Finance and SCM
John H. Vande Vate
Fall, 2009
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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
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The Bottom Line
• Financial Performance is
– Harder to achieve
– More essential than ever
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Return On Equity:
Non-Financial Services Companies*
18.0%
15.8%
16.0%
14.0%
12.0%
11.7% 12.0%
9.5%
10.0%
8.1%
8.0%
7.3%
8.3%
6.0%
4.0%
1.3%
2.0%
0.0%
1999
2000
2001
2002
2003
Median
1st
4th
Quartile Quartile
Average 1999-2003
*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.
Financial Performance
Financial Performance
Profitability
Cost of Goods Sold
Growth
Selling Price
Capital Utilization
Fixed Capital Utilization
Working Capital Utilization
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Revenue Growth
Financial Performance
Profitability
Growth
Capital Utilization
Lead Time
Forecast Accuracy
Speed to Market
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Capital Utilization
Financial Performance
Profitability
Growth
Capital Utilization
Fixed Capital Utilization
Working Capital Utilization
Days of Inventory
Days Sales Outstanding
Days Purchases O
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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
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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
• Interest Expenses
$ 3,000/month
• Change in Net Worth ($ 1,000/month)
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Capital Utilization
Question: 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 Added
Shareholder Value Added
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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?
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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?
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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
Improve!
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
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http://finance.yahoo.com
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ADTN Share Price
• CAGR?
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Splits & Dividends
• 2:1 Stock Split Dec. 03
• Quarterly dividends
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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
13%
87%
• Debt $57,290 or ~11% Cost of Debt 5% * (1-31.7%) = 3.4%
• Equity is ~89% Cost of Equity 8.6%
Or 4.7%?
• Cost of Capital 11%*3.4% + 89%*8.6% =7.7%
•
13%*3.4% +87%*4.7% = 4.5% (low)
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Adtran Economic Profit
Current
Average
Economic Profit
across broad
range of publicly
traded stocks is
~0%
Operating Expenses
Operating Income
Non-Operating Income (Expense)
Net Operating Profit Before Taxes
Cash Taxes
Net Operating Profit After Taxes
% NOPAT / Revenue
$
$
$
$
$
$
352.76
101.76
10.80
112.56
34.88
77.68
17.09%
Capital
Cost of Capital
Capital Charge
% Capital Charge / Revenue
$
523.93
7.7%
40.34 $
8.9%
433.5
7.70%
33.38
6.7%
$37.34 $
8.22%
45.20
9.03%
Economic Profit
% Economic Profit / Revenue
$
386.88
113.8
4.47
118.27
39.69
78.58
15.69%
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The Main Difference
• Adtran ran more revenue across fewer
assets at a slightly lower margin
• Margin X SPEED = ROIC
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ROIC
•
•
•
•
Return on Invested Capital
ROIC = NOPAT/Capital
= NOPAT/Revenue X Revenue/Capital
= Margin X SPEED
HP
Revenue $ 118,364,000 $
NOPAT
$
8,329,000 $
Capital
$ 81,014,000 $
SPEED
1.46
Margin
7%
ROIC
10%
DELL
61,101,000
2,478,000
18,185,000
3.36
4%
14%
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6%
Automotive
-12%
VW
-7%
Hyundai
-4%
BMW
-5%
TOYOTA MOTOR CORP ADS
-1%
NISSAN MOTOR CO LTD ADR
-11%
VISTEON CORPORATION
-2%
TENNECO AUTOMOTIVE INC
0%
-14%
GENERAL MOTORS CORP
-12%
FORD MOTOR CO
-12%
FEDERAL-MOGUL CORP
-5%
DELPHI CORP
-5%
DANA CORP
-9%
DAIMLERCHRYSLER AG
-2%
-2%
-14%
MAGNA INTERNAT INC CL A
-12%
-10%
-8%
-6%
-4%
-2%
BORG WARNER INC
ARVINMERITOR INC
0%
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Working Capital
Financial Performance
Profitability
Growth
Capital Utilization
Fixed Capital Utilization
Working Capital Utilization
Days of Inventory
Days Sales Outstanding
Days Purchases Outstanding
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Days of Inventory
Value of Inventory
• Days of Inventory =
Cost per Day
• Cost per Day is Cost of Goods Sold or
Cost of Sales/365
• Slightly different idea than
Revenue
• Turns =
Value of Inventory
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Adtran Example
Inventory
$ 42,316 Half a million
per day
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.
