Finance and SCM

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Finance and SCM
John H. Vande Vate Spring, 2007
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Todays 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 EquityNon-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.
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Financial Performance
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Revenue Growth
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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

Good?
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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)

Good?
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Capital Utilization

• Question Effect on Net Shareholder Value?
• Revenue 10,000/month
• Operating Expenses
• COGS, SGA 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 (000s)
• 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
• Thats a CAGR of 8.6
• 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

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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
• NIBCLs 36,015
• Capital 523,927
• 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 113.4 898.6 7.7

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Adtran Economic Profit
Average Economic Profit across broad range of
publicly traded stocks is 0
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Automotive
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Computer
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Working Capital
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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
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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.

Adtrans gross margin is 57
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Days Sales Outstanding

• Days Sales Outstanding
• Measures the average time to collect on sales
• This is capital you are lending to customers
• Adtran Example (000s)
• 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
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Days Purchases Outstanding

• Days Sales Outstanding
• Measures the average time to pay bills
• This is capital your suppliers are lending you
• Adtran Example (000s)
• Accounts Payable 22,856
• Purchases per Day 530
• Days Purchases Outstanding 43 days

Typically use cost per day
Accounts Payable Purchases per Day
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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
• Carrefours Trade Payables 14,721 mil.
• Thats 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 80
• Days Sales Outstanding 56
• Days Purchases Outstanding 43
• Cash-to-Cash Cycle 93 days

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Some Examples
39 days
-43 days
167 days
52 days
-52 days
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Dr. Klauss Time-Money Map

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

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Dells Magic
Days Sales Outstanding Days in Inventory
4 Billion in Working Capital
Days Payments Outstanding
Cash-to-Cash Cycle
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Automotive
Reduction in Days of Inventory since 1991

• 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)

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Electronics
Reduction in Days of Inventory since 1995

• 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)

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Aircraft
Reduction in Days of Inventory since 1999

• 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

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Retail/Consumer Goods
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)
• 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

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Growing Inventories
Added Days of Inventory from 2003 to 2004
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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 theres lean

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Why Carry Inventory

• Deterministic inventory (the grease that lets
  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