ptg16393080 F I INANCIAL NTELLIGENCE S C FOR UPPLY HAIN M ANAGERS ptg16393080 This page intentionally left blank ptg16393080 F I INANCIAL NTELLIGENCE S C FOR UPPLY HAIN M ANAGERS ptg16393080 Understand the Link between Operations and Corporate Financial Performance STEVEN M. LEON Publisher: Paul Boger Editor-in-Chief: Amy Neidlinger Executive Editor: Jeanne Glasser Levine Development Editor: Natasha Wolmers Editorial Assistant: Kristen Watterson Cover Designer: Chuti Prasertsith Managing Editor: Kristy Hart Project Manager: Namita Gahtori, Cenveo® Publisher Services Copy Editor: Cenveo Publisher Services Proofreader: Cenveo Publisher Services Indexer: Cenveo Publisher Services Compositor: Cenveo Publisher Services Manufacturing Buyer: Dan Uhrig ©2016 by Steven M. Leon Published by Pearson Education, Inc. Old Tappan, New Jersey 07675 For information about buying this title in bulk quantities, or for special sales opportunities (which may include electronic versions; custom cover designs; and content particular to your business, training goals, marketing focus, or branding interests), please contact our corporate sales department at [email protected] or (800) 382-3419. For government sales inquiries, please contact [email protected] . For questions about sales outside the U.S., please contact [email protected] . Company and product names mentioned herein are the trademarks or registered trademarks of their respective owners. ptg16393080 All rights reserved. No part of this book may be reproduced, in any form or by any means, without permission in writing from the publisher. Printed in the United States of America First Printing November 2015 ISBN-10: 0-13-383831-5 ISBN-13: 978-0-13-383831-2 Pearson Education Ltd. Pearson Education Australia PTY, Limited Pearson Education Singapore, Pte. Ltd. Pearson Education Asia, Ltd. Pearson Education Canada, Ltd. Pearson Educación de Mexico, S.A. de C.V. Pearson Education—Japan Pearson Education Malaysia, Pte. Ltd. Library of Congress Control Number: 2015950135 Contents Acknowledgments . . . . . . . . . . . . . . . . . . . . . .x About the Author . . . . . . . . . . . . . . . . . . . . . . xii Chapter 1 I ntroduction . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 What Is Important to the CEO? . . . . . . . . . . . . . . . 3 Supply Chain and Operations Value Proposition. . . 4 The Role of Supply Chain and Operations . . . . . . . 5 Value Chain . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7 Supply Chain and Operations Financial Impact . . . 8 Value from a Different Perspective . . . . . . . . . . . . 11 Structure of the Book . . . . . . . . . . . . . . . . . . . . . . . 13 Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16 Chapter 2 F inancial Statements Overview . . . . . . . . . . . 17 What Are Financial Statements? . . . . . . . . . . . . . . 17 ptg16393080 What Are Financial Statements Used For? . . . . . . 20 A Closer Look at the Elements of Financial Statements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22 Balance Sheet . . . . . . . . . . . . . . . . . . . . . . . . . . 22 Income Statement . . . . . . . . . . . . . . . . . . . . . . 26 Statement of Cash Flows . . . . . . . . . . . . . . . . . 30 Relationship between Financial Statements . . . . . 34 Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 36 Chapter 3 F inancial Statement Primer Essentials . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 7 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 37 Value of Assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 40 Property Example . . . . . . . . . . . . . . . . . . . . . . . 41 Plant and Building Example . . . . . . . . . . . . . . 41 Equipment . . . . . . . . . . . . . . . . . . . . . . . . . . . . 41 Noncash Transactions . . . . . . . . . . . . . . . . . . . . . . . 42 Tangible Assets and Depreciation . . . . . . . . . . 42 v vi CONTENTS Net Fixed Assets . . . . . . . . . . . . . . . . . . . . . . . . . . . 46 Nontangible Assets and Amortization . . . . . . . . . . 47 Inventory Costing and Cost of Goods Sold . . . . . . 47 Operating Leases and Off-Balance Sheet Transactions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 52 Net Accounts Receivable . . . . . . . . . . . . . . . . . . . . 