Non Working Capital Turns - PowerPoint

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					Finance and SCM


  John H. Vande Vate
     Spring, 2006

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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
                                           Financial Performance


                 Profitability                    Growth                   Capital Utilization


Cost of Goods Sold               Selling Price          Fixed Capital Utilization     Working Capital Utilization




                                                                                                         5
                                                                                                                    5
     Revenue Growth
                Financial Performance


Profitability          Growth           Capital Utilization


                     Lead Time


        Forecast Accuracy    Speed to Market

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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 Profit       ($ 1,000/month)
 Economic Value Added
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Shareholder Value Added                                          9
  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, e.g.,
• +% 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
•   That’s 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                 12
       http://finance.yahoo.com                           12
     Average Cost of Capital
• % of Equity * Cost of Equity, e.g.,
• +% 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 11%*3.4% + 89%*8.6% =7.7%
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         Adtran Economic Profit
     Average
      Revenue                             $   454.52
      Operating Expenses                  $   352.76
 Economic Profit
      Operating Income                    $   101.76
      Non-Operating Income (Expense)      $    10.80
across broad range
      Net Operating Profit Before Taxes
      Cash Taxes
                                          $
                                          $
                                              112.56
                                               34.88
      Net Operating Profit After Taxes
of publicly traded
      % NOPAT / Revenue
                                          $    77.68
                                              17.09%

  stocks is ~0%
      Capital
      Cost of Capital
                                          $   523.93
                                                7.7%
      Capital Charge                      $    40.34
      % Capital Charge / Revenue                8.9%

      Economic Profit                         $37.34
      % Economic Profit / Revenue              8.22%
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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%
                                                                                                          15
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                  Computer




-3%   -2%   -1%   0%   1%   2%   3%   4%        5%




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                         Working Capital

                                             Financial Performance


         Profitability     Growth                       Capital Utilization


Supply Chain Can Affect             Fixed Capital Utilization       Working Capital Utilization
        These
                                       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
• Turns =        Revenue
           Value of Inventory
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            Adtran Example
• Inventory         $ 42,316        Half a million
• Cost of Good Sold $193,455           per day
• Cost per Day       $ 530
• Days of Inventory ~ 80 days = 42,316/530
• Note: A reduction of 1 day in inventory frees up
                                       Adtran’s
  about how much working capital?
                                         gross
• Turns ~ 11 = 454.517/42.316          margin is
• Note: The company will talk about holding
                                        ~57%
  approximately 33 days of inventory. Explain the
  discrepancy between 80 and 33.
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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?                  20
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  Days Purchases Outstanding
• Days Sales Outstanding
                        Typically use
       Accounts Payable cost per day
       Purchases 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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        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
Northrop
                                                            (25)       19         45                      -43 days
                                                                                                           Days in Inventory

                                                                                                           Days Sales Outstanding

                                                                                                           Days Payments



     Dell
                                              (79)                 4        32
                                                                                                           167 days
                                                                                                           Outstanding




    Cray
                                                       (38)                             130               52 days  75




Solectron
                                                     (51)                    51               52          -52 days
                               (165)                                         48                65
  Kodak



       (200)   (150)   (100)           (50)                    -                   50               100      150           200      250

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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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                                                         4
                 + Days in Inventory

                         -79

                                      Days Payments
                    $ 4 Billion in Working Capital Outstanding
                               -43




                                       Cash-to-Cash Cycle


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

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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%)
                                          27
0%                                                27
                   Electronics
           % Reduction in
          Days of Inventory
       • HP since 1995
100%     – 110 days in 1995 to 43 days today (61%)
       • Itautec
          – 112 days in 1999 to 68 days today (39%)
80%



60%    • Lenovo
          – 56 days in 1999 to 22 days today (61%)
40%
       • Nokia
20%
          143 days in 1999 to 26 days today (82%)
                                                      28
 0%                                                        28
                 Aircraft
       % Reduction in
      Days of Inventory
80%   • BAE 1999
         since
         – 81 days in 1999 to 36 days today (56%)
60%
      • Boeing
         – 41 days in 1999 to 30 days today (27%)
      • Lockheed Martin
40%




20%
         – 57 days in 1999 to 19 days today (67%)
      • Northrop Grumman
0%       – 48 days in 1999 to 13 days today (73%)
      • Embraer                                 29
         – 138 days in 1999 to 143 days today        29
 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
0%       – 56 days in 1999 to 49 days today (13%)
      • Carulla Vivero                              30
                                                         30
         – 36 days in 1999 to 58 days today
     Growing Inventories
      Added Days of
      Inventory from
50     2003 to 2004

40




30




20




10




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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
• We will talk about this in two ways
• Deterministic inventory (the grease that
  let’s the gears move)
• 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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