puzzled.
“Did you introduce him to your mother?”
“Yes, he came home to Bexhill once and stayed the week-end at the
Sackville. Mother liked him awfully, but at the same time she thought
I was too young to marry.”
“Then during the time of your engagement he was mostly away—
eh? Did you ever meet any of his relatives?”
“No,” she replied—rather hesitatingly. I thought then she endeavored
to change the topic of our conversation.
I, however, pursued it. A suspicion forced itself on my mind that she
really knew a good deal more than she would tell me. But though I
persisted for some time she would tell me nothing more and naturally
I began to be annoyed. I did not wish to think hardly of her, but it was
impossible to stifle entirely the suspicions that insisted on forcing
themselves upon my mind. Had I been caught in some carefully
prepared trap or had I merely made a colossal fool of myself?
Ten minutes later, my companion, bursting into tears she could no
longer control, blurted out—
“I’ve been foolish, Mr. Yelverton—so very foolish! The fact is I—I’ve
married a man—a man—I did not know!”
“Did not know,” I gasped in turn. “Is that really the truth?”
“It is,” she said sobbing. “I—I believed all that he told me, but now I
have found out that what he said was false. And—and already he
has deserted me!”
“But you love him,” I said, full of sympathy for her in her obviously
genuine distress. “Perhaps, after all, we are misjudging him.
Something has occurred which prevents his return. I will wire at once
to Half Moon Street and see whether we can get any news.”
“Yes, do,” she urged. “Mr. Belton is the man who keeps the
chambers. I recollect the name.”
So we turned back to the chalet post office whence I sent a reply-
paid telegram. Next evening came the answer. “Mr. Audley left for
abroad about two months ago—Belton.”
That was all. We had at least one person who knew him and who
might place us in possession of more facts than we had at present.
After dinner that night Dr. Feng asked me to go with him to his room.
“I have had some telegrams from China,” he said, when he had
established me comfortably in an easy chair with a whiskey and
soda at my hand.
“Any news about Thelma?” I asked.
“Yes,” he replied: “it’s a very curious story. Of course, I have no
details and I am afraid we shall never get any. But there is enough
information to show, as I expected, that the crystal claw was sent to
Mrs. Audley in recognition of services rendered by her father to a
powerful member of the Thu-tseng. Have you ever heard of Sung-
tchun?”
I nodded. “Wasn’t he the chap who escaped from Siberia under
rather extraordinary circumstances in the early years of the war—
about 1916 or 1917? There was a lot about him in the papers, I
remember, but I never saw any reason given for his imprisonment.”
“No public explanation ever was given,” said Dr. Feng, “but, as a
matter of fact, he was arrested on Russian territory north of China on
a trumped-up charge. As a matter of fact his party stood in the way
of certain Russian ambitions in China and he was quietly removed.
Incidentally I can tell you that after his escape the Russian
government paid very handsome compensation and apologized. But
all that was kept private.
“Now the interest to us is this: Sung-tchun’s escape was planned
and directed, from start to finish, by Mrs. Audley’s father. Of course,
he was not actively engaged in the actual rescue: he could not leave
his ship. But he organized and financed the whole thing. Sung-tchun
was a really important figure in China—far more important than the
outside world realized—and to have done them such a service would
have been ample to earn the undying gratitude of the Thu-tseng,
who never forget a friend or a foe. That is all the information my
friends can get, and I fancy it is all we shall ever get. What Captain
Shaylor’s motive was and how he was dragged into or embarked
upon the affair and where he obtained the huge sums of money the
rescue must have cost, we shall never know.”
“But why,” I cried, “has the crystal claw only just arrived? Thelma’s
father died over a year ago.”
“That is one of the questions I asked,” replied Dr. Feng. “Sung-tchun
died only last year and I imagine he must have kept very closely the
secret of his escape. In all probability the sending of the claw was a
kind of death-bed gift from him to the man who had helped him—or
rather to his daughter. That would be quite in accordance with Sung-
tchun’s known character.”
“Then the crystal claw does not imply a threat or any danger?” I
exclaimed.
