Featuring a new chapter on accountability and ethics, and complete with Excel templates, study questions, and a teaching guide on the Web www. As a manager, it's up to you to understand how and why.
Finance for Nonfinancial Managers helps you understand the information in essential financial reports and then shows you how to use that understanding to make informed, intelligent decisions. It provides a solid working knowledge of: Basic Financial Reports--All about balance sheets, income statements, cash flow statements, and more Cost Accounting--Methods to assess which products or services are most profitable to your firm Operational Planning and Budgeting--Ways to use financial knowledge to strengthen your company Briefcase Books, written specifically for today's busy manager, feature eye-catching icons, checklists, and sidebars to guide managers step-by-step through everyday workplace situations.
Look for these innovative design features to help you navigate through each page: Key Terms: Clear defi nitions of key terms and concepts Smart Managing: Tactics and strategies for managing change Tricks of the Trade: Tips for executing the tactics in the book Mistake Proofing: Practical advice for minimizing the possibility of error Caution: Warning signs for when things are about to go wrong For Example: Examples of successful change-management tactics Tools: Specific planning procedures, tactics, and hands-on techniques.
A source of invaluable expert advice on all the essential aspects of financial management within the context of running a business, it covers: business structures, accounting and financial statements, analysis and ratios, planning, budgeting, product and service costing, setting selling prices, investment appraisal, finance and working capital, taxation and international transactions.
This book explains financial literacy in the context of management, showing how improved awareness of finances can lead to increased value creation and protection for your business. Aimed at the practicing business manager, Financial Management for Non-Financial Managers includes case studies, spreadsheets and worked examples to accompany key skills and practices explained in the book.
Finance for Non-Financial Managers, Seventh Edition, offers a practical introduction to financial decision making for students with no previous exposure to accounting or finance principles or for those that want to broaden their understanding of financial analysis or upgrade old skills in the field of financial management and accounting.
This seventh edition improves the clarity and conciseness of many finance techniques and the relationship between the various concepts covered in the book, enabling students to master the language and concepts of finance and accounting to assist them in future careers as managers or entrepreneurs. The high-profile accounting scandals of recent years have made one thing clear: You can't know too much about the company for which you work.
What are the numbers? Where do you find them? How do they affect you and your staff? This fully revised and updated third edition of The McGraw-Hill Hour Course: Finance for Nonfinancial Managers provides a firm grasp on what all the numbers really mean. Designed to let you learn at your own pace, it walks you through: The essential concepts of finance, so you can ask intelligent questions and understand the answers Vital statements and reports, with sections on pro forma financial statements and expensing of stock options The auditing process--what is measured, how it's measured, and how you can help ensure accuracy and completeness With chapter-ending quizzes and an online final exam, The McGraw-Hill Hour Course: Finance for Nonfinancial Managers serves as a virtual professor, providing the curriculum you need to crunch the numbers like a pro!
Written in a conversational, easy-to-understand tone, the course treats finance and accounting from the perspective of users of financial information—it enhances their ability to communicate effectively with subordinates, other managers, senior executives, and accounting and finance professionals. It offers managers the ability to use and analyze financial information to improve the performance of their operations and to identify—and avoid—potential problems. The third edition includes discussion of the continuing transition of financial reporting to an international standard as well as consideration of the effects on accounting and finance resulting from the Recession of New sections on how to read an annual report and navigating the shifts in the marketplace are also included.
This edition has been updated throughout to provide managers with the most current and complete information available. Selected Learning Objectives Participants will learn how to: Prepare budgets Read, understand, and use financial and operational measures Manage short-term assets Relate department performance to the big picture.
If you want to take the course for credit you need to either purchase a hard copy of the course through amaselfstudy. The high-profile accounting scandals of recent years have made one thing clear: You can't know too much about the company for which you work. What are the numbers? Where do you find them? This letter indicates that the company holds those cast members in very high esteem. It presents, in a very direct manner, some very pointed themes.
Revitalizing underperforming areas home video and con- sumer products. Disney is focusing on some issues to address and wants us to know that it knows that these issues need to be addressed.
Achieving greater profitability from existing assets con- trolling costs. The letter describes the need for greater efficiency and indicates that the company need not re- main in all its current businesses forever.