53 Net Revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 54 Net Credit Sales . . . . . . . . . . . . . . . . . . . . . . . . . . . 55 Foreign Exchange . . . . . . . . . . . . . . . . . . . . . . . . . . 56 Revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 56 Inventory Purchases . . . . . . . . . . . . . . . . . . . . . 57 Stockholders . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 58 Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 59 Chapter 4 R atio Analysis with Financial Statements . . . . . . . . . . . . . . . . . . . 61 Benchmarking . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 63 Ratio Analysis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 65 ptg16393080 Caveats to Ratio Analysis . . . . . . . . . . . . . . . . . 66 Financial Ratios . . . . . . . . . . . . . . . . . . . . . . . . . . . . 69 Liquidity Ratios . . . . . . . . . . . . . . . . . . . . . . . . . . . . 72 Current Ratio . . . . . . . . . . . . . . . . . . . . . . . . . . 73 Quick Ratio . . . . . . . . . . . . . . . . . . . . . . . . . . . . 74 Operating Cash Flow Ratio . . . . . . . . . . . . . . . 75 Profitability Ratios . . . . . . . . . . . . . . . . . . . . . . . . . . 77 Profit Margin . . . . . . . . . . . . . . . . . . . . . . . . . . 78 Operating Profit Margin Ratio . . . . . . . . . . . . . 79 Gross Profit Margin Ratio . . . . . . . . . . . . . . . . 80 Basic Earnings Power Ratio . . . . . . . . . . . . . . . 80 Return on Total Assets Ratio . . . . . . . . . . . . . . 80 Return on Equity Ratio . . . . . . . . . . . . . . . . . . 81 Valuation Ratios . . . . . . . . . . . . . . . . . . . . . . . . . . . . 82 Earnings per Share (EPS) . . . . . . . . . . . . . . . . 82 Price-to-Earnings (P/E) Ratio . . . . . . . . . . . . . 83 Price/Cash Flow Ratio . . . . . . . . . . . . . . . . . . . 83 Market/Book (M/B) Ratio . . . . . . . . . . . . . . . . 84 Dividend Yield . . . . . . . . . . . . . . . . . . . . . . . . . 85 Dividend Payout Ratio . . . . . . . . . . . . . . . . . . . 85 CONTENTS vii Asset Management Ratios . . . . . . . . . . . . . . . . . . . 86 Inventory Turnover Ratio . . . . . . . . . . . . . . . . . 86 Days in Inventory . . . . . . . . . . . . . . . . . . . . . . . 87 Accounts Receivable Turnover Ratio . . . . . . . . 88 Days Sales Outstanding . . . . . . . . . . . . . . . . . . 88 Fixed Asset Turnover Ratio . . . . . . . . . . . . . . . 89 Total Assets Turnover Ratio . . . . . . . . . . . . . . . 89 Debt Management Ratios . . . . . . . . . . . . . . . . . . . . 90 Debt Ratio . . . . . . . . . . . . . . . . . . . . . . . . . . . . 90 Debt-to-Equity Ratio . . . . . . . . . . . . . . . . . . . . 91 Times Interest Earned . . . . . . . . . . . . . . . . . . . 92 Debt Service Coverage Ratio . . . . . . . . . . . . . . 92 Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 93 Chapter 5 C ompany Valuation . . . . . . . . . . . . . . . . . . . .9 6 Value . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 97 Competitive Advantage . . . . . . . . . . . . . . . . . . . . . . 99 Reorganizing Traditional Financial ptg16393080 Statements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 100 NOPLAT . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 101 Invested Capital . . . . . . . . . . . . . . . . . . . . . . . 103 Return on Invested Capital . . . . . . . . . . . . . . 105 Free Cash Flow . . . . . . . . . . . . . . . . . . . . . . . 107 Cost of Capital . . . . . . . . . . . . . . . . . . . . . . . . . . . . 109 Performance Trees . . . . . . . . . . . . . . . . . . . . . . . . 110 Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 110 Chapter 6 D ecision-Making Tools . . . . . . . . . . . . . . . . 112 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 112 DuPont Model . . . . . . . . . . . . . . . . . . . . . . . . . . . 113 Extended DuPont Model . . . . . . . . . . . . . . . . . . . 116 Capital Budgeting . . . . . . . . . . . . . . . . . . . . . . . . . 118 Net Present Value . . . . . . . . . . . . . . . . . . . . . . 119 Internal Rate of Return . . . . . . . . . . . . . . . . . 124 Payback Period . . . . . . . . . . . . . . . . . . . . . . . . 125 Risk and Decision Making . . . . . . . . . . . . . . . . . . 126 Decision Trees . . . . . . . . . . . . . . . . . . . . . . . . 