“Certainly not,” declared Dr. Feng. “It is an expression of the very
utmost good will. Any member of the Thu-tseng would be bound by
the most solemn obligation to help in every way in his power the
owner of the crystal claw.”
“Well,” I said as I rose to say good-night, “at any rate, I am glad there
is no danger about it. But I don’t see how the Thu-tseng can ever
help Thelma.”
Old Feng gave me a queer look. “You can never tell,” he said slowly.
“Most people want help badly at some time in their lives. Mrs.
Audley, for instance, is in a position of considerable difficulty at the
moment and may be in a worse one very soon. And remember this,
my boy—the Thu-tseng has an arm longer than you dream of.”
As the days slipped by I became more and more concerned about
Thelma. Feng’s antagonism to herself and her husband became
daily more apparent, and I was glad when, the day after old
Humphreys had departed, he left for London. However, we parted
good friends. He was going to London first and then to the Riviera
and he gave me his solicitor’s address so that I might write to him.
Before he left I mentioned to him the effect the sight of the crystal
claw had had on old Humphreys. “Does he know all about the crystal
claw?” I asked, half banteringly.
Feng was not even mildly interested. “He spent some years in China,
I know,” he remarked indifferently, “but I fancy you must have been
mistaken. All his interests were in trade and finance—not in politics.
Probably what you took for an expression of rage and fear was the
result of the terrible spasms of pain that seize him occasionally.”
The explanation seemed so reasonable that I accepted it without
hesitation. After all, it was extremely unlikely that old Humphreys
could have been mixed up with the Thu-tseng and Feng, I thought,
could hardly have been so unmoved had he really thought there was
anything in my suspicions.
But I was to learn months later that the astute Chinese had
completely hoodwinked me. I had made no mistake at all. The
information I had given him was to prove of supreme importance in
the game Dr. Feng was playing, so we learned when the final move
had been played. The man must have had nerves of iron. He was off
his guard when the crystal claw arrived, it is true, but the news—of
tremendous import, as events showed—that Humphrey’s had good
reason to fear the Thu-tseng did not cause even the quiver of an
eyelash. There are few things in nature so utterly impassive as the
face of the cultured Chinese!
Thelma passed day after day in tense anxiety for news of Stanley. To
fill time we made frequent skiing excursions to the Schelthorn or the
Seeling furen but every evening at half-past five we were at the little
shed-like station, breathlessly awaiting the train bringing up travelers
from England.
And each evening we hurried away disappointed.
In the hotel, on the ski-fields, and on the bob-run the fun was fast
and furious, but the laughter and the dance music jarred upon the
nerves of both of us. And, to make matters worse, many visitors
were beginning to look askance at Thelma, now that young Audley
did not return.
Questions were asked of Thelma on all sides, and to them she was
compelled to give evasive, and sometimes, untrue, answers.
Ten days after young Audley should have returned, I had, late at
night, left the ball-room at the Kürhaus opposite the hotel after a
couple of hours of strenuous drumming in the jazz orchestra.
Thelma had retired early, and, though in no mood for gaiety, I had
been compelled to help my brother amateur bandsmen. So at two
o’clock we had closed down and the dancers were all crossing the
snowy road back to the hotel.
The moon was shining brilliantly over the towering glaciers,
transforming the silent snow-clad mountains and forests into a
veritable fairyland. Such a clear, frosty night was inviting for a stroll
and many couples wrapped in coats had put on their “gouties”—or
snow-shoes—and were going for walks before turning in.
I turned into the hotel gardens where the trees were heavily laden
with freshly fallen snow, and entered a path where the snow was
piled six feet on either side. My footsteps fell noiselessly on the fresh
snow and suddenly I heard voices in the path that ran parallel with
mine—the voices of a man and a woman.
Instantly I recognized the woman’s voice as Thelma’s and I stood in
surprise that she should be out of doors at such an hour.
“Now, for the last time I ask you, Thelma, where Stanley is,” I heard
a man’s voice say. “You had a telegram from him today. Where is
he? I want to see him very urgently.”