Capital efficiency initiatives to drive long-term growth how best to invest. Disney has included outside partners in many of its ventures and to some extent is becoming a theme park management company. This provides more focus on and cash from its core competencies.
Continued product development being Disney. Disney is an entertainment company that is quite successful in its cross-branding strategy. Its parks, cruises, movies, TV and cable, and consumer products mostly carry the Disney brand and cross-sell one another. Management Discussion and Analysis This section of the annual report provides an extensive, some- what detailed review of the past year.
In paragraph form, the company discusses its financial results in considerable detail. This is referred to as segment reporting. Many years ago, when companies diversified into somewhat unrelated businesses, it became difficult for analysts to bench- mark these companies against their competitors because their business identity was difficult to determine. The result was a re- quirement that a company include in its annual report financial information for each of its business segments.
While segment reporting provides only summary information, it is competitively valuable. DuPont also reveals that the risk- adjusted hurdle rate the company uses to evaluate capital expen- ditures is 15 percent.
The significance of this is discussed in Chapter 10 of this book. This part of the report is called an outlook. Management must be very careful about this presentation. It might cause existing and potential in- vestors to make decisions about their investments in the com- pany that may have an undesirable outcome. It makes the following statement: The Private Securities Reform Act of the Act provides a safe harbor for forward-looking statements made by or on behalf of our company.
Management believes that all statements that express expectations and projections with respect to future matters, including. Management is rightly protected from litigation over these views; if it were not, it could not afford to take the risk of presenting its assessment.
Imagine the political and legal issues that would arise if the company had to publish its budget. They might even be worse if actual perform- ance exceeded budgeted projections. No forecast numbers are provided, and rightly so.
Only strategies and issues are in- cluded in the discussion. It is addressed to the stockholders of the company, to whom the accounting firm reports, and sometimes also to the board of di- rectors. When the company sends out the notice of the annual meeting, it will include a proxy statement that identifies the major issues that will be decided by shareholder vote at the an- nual meeting. No alternative CPA firm is presented.
The Audit Process. A staff of internal auditors regularly monitors the adequacy and application of internal controls on a worldwide basis. These are both multinational CPA firms with offices in most parts of the world and thousands of partners. Auditors ensure that transactions were recorded correctly.
They verify the accuracy of the financial statements and the many estimates that were made by management. All publicly traded companies in the United States are required to have their financial statements audited. Most large private companies have their financial statements audited, as well. This process is be- coming global, as it facilitates international transactions and ven- tures. The Letter. The CPA firm writes a letter to the stockholders.
Our responsibil- ity is to express an opinion on these financial statements based upon our audit. We conducted our audit in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to ob- tain reasonable assurance about whether the financial state- ments are free of material misstatement. An audit also in- cludes assessing the accounting principles used and signifi- cant estimates made by management This letter has some very interesting features that provide in- sights into the accounting and audit processes.
The first sentence makes it very clear what role Arthur Andersen played: It audited. The next statement confirms that Merck is responsible for the numbers.
Arthur Andersen expresses an opinion on the financial statements. This is a very simple term that has been the subject of an incredible amount of controversy over the years. The letter does not refer to a warranty or fact. The burden is on Merck to prove that assets are listed at the lower of cost or market and that all other accounting principles have been adhered to. The last statement in the letter confirms that the financials reflect estimates. Depreciation expense is based upon the esti- mated number of years that the machinery will last.
Reserve for bad debts is an estimate of the portion of the accounts receivable that will not be collected. The pension fund calculation is based upon projections of how much employees will have earned when they retire and how many employees will be eligible. These esti- mates are based on the best available information, but they are nonetheless estimates.
After all of the accounting and auditing work has been done, the CPA firm will provide one of three responses. An unqualified opinion really means an opinion without qualification or reserva- tion. It indicates that the company being audited has done a very good job in keeping its books and preparing its financial state- ments in accordance with generally accepted accounting princi- ples.
This is usually an interpretation of a GAAP issue or the accounting for a single business event, such as the purchase or sale of a business. If the client company is in serious fi- nancial trouble, to the point that its continuance as an ongoing business is in question, the audit letter will also discuss this issue.
