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11

Finance and SCM

John H. Vande Vate

Fall, 2009

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22

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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33

The Bottom Line

Financial Performance is

Harder to achieve

More essential than ever

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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

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55

Financial Performance

C o s t o f S e l l i n g

P r o f i t a G r o w t

F i x e d C a W o r k i n g

C a p i t a l

F i n a n c i a

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66

Revenue Growth

P r o f i t

F o r e c a

S p e e d

L e a d

G r o w

C a p i t a

F i n a n c i a

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7

Capital Utilization

P r o f i t a G r o w

F i x e d C

D a y s o ID a y s S D a y s

W o r k i n g

C a p i t a

F i n a n c i

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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

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9

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)

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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/mon

Capital Charge $ 3,000/month

Economic Profit ($ 1,000/month)AKA:

Economic Value Added

hareholder Value Added

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11

Corporate Interest Expense

Opportunity Cost of Money

Average Cost of Capital

Sources of CapitalShareholders Equity

Bond holders and Lessors Debt

Question:Which gets a higher return?

Why?

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1212

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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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

Thats a CAGR of 8.6%

Thats a CAGR of 4.7%

So investors expect these returns to continue Or use the CAPM

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

Improve!

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1414

ADTN Share Price

CAGR?

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1515

Splits & Dividends

2:1 Stock Split Dec. 03

Quarterly dividends

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1717

Adtran Economic Profit

Operating Expenses 352.76$ 386.88

Operating Income 101.76$ 113.8

Non-Operating Income (Expense) 10.80$ 4.47

Net Operating Profit Before Taxes 112.56$ 118.27

Cash Taxes 34.88$ 39.69

Net Operating Profit After Taxes 77.68$ 78.58% NOPAT / Revenue 17.09% 15.69%

Capital 523.93$ 433.5

Cost 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 broadrange of publicly

traded stocks is

~0%

Current

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1919

ROIC

Return on Invested Capital

ROIC = NOPAT/Capital

= NOPAT/Revenue X Revenue/Capital

= Margin X SPEEDHP DELL

Revenue 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%

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2020

-2 %

-2 %

-9 %

-5 %

-5 %

-12%

-12%

-14%

-2 %

-11%

-1 %

-5 %

-4 %

-7 %

-12%

0%

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

ARVINM ERITOR INC

BORG W ARNER INC

DAIM LERCHRYSLER A

DANA CORP

DELPHI CORP

FEDERAL-M OGUL COR

FORD M OTOR CO

GENERAL M OTORS CO

M AGNA INTERNAT INC

TENNECO AUTOM OTIV

VISTEON CORPORATIO

NISSAN M OTOR CO LT

TOYOTA M OTOR CORP

BM W

Hyundai

VW

Automotive

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2121

Working Capital

P r o f i t a G r o w

F i x e d C

D a y s o ID a y s S D a y s P u

W o r k i n g

C a p i t a

F i n a n c i

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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 Inventory

Cost per Day

Revenue

Value of Inventory

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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 holdingapproximately 33 days of inventory. Explain thediscrepancy between 80 and 33.

Half a millionper day

Adtrans gross

margin is

~57%

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Days Sales Outstanding

Days Sales Outstanding

Measures the average time to collect on salesThis 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 approximatelyhow much capital?

Accounts Receivable

Revenue Per Day

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Days Purchases Outstanding

Days Purchases 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

Accounts Payable

Purchases per Day

Typically

use cost per

day

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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 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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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.

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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

Dr Kla ss

http://www.isye.gatech.edu/~jvandeva/Classes/6203/2009/WorkingCapitalModel.ppt

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3030

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

Head Fraunhofer ATL, Nrnberg

Dr. Klauss

Time-Money Map

http://www.isye.gatech.edu/~jvandeva/Classes/6203/2009/WorkingCapitalModel.ppthttp://www.isye.gatech.edu/~jvandeva/Classes/6203/2009/WorkingCapitalModel.ppthttp://www.isye.gatech.edu/~jvandeva/Classes/6203/2009/WorkingCapitalModel.ppthttp://www.isye.gatech.edu/~jvandeva/Classes/6203/2009/WorkingCapitalModel.ppthttp://www.isye.gatech.edu/~jvandeva/Classes/6203/2009/WorkingCapitalModel.ppthttp://www.isye.gatech.edu/~jvandeva/Classes/6203/2009/WorkingCapitalModel.ppthttp://www.isye.gatech.edu/~jvandeva/Classes/6203/2009/WorkingCapitalModel.ppthttp://www.isye.gatech.edu/~jvandeva/Classes/6203/2009/WorkingCapitalModel.ppt

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3131

Dells Magic

-43

-79

32 4

-100 -80 -60 -40 -20 0 20 40 6

Days Sales Outstanding+ Days in Inventory

Days Payments Outstanding

Cash-to-Cash Cycle

$ 4 Billion in Working Capital

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3232

Dells 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

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3333

Automotive

Ford32 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

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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%)

Nokia

143 days in 1999 to 26 days today (82%)

0%

20%

40%

60%

80%

100%

% Reduction in

Days of Inventory

since 1995

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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 today0%

20%

40%

60%

80%

% Reduction in

Days of Inventory

since 1999

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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 today0%

20%

40%

% Reduction in

Days of Inventory

since 1999

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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 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.

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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