supply chain finance: fundamentals for supply chain professionals

The 5th Annual Orthopaedic Manufacturing and Technology Exposition and Conference

1June 24, 2009

Supply Chain Finance:Fundamentals for Supply

Chain Professionals

Samuel C. Weaver, PhD

Swartley Professor of Finance

Lehigh University


2June 24, 2009

Agenda

• Financial Statements as a Business Tool• Financial Statement Analysis

– Managing your business– Reviewing competitors – Evaluating customers– Analyzing suppliers

• Overview of Supply Chain Finance• Evaluating Investments


3June 24, 2009

Samuel C. WeaverSwartley Professor of Finance

Lehigh UniversityRauch Business Center

621 Taylor StreetBethlehem, PA 18015

[email protected]


4June 24, 2009

Financial Statements as a Business Tool


5June 24, 2009

Primary Financial Statements• Income Statement

– Business performance and income generation over a period of time.

– Sales less Expenses = Income

• Balance Sheet– What you own (assets) and what you owe (liabilities) at

any point in time.– Assets = Liabilities + Equity– Current vs. Long-Term: Assets and Liabilities

• Cash Flow Statement– Where does your cash come from and where does it go?– Operations, Investing, and Financing


6June 24, 2009

Financial Statements

Income Statement

BalanceSheet

Cash Flow Statement

Sales Current Assets Cash from Operations

Expenses Long-term Assets Cash (Used for) Invest

Income Total Assets Cash from Financing

Current Liabilities Cash Flow

Long-term Liabilities

Stockholders’ Equity

Total Liab & Equity


7June 24, 2009

Timing of Primary Financial Statements

Cash Flow Statement

December 31, 2007Balance Sheet

December 31, 2008Balance Sheet

2008Income Statement


8June 24, 2009

Financial Statements:Distinction Between Cash and Other Accounts

• Cash Accounting vs. Accrual-Based Accounting• Not all Expenditures are Expenses

– Expenses: Benefits consumed in one-year.• Wages and salaries, supplies, etc.

– Capital Expenditures: Benefits consumed over a number of years.

• Equipment, buildings, land, etc.

• Not all Expenses are Expenditures– Non-Cash Expenses

• Depreciation, warranty, etc.


9June 24, 2009

Financial Statement Focus

• Corporate Level• Divisional Level• Economic Business Unit or

Manufacturing Unit• Cost Center or Project Level• Product or Customer Profitability


10June 24, 2009

• Period of Time– Current Month

• Or Shorter• Partial or Full

Financials

– Year-to-Date– Full Year

• Comparison– Actual vs. Plan– Actual vs. Prior Year

• Full Year Focus– Plan – Forecast (Outlook)– Prior Year

Internal Company Income Statements


11June 24, 2009

Hypothetical Cost Center ReportCurrent Month

MAY Variance-Better (Worse) Variance-Better (Worse)Actaul Budget $ % Prior Year $ %

Saleries 22,500$ 25,000$ 2,500$ 10.0% 23,787$ 1,287$ 5.4%Over Time Wages 100 300 200 66.7% 81 (19) -23.5%

Total Salaries and Wages 22,600 25,300 2,700 10.7% 23,868 1,268 5.3%

Travel - Auto 723 600 (123) -20.5% 573 (150) -26.2%Travel - Other 2,571 3,000 429 14.3% 3,531 960 27.2%Meals 322 250 (72) -28.8% 433 111 25.6%Lodging 897 1,000 103 10.3% 719 (178) -24.8%Meeting Expense 65 500 435 87.0% 575 510 88.7%Conference Expense 700 200 (500) -250.0% 125 (575) -460.0%

Total Travel Expense 5,278 5,550 272 4.9% 5,956 678 11.4%

Office Supplies 79 100 21 21.0% 89 10 11.2%Computer Supplies 43 100 57 57.0% 289 246 85.1%Computer Equipment 1,467 - (1,467) n/a - (1,467) n/aCopying Expense 25 20 (5) -25.0% 7 (18) -257.1%Postage 10 20 10 50.0% 56 46 82.1%UPS Expense 72 85 13 15.3% 115 43 37.4%

Total Office Expense 1,696 325 (1,371) -421.8% 556 (1,140) -205.0%

Training Expense 2,700 2,400 (300) -12.5% - (2,700) n/aTuition Reimbursement 1,830 1,830 - 0.0% 3,600 1,770 49.2%Consulting Expense - - - n/a 15,275 15,275 100.0%Miscellaneous Expense - 50 50 100.0% 27 27 100.0%