No opinion or an adverse opinion results when the account- ing books are in such disarray that the auditors cannot confirm the numbers. Control procedures may be poor or absent. Ac- counting irregularities will certainly trigger this result, as will a pattern of not adhering to GAAP. As a general rule, changing CPA firms is not something that a major company does casually. The relationship between the company and the firm has been built up over many years and involves a considerable degree of coop- eration and trust.
If the CPA firm resigns or is asked to do so, this is usually evidence of severe disagreements over the accounting process or reporting of results. Footnotes The footnotes to the financial statements are a critical part of the annual report presentation and also contain some useful infor- mation: 1. Prices of transactions are sometimes included. We can see how the company manages the risk associated with being global.
For example, Merck provides an analy- sis that includes currency rates, commodity prices, and interest rates. We can learn how the company deals with legal and envi- ronmental issues. This can be an excellent way for you to focus in on those seg- ments against which you compete.
Other Important Information in the Annual Report 1. Financial and statistical information for five or ten years is often included. It is interest- ing to compare the ten-year history with the behavior of the U. This may provide some indication of how economic events affect the company and how the company deals with this environment.
A list of the management team and the board of directors is given. Outside directors who are or were CEOs of other companies may become candidates for the top job at this company if the management team does poorly and an outside perspective is required. The annual report also provides certain corporate infor- mation that appears to be routine.
Shareholders had very few rights other than the right to sell their shares if they were not happy with their investment. What happened over time was the development of a group of people known as shareholder activists. It would be reasonable to assume that company managements used descriptions of these people that were much less friendly.
For a long-term perspective on this movement, every businessperson should know about the Gilbert brothers, John and Lewis see sidebar. The Gilbert Brothers— The Original Shareholder Activists Background If you saw the movie Wall Street, you saw Michael Douglas as Gordon Giecko browbeat the board of directors of a multina- tional company because the directors were arrogant and de- tached from the needs of the stockholders and the company.
They were making big salaries and bonuses even though the company was not performing well. There were too many senior executives who were not doing much except consuming time and space. This is not make-believe. In fact the role was mod- eled on two real-life people, John and Lewis Gilbert. Everyone in business and everyone who is interested in the stock market should know what they did. Their Contribution The Gilbert brothers were born early in the century in very fi- nancially comfortable circumstances.
They were the original shareholder activists. Stockholders should receive adequate notice of sched- uled annual meetings. Stockholders should receive audited financial statements before the annual meeting. Annual meetings should be held in a location that is geo- graphically convenient, so that some shareholders can actually attend.
An issue in the Transamerica lawsuit, de- scribed later, was that the insurance company held its an- nual meetings in Delaware rather than in California, where its operations and many shareholders were located. The tradition of remote locations for annual meetings has been changed.
Shareholders can present resolutions for shareholder vote. In , the Securities and Exchange Commission ruled that not only can shareholders present resolutions for a vote, but that their proposals must be circulated to other shareholders at company expense.
Shareholders can ask questions at annual meetings and actually expect that these questions will be answered. It was common in the s for annual meetings to be filled with company employees who would shout down any stockholder who made an unfavorable comment.
Putting executive pay in the proxy statement had its effect as early as The chair- man of Bethlehem Steel had to take a pay cut after receiv- ing pressure from the Gilberts. Auditors are elected by shareholders, not by manage- ment. Stockholder proposals are included in proxy statements. In , the Gilbert brothers sued Transamerica Insurance Company because management refused to include in its proxy statement proposals that the Gilberts had made.
These issues seem somewhat obvious in this modern day of shareholder activism and the availability of seemingly unlimited amounts of information through the Internet. When Lewis and John Gilbert hit their full stride in the s, the opposite was true. They are known to have annoyed more than one board chairman with their questions, stockholder resolutions, and challenges.
The Effort Continues Many years ago, the brothers created a foundation, appropri- ately called Corporate Democracy, Inc. A team of ten has been organized that travels to many dozens of annual meetings, wherever and whenever they may be held. Meetings that can be reached only after multiple plane rides and car rentals still occasionally occur, but not nearly as frequently as in the past.
