11

Finance and SCM

John H. Vande Vate

Fall, 2009

22

Today’s Challenges• Low Cost Competitors

– Reducing Margins– Harder to grow sales

• Shorter Product Life Cycles– Less time to recoup investment

• Greater Product Segmentation– Harder to achieve economies of scale– Higher capital demands

• Competing for Capital in Global Markets– Investors can go anywhere

33

The Bottom Line• Financial Performance is

– Harder to achieve– More essential than ever

Return On Equity:Non-Financial Services Companies*

*Based on a sample of approximately 2,000 publicly traded companies throughout the world in non-financial services industries like industrial, wholesale distribution and retail.

11.7% 12.0%

8.1%7.3%

8.3%9.5%

15.8%

1.3%

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

14.0%

16.0%

18.0%

1999 2000 2001 2002 2003

Average 1999-2003

Median 1st

Quartile4th

Quartile

55

Financial Performance

C o st o f G o od s S o ld S e llin g P rice

P ro fita b ility G ro w th

F ixe d C a p ita l U tiliza tion W o rk in g C a p ita l U tiliza tion

C a p ita l U tiliza tion

F in a nc ia l P e rfo rm a n ce

66

Revenue Growth

P ro fita b ility

F o re ca s t A ccu ra cy S p ee d to M arke t

L e a d T im e

G ro w th C a p ita l U tiliza tion

F in a nc ia l P e rfo rm a n ce

77

Capital Utilization

P ro fita b ility G ro w th

F ixe d Ca p ita l U tiliza tion

D a ys o f In ve n to ry D a ys S a les O uts tan d ing D a ys P u rch a ses O u ts tan d ing

W o rk in g C a p ita l U tiliza tion

C a p ita l U tiliza tion

F in a nc ia l P e rfo rm a n ce

88

Why Capital Utilization?Question: Effect on Net Personal Wealth?

• Salary $10,000/month

• Expenses– Food, Clothing, Utilities $ 5,000/month

• Net Operating Income $ 5,000/month

• Taxes (30%) $ 3,000/month

• Net Income After Tax $ 2,000/month

99

Capital UtilizationQuestion: Effect on Net Personal Wealth?• Salary $10,000/month• Expenses

– Food, Clothing, Utilities $ 5,000/month

• Net Operating Income $ 5,000/month• Taxes (30%) $ 3,000/month• Net Income After Tax $ 2,000/month• Interest Expenses $ 3,000/month• Change in Net Worth ($ 1,000/month)

1010

Capital UtilizationQuestion: Effect on Net Shareholder Value?• Revenue $10,000/month• Operating Expenses

– COGS, SG&A $ 5,000/month

• Net Operating Income $ 5,000/month• Taxes $ 3,000/month• NOPAT $ 2,000/month• Capital Charge $ 3,000/month• Economic Profit ($ 1,000/month)AKA:

Economic Value AddedShareholder Value Added

1111

Corporate “Interest Expense”

• Opportunity Cost of Money

• Average Cost of Capital

• Sources of Capital– Shareholders – Equity– Bond holders and Lessors – Debt

• Question: – Which gets a higher return?– Why?

1212

Average Cost of Capital

• % of Equity * Cost of Equity, • +% of Debt * Cost of Debt (1-Tax Rate)• Example: Adtran

– From the Balance sheet ($000’s)• Total Assets $559,942• NIBCLs $ 36,015• Capital $523,927

• Debt $57,290 or ~11% Cost of Debt 5%• Equity is ~89% Cost of Equity?

1313

Historical Cost of Equity

• Adtran Stock closed at – 12.78 in Jan 96*– 29.17 in Jan 06

– 12.01 in Jan 96– 22.47 last week

• That’s a CAGR of 8.6%• That’s a CAGR of 4.7%• So investors expect these returns to continue• Or use the CAPM

– *accounting for splits and dividends. Yahoo Finance will do these calculations for you http://finance.yahoo.com

Improve!

1414

ADTN Share Price

• CAGR?