The voice, beyond any possibility of mistake was Ruthen’s. Thelma
had assured me she disliked him, that he pestered her with
unwelcome attentions. Yet here she was talking to him at two o’clock
in the morning, three hours after she had said good-night and,
apparently, gone to bed!
“I tell you it is no business of yours,” came her reply in a hard,
resolute voice. “He is my husband and if he tells me to keep silence I
shall do so.”
“Then you refuse to let me see the wire?” he asked. “I arranged ten
days ago that I should know if you received a telegram. It was
delivered to your room at five o’clock tonight—and you know where
Stanley is, though to everybody, including that fool Yelverton, you
pretend ignorance and shed crocodile’s tears!”
“Oh! let me get back,” cried the girl. “I won’t be insulted! Mr.
Yelverton does not know the truth, but he is at least kind and
considerate towards me.”
“And takes Stanley’s place in your heart—eh?” the fellow sneered.
“Now, I ask you once again if you will tell me where I can find
Stanley. Every hour is of the greatest importance to both of us. If you
tell me, then your husband may be saved, after all!”
“Mr. Ruthen, if I could trust you, I would reply. But I don’t!” was her
plain answer.
I held my breath as I listened to that strange conversation.
“But surely you know me well enough, Thelma, to know that I am
acting only in your interest! Yelverton is a very good fellow, but
happily he is in ignorance, and his devotion to his duty as your
guardian makes it all the easier for us. Now, don’t be a little fool.
Where can I get into communication with Stanley?” he asked.
“I refuse to tell you!” replied the girl. “I know a little more than you
think, and I would rather trust Stanley than you—even though I have
to make pretence of ignorance to Mr. Yelverton.”
“To fool him, you mean!” laughed the man superciliously.
“Well, and if I have to fool him, it is for my benefit, not yours,” she
said defiantly.
“And suppose I told him all that I know?” said Ruthen. “I know that he
is your admirer—that Stanley ought never to have left you in his
charge, and—well it is patent to everybody that you are fonder of
Rex Yelverton than of your newly-married husband.”
“How dare you say such a thing!” she cried in fierce anger.
“Because it is true, my dear young lady,” was the cool reply. “I did not
come out here for nothing. Stanley has disappeared, and this
afternoon you had a telegram from him telling you, in secret, of his
hiding-place. I want to know it!”
“And I refuse to tell you. He has cut himself adrift from you forever.”
The man laughed jeeringly.
“That would be more difficult than you imagine,” he said. “You are
treading upon very dangerous ground now, Thelma. Tell me what I
want to know, and I will help both Stanley and yourself. You must
know he is in serious danger.”
“I refuse!” she said. “I will not betray Stanley.”
“Betray him! It is not a case of betrayal. He is already betrayed. It is
a matter of saving him.”
“From what?”
“You know. Don’t pretend ignorance, my dear Thelma! Surely we
know each other well enough to be friends when Stan’s safety is
concerned! He doesn’t know I’m here in Mürren, or he would have
wired me his whereabouts, so that I could go straight to him.”
I listened amazed to this extraordinary conversation. I had never
dreamed that the tall fair-haired young man who posed as a stranger
to my temporary bride, was, after all, an intimate friend of her
husband’s.
“Remember,” he went on. “Yelverton is highly inquisitive—and very
naturally. He has been bamboozled from the very first. I wonder he
hasn’t smelt a rat long ago. But, of course, he is your admirer. But
we can’t waste time—we’ve been out here too long now. Tell me
where I can find Stanley.”
“I refuse,” was her firmly repeated reply.
“In that case I shall act as I have already warned you.”
“I do not intend that you should meet him again. I know sufficient
concerning your friendship—too much indeed,” she said
determinedly. “I am not blind to the fact that you are my enemy and
Stanley’s. He has hidden himself from his enemies, of whom you are
one, and it is not likely I shall tell you,” she added.
“Very well, then—take the consequences. I shall tell what I know,”
the man said.
“In which case I shall also tell what I know—which, I venture to think
you will find a trifle awkward for yourself. So think it over,” she said
defiantly in a low clear voice. “Good-night.”
Her footsteps were muffled in the soft snow as she made her way
back to the hotel, alone. Ruthen followed a few minutes later: no one
would have guessed that they had been out together.