The team still reports the existence of nonresponsive CEOs. In addition to the activities of this team, Securities and Exchange Commission regulations have increased accountability, and the Internet has vastly expanded the availability of information. However, the effort continues, building momentum for a proc- ess that began many years ago. In fact, these analysts were often made aware of information before it was made available to the general public.
They could then ad- vise their clients of critical developments before the general public was aware of them. To prevent the perception and the fact that the fa- vored few were privy to valuable, otherwise private information, companies are beginning to invite everyone to listen in on their conference calls.
Major developments are now often announced to everyone at the same time, either through press releases or through SEC filings. All of this has come about because of the original shareholder activists. It contains all the reports required by regulatory agencies that are contained in the annual report, and more besides. There is no public relations information or photographs. Some 10K reports contain considerable informa- tion about the directors and executives, similar to what is given in the proxy statement.
It would be helpful if every company were this honest and forthright in assessing its future. The company also describes in considerable detail how it is cop- ing with each of these risks. It would be valuable to learn what your company and its competitors identify as the risks that might affect its chances of being successful in the future.
The Proxy Statement The proxy statement is the package of information that each shareholder receives as part of the annual meeting announce- ment. Shareholders get to vote for: The annual contract with the CPA firm Members of the board of directors Proposals to change corporate bylaws Executive stock option and incentive plans Proposals submitted by shareholders The votes are always yes or no options, and the proxy almost always indicates the vote that is recommended by the board of directors.
The proxy statement also includes other information that is of great interest: 1. Notification of the fact that a list of all shareholders is available at corporate headquarters and at the annual meeting.
This is of special interest to shareholder activists like the Gilberts who seek to arouse interest in a particular issue. It is also valuable to potential acquirers of the com- pany, who need to communicate with shareholders to seek support for their efforts. A list of the members of the board of directors, their affil- iations, and their compensation. Board members may re- ceive an annual retainer, a fee for each board meeting, a fee for each committee meeting, stock options, and de- ferred compensation.
The compensation package for each corporate officer, in- cluding deferred compensation and stock options. It is a very positive situation if every director and corporate of- ficer has a stake in the success of the company, and if their rewards are commensurate with that success, or its absence. A description of executive pension and severance pack- ages. There has been considerable negative press cover- age concerning departed executives who were paid more for leaving involuntarily than they were compensated when they were employed.
The rationale is that their stay- ing with the company would have been more expensive. The first is from the company itself. The second is through a service provided by a company called Public Register. The service provides the annual reports of thousands of companies. The web site is www.
Reports are usually received within two business days. This service is free. The Wall Street Journal has a very similar service.
The phone number is Order forms can also be faxed. It is helpful to get a hard copy of the listing of companies even if you use the Wall Street Journal or Public Register Web sites. The most comprehensive of these services is Morningstar Reports. Morningstar is a Chicago-based organization that is a leading provider of investment information, research, and analy- sis.
It can easily be accessed through America Online. Profitability ratios include gross profit per- centage, operating margin, and return on sales. The most interesting and helpful section of the report com- pares the ratios of the subject company with the average ratios for its industry. The benchmarking value of this information is extraordinary. To make the information even more valuable, if that were possible, at the end of the ratios section are the stock symbols of the other forty-nine companies in the chemical database.
Each of these other companies can also be accessed. The Securities and Exchange Commission The Securities and Exchange Commission SEC is a federal gov- ernment, executive branch agency responsible for assuring fair- ness in the securities markets. This law, together with the Securities Act of that preceded it, requires public companies to provide investors with financial and other significant information about securities being offered to the public. These laws also prohibit deceit, misrepresentation, and fraud in the sale of securities.
By requiring these companies to register their securities, the SEC provides the public with the information they need if they are to make informed investment decisions. SEC rules also govern the solicitation of shareholder votes; proxy statements must be filed with the SEC before the solicita- tion actually occurs. A tender offer is an offer to purchase shares in large quantities.
Tender offers are often announced in the Wall Street Journal in an advertisement called a tombstone. Many people or companies that anticipate making an unfriendly tender offer one that the buyer expects the target company to resist often purchase 4.
Once their holdings exceed 5 percent and their intentions become public, the stock price will move up. Therefore, the buyers will keep their holdings below the threshold until as late in the process as possible in order to keep their intentions secret.