Total Cost Center Expense 34,104$ 35,455$ 1,351$ 3.8% 49,282$ 15,178$ 30.8%


12June 24, 2009

Income Statement

(P&L Statement)


13June 24, 2009

Income Statement($ millions, except earnings per share)

Arthro- Smith &Care ConMed Nuvasive Orthofix Nephew Stryker Wright Zimmer

Total revenue 319.2$ 646.8$ 250.1$ 519.7$ 3,801.0$ 6,718.2$ 465.5$ 4,121.1$

Cost of products sold 84.7 334.0 44.3 152.0 1,077.0 2,131.4 134.3 997.3

Gross profit (income) 234.5 312.8 205.8 367.7 2,724.0 4,586.8 331.2 3,123.8

Research and development 26.9 30.7 25.9 30.9 152.0 367.8 33.3 194.0 Selling, general and administrative 147.2 234.8 186.8 288.7 1,942.0 2,625.1 261.4 1,702.3 Other expense (income) - recurring 7.2 5.2 20.9 17.1 - 40.0 7.4 -

Operating profit (loss) - recurring 53.2 42.1 (27.8) 31.0 630.0 1,553.9 29.1 1,227.5

Other operating expenses - extraordinary - 46.7 - 287.9 - 34.9 6.7 137.5

Operating profit (loss) 53.2 (4.6) (27.8) (256.9) 630.0 1,519.0 22.4 1,090.0

Interest and other, net 2.2 19.8 0.3 (38.1) 66.0 (61.2) 0.8 31.8

Earnings before income taxes 55.4 (24.4) (27.5) (295.0) 564.0 1,580.2 21.6 1,121.8

Provision for (benefit from) income taxes 12.2 (11.9) - (66.4) 187.0 432.4 18.4 272.3 Other (income) expense, net - - - - - - - (0.9)

Net earnings 43.2$ (12.5)$ (27.5)$ (228.6)$ 377.0$ 1,147.8$ 3.2$ 848.6$


14June 24, 2009

Detailed Income

Statement

($ millions)


RevenuesNet sales 307.6$ 646.8$ 250.1$ 519.7$ 3,801.0$ 6,718.2$ 465.5$ 4,121.1$ Royalties, fees and other 11.6 Total revenue 319.2$ 646.8$ 250.1$ 519.7$ 3,801.0$ 6,718.2$ 465.5$ 4,121.1$

Cost of products sold 84.7 334.0 44.3 152.0 1,077.0 2,131.4 134.3 997.3

Gross profit (income) 234.5 312.8 205.8 367.7 2,724.0 4,586.8 331.2 3,123.8

Research and development 26.9 30.7 25.9 30.9 152.0 367.8 33.3 194.0

Sales and marketing 123.2 206.9 General and administrative 24.0 81.8 Selling, general and administrative 147.2 234.8 186.8 288.7 1,942.0 2,625.1 261.4 1,702.3

Amortization of intangibles 7.2 17.1 40.0 4.9 Acquired (purchased) in-process R&D 20.9 - 2.5 Other expense (income) 5.2 Other expense (income) - recurring 7.2 5.2 20.9 17.1 - 40.0 7.4 -

Operating profit (loss) - recurring 53.2 42.1 (27.8) 31.0 630.0 1,553.9 29.1 1,227.5

Restructuring changes 34.9 6.7 Intangible asset impairment 46.7 289.5 - (Gain) on sale of operations (1.6) Settlement - Certain claims 69.0 Acquisition, integration and other 68.5 Other operating expenses - extraordinary - 46.7 - 287.9 - 34.9 6.7 137.5

Operating profit (loss) 53.2 (4.6) (27.8) (256.9) 630.0 1,519.0 22.4 1,090.0

Interest receivable or income 2.1 0.5 5.0 Interest payable or expense (1.0) 19.1 (20.2) 71.0 Loss on interest rate swap (8.0) Loss on refinancing (5.7) Other finance (costs)/income (0.7) (1.0) Interest expense (income), net 2.1 Interest expense (income), net 1.1 19.8 - (33.4) 65.0 - 2.1 -

Share of results of associates 1.0 Other (income) expense, net 1.1 (4.7) (61.2) (1.3) Other (income) expense, net 1.1 - - (4.7) 1.0 (61.2) (1.3) -

Interest and other, net 2.2 19.8 0.3 (38.1) 66.0 (61.2) 0.8 31.8

Earnings before income taxes 55.4 (24.4) (27.5) (295.0) 564.0 1,580.2 21.6 1,121.8

Provision for (benefit from) income taxes 12.2 (11.9) - (66.4) 187.0 432.4 18.4 272.3

Earnings from discontined operations - Gain (loss) on sale of discontinued oper - Minority interest (0.9) Other (income) expense, net - - - - - - - (0.9)

Net earnings 43.2$ (12.5)$ (27.5)$ (228.6)$ 377.0$ 1,147.8$ 3.2$ 848.6$


15June 24, 2009

Income Statement Take Aways

• The most important general management financial statement.