1515

Splits & Dividends

• 2:1 Stock Split Dec. 03

• Quarterly dividends

1616

Average Cost of Capital

• % of Equity * Cost of Equity• +% of Debt * Cost of Debt (1-Tax Rate)• Example: Adtran

– From the Balance sheet• Total Assets $559,942 $473,620• NIBCLs $ 36,015 $ 40,120• Capital $523,927 $433,500

• Debt $57,290 or ~11% Cost of Debt 5% * (1-31.7%) = 3.4%• Equity is ~89% Cost of Equity 8.6%• Cost of Capital 11%*3.4% + 89%*8.6% =7.7% • 13%*3.4% +87%*4.7% = 4.5% (low)

13%

Or 4.7%?87%

1717

Adtran Economic Profit

Operating Expenses 352.76$ 386.88Operating Income 101.76$ 113.8Non- Operating Income (Expense) 10.80$ 4.47Net Operating Profit Before Taxes 112.56$ 118.27Cash Taxes 34.88$ 39.69Net Operating Profit After Taxes 77.68$ 78.58% NOPAT / Revenue 17.09% 15.69%

Capital 523.93$ 433.5Cost of Capital 7.7% 7.70%Capital Charge 40.34$ $ 33.38 % Capital Charge / Revenue 8.9% 6.7%

Economic Profit $37.34 $ 45.20 % Economic Profit / Revenue 8.22% 9.03%

Average Economic Profit

across broad range of publicly traded stocks is

~0%

Current

1818

The Main Difference

• Adtran ran more revenue across fewer assets at a slightly lower margin

• Margin X SPEED = ROIC

1919

ROIC

• Return on Invested Capital• ROIC = NOPAT/Capital• = NOPAT/Revenue X Revenue/Capital• = Margin X SPEED

HP DELLRevenue 118,364,000$ 61,101,000$ NOPAT 8,329,000$ 2,478,000$ Capital 81,014,000$ 18,185,000$ SPEED 1.46 3.36 Margin 7% 4%ROIC 10% 14%

2020

-2%

-2%

-9%

-5%

-5%

-12%

-12%

-14%

-2%

-11%

-1%

-5%

-4%

-7%

-12%

0%

-16% -14% -12% -10% -8% -6% -4% -2% 0%

ARVINMERITOR INC

BORG WARNER INC

DAIMLERCHRYSLER AG

DANA CORP

DELPHI CORP

FEDERAL-MOGUL CORP

FORD MOTOR CO

GENERAL MOTORS CORP

MAGNA INTERNAT INC CL A

TENNECO AUTOMOTIVE INC

VISTEON CORPORATION

NISSAN MOTOR CO LTD ADR

TOYOTA MOTOR CORP ADS

BMW

Hyundai

VW

Automotive

2121

Working Capital

P ro fita b ility G ro w th

F ixe d Ca p ita l U tiliza tion

D a ys o f In ve n to ry D a ys S a les O uts tan d ing D a ys P u rch a ses O u ts tan d ing

W o rk in g C a p ita l U tiliza tion

C a p ita l U tiliza tion

F in a nc ia l P e rfo rm a n ce

2222

Days of Inventory

• Days of Inventory =

• Cost per Day is Cost of Goods Sold or Cost of Sales/365

• Slightly different idea than

• Turns =

Value of InventoryCost per Day

RevenueValue of Inventory

2323

Adtran Example

• Inventory $ 42,316• Cost of Good Sold $193,455• Cost per Day $ 530• Days of Inventory ~ 80 days = 42,316/530• Note: A reduction of 1 day in inventory frees up

about how much working capital?• Turns ~ 11 = 454.517/42.316• Note: The company will talk about holding

approximately 33 days of inventory. Explain the discrepancy between 80 and 33.

Half a million per day

Adtran’s gross margin is

~57%

2424

Days Sales Outstanding

• Days Sales Outstanding

Measures the average time to collect on salesThis is capital you are lending to customers

• Adtran Example ($000’s)– Accounts Receivable $70,504– Revenue per Day $1,250 = $454,517/365– Days Sales Outstanding = 56+ days

• Note: Collecting one day faster frees up approximately how much capital?

Accounts ReceivableRevenue Per Day

2525

Days Purchases Outstanding

• Days Purchases Outstanding

Measures the average time to pay bills

This is capital your suppliers are lending you

• Adtran Example ($000’s)– Accounts Payable $22,856

– Purchases per Day $530

– Days Purchases Outstanding = 43+ days

Accounts PayablePurchases per Day

Typically use cost per

day

2626

Carrefour

• 2005 Cost of Sales €57,052 million• Cost per Day €156 million• Apparent political pressure to reduce days in

terms of sale – 30 days• Carrefour’s Trade Payables € 14,721 mil.• That’s about 94 days• 48% of Net Sales generated in France• Assume € 7,000 mil. of Trade Payables in France• Assume same average 94 days.• Reduce to 30 days means what?

2727

Impact

• Carrefour would need to come up with– 64/94*€ 7,000 mil or about € 4,700 mil.

• 2005 Earnings before Interest and Taxes – € 3,100 mil.