The securities laws also govern the actions of insiders. The term insider has two meanings. The legal definition is officers, directors, and anyone who holds more than 5 percent of the stock. These insiders may certainly buy and sell shares, but they must notify the SEC of their transactions. However, anyone who has critical information not available to the general public, far beyond just company management, can also be considered an insider and may not trade the stock on the basis of that informa- tion.
Morningstar Reports provides information about manage- ment purchases and sales of company stock. These SROs must create and enforce rules for their members that re- quire them to conform to the SEC regulations and must provide disciplinary proceedings for those whose actions are in violation of these rules but fall short of what is considered criminal.
This ensures market integrity and investor protection. They help the company to determine whether trends are improving or deterio- rating. They are calculated by comparing two numbers with each other. The most valuable use that can be made of ratios is to compare the ratios for this year with the same ratios for the previ- ous year and with the ratios of other companies in a similar busi- ness.
Ratios also serve as goals for future performance. Statistical Indicators Many of us use statistical indicators, many of which are actually ratios, to monitor the business. These statistical indicators are very much the domain of in- ternal management.
While internal statistical information would certainly be interesting and might be valuable to outsiders, they have little or no access to it. Interestingly, in the automobile busi- ness, information concerning units produced, units sold, and available inventory are public information.
But this is an excep- tion. First-level line managers in both sales and operations re- quire detailed statistical information on a regular basis—and fre- quently. Operations supervisors fine-tune machinery, redeploy labor resources, and manage the logistics of inventory.
Sales managers direct daily or weekly sales calls, schedule appearances at trade shows, and determine immediate customer satisfaction. Financial Ratios Financial ratios provide more of an overview. These include: External Security analysts Potential and existing stockholders Bankers and other lenders Suppliers and their credit managers Competitors Regulators Internal Board of directors Senior management Operations, sales, finance, human resources, marketing Strategic planners Each of these groups has its own perspectives and needs.
The value of statistical indicators has been discussed. Many business and en- vironmental factors have been identified. As mentioned pre- viously, the most valuable use that can be made of ratios is to look at them as part of a trend and to compare them with the same ratios for competitors. Financial ratios can be divided into four major groupings: 1.
Liquidity ratios 2. Working capital management ratios 3. Measures of profitability 4. What follows is an extensive description of the key ratios, pre- sented with very workable definitions. There are two commonly used ratios that help to evaluate this, the current ratio and the quick ratio. Current Ratio The current ratio compares current assets with current liabilities. This is a clear indication that the company has liquid- ity problems. However, a ratio in excess of 1. Higher is not necessarily better.
The ratio can be high because the company has too much inventory or does a poor job of collecting its ac- counts receivable in a timely manner. Conversely, the ratio can be low because the company does not have or cannot afford the levels of inventory necessary to serve its customers in a competi- tive manner.
Key Financial Ratios 83 An appropriate ratio can be intelligently developed by evalu- ating each individual component. The questions to be answered include: How much cash and near cash does the company need in order to pay its bills and manage its very short-term liquidity?
What credit terms should the company offer its customers as part of its strategy to satisfy those customers? What levels of finished goods inventory are needed to serve the marketplace? How much raw materials and components inventory is required to assure efficient production operations? These and other questions need to be answered in order to determine the current ratio that the company should try to achieve. So, an ex- ample of the target ratio to assure intelligent asset management might be 1.
Bank debt and accounts payable have increased, primarily to finance the much higher levels of inventory. As long as the interest on the bank debt and the conditions or restrictions imposed by the loan are not too burdensome, there does not appear to be a problem.
The ratio itself remains at a reasonable level, especially for a manufacturing company. It is the same as the current ratio except that it does not include inventory. When a company is owed money by its customers accounts receivable , it has already done its work; it has fulfilled its commitment by delivering fine products and services. Whatever money was necessary to accom- plish this has already been spent. Raw materials and work-in-process in- ventory have not yet become finished products.
There is still work to be done, and funds still must be spent. While finished goods inventory has been completed, it has not yet been sold and delivered. Therefore, inventory is not a very liquid asset. It is classified as a current asset because it is expected to be turned into cash in less than a year, possibly within six months or even two months. Thus, it is a liquid asset when compared to fixed assets and long-term investments, but it is not liquid in the way that marketable securities and accounts receivable are.