• Companies present details differently, even call the same item different names (profit, income, earnings) and sometimes represent the same value with either a “+” or “–” sign.

• Some expenses are “extraordinary” or non-recurring: impairment, restructuring, etc.

• Many different measures of income: gross, operating (EBIT), pre-tax, net income, etc.


16June 24, 2009

Income Statement Summary

• Necessary and key to running a business as well as evaluating suppliers and customers.

• As a non-finance professional, don’t be overwhelmed.

• Not necessary to know the last detail until you establish a foundation.

• Regardless of labels, details, even signs, an income statement is simply:

Sales - Cost of sales

Gross income - Operating expenses (or SG&A)

Operating income (or EBIT) - Interest expense (income)

Pre-tax income - Taxes

Net income


17June 24, 2009

Balance Sheet


18June 24, 2009

Balance Sheet ComparisonArthro- Smith &Care ConMed Nuvasive Orthofix Nephew Stryker Wright Zimmer

AssetsCurrent Assets

Cash and marketable securities 43.3$ 11.7$ 178.0$ 25.6$ 145.0$ 2,195.6$ 145.5$ 215.3$ Accounts receivable 69.9 80.6 51.6 110.7 961.0 1,129.5 102.0 732.8 Inventories 61.7 165.0 68.9 91.2 879.0 952.7 176.1 928.3 Deferred taxes 10.4 11.7 17.5 521.9 29.9 198.3 Prepaid expenses and other current 5.2 10.0 3.5 29.6 - 179.6 23.2 103.9

Total current assets 190.5 279.0 302.0 274.6 1,985.0 4,979.3 476.7 2,178.6

Property and equipment, net 43.4 123.7 73.7 32.7 725.0 963.8 133.6 1,264.1 Intangible assets, net 37.7 191.8 53.5 376.0 368.0 21.1 872.1 Goodwill 166.8 289.5 182.6 1,189.0 567.5 49.7 2,774.8 Other assets - total 11.7 10.0 111.7 17.8 233.0 724.7 11.0 149.4

Total Assets 450.1$ 894.0$ 487.4$ 561.2$ 4,508.0$ 7,603.3$ 692.1$ 7,239.0$

Liabilities and EquityCurrent liabilities

Accounts payable 15.9$ 39.0$ 26.7$ 23.9$ 607.0$ 274.3$ 15.9$ 186.4$ Accrued liabilities 12.9 641.9 59.2 Accrued compensation 12.7 19.7 17.1 336.8 Current portion of long-term debt 3.4 3.3 54.0 20.5 0.1 Bank borrowings 1.9 115.0 Other current liabilities - total 0.7 15.2 1.7 45.9 192.0 188.6 - 584.7

Total current liabilities 42.2 77.3 45.5 75.0 968.0 1,462.1 75.2 771.1

Long-term debt (notes payable) 60.0 219.5 230.0 277.5 1,358.0 200.1 460.1 Deferred tax liabilities 0.4 71.2 4.5 46.0 0.2 Other long-term liabilities - total 7.0 21.0 24.3 2.1 437.0 734.5 5.0 357.5

Total Liabilities 109.6 389.0 299.8 359.1 2,809.0 2,196.6 280.5 1,588.7

Stockholders' equity 340.5 505.0 187.6 202.1 1,699.0 5,406.7 411.6 5,650.3

Total liabilities and equity 450.1$ 894.0$ 487.4$ 561.2$ 4,508.0$ 7,603.3$ 692.1$ 7,239.0$


19June 24, 2009

Goodwill (Intangibles Resulting from Business Acquisition)

• When you acquire a business:– Say, you pay $100mm for a business– Get assets valued at $60mm and liabilities of

$15mm or in total “net assets of $45mm”.– Paid $100mm so the remaining $55mm is

Goodwill• Amortization or “expensing”

– Old approach: Amortized the Goodwill over 40 years (straight-line)

– New approach: • Revalue the business every year• If no change in “fair” value no expense.• If the “fair” value falls below $100mm to say $80mm,

then $20mm of “asset impairment” must be expensed.


