Managing Costs & Revenues

1. Managing Costs & Revenues Professor William F. O’Brien, MBA, CPA Spring 2012

2. Session 4 EVA® The Goal

3. Economic Value-added AnalysisEVA® • Measurement Alternative for Shareholder Value • Elements MANAGING COSTS AND REVENUES-2012

4. Sources of Capital -Debt -Equity Capital Buys “Stuff” “Stuff” Generates Income Let’s Define EVA® When the Cost of Capital is less than the Operating Income from that Capital, you create EVA®!!! MANAGING COSTS AND REVENUES-2012

5. EVA® Elements • Cost of Debt Financing • Cost of Equity Financing • Components of Capital • Adjusted Net Operating Income MANAGING COSTS AND REVENUES-2012

6. Cost of Debt Financing • Interest Expense • After-tax Impact • Consider all Debt, Excluding A/P MANAGING COSTS AND REVENUES-2012

7. Cost of Equity Financing • Shareholder Hurdle Rate • Price Appreciation • Dividend Rate • “Six Percentage Point” Rule MANAGING COSTS AND REVENUES-2012

8. Components of Capital • Net Working Capital • Net Long-lived Tangible Assets • R & D Spending • Employee Development Spending MANAGING COSTS AND REVENUES-2012

9. Adjusted Net Operating Income • Substitute R&D and Employee Development Costs with Annual Amort. • Use Net Income from Continuing Operations • Adj. Net Op. Income Minus Cost of Financing Equals Economic Value Added MANAGING COSTS AND REVENUES-2012

10. EVA® Uses • Planning Tool • Business Unit Evaluation • Incentive Compensation Base • Merger and Acquisition Analysis • Capital Asset Analysis MANAGING COSTS AND REVENUES-2012

11. Corporate Examples • CSX • Quaker Oats MANAGING COSTS AND REVENUES-2012

12. Ways to Raise EVA® • Increase Profits • Reduce Capital Spending • Reduce Investment in Working Capital • Increase High-margin Capital Investments MANAGING COSTS AND REVENUES-2012

13. EVA® Implementation • Top management buy-in • Make it a way of life • Implement Gradually • Keep it Simple • Train the users MANAGING COSTS AND REVENUES-2012

14. Theory of Constraints • The Concept • The Process • The Measures MANAGING COSTS AND REVENUES-2012

15. The Concept • Presented in Eliyahu Goldratt’s The Goal • The goal of a business is to make money…consistent with stakeholder satisfaction • Continuous flow • Avoid the “herbies” • Eliminate the bottlenecks first MANAGING COSTS AND REVENUES-2012

16. The Process • Identify the constraints • Exploit the constraints (reduce the bottlenecks) • Subordinate everything else • Elevate the constraints (remove the bottlenecks) • Reiterate the process MANAGING COSTS AND REVENUES-2012

17. The Measures • Throughput - Net income • Inventory - ROI • Ops. Expenses - Cash Flow MANAGING COSTS AND REVENUES-2012

18. Critical Questions from “The Goal” • What is the modified goal of “The Goal”? • Apply the “What” and the “How” to Alex. • What are Herbies…the boy and the process? • Is Jonah a crutch or catalyst? • Define Lou’s ethical dilemma. • Identify three critical measures from the book. • What’s your “Four on the Floor” from “The Goal”? MANAGING COSTS AND REVENUES-2012