Given all of this, a quick ratio in the vicinity of 0. Because a service business has no or little inventory, its current and quick ratios will be the same number.
We will examine these issues further when we analyze working capital management. Exceptions to Comfortable Levels There are exceptions to our prior statement concerning comfort- able levels for these liquidity ratios. Working Capital Management Ratios These ratios and measures assist a company in evaluating its per- formance regarding the management of the credit function, as reflected in accounts receivable, and also the management of in- ventory.
Credit terms are provided because giving credit helps to sell product. This should be measured against the credit terms of sale. If credit terms are 30 days, a collection period of 40 to 42 days should be perceived as acceptable. Cash sales, if any, should be excluded from the calculation.
The salespeople proba- bly are not communicating the terms of sale clearly, if they are communicating them at all, and collection procedures overall need to be improved.
To analyze the receivables management further, and to ensure that this conclusion is not distorted by statistical or seasonal aberration, the finance manager should also prepare an aging of accounts receivable. Aging of Accounts Receivables An aging of accounts receivable is a detailed listing of how long the company has been waiting for its customers to pay their bills. Generally, much of the accounts receivable balance will not yet be due, as the amounts will have been billed less than 30 days earlier.
A considerable sum might be more than 30 but less than 45 days old, or less than 15 days overdue. The probability that the company will be able to col- lect those that are over 60 days old is not good.
The collections people in the accounting department clearly have challenges ahead if they are to get that money. The desirability of continuing to do business with those customers should be evaluated.
Those customers whose receivables are in the to day range should receive some attention before they too become a worsen- ing problem. Clearly, Metropolitan Manufacturing must change its attitude and those of its customers and begin to change some of its philosophies and practices.
Receivables Management Can Be Improved Reducing accounts receivable without jeopardizing sales volume is a very effective way for your company to improve its cash flow. The following list gives basic concepts of credit management that you should consider when you are negotiating with existing and potential customers. Not every idea will work in all situations, and some of these ideas may not be appropriate for your busi- ness at all. Be aware that credit is a sales tool. Credit is granted to customers permitting them to defer payment on mer- chandise that they already possess and are benefiting from in order to motivate them to buy and in order to provide an additional competitive advantage.
Will it motivate the customer to buy more or buy again? You are entitled to your money. You have earned it; you have spent money to make the sale, and you have provided the customer with the finest product or service of its kind. Never make the extension of credit automatic. Train your sales, service, and delivery people to reinforce your credit strategies. Cheerfully extend credit if the customer asks for it and de- serves it.
Ask the customer how much time he would like to have. Never extend credit for an automatic 30 or 60 days. Some customers will ask for less credit than you would otherwise have granted. Customers will pay faster in order to maintain credibility with a very important sup- plier. Train your customers to pay fast. Understanding that old habits die slowly, let the quality of your products and ser- vices, rather than your willingness to be a banker, be their motive for buying from you.
Get the clock ticking. Agreed-upon credit terms should start the day the product is delivered, not the day the in- voice is mailed.
Mail out invoices and statements more frequently. This is effective and is rarely noticed. Give the customer the invoice upon delivery, if possible. This re- duces mailing expenses and makes the customer even more conscious of the responsibility to pay you fast.
Never apologize for asking for your money. You earned it by providing the finest products and services in your mar- ketplace. Search for opportunities to reduce your outstanding receiv- ables. Start slowly, with your new customers and your least desirable existing customers. Train them and those who work for you. Set yourself a six-month target and work toward it. Watch your bank account grow. It describes the relationship between the cost of the product sold over the course of a year and the average inventory the company maintained to support those sales.
Of course, determining the appropriate amount of inventory for a company is much more complex than calculating this ratio, however valuable the ratio may be. Efficiency of Production. The more efficient the production operations are, the less finished product a company must maintain. If operations are inefficient, the company will have to have a safety stock of finished product to assure adequate customer service.
A company that makes prod- uct without an order in hand will have to maintain extra inven- tory because of the uncertainty associated with what products customers will demand. A company that makes product in re- sponse to specific orders, especially custom-designed product, will require very little or no inventory on hand other than the inventory that is being accumulated for shipment.
