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FINANCE FOR EXECUTIVES Managing for Value Creation. Gabriel Hawawini Claude Viallet. ASSESSING LIQUIDITY AND OPERATIONAL EFFICIENCY. EXHIBIT 3.1a: OS Distributors’ Balance Sheets. Figures in millions of dollars. DEC. 31, 1995. DEC. 31, 1996. DEC. 31, 1997. ASSETS. ·. $104.0. $119.0.

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FINANCE FOR EXECUTIVES Managing for Value Creation


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slide1

FINANCE FOR EXECUTIVES

Managing for Value Creation

Gabriel Hawawini

Claude Viallet

ASSESSING LIQUIDITY ANDOPERATIONAL EFFICIENCY

slide2

EXHIBIT 3.1a:

OS Distributors’ Balance Sheets.Figures in millions of dollars

DEC. 31, 1995

DEC. 31, 1996

DEC. 31, 1997

ASSETS

·

$104.0

$119.0

$137.0

CURRENT ASSETS

Cash1

$6.0

$12.0

$8.0

Accounts receivable

44.0

48.0

56.0

Inventories

52.0

57.0

72.0

Prepaid expenses2

2.0

2.0

1.0

·

56.0

51.0

53.0

NONCURRENT ASSETS

Financial assets & intangibles

0.0

0.0

0.0

Property, plant, & equip. (net)

56.0

51.0

53.0

Gross value3

$90.0

$90.0

$93.0

Accumulated depreciation

(34.0)

(39.0)

(40.0)

TOTAL ASSETS

$160.0

$170.0

$190.0

slide3

EXHIBIT 3.1b:

OS Distributors’ Balance Sheets.Figures in millions of dollars

DEC. 31, 1995

DEC. 31, 1996

DEC. 31, 1997

LIABILITIES AND

OWNERS’ EQUITY

·

$54.0

$66.0

$75.0

CURRENT LIABILITIES

Short-term debt

$15.0

$22.0

$23.0

Owed to banks

$7.0

$14.0

$15.0

Current portion of long-term debt

8.0

8.0

8.0

Accounts payable

37.0

40.0

48.0

Accrued expenses4

2.0

4.0

4.0

·

42.0

34.0

38.0

NONCURRENT LIABILITIES

Long

-term debt5

42.0

34.0

38.0

·

64.0

70.0

77.0

Owners’ equity6

64.0

70.0

77.0

TOTAL LIABILITIES AND

$160.0

$170.0

$190.0

OWNERS’ EQUITY

slide4

EXHIBIT 3.2a:

The Managerial Balance Sheet Versus the Standard Balance Sheet.

THE MANAGERIAL BALANCE SHEET

INVESTED CAPITAL OR NET ASSETS

CAPITAL EMPLOYED

Short-term debt

Long-term financing

Long-term debt

plus

Owners’ equity

Cash

Working capital requirement

(WCR)

Operating assets less Operating liabilities

Net fixed assets

slide5

EXHIBIT 3.2b:

The Managerial Balance Sheet Versus the Standard Balance Sheet.

THE STANDARD BALANCE SHEET

LIABILITIES

AND OWNER’S EQUITY

TOTAL ASSETS

Cash

Short-term debt

Operating assets

Operating liabilities

Accounts receivable plus Inventories plus Prepaid expenses

Accounts payable plus Accrued expenses

Long-term financing

Long-term debt plus Owners’ equity

Net fixed assets

slide6

EXHIBIT 3.3:

The Firm’s Operating Cycle and Its Impact on the Firm’s Balance Sheet.

D = Change in the balance sheet account

slide7

EXHIBIT 3.4:

The Firm’s Operating Cycle, Showing Cash-to-Cash Period.

slide8

EXHIBIT 3.5:

Extracts from Carrefour’s Balance Sheets and Income Statements.

Figures in millions of dollars

YEAR RECEIVABLES INVENTORIES PAYABLES WCR1 CASH2 SALES

1994 $68 $1,939 $5,296 –$3,289 $3,123 $27,260

1995 84 2,172 5,484 –3,228 3,281 28,922

Source: Company’s Annual Report.

1WCR = Working capital requirement = Receivables + Inventories – Payables

2Includes cash lent to other companies.

slide9

EXHIBIT 3.6:

OS Distributor’s Managerial Balance Sheets.

