Supply Chain Financial Analysis - MIT CTL

SupplyChainFinancialAnalysis

JarrodGoentzelgoentzel@mit.edu

Source:Higgins,R.AnalysisforFinancialManagement.10thed.McGraw-HillIrwin,2011

ThefirstprincipleinacommonMBAfinancetextbook

“Acompany’sfinancesandoperationsareintegrallyconnected.”

Whyisoperationsundervalued?

• “Inourcompany,operationsisnotglamorous.Dealsare.”

• Operationsisabranchofengineeringrequiringadifferentskillsetandmindset

• Topmanagers– whoenteredthroughfinance,strategy,ormarketing– areignorantaboutoperationsanduninterestedinlearningmore,relyingonotherstomindthedetailsofactualwork

• “Financialdatadominatethediscourseinthemodernorganization,althoughoperationalperformanceisthedriveroffinancialresults.”

Source:“DeepChange:HowOperationalInnovationCanTransformYourCompany,”MichaelHammer,HarvardBusinessReview,Vol.82Issue4,April2004,pp.84-93.

Answerthesequestionsforyourfirm

• WhatfinancialKPIsdoyouusetomeasuresupplychainperformance?

• Whatfinancialanalysisdoyouusetomakesupplychaindecisions?

TheLanguageofFinance

• FinancialStatements– BalanceSheet– IncomeStatement

• FinancialAnalysis– Ratios– Acronyms(ROA,ROIC,EVA,…)

BalanceSheet

• Snapshotofthefirm’svalue– Approximation:accountantsmeasuredvalueatthetimethetransactiontookplace– Bookvalueisthelowerofcostormarketvalue

• Assets(listedinorderofliquidity)– Current:cash,marketablesecurities,accountsreceivable,inventories– Fixed:property,plant,equipment(lessaccumulateddepreciation)– Intangible:patents,goodwill…“growthassets”

• Liabilities(listedinorderinwhichtheymustbepaid)– Current:accountspayable,notespayable,…– Long-term:notes,bonds,deferredincometaxes,…

• Shareholders’equity(a.k.a.networth)– Stock:preferred,common– Retainedearnings

Lasttobepaidifafirmisdissolved

consumedinthecurrentyear

consumedinthefuture

consumedtheoretically

IncomeStatement

• Performancerecordbetweensnapshots• Explainswhyretainedearningshaschangedovertime

– Sales(netofmarkdowns)– Costofgoodssold– GROSSINCOME– Selling,general&administrative(SGA)expenses– OPERATINGINCOME– Depreciation&amortization– OPERATINGINCOME

– Interestexpense– Othernonoperatingexpenses/income

– Incometaxes– Extraordinaryitems– NETINCOME

EBITDA

EIATBS

FinancialStatements

“Financialstatementsarelikefineperfume;tobesniffedbutnotswallowed.”

− AbrahamBrilloff

Source:Higgins,R.AnalysisforFinancialManagement.10thed.McGraw-HillIrwin,2011.

FinancialAnalysis

“accountantstrytomeasurethecurrentstandingandimmediatepastperformanceofafirm,whereasfinancialanalysisismuchmoreforwardlooking.”

− Aswath Damodaran,SternSchoolofBusiness

Source:http://pages.stern.nyu.edu/~adamodar/New_Home_Page/AccPrimer/accstate.htm

FinancialAnalysis

• Analogyaboutmanagingacompany’sfinancialperformance– stick,throttle,rudder

• “Weanalyzefinancialstatementsforthepurposeof– evaluatingperformanceand– understandingtheleversofmanagementcontrol.”

FinancialAnalysis

• Higgins’threeleversofmanagementcontrol– Netmargin:Netincome/Sales– Assetturnover:Sales/Assets– Financialleverage:Assets/Shareholders’equity

• Studythe“tiesbetweenacompany’soperatingdecisions…anditsfinancialperformance.”– “Operatingdecisionsaretheleversbywhichmanagementcontrolsfinancialperformance.”

