Week3: Getting it together

Situation & Swot Analysis Draft Mission & Vision Statements & Select Growth & Competitive Strategies Formulate “functionally aligned” strategic & tactical decisions…

Process of Planning & Evaluating Strategy Corp. & SBU Strategy: Mission & Vision Growth & Competitive Strategy Market Research: Situation & SWOT Analysis Performance Assessment: Success Measures & Financial Ratios Functional Planning: Marketing Production R&D, HR Finance

Evaluating Strategy- Step #4: Performance Assessment “SHOW ME THE MONEY”

Let’s Examine: Ways to plan & evaluate your financial performance Some Financial Planning guidelines

Financial Proformas & Reports Cash Flow Income Statement Balance Sheet Financial Ratios

Shows cash movement in & out of organization & how much cash is available

Compares revenues & expenses for the period Indicates profitability

What Co. Owns What Co. Owes Who Owns Co. http://www.fool.com/school/valuation/howtoreadabalancesheet.htm

Financial Ratios Provide insights into company’s operations & strategy Used internally to evaluate performance & set goals Used externally to make investment decisions ROE ROA ROS Asset T/O P:E

Financial Ratios Answer 5 key Questions 1) How liquid is your firm? 2) How profitable is your Firm? 3) How effectively are you utilizing your assets ? 4) How are you financing your assets? 5) Are you providing your owners an adequate return on their investment ?

Your Company’s ratios as reported annually in the Capstone Courier

Financial Guidelines Re: Liquidity

IF Then You Produce a crappy product &/or Your Competitors produce a better product &/or You produce too much product IF You’ll be left w/less revenue than anticipated PLUS production & inventory carrying costs that must be paid.. Then

You’re left w/less revenue than anticipated and did not plan & allocate enough cash to cover your production & inventory carrying costs.... IF Then Big Al arrives -- pays your bills, and leaves you with a loan & a stiff interest payment

Maintain Adequate working capital & cash reserves In order to: Need to: Avoid a Liquidity Crisis- & “Big AL” Maintain Adequate working capital & cash reserves Have realistic/ accurate sales forecasts

Basic Steps of Sales Forecasting 1 2 3 4 BEST CASE WORST CASE Your Product/Total Customer survey scores = Demand

Enter WORSE case- in “your sales forecast” on marketing spreadsheet Enter BEST case- in “production schedule” on production spreadsheet Spread show up as inventory on proforma BALANCE SHEET

In WORSE CASE: You should observe lots of Inventory & little or no Cash. $0.00

Return to Marketing Spreadsheet. Enter your best case forecast. Observe that your Balance Sheet will now reflect: lots of Cash and no Inventory 000

Important Considerations re: BEST-WORST Scenario Analyses By adjusting your CASH POSITION according to your WORST CASE estimate– will avoid …

In WORSE CASE: You will have lots of Inventory & thus need to drive your cash position to the black… $0.00

Liquidity Guidelines To adjust your cash position -- If you are cash poor, issue Stock /Bonds ; or if necessary consider a short term loan If you are cash rich, pay dividends and/or buy back stock.

Important Considerations re: BEST-WORST Scenario Analyses By adjusting production according to BEST CASE estimate– will minimize loss of profit due to Stock-outs Fixed costs (marketing, R&D, interest or depreciation) already covered Thus, any additional sales would only incur variable (production) costs

For example, If your annual sales were $120M, in one month you’d sell $10M. If a months material & labor costs = $7M, you missed contributing $3M to Net Margin. This would be taxed in the simulation at 35%, so your opportunity cost is a missed $2M in profit.

Financial Ratios 2nd Key Question 1) How liquid is your firm? 2) How profitable is your Firm? 3) How effectively are you utilizing your assets ? 4) How are you financing your assets? 5) Are you providing your owners an adequate return on their investment ?

ROS---Return on Sales ROA—Return on Assets ROE-- Return on Equity Profitability Ratios Show how profitable company is ROS---Return on Sales ROA—Return on Assets ROE-- Return on Equity

Main ratio of Profitability Return on Sales “ROS indicates the percentage of each sales dollar that results in net income.” net profit net sales Return on Sales =

Financial Guidelines: Profitability

2) How Profitable is your Firm? ROS Contribution Margin

If your Contribution Margin is below 30%, … If your Contribution Margin is below 30%, …..the problem = combination of Marketing (customers hate your products), Production (your labor and material costs are too high), or Pricing (you cut the price too much). If your ROS is below 5%, but your Net Margin Percentage is above 20%, ….you either experienced some extraordinary "Other" expense like a write-off on plant you sold, or you are paying too much Interest (If TQM is enabled, you may also have spent heavily on TQM initiatives). If your Net Margin Percentage is below 20%, but Contribution Margin is above 30%,… the problem is heavy expenditures on Depreciation (perhaps you have idle plant) or on SGA (perhaps you are pushing into diminishing returns on your Promo and Sales Budgets).

Financial Ratios 3rd Key Question 1) How liquid is your firm? 2) How profitable is your Firm? 3) How effectively are you utilizing your assets ? 4) How are you financing your assets? 5) Are you providing your owners an adequate return on their investment ?