126 Simulation Models . . . . . . . . . . . . . . . . . . . . . 128 viii CONTENTS Break-Even Analysis . . . . . . . . . . . . . . . . . . . . . . . 129 Break-Even and Make or Buy Decisions . . . 132 Real Options . . . . . . . . . . . . . . . . . . . . . . . . . . 135 Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 135 Chapter 7 P roject Management . . . . . . . . . . . . . . . . . . 136 Managing Projects . . . . . . . . . . . . . . . . . . . . . . . . . 137 Project Success and Failure . . . . . . . . . . . . . . . . . 139 Project Selection . . . . . . . . . . . . . . . . . . . . . . . . . . 140 Project Implementation . . . . . . . . . . . . . . . . . . . . 143 Project Completion . . . . . . . . . . . . . . . . . . . . . . . . 149 Projects and KPI Trees . . . . . . . . . . . . . . . . . . . . . 152 Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 153 Chapter 8 S upply Chain Network Design and Location Analysis . . . . . . . . . . . . . . . . . . . . . 154 Business Strategy and Competition . . . . . . . . . . . 154 Supply Chain Network Design . . . . . . . . . . . . . . . 156 Location Selection. . . . . . . . . . . . . . . . . . . . . . . . . 158 ptg16393080 Cost Behavior . . . . . . . . . . . . . . . . . . . . . . . . . . . . 160 Supply Chain Network Modeling . . . . . . . . . . . . . 161 Case Example Mid-Atlantic Hospital System . . . . . . . . . . . . . . . . . . . . . . . 162 Network Design Analysis . . . . . . . . . . . . . . . . . . . 163 Capital Budgeting . . . . . . . . . . . . . . . . . . . . . . . . . 167 DuPont Model . . . . . . . . . . . . . . . . . . . . . . . . . . . 170 Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 173 Chapter 9 I nventory Management . . . . . . . . . . . . . . . . 174 How Much Inventory to Order . . . . . . . . . . . . . . 176 Total Inventory Costs . . . . . . . . . . . . . . . . . . . . . . 177 When to Reorder Inventory . . . . . . . . . . . . . . . . . 180 Inventory Reduction . . . . . . . . . . . . . . . . . . . . . . . 182 Safety Stock . . . . . . . . . . . . . . . . . . . . . . . . . . . 183 Just-in-Time . . . . . . . . . . . . . . . . . . . . . . . . . . 184 Inventory Tracking . . . . . . . . . . . . . . . . . . . . . . . . 185 Demand Forecasts . . . . . . . . . . . . . . . . . . . . . . . . 187 Financial Performance . . . . . . . . . . . . . . . . . . . . . 190 Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 192 CONTENTS ix Chapter 10 S ourcing and Supply Management . . . . . . . 193 Why Is Sourcing and Supply Management Important . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 194 Financial . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 194 Environmental . . . . . . . . . . . . . . . . . . . . . . . . 196 Social . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 197 Organizational Purchasing Structure . . . . . . . . . . 198 Sourcing and Supply Management Objectives . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 200 Purchasing Strategies that Support Organizational Goals and Objectives . . . . . . . 200 Supply Continuity to Support Operations . . . 205 Obtain and Develop Suppliers . . . . . . . . . . . . 208 Reasons to Outsource . . . . . . . . . . . . . . . . . . . 209 Selecting and Evaluating Suppliers . . . . . . . . 210 How Many Suppliers to Use . . . . . . . . . . . . . 211 Supplier Involvement and Development . . . . . . . . . . . . . . . . . . . . . . . . . 213 ptg16393080 Managing the Sourcing Process Effectively and Efficiently . . . . . . . . . . . . . . . 213 Supplier Location and Total Cost of Ownership . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 215 Purchase at Lowest Total Cost of Ownership . . . . . . . . . . . . . . . . . . . . . . . . . . . . 216 Supply Management and the Financial Connection . . . . . . . . . . . . . . . . . . . . . . 217 DuPont Model . . . . . . . . . . . . . . . . . . . . . . . . 217 Accounts Payable Turnover . . . . . . . . . . . . . . 220 Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 222 Chapter 11 S upply and Value Chain Metrics . . . . . . . . . 223 Supply Chain and Competition . . . . . . . . . . . . . . 224 A Case of Outsourcing Production . . . . . . . . . . . . 231 Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 236 Index . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 237