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%
11.7% 12.0%
12.0%

10.0% 9.5%
8.1% 8.3%
8.0% 7.3%

6.0%

4.0%

2.0% 1.3%

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
F in a n c ia l P e r f o r m a n c e

P r o f it a b ility G r o w th C a p it a l U t iliz a t io n

C o s t o f G o o d s S o ld S e llin g P r ic e F ix e d C a p it a l U t iliz a t io n W o r k in g C a p it a l U t iliz a t io n

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 Revenue Growth
F in a n c ia l P e r f o r m a n c e

P r o f it a b ility G r o w th C a p it a l U t iliz a t io n

L e a d T im e

F o re c a s t A c c u ra c y S p e e d to M a rk e t

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 Capital Utilization

F in a n c ia l P e r f o r m a n c e

P r o f it a b ility G r o w th C a p it a l U tiliz a t io n

F ix e d C a p it a l U tiliz a t io n W o r k in g C a p it a l U tiliz a t io n

D a y s o f In v e n to ry D a y s S a le s O u t s t a n d in g D a y s P u rc h a s e s 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
AKA:
•
Economic Value Added
Economic Profit ($ 1,000/month)
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Shareholder Value Added 10
 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
• That’s a CAGR of 8.6%
Improve!
• 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
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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
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

Average Cost of Capital 7.7% 7.70%
Economic Profit Capital Charge $ 40.34 $ 33.38
across broad % Capital Charge / Revenue 8.9% 6.7%
range of publicly
traded stocks is Economic Profit $37.34 $ 45.20
~0% % Economic Profit / Revenue 8.22% 9.03%

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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 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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 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% MAGNA INTERNAT INC CL A

-14% GENERAL MOTORS CORP

-12% FORD MOTOR CO

-12% FEDERAL-MOGUL CORP

-5% DELPHI CORP

-5% DANA CORP

-9% DAIMLERCHRYSLER AG

-2% BORG WARNER INC

-2% ARVINMERITOR INC

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

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 Working Capital

F in a n c ia l P e r f o r m a n c e

P r o f it a b ility G r o w th C a p it a l U tiliz a t io n

F ix e d C a p it a l U tiliz a t io n W o r k in g C a p it a l U tiliz a t io n

D a y s o f In v e n to ry D a y s S a le s O u t s t a n d in g D a y s P u r c h a s e s O u ts ta n d in g

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 Days of Inventory

• Days of Inventory = Value of Inventory

Cost per Day

• Cost per Day is Cost of Goods Sold or

Cost of Sales/365
• Slightly different idea than
• Turns = Revenue
Value of Inventory
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 Adtran Example
• Half a million
Inventory $ 42,316
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
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is
~57% 23
 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
Typically
Accounts Payable use cost per
Purchases per Day 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? 26
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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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 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
Days Sales Outstanding

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+ Days in Inventory

4
$ 4 Billion in Working Capital
Days Payments Outstanding
-79

-43

Cash-to-Cash Cycle

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

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 Dell’s Magic Updated
Days Sales Outstanding

28.26

6.31
+ Days in Inventory

$ 3.5 Billion in Working

-60.5 Capital
Days Payments Outstanding

-25.93
Cash-to-Cash Cycle

-80 -60 -40 -20 0 20 40

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 Automotive
% Reduction in
Days of Inventory
since 1991
• Ford
40% – 32 days in 1991 to 29 days today (9%)
30% • GM
– 38 days in 1991 to 28 days today (26%)
20%
• Nissan
10% – 45 days in 1991 to 27 days today (40%)
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0% 33
 Electronics
% Reduction in
Days of Inventory
• HP since 1995
100% – 110 days in 1995 to 43 days today (61%)
• Itautec
80%
– 112 days in 1999 to 68 days today (39%)
60% • Lenovo
– 56 days in 1999 to 22 days today (61%)
40%
• Nokia
20% 143 days in 1999 to 26 days today (82%)
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 Aircraft
% Reduction in
Days of Inventory
80%
• BAE
since 1999
– 81 days in 1999 to 36 days today (56%)
60% • Boeing
– 41 days in 1999 to 30 days today (27%)
40%
• Lockheed Martin
– 57 days in 1999 to 19 days today (67%)
20%
• Northrop Grumman
– 48 days in 1999 to 13 days today (73%)
0%
• Embraer
– 138 days in 1999 to 143 days today 35
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 Retail/Consumer Goods
% Reduction in
Days of Inventory
40%
• Carrefour since 1999
– 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
– 56 days in 1999 to 49 days today (13%)
0%
• Carulla Vivero
– 36 days in 1999 to 58 days today 36
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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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