Adtran’s gross
•
•
•
•
•
margin
is
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~57%
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Days Sales Outstanding
• Days Sales Outstanding
Accounts Receivable
Revenue Per Day
Measures the average time to collect on sales
This 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?
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Days Purchases Outstanding
• Days Purchases Outstanding
Accounts Payable
Purchases per Day
Typically use
cost per day
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
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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?
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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.
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Working Capital
• Longer Lead Times
• Greater Volatility
• More complex relationships
Greater demand for Working Capital in Supply Chains
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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
Days Sales Outstanding
Days Purchases Outstanding
Cash-to-Cash Cycle
80
56
43
93 days
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Dr. Klaus’s
Time-Money Map
Prof. Peter Klaus, D.B.A./Boston Univ.
Chair Business Logistics, Universitaet Erlangen-Nürnberg and
Head Fraunhofer ATL, Nürnberg
<klaus@logistik.uni-erlangen.de>
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Dell’s Magic
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Days Sales Outstanding
+ Days in Inventory
-79
$ 4 Billion in Working
Capital Outstanding
Days Payments
-43
-100
-80
-60
-40
-20
Cash-to-Cash Cycle
0
20
40
60
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Dell’s Magic Updated
6.31
28.26
Days Sales Outstanding
+ Days in Inventory
-60.5
$ 3.5 Billion in Working
CapitalOutstanding
Days Payments
-25.93
-80
-60
-40
-20
Cash-to-Cash Cycle
0
20
40
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Automotive
% Reduction in
Days of Inventory
since 1991
• Ford
40%
30%
– 32 days in 1991 to 29 days today (9%)
• GM
– 38 days in 1991 to 28 days today (26%)
20%
10%
• Nissan
– 45 days in 1991 to 27 days today (40%)
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0%
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Electronics
100%
% Reduction in
Days of Inventory
• HP since 1995
– 110 days in 1995 to 43 days today (61%)
• Itautec
80%
60%
– 112 days in 1999 to 68 days today (39%)
• Lenovo
– 56 days in 1999 to 22 days today (61%)
40%
20%
• Nokia
143 days in 1999 to 26 days today (82%)
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0%
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Aircraft
80%
60%
% Reduction in
Days of Inventory
• BAE
since 1999
– 81 days in 1999 to 36 days today (56%)
• Boeing
– 41 days in 1999 to 30 days today (27%)
40%
20%
• Lockheed Martin
– 57 days in 1999 to 19 days today (67%)
• Northrop Grumman
0%
– 48 days in 1999 to 13 days today (73%)
• Embraer
– 138 days in 1999 to 143 days today
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Retail/Consumer Goods
40%
% Reduction in
Days of Inventory
since 1999
• Carrefour
– 62 days in 1999 to 40 days today (35%)
• Royal Ahold
– 36 days in 1999 to 25 days today (31%)
20%
• Unilever
– 43 days in 1999 to 36 days today (16%)
• Wal-Mart
0%
– 56 days in 1999 to 49 days today (13%)
• Carulla Vivero
– 36 days in 1999 to 58 days today
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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
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Total Cost of Carrying Inventory
• Total (Pre-Tax) Cost of Carrying Inventory
Non-Capital Charge (e.g., 10%)
Capital Charge/(1-Tax Rate)
• Adtran Example
Non-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.
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Why Reduce Inventory
•
•
•
•
Reduces the capital and non-capital costs
Reduces requirements for working capital
Improves return on capital
Then there’s lean…
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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)
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Next
• Deterministic Inventory
– Pipeline
– Cycle Stock
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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
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