– Examplesgiven:howmanyunitstomakethismonth,howtopricethem

DupontAnalysis

assets TotalSalesoverAsset turn =

SalesincomeNet marginNet =

overAsset turn margin Net ROA ´=

Equityassets Totalleverage Financial =

leverage FinancialoverAsset turnmarginNet ROE ´´=

InventoryTurnover, anarrowerfocusthanAssetTurnover,isoftenametricforsupplychainprofessionals

GrossorOperatingMarginisamorecommonmetricforsupplychainprofessionalsthanNetMargin

Financeandsupplychainworktogethertocreatestockholdervalue

dInvestors

(Equity)

Investors

(Debt)

Operational Assets

Firm invests

Future cash flows: revenues, expenses, etc.

Operations/supplychain:usefundstogeneratereturns

Finance:acquirefunds

Finance:allocatefunds

LeversofPerformancefor10DiverseCompanies,2010

Principalratiodefinitions(Higgins)*

*Excludingtheleverageandliquidityratios

Usingratioseffectively

• Ratiovaluesneedtobeunderstoodincontext• Usually,no“correct”valuesforratios• Relyonruleofthumbassessmenttechniques,comparisonwithindustryaveragesandspecificcompetitors,andlookingfortrends

YouarenowreadytobeCEO

SunflowerNutraceutical(SNC)Simulation

SunflowerNutraceutical(SNC)

• HowdidyoulikebeingCEO?• Whatwasyourobjectiveinmakingdecisions?• Whatapproachesdidyouusetoevaluateoptions?

SunflowerNutraceutical(SNC)Results

TwoGoalsoftheCEO

• ProvideShareholderValue• …andstayoutofjail

JarrodGoentzelgoentzel@mit.eduSource:http://www.maaw.info/ArticleSummaries/ArtSumKaplanNorton2001.htm

Source:website,TradeDynamics,LLC

Source:website,FinlisticsSolutions

DeloitteEnterpriseValueMap

GoaloftheCEO

• ProvideShareholderValue

• DriversofShareholderValue– RevenueGrowth– OperatingMargin– AssetUtilization

Supplychainprofessionalscanaffectallthree!

Driversofshareholdervalue

RevenueGrowth

AssetUtilization

OperatingMargin

Leverage

Howdoessupplychainperformancemakeanimpactonfinancialresults?

• Tradeoffsexist• Wheredoyoufocus?

AssetUtilizationOperatingMargin

RevenueGrowth

Responsiveness(productavailability)Capability(newmarkets)

Leanness(reduceassets)Agility(adaptcapacities)

Leanness(reducecost)Segmentation(identifyopportunities)

SunflowerNutraceutical(SNC)Analysis

Dupont AnalysisassessestheMargin–AssetUtilizationtradeoffatahighlevel

AssetUtilizationOperatingMargin

RevenueGrowth

DoyouseeanyextremeexamplesofProfitPathandTurnoverPath?

Leveragedrivesvalue+increasesrisk

RevenueGrowth

AssetUtilization

OperatingMargin

Leverage

• ReturnonInvestedCapitala.k.a.RONA(ReturnonNetAssets)

• ROIC=EBIT(1-Taxrate)/(Interest-bearingdebt+Equity)

• Numerator:earningsaftertaxifitwereallequityfinanced(i.e.,notconsideringinterestexpenseortaxbooks)

• Denominator:sumofallsourcesofcashonwhichareturnmustbeearned

ROICisnotaffectedbyfinancingscheme

BalanceSheet

IncomeStatement

EVA™

• EVA™=economicvalueadded=NOPAT– (IC*COC)

• where– IC=investedcapital– COC=costofcapital[i.e.WACC]– NOPAT=netoperatingprofitaftertaxes[i.e.EBIT*(1-TaxRate)]

• Transformaccountingprofitintoeconomicprofit– Convertaccrual-basedearningsintoacash-basedNOPAT– Converttotalassetstoinvestedcapital– Assessthequantityofcapitalusedtogeneratetheincome– ThecomplexityandefforttoadjustGAAPisaweaknessofEVA

JarrodGoentzelgoentzel@mit.eduNote:EVA™isatrademarkedsymbolof Stern,Stewart&Co.