Forecasting Sales. The more effectively a company can pre- dict what its customers will want, the less finished product inven- tory it will require. Lead Times. The more notice that the customers give the company concerning their product requirements, the less extra inventory the company must maintain.
Low-value-added distributors must have adequate supplies of almost everything on hand in order to serve their customers and be competitive.
In fact, their value added is precisely their having everything on hand, ready for immediate delivery or pickup. The ultimate low-value-added business is a supermarket.
It changes the nature or content of the product very little; all it does is take crates of twelve or more items, open them, and put the contents on convenient shelves. Its value added is having 35, of these products in one large, clean, comfortable room. Key Financial Ratios 91 And, a supermarket cannot run out of any essential items and hope to keep its customers happy.
Number of Warehouse Locations. Some companies serve their entire marketplace from a single warehouse. This is efficient if the marketplace is geographically concentrated and can be properly served from that one location. It can be effective even if the marketplace is national in scope if the product is very valu- able or orders are very large, making transportation a small part of the total cost. It can also be effective if deliveries are not too time-sensitive, so that surface or ocean transportation can be used.
However, in the absence of any of these conditions, many businesses must use a network of warehouses, and perhaps even satellites of those warehouses, to serve their customers. If a com- pany has warehouses at multiple locations, inventory levels rela- tive to volumes sold will be higher than those of a business with a single warehouse.
Safety stocks will also be higher to protect against transportation uncertainties. Minimum stocks of each product line must be stored in order to assure customer service. The offset to these higher costs and inventory levels should be more timely customer service and more efficient transportation, with products being transported in bulk over the long distances from the factory to each warehouse rather than being trans- ported individually over the long distances from the central warehouse to each customer.
A financial analysis of these alter- natives should be provided to assure cost efficiency. Product Diversity. The greater the variety of products that a company manufac- tures, the greater the amount of raw materials and components that it must keep on hand.
For each type of product, the com- pany needs to have a minimum stock of materials and compo- nents on hand. Com- monality of components contributes considerably to the mini- mization of inventory.
An excellent example of this is the automobile industry. Many different models of cars actually have many components, including the frames, in common. Supply Chain Management. Technology has had a dramatic impact on inventory management and has resulted in drastic re- ductions in all forms of inventory.
When a company goes online with its vendors, its product needs are automatically communi- cated to those vendors electronically. This shortens lead times, reduces mistakes, and accelerates the supply process.
Greater competitive intensity forces suppliers to provide faster delivery of high-quality products. Safety stock can be reduced when quality problems are reduced. Technology, especially the business-to-business B2B capabilities of the Internet, has created both incredible supply chain turmoil and incredible op- portunity at the same time.
On the other hand, product web sites and transportation logistics have created a nationwide supply mar- ket. Companies used to buy product from relatively local ven- dors. Now they can access the Internet and locate suppliers all over the country. The intensity of the resulting competition, along with very dependable transportation support from compa- nies like Federal Express and UPS, leads to lower purchase costs, shorter lead times, and less inventory. In this example, for simplicity, I have used ending inventory.
The inventory turnover ratio for Metropolitan Manufacturing Company is quite low. Perhaps Metropolitan is a very vertically integrated manufacturing company.
Or perhaps Metropolitan is in a service-intensive business with short lead times, resulting in a need for vast quantities of finished goods inventory. Or the company could be purchasing raw materials inventory in large quantities in order to take advantage of quan- tity discounts. Alternatively, the high levels of inventory could be the result of gross inefficiencies, ineffective purchasing, and overly optimistic sales forecasts that are not being achieved. They focus on: Profitability achieved by the management team Assets invested in the business Revenue achieved by the business The funds that the owners have invested in the business Some review of terms will be helpful.
The line numbers used here and later in the chapter refer to the financial statements in Chap- ters 1 and 2 Exhibits and Revenue: The value of products and services sold. Cost of goods sold: The cost of the labor, materials, and manufacturing overhead used to produce the products sold. General and administrative expenses: The cost of op- erating the company itself; this category includes all other support spending necessary to conduct the busi- ness.
Depreciation and other noncash expense.
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