I went to my room more puzzled than ever.
 CHAPTER V
ESTABLISHES SOME CURIOUS FACTS

When I met Thelma next morning I noticed that she was pale and
obviously nervous and ill at ease. I longed to question her, but to do
so would have been to reveal the fact that—unintentionally, it was
true—I had been eavesdropping.
It was now plain that the man Ruthen, whom I had thought to be a
mere hotel acquaintance of Stanley Audley’s, was, in truth,
something more, whether friend or enemy I was still not quite sure.
Thelma’s attitude, it was true, suggested the latter, though Ruthen
had professed friendly motives. His attitude towards her thoroughly
incensed me. But I realized that there must be some reason,
unknown to me, why Thelma never acknowledged him when I was
present. It was evident too that she hated and possibly feared him
and that she, at any rate, regarded him as her husband’s enemy.
She made no mention of the telegram from her husband that Ruthen
had referred to and, as she had not denied having received it, I
assumed that Ruthen’s information was correct. It might have been,
of course, a reassuring message, but if this was so there was no
apparent reason why she should not have told me about it and her
obvious anxiety and nervousness seemed entirely to contradict the
suggestion that it could have contained any good news.
That morning we took our skis up the cable railway to the
Allmendhubel, a thousand feet further up the mountain side, and
thoroughly enjoyed our sport on the steep snowy incline above the
village. A ski-jumping competition had been arranged for the
afternoon and we spent an hour watching the competitors “herring-
boning” and “side-stepping” as they climbed over the snow up the
distant heights in readiness for the swift descent ending with the high
jump that only experts can accomplish.
Thelma seemed silent and distraite all the morning. At length I asked
her what was troubling her.
“I really didn’t know I was glum!” she replied. “Forgive me, Mr.
Yelverton, won’t you? I am awfully worried about Stanley. I really
think it is useless for me to remain here in Mürren any longer. I had
better go home to Bexhill.”
The suggestion seemed to confirm my suspicion that she knew her
husband’s whereabouts, and felt it useless to await any longer for
him.
“My time is growing short, too,” I said. “I fear I must be back at my
office on Monday. My partner writes that he is very busy.”
“Then you will go on Saturday—the day after tomorrow, I suppose? If
so—may I travel with you?”
“Certainly,” I said. And as she had not booked a sleeping-berth on
the Interlaken-Boulogne express, I promised that I would see after it
during the afternoon.
Later that day I found that Audley had left her with only about a
hundred francs, and she was compelled to allow me to settle her
hotel bill.
As we came up into the hall after dinner the concierge handed
Thelma a note, saying—“Mr. Ruthen has left, miss, and he asked me
to give you this!”
She held it in her hand for a second, and then, after glancing at me,
moved away and tore it open.
The words she read had an extraordinary effect upon her. Her face
went as white as the paper, and she held her breath, her eyes
staring straight before her. Then she crushed the flimsy paper in her
hand.
She reeled against a small table, and would have fallen had she not,
with a supreme effort, recovered herself, and quickly stood erect
again.
“Forgive me, Mr. Yelverton,” she managed to ejaculate. “I’m not
feeling very well. Excuse me, I—I’ll go to my room!”
And she turned and ascended the stairs, leaving me astonished and
mystified.
What, I wondered, did that farewell note contain.
I saw her no more till next day. She sent me a message by the
chambermaid to say that she was not coming down again and I
passed the evening gossiping with Major Burton and two other
“bobbing” enthusiasts.
By this time I had pretty thoroughly wearied of the eternal round of
pleasure. Thelma’s obvious distress and the extraordinary mystery
into which I had stumbled occupied all my thoughts and I could no
longer take the slightest pleasure in the gay life which seethed and
bubbled around me. It was therefore with a feeling of genuine relief
that I found myself at last in the restaurant car of the Boulogne
express, slowly leaving Interlaken for the long night run across
France by way of Delle and Rheims. Already we had left behind us
the crisp clear air of the mountains. The snow everywhere was half
melted and slushy and the train pushed its way onward through a
dense curtain of driving sleet.