2828

Working Capital

• Longer Lead Times

• Greater Volatility

• More complex relationships

Greater demand for Working Capital in Supply Chains

2929

Cash-to-Cash Cycle

• How many days of operations the company must finance with capital Days Of Inventory

+ Days Sales Outstanding

- Days Purchases Outstanding

• Adtran Example• Days of Inventory 80

• Days Sales Outstanding 56

• Days Purchases Outstanding 43

• Cash-to-Cash Cycle 93 days

3030

Prof. Peter Klaus, D.B.A./Boston Univ.Chair Business Logistics, Universitaet Erlangen-Nürnberg and

Head Fraunhofer ATL, Nürnberg <klaus@logistik.uni-erlangen.de>

Dr. Klaus’s Time-Money Map

3131

Dell’s Magic

-43

-79

32 4

-100 -80 -60 -40 -20 0 20 40 60

Days Sales Outstanding + Days in Inventory

Days Payments Outstanding

Cash-to-Cash Cycle

$ 4 Billion in Working Capital

3232

Dell’s Magic Updated

-25.93

-60.5

28.26

6.31

-80 -60 -40 -20 0 20 40

Days Sales Outstanding + Days in Inventory

Days Payments Outstanding

Cash-to-Cash Cycle

$ 3.5 Billion in Working Capital

3333

Automotive

• Ford – 32 days in 1991 to 29 days today (9%)

• GM– 38 days in 1991 to 28 days today (26%)

• Nissan– 45 days in 1991 to 27 days today (40%)

0%

10%

20%

30%

40%

% Reduction in Days of Inventory

since 1991

3434

Electronics

• HP– 110 days in 1995 to 43 days today (61%)

• Itautec– 112 days in 1999 to 68 days today (39%)

• Lenovo– 56 days in 1999 to 22 days today (61%)

• Nokia143 days in 1999 to 26 days today (82%)

0%

20%

40%

60%

80%

100%

% Reduction in Days of Inventory

since 1995

3535

Aircraft

• BAE– 81 days in 1999 to 36 days today (56%)

• Boeing– 41 days in 1999 to 30 days today (27%)

• Lockheed Martin– 57 days in 1999 to 19 days today (67%)

• Northrop Grumman– 48 days in 1999 to 13 days today (73%)

• Embraer– 138 days in 1999 to 143 days today

0%

20%

40%

60%

80%

% Reduction in Days of Inventory

since 1999

3636

Retail/Consumer Goods

• Carrefour– 62 days in 1999 to 40 days today (35%)

• Royal Ahold– 36 days in 1999 to 25 days today (31%)

• Unilever– 43 days in 1999 to 36 days today (16%)

• Wal-Mart– 56 days in 1999 to 49 days today (13%)

• Carulla Vivero– 36 days in 1999 to 58 days today

0%

20%

40%

% Reduction in Days of Inventory

since 1999

3737

Cost of Holding Inventory• Non-Capital Charges as % of Inventory

– Warehousing

– Obsolescence

– Pilferage

– Damage

– Insurance & Taxes

– Other

• Does this depend on the SKU?

• Typical charge is ~10%

• These are PRE-TAX costs

• Capital charge was AFTER TAX

3838

Total Cost of Carrying Inventory

• Total (Pre-Tax) Cost of Carrying InventoryNon-Capital Charge (e.g., 10%)Capital Charge/(1-Tax Rate)

• Adtran ExampleNon-Capital Charge (we will guess 10%) 10%Capital Charge 7.7%/(1-31.7%) ~11.3%Total Cost of Carrying Inventory 21.3%

• What does this mean? – Adtran holds $42.3 Million in inventory– The annual cost of carrying that inventory is ~$9 Mill.

3939

Why Reduce Inventory

• Reduces the capital and non-capital costs

• Reduces requirements for working capital

• Improves return on capital

• Then there’s lean…

4040

Why Carry Inventory

• Deterministic inventory (the grease that let’s the gears move) – “Cycle” Stock– Pipeline Inventory– Anticipatory Inventory

• Stochastic Inventory (the buffer that protects the gears from jolts)

4141

Next

• Deterministic Inventory– Pipeline– Cycle Stock

4242

Summary

• Financial Performance– Profitability, Growth, Capital Utilization

• Capital Utilization & Economic Profit• Pre-tax cost of capital• Working Capital

– Cash-to-Cash Cycle• Days of Inventory• Days Sales Outstanding• Days Purchases Outstanding

• Non-Capital Costs of Holding Inventory• Inventory Holding Costs