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

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

Let’s Examine: 1. Ways to plan & evaluate your financial performance 2. Some Financial Planning guidelines

Financial Proformas & Reports BalanceSheetFinancialRatios CashFlow IncomeStatement

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

Compares revenues & expenses for the period Indicates profitability Compares revenues & expenses for the period Indicates profitability

What Co. Owns What Co. Owes Who Owns Co.

Provide insights into company’s operations & strategy Used internally to evaluate performance & set goals Used externally to make investment decisions Provide insights into company’s operations & strategy Used internally to evaluate performance & set goals Used externally to make investment decisions Financial Ratios 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

You’ll be left w/less revenue than anticipated PLUS production & inventory carrying costs that must be paid.. IF You Produce a crappy product &/or Your Competitors produce a better product &/or You produce too much product 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: Have realistic/ accurate sales forecasts Avoid a Liquidity Crisis- & “Big AL” Need to:

Basic Steps of Sales Forecasting 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

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

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 … By adjusting your CASH POSITION according to your WORST CASE estimate– will avoid …

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

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. 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 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, 1. If your annual sales were $120M, in one month you’d sell $10M. 2. If a months material & labor costs = $7M, you missed contributing $3M to Net Margin. 3. 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 ?

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

“ROS indicates the percentage of each sales dollar that results in net income.” Main ratio of Profitability Return on Sales Return on Sales = net profit net sales net profit net 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%, 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%,… 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 Reveals how effective assets are at generating sales revenue. The higher the better = more efficient use of assets Asset Turnover = sales assets sales assets $103,777/ $96,043 = 1.08 Firm can generate $1.08 in sales for every $1 assets

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

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. A Leverage of 3.0 says, "For every $3 of Assets there is $1 of Equity Leverage Assets Debt Equity 1.0 $1 $0 $1 2.0 $2 $1 3.0 $3 $2 $1 4.0 $4 $3 $1 LEVERAGE: 1.8to2.8 Optimal Corp assets fin.w/ debt

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 Leverage from lenders’ perspective impacts bond ratings:

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

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

DuPont Formula Return on Equity = net profit equity salessalesassetsassetsequity xxxx Profitability * Asset Mgt * Leverage

Return on Equity = net profit equity Improve ROE by: 1)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 Improve ROE by: 1)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

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

TODAY’S Determine Relative Weightings for Your Selected Success Measures Enter weightings – in preparation for simulation: Practice Round #1 Determine Relative Weightings for Your Selected Success Measures Enter weightings – in preparation for simulation: Practice Round #1