All data from the balance sheets in Exhibit 3.1; figures in millions of dollars

DEC. 31, 1995

DEC. 31, 1996

DEC. 31, 1997

INVESTED CAPITAL OR

NET ASSETS

• Cash

• Working capital requirement (WCR)1

• Net fixed assets

$12.0 10% 63.0 50%

51.0 40%

$126.0 100%

$ 8.0 6% 77.0 56%

53.0 38%

$138.0 100%

$ 6.0 5% 59.0 49%

56.0 46%

$121.0 100%

TOTAL INVESTED CAPITAL OR

NET ASSETS

CAPITAL EMPLOYED

• Short-term debt

• Long-term financing

Long-term debt

Owners’ equity

$ 15.0 12% 106.0 88%

$42.0

64.0

$121.0 100%

$ 22.0 17% 104.0 83%

$34.0

70.0

$126.0 100%

$ 23.0 17% 115.0 83%

$38.0

77.0

$138.0 100%

TOTAL CAPITAL EMPLOYED

1 WCR = (Accounts receivable + Inventories + Prepaid expenses) – (Accounts payable + Accrued expenses).

These amounts are given in Exhibit 3.1.

slide10

EXHIBIT 3.7:

The Behavior of Working Capital Requirement overTime for a Firm with Seasonal Sales.

WCR is assumed to be set at 25 percent of sales

slide11

EXHIBIT 3.8a:

OS Distributor’s Net Investment in Its Operating

Cycle and Its Financing.

All data from the balance sheets in Exhibit 3.1; figures in millions of dollars

DECEMBER 31, 1995

NET INVESTMENT IN THE OPERATING CYCLE OR

WORKING CAPITAL REQUIREMENTS (WCR)

WCR

= [Accounts receivable + Inventories + Prepaid expenses]

[$44 + $52 + $2] – [$37 + $2] =

$59

– [Accounts payable + Accrued expenses]

THE FINANCING OF THE OPERATING CYCLE

Net long-term financing (NLF)

=

Long-term debt + Owners’

equity – Net fixed assets

$50

$42 + $64 – $56 =

Net short-term financing (NSF)

= Short-term debt – Cash

$9

$15 – $6 =

NLF/WCR

=

percentage of working capital

requirement financed long term

84.7%

$

50/$59 =

NSF/WCR

=

percen

tage of working capital

15.3%

$

9/$59 =

requirement financed short term

100.0%

WORKING CAPITAL REQUIREMENT AND ITS FINANCING

15.3%

84.7%

WCR NSF $9

$59 NLF

$50

slide12

EXHIBIT 3.8b:

OS Distributor’s Net Investment in Its Operating

Cycle and Its Financing.

All data from the balance sheets in Exhibit 3.1; figures in millions of dollars

DECEMBER 31, 1996

NET INVESTMENT IN THE OPERATING CYCLE OR

WORKING CAPITAL REQUIREMENTS (WCR)

WCR

= [Accounts receivable + Inventories + Prepaid expenses]

[$48 + $57 + $2] – [$40 + $4] =

$63

– [Accounts payable + Accrued expenses]

THE FINANCING OF THE OPERATING CYCLE

Net long-term financing (NLF)

=

Long-term debt + Owners’

equity – Net fixed assets

$53

$34 + $70 – $51 =

Net short-term financing (NSF)

= Short-term debt – Cash

$10

$22 – $12 =

NLF/WCR

=

percentage of working capital

requirement financed long term

84.1%

$53/$63 =

NSF/WCR

=

percen

tage of working capital

15.9%

$10/$63 =

requirement financed short term

100.0%

WORKING CAPITAL REQUIREMENT AND ITS FINANCING

WCR NSF $10

$63 NLF

$53

15.9%

84.1%

slide13

EXHIBIT 3.8c:

OS Distributor’s Net Investment in Its Operating

Cycle and Its Financing.

All data from the balance sheets in Exhibit 3.1; figures in millions of dollars

DECEMBER 31, 1997

NET INVESTMENT IN THE OPERATING CYCLE OR

WORKING CAPITAL REQUIREMENTS (WCR)

WCR

= [Accounts receivable + Inventories + Prepaid expenses]

[$56 + $72 + $1] – [$48 + $4] =

$77

– [Accounts payable + Accrued expenses]

THE FINANCING OF THE OPERATING CYCLE

Net long-term financing (NLF)

=

Long-term debt + Owners’

equity – Net fixed assets

$62

$38 + $77 – $53 =

Net short-term financing (NSF)

= Short-term debt – Cash

$5

$23 – $8 =

NLF/WCR

=

percentage of working capital

requirement financed long term

80.5%

$62/$77 =

NSF/WCR

=

percen

tage of working capital

19.5%

$15/$77 =

requirement financed short term

100.0%

WORKING CAPITAL REQUIREMENT AND ITS FINANCING

WCR NSF $15

$77 NLF

$62

19.5%

80.5%

slide14

EXHIBIT 3.9a:

Some Benchmark Ratios of Working Capital

Requirement to Sales for a Sample of U.S. Sectors1.