Simplebottomline

Ifeconomicvalueaddedispositiveinagivenyear,thefirmhasearnedmorethan

theamountrequiredtocompensatedebtholdersandshareholders

EconomicValueAdded

GROSSMARGIN

TOTALEXPENSES

NETPROFIT(EBIT)

CAPITALCHARGE

TOTALCAPITAL

COSTOFCAPITAL(%)

CURRENTASSETS

FIXEDASSETS

OTHERCURRENTASSETS

INVENTORY

OTHER+

Source:“Supplychainmetrics,”DouglasM.LambertandTerranceL.Pohlen.InternationalJournalofLogisticsManagement,Vol.12No.1,2001,pp.1-19.

Example:supplychaintradeoff

New Proposal

100,000$

86,500$ 11,500$ 75,000$

13,500$ 5,130$ 8,370$

60,000$ 44,000$ 16,000$

6,000$ 4,400$ 1,600$

2,370$ 103.0%

Revenues 100,000$

Operating Costs - 85,000$ SC 10,000$ Non-SC 75,000$

EBIT = 15,000$ Taxes 38% - 5,700$ NOPAT = 9,300$

Capital 70,000$ SC 54,000$ Non-SC 16,000$

Cost of Capital 10%Capital Charge - 7,000$

SC 5,400$ Non-SC 1,600$

EVA = 2,300$

Revenues 100,000$

EBIT = 15,000$ Taxes 38% - 5,700$ NOPAT = 9,300$

Capital 70,000$ SC 54,000$ Non-SC 16,000$

SC 5,400$ Non-SC 1,600$

EVA = 2,300$

New Proposal

100,000$

86,500$ 11,500$ 75,000$

13,500$ 5,130$ 8,370$

60,000$ 44,000$ 16,000$

6,000$ 4,400$ 1,600$

2,370$ 103.0%

Example:supplychainimprovement

Ops better 10%

100,000$

84,000$ 9,000$

75,000$

16,000$ 6,080$ 9,920$

70,000$ 54,000$ 16,000$

7,000$ 5,400$ 1,600$

2,920$ 127.0%

Revenues 100,000$

EBIT = 15,000$ Taxes 38% - 5,700$ NOPAT = 9,300$

Capital 70,000$ SC 54,000$ Non-SC 16,000$

SC 5,400$ Non-SC 1,600$

EVA = 2,300$

Cap better 10%

100,000$

85,000$ 10,000$ 75,000$

15,000$ 5,700$ 9,300$

64,600$ 48,600$ 16,000$

6,460$ 4,860$ 1,600$

2,840$ 123.5%

EVAisalignedwithNPV

ThepresentvalueofEVAsfromagivenprojectismathematicallyequivalenttotheNPVoftheproject

EVAisnotnew,sowhyisitpopular?

• Consultantsaregoodatrepackagingoldideas– BasicideausedbyGeneralMotorsin1920s– LabeledbyGeneralElectricin1950sas“residualincome”– TrademarkedbySternStewartin1990sasEVA™(withfurthernewterminologysuchasNOPAT)

• Uniformity:itcanbeusedforthreecrucialmanagementfunctions– Investmentanalysis(insteadofNPV,IRR,BCR)– Businessunitperformanceappraisal(insteadofROE,ROA)– Compensationincentive(turnmiddlemanagersinto“owners”)

• ItismorestreamlinedthanrelyingonahostofmeasuressuchasNPV,IRR,BCR,ROE,ROIC,EPS,etc.

Source:Higgins,R.AnalysisforFinancialManagement.10thed.McGraw-HillIrwin,2011

“EVApromisestocompletethetransformationofvaluecreationfromameresloganintoapowerfulmanagementtool,onethatmayatlastmove

modernfinanceoutoftheclassroomandintotheboardroom– andperhapsevenontotheshopfloor.”

Supply Chain Financial Analysis - MIT CTL

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