We ate our dinner amid a gay crowd of holiday makers returning, not
only from Mürren but from Grindelwald, Wengen, Adelboden,
Kandersteg, and other winter sports centres. The talk was gay and
animated, merry laughter resounded through the long car. Yet
Thelma sat pale, silent and nervous and her tired eyes told their own
tale of sleeplessness and anxiety. She gave me the impression that
she had been crushed by some sudden and unexpected shock and
though more than once I fancied she was on the edge of confiding in
me, she remained almost dumb and was clearly disinclined to talk.
We arrived at Victoria on Sunday afternoon and I drove with her in a
taxi to Charing Cross. On the way she suddenly seized my hand and
looking straight into my eyes said—
“I really do not know how to thank you, Mr. Yelverton, for all your
great kindness towards me. I know I have been a source of great
worry to you—but—but—” she burst into tears without concluding the
sentence.
I drew her towards me and strove to comfort her, declaring that I
would continue to act as her friend and leave no stone unturned in
my efforts to trace Stanley.
At last, as we went down the Mall, she dried her eyes and became
more tranquil. We were approaching the terminus whence she was
to travel to Bexhill.
“Now—tell me truthfully,” I said to her at last, “do you, or do you not,
know where Stanley is?”
She started, her lips parted, and she held her breath.
“I—I deceived you once, Mr. Yelverton. I—I did once know where he
was. But I do not now.”
“Then you wish me to discover him?” I asked.
“Yes. But—but, I fear you will never succeed. He can never return to
me—never!”
“Never return to you? Why? Was he already married?” I gasped.
“No. Not that. Not that! I love Stanley, but he can never come back to
me.”
The taxi had stopped, and a porter had already opened the door. I
asked her to explain, but she only shook her head in silence.
Ten minutes later, I grasped her hand in farewell, and she waved to
me as the train moved off to the pleasant little south-coast resort
where her mother was living. Thelma Audley’s was surely a sad
home-going.
Back in my rooms high-up in gray and smoky Russell Square, I
found old Mrs. Chapman, with her pleasant face and white hair, had
prepared everything for my comfort. The night was cold and rainy,
and the London atmosphere altogether depressing and unpleasant
after that bright crisp climate of the high Alps.
I looked through a number of letters which had not been sent on and,
after a wash, ate my dinner, Mrs. Chapman standing near and
gossiping with me the while. My room was warm and cozy, and with
the familiar old silhouettes and caricatures upon its walls, the side-
board with some of the Georgian plate belonging to my grandfather,
and a blazing fire, had that air of homelike comfort, which is always
refreshing after hotel life.
After I had had my coffee, and my trusted old servant had
disappeared, I threw myself into my big arm chair to think over the
amazing tangle in which I had allowed myself to become involved.
Was I falling in love with Thelma—falling in love foolishly and
hopelessly with a girl who was already married? I tried hard to
persuade myself that my feeling towards her was nothing but a deep
and honest affection, born of her sweet disposition and the queer
circumstances that had thrown us together. Stanley Audley,
whatever the explanation of his amazing conduct might be, had
trusted me and I fought hard in my own mind against a temptation
which I realized would, in normal circumstances, be a gross betrayal
of confidence. I had been brought up in a public school where “to
play the game” was the one rule of conduct that mattered and
hitherto I had prided myself on my punctiliousness in all the ordinary
matters of life. Was I to fail utterly in the first great temptation that life
had brought me?
I could not disguise from myself, try how I would, that even an
honest admiration for Thelma had its perils. As Dr. Feng had said, it
was dangerous. We were both young. I had hitherto escaped heart-
whole, Thelma was not only more than ordinarily beautiful but she
possessed a degree of charm and fascination—for me, at any rate—
that was well-nigh irresistible.
For a long time I paced my room in indecision. To act as Dr. Feng
had suggested would be to break off our acquaintanceship, treating
it merely as the passing incident of a pleasant holiday. But that, I
argued, was impossible. I had promised Audley to look after his wife
when everything seemed plain and straightforward: to desert her
now when she was clearly in difficulty and distress was unthinkable.