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Finance and SCM

Finance and SCM. John H. Vande Vate Fall, 2009. 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

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Finance and SCM

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  1. Finance and SCM John H. Vande Vate Fall, 2009 1

  2. 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 2

  3. The Bottom Line • Financial Performance is • Harder to achieve • More essential than ever 3

  4. 1st Quartile 4th Quartile Median Average 1999-2003 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.

  5. Financial Performance 5

  6. Revenue Growth 6

  7. Capital Utilization 7

  8. 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 Good? 8

  9. 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) Good? 9

  10. 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 10

  11. 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? 11

  12. 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? 12

  13. 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! 13

  14. ADTN Share Price • CAGR? 14

  15. Splits & Dividends • 2:1 Stock Split Dec. 03 • Quarterly dividends 15

  16. 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% 87% Or 4.7%? 16

  17. Adtran Economic Profit Current Average Economic Profit across broad range of publicly traded stocks is ~0% 17

  18. The Main Difference • Adtran ran more revenue across fewer assets at a slightly lower margin • Margin X SPEED = ROIC 18

  19. ROIC • Return on Invested Capital • ROIC = NOPAT/Capital • = NOPAT/Revenue X Revenue/Capital • = Margin X SPEED 19

  20. Automotive 20

  21. Working Capital 21

  22. 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 Inventory Cost per Day Revenue Value of Inventory 22

  23. Adtran Example Half a million per day • 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. Adtran’s gross margin is ~57% 23

  24. Days Sales Outstanding • Days Sales Outstanding 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? Accounts Receivable Revenue Per Day 24

  25. 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 Typically use cost per day Accounts Payable Purchases per Day 25

  26. 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? 26

  27. 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. 27

  28. Working Capital • Longer Lead Times • Greater Volatility • More complex relationships Greater demand for Working Capital in Supply Chains 28

  29. 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 29

  30. 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> 30

  31. Dell’s Magic Days Sales Outstanding + Days in Inventory $ 4 Billion in Working Capital Days Payments Outstanding Cash-to-Cash Cycle 31

  32. Dell’s Magic Updated Days Sales Outstanding + Days in Inventory $ 3.5 Billion in Working Capital Days Payments Outstanding Cash-to-Cash Cycle 32

  33. 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%) % Reduction in Days of Inventory since 1991 33

  34. 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%) • Nokia 143 days in 1999 to 26 days today (82%) % Reduction in Days of Inventory since 1995 34

  35. 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 % Reduction in Days of Inventory since 1999 35

  36. 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 % Reduction in Days of Inventory since 1999 36

  37. 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 37

  38. 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. 38

  39. Why Reduce Inventory • Reduces the capital and non-capital costs • Reduces requirements for working capital • Improves return on capital • Then there’s lean… 39

  40. 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) 40

  41. Next • Deterministic Inventory • Pipeline • Cycle Stock 41

  42. 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 42

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