Drive Asset Turnover sales assets Asset Turnover = Reveals how effective assets are at generating sales revenue. The higher the better= more efficient use of assets sales assets Asset Turnover = $103,777/ $96,043 = 1.08 Firm can generate $1.08 in sales for every $1 assets

Drive- Return on Assets “ROA measures company’s ability to use all its assets to generate earnings.” net profit assets Return on Assets =

Financial Ratios 4th Key Question 1) How liquid is your firm? 2) How profitable is your Firm? 3) How effectively are you utilizing your assets ? 4) How are you financing your assets? 5) Are you providing your owners an adequate return on their investment ?

Assets/Equity – simulation takes owner's perspective. LEVERAGE: Assets/Equity – simulation takes owner's perspective. Corp assets fin.w/ debt Optimal Leverage     Assets Debt Equity 1.0   $1 $0 2.0 $2 3.0 $3 4.0 $4 A Leverage of 3.0 says, "For every $3 of Assets there is $1 of Equity 1.8 to 2.8

As your debt-to-assets ratio increases… Leverage from lenders’ perspective impacts bond ratings: AAA/AA/A/BBB/… BB & beyond is Junk… B/CCC /CC/C/D = default As your debt-to-assets ratio increases… Your short term interest rate increases… For each additional .5% increase in interest You drop one category

Last Key Question Are you providing your owners an adequate return on their investment

Owners evaluate profits w/ two stat’s: ROE (Return On Equity) ROE = Profits/Equity = Profits/Assets * Assets/Equity = ROA * Leverage. EPS (Earnings Per Share) EPS = Profits/Shares Outstanding

STOCK PRICE Function of: Book Value Equity/ # shares issued Earnings per Share (wgtg 2-3?) Net Profit/ Shares Dividend Policy (wgtg 5-8?)

Profitability * Asset Mgt * Leverage ROE Encompasses the 3 main levers used by mgt to generate return on investors equity Profitability * Asset Mgt * Leverage

Profitability * Asset Mgt * Leverage DuPont Formula Return on Equity = net profit equity sales assets x Profitability * Asset Mgt * Leverage

Return on Equity = Improve ROE by: net profit equity Increase sales w/out increase costs & expenses 2) Reduce COG or operating expenses 3) Increase sales relative to asset base- either by increasing sales or by reducing company assets 4) Increase use of debt relative to equity-- but only to extent it does not jeopardize firm’s financial position

Success Measures Cumulative Profits Ending Market Share ROS Asset Turnovers ROA ROE Ending Stock Price Market Capitalization (Ave # Shares) * (Closing Price) Performance Measures- Defined Performance Measures-Dynamics

Select Success Measures & Determine Relative Weightings Need to enter weightings – prior to round-1

Diff Strategies Play into Different Success Measures Cost Strategy = higher leverage/more investment/ more assets/more debt/ less equity Focused Strategies should operate more effectively & have overall less sales Profit MS SP & MC ROE pf/e ROS pf/s AT s/a ROA pf/a BCL L=2-3 X Cost- Niche & PLC B-Diff L=1.5-2 Niche-PLCDiff All Segments= more sales & thus enable greater Cum. profit & overall market share Differentiation Strategy =lower leverage/less investment/ less assets

It is important to look at the means used to achieve outcomes … It is important to look at the means used to achieve outcomes …. not just focus on the outcomes themselves To only focus on traditional financial accounting measures (such as ROA, ROE, EPS) …..does not give mgt the whole picture….

Performance needs to be judged thru mix of both financial & non-financial measures…. As some non-financial measures are drivers of financial outcomes

Management benefits from a multi-dimensional perspective which includes not only financial– but customer, internal & organizational learning/improvement perspectives as well…

The Logic STRATEGY Financial Perspective Customer Perspective "If we succeed, how will we look to our shareholders?” Financial Perspective "To achieve my vision, how must I look to my customers?” Customer Perspective "To satisfy my customers, at which processes must excel?” Internal Perspective "To achieve my vision, how must my organization learn and improve?” Organization Learning STRATEGY The Logic

What is measured gets noticed What is noticed gets acted on What is acted on gets improved Today … ~ 70% of Fortune 1,000 companies utilize a Balanced Scorecard to help manage performance— because…..

Basic Scorecard Terminology (Southwest Airlines Example) Strategy Map Strategic Theme: Operating Efficiency Measures How performance is measured against objectives Targets The level of performance or rate of improvement needed InitiativesKey action programs required to achieve targets Objectives: What the strategy is trying to achieve Profits and RONA Financial Grow Revenues Fewer planes Attract & Retain More Customers Customer On-time Service Lowest prices Objectives Fast ground turnaround Measures Targets Initiatives Internal Fast ground turnaround On Ground Time On-Time Departure 30 Minutes 90% Cycle time optimization Learning Ground crew alignment 17

A Complete Scorecard is a Program for Action Strategic Theme: Operations Excellence Objectives Measures Targets Initiatives Strategic Theme: Operating Efficiency Profits and RONA Financial Profitability Grow Revenues Fewer planes 30% +/yr 20% 5% Grow Revenues Fewer planes Attract & Retain More Customers More Customers Flight is on -time Lowest prices # Customers FAA On Time Arrival Rating Market Survey 12% growth Ranked #1 Customer loyalty program Quality management Customer On-time Service Lowest prices Internal Fast ground turnaround On Ground Time On-Time Departure 30 Minutes 90% Cycle time optimization Fast ground turnaround Ground crew alignment % Ground crew trained % Ground crew stockholders yr. 1 70% yr. 3 90% yr. 5 100% Ground crew training ESOP Learning Ground crew alignment 17

Capstone's Balanced Scorecard

Your Business Plan

BizPlan: Format & Contents- Guide