WORKING CAPITAL REQUIREMENT

SECTOR AS PERCENTAGE OF SALES

1996 Highest 1992–96 Lowest 1992–96

Electronic components 24% 25% 22%

Aircraft 22% 22% 19%

Measurement instruments 21% 22% 21%

Steel works 20% 20% 18%

Motor vehicles 20% 20% 19%

Machinery & equipment 19% 21% 18%

Textiles 17% 20% 17%

Chemicals 17% 17% 14%

Wood products & buildings 16% 16% 14%

Apparel products 15% 17% 15%

Department stores 15% 19% 13%

Plastic products 14% 15% 14%

Computing equipment 14% 17% 14%

Retail: Nongrocery stores 12% 15% 12%

Paper 11% 12% 10%

AVERAGE: ALL SCORES 10% 11% 10%

1 Source: Calculated by the authors using Compustat data.

slide15

EXHIBIT 3.9b:

Some Benchmark Ratios of Working Capital

Requirement to Sales for a Sample of U.S. Sectors1.

WORKING CAPITAL REQUIREMENT

SECTOR AS PERCENTAGE OF SALES

1996 Highest 1992–96 Lowest 1992–96

Drugs 10% 13% 10%

Wholesale: Durables 10% 10% 7%

Soaps & perfumes 8% 8% 7%

Food 7% 7% 5%

Wholesale: Nondurables 5% 6% 5%

Telephone 3% 3% –2%

Oil & natural gas 2% 3% 2%

Publishing 2% 2% 1%

Beverages 1% 1% 0%

Electric services 0% 2% 0%

Grocery stores 0% 1% 0%

Natural gas: Distribution –1% 2% –1%

Services2 –1% –1% –5%

Air transportation3 –13% –11% –13%

2The services sector covers a variety of industries, including advertising, cleaning, data processing, research and development, and management consultancy.

3The air transportation sector covers scheduled and nonscheduled air transportation as well as air courier services and airports and terminal services.

slide16

EXHIBIT 3.10:

OS Distributor’s Management of Its Operating Cycle.

All data from the balance sheets in Exhibit 3.1 and the income statements in Exhibit 2.2; figures in millions of dollars

DEC. 31, 1995

DEC. 31, 1997

OBJECTIVE

To evaluate the overall efficiency with which the firm’s operating cycle is managed

Working capital requirement (WCR)1

Sales

Cost of goods sold (COGS)

Inventories

Accounts receivable

Average daily sales2

Accounts payable

Average daily purchases2,3

$77

$420

$59

$390

= 16%

= 15%

To evaluate the efficiency with which inventories are managed

$400

$72

$328

$52

= 5.6 times

= 6.3 times

To evaluate the efficiency with which accounts receivable are managed

$44

$390/365

$56

$480/365

= 41 days

= 43 days

To evaluate the efficiency with which accounts payable are managed

$37

$332/365

$48

$415/365

= 41 days

= 42 days

1 WCR is found in Exhibit 3.6.

2 We assume the year has 365 days.

3 Purchases are equal to COGS plus the change in inventories (see equation 3.11). In 1994, inventories were $48, thus purchases (1995) = $328 + ($52 – $48) = $332. Purchases (1996) = $353 + ($57 – $52) = $358; and purchases (1997) = $400 + ($72 – $57) = $415.

slide17

EXHIBIT 3.12:

OS Distributor’s Net Working Capital (NWC)

and Current and Quick Ratios.

All data from the balance sheets in Exhibit 3.1; figures in millions of dollars

DEC. 31, 1995

DEC. 31, 1996

DEC. 31, 1997

• NWC = [Current assets –

Current liabilities]1

• NWC = [Long-term financing2 –

Net fixed assets]3

• Current ratio = Current assets

Current liabilities

• Quick ratio = Cash + Accts receivable

Current liabilities

$119 – $66 = $53

$104 – $54 = $50

$137 – $75 = $62

($42 – $64) – $56 = $50

($38 + $77) – $53 = $62

($34 + $70) – $51 = $53

$119

$66

$137

$75

$104

$54

= 1.80

= 1.83

= 1.93

$12 + $48

$66

$8 + $56

$75

$6 + $44

$54

= 0.91

= 0.85

= 0.93

1 This is the traditional definition of net working capital.

2 Long-term financing = Long-term debt + Owners’ equity.

3 According to this definition, net working capital is the same as net long-term financing (see equation 3.4).

slide18

EXHIBIT A3.1:

Financing Investments Using a Matched Strategy.

slide19

EXHIBIT A3.2:

Financing Investments Using a Conservative Strategy.

slide20

EXHIBIT A3.3:

Financing Investments Using an Aggressive Strategy.