20June 24, 2009

Detailed Balance Sheet Comparison: AssetsArthro- Smith &Care ConMed Nuvasive Orthofix Nephew Stryker Wright Zimmer


Cash and cash equivalents 39.4$ 11.7$ 132.3$ 14.6$ 145.0$ 701.1$ 87.9$ 212.6$ Restricted cash 11.0 1,494.5 2.7 Short-term investments 3.9 45.7 57.6 Cash and marketable securities 43.3 11.7 178.0 25.6 145.0 2,195.6 145.5 215.3

Accounts receivable 69.9 80.6 51.6 110.7 961.0 1,129.5 102.0 732.8 Inventories 61.7 165.0 68.9 91.2 879.0 952.7 176.1 928.3 Deferred taxes 10.4 11.7 17.5 521.9 29.9 198.3

Income tax receivable 1.4 Prepaid expenses and other current assets 5.2 8.6 3.5 6.9 179.6 14.3 103.9 Other current assets 22.7 8.9 Prepaid expenses and other current 5.2 10.0 3.5 29.6 - 179.6 23.2 103.9 Total current assets 190.5 279.0 302.0 274.6 1,985.0 4,979.3 476.7 2,178.6

Land, building and improvements 686.7 Machinery and equipment 1,184.3

Property and equipment, gross 1,871.0 less allowance for accumulated depreciation 907.2 Property and equipment, net 43.4 123.7 73.7 32.7 725.0 963.8 133.6 1,264.1

Intangible assets, net 37.7 191.8 53.5 376.0 368.0 21.1 872.1 Goodwill 166.8 289.5 182.6 1,189.0 567.5 49.7 2,774.8

Loaner instrumentation 275.2 Long-term marketable securities 45.3 Deferred tax assets 5.0 57.1 214.0 212.2 3.0 Investments 2.1 19.0 Other assets 6.7 10.0 9.3 15.7 237.3 8.0 149.4

Other assets - total 11.7 10.0 111.7 17.8 233.0 724.7 11.0 149.4

Total Assets 450.1$ 894.0$ 487.4$ 561.2$ 4,508.0$ 7,603.3$ 692.1$ 7,239.0$


Accounts payable 15.9$ 39.0$ 26.7$ 23.9$ 607.0$ 274.3$ 15.9$ 186.4$ Accrued liabilities 12.9 641.9 59.2 Accrued compensation 12.7 19.7 17.1 336.8 Current portion of long-term debt 3.4 3.3 54.0 20.5 0.1 Bank borrowings 1.9 115.0

Royalties payable 1.7 Deferred tax liabilities 0.6 Income taxes payable 0.1 - 192.0 30.0 6.6 Dividends payable 158.6 Other current liabilities 15.2 45.9 578.1 Other current liabilities - total 0.7 15.2 1.7 45.9 192.0 188.6 - 584.7


Long-term debt (notes payable) 60.0 219.5 230.0 277.5 1,358.0 200.1 460.1 Deferred tax liabilities 0.4 71.2 4.5 46.0 0.2

Retirement benefit 350.0 Other long-term payables 87.0 Minority interest 3.6 Other long-term liabilities 7.0 21.0 24.3 2.1 734.5 5.0 353.9 Other long-term liabilities - total 7.0 21.0 24.3 2.1 437.0 734.5 5.0 357.5





21June 24, 2009

Detailed Balance Sheet Comparison: Liabilities & Equity





Income tax receivable 1.4 5.2 8.6 3.5 6.9 179.6 14.3 103.9

Other current assets 22.7 8.9 Prepaid expenses and other current 5.2 10.0 3.5 29.6 - 179.6 23.2 103.9 Total current assets 190.5 279.0 302.0 274.6 1,985.0 4,979.3 476.7 2,178.6






Total Assets 450.1$ 894.0$ 487.4$ 561.2$ 4,508.0$ 7,603.3$ 692.1$ 7,239.0$














Income tax receivable 1.4 5.2 8.6 3.5 6.9 179.6 14.3 103.9

Other current assets 22.7 8.9 Prepaid expenses and other current 5.2 10.0 3.5 29.6 - 179.6 23.2 103.9 Total current assets 190.5 279.0 302.0 274.6 1,985.0 4,979.3 476.7 2,178.6






Total Assets 450.1$ 894.0$ 487.4$ 561.2$ 4,508.0$ 7,603.3$ 692.1$ 7,239.0$











22June 24, 2009

Balance Sheet Take Aways

• The most ignored general management financial statement…unless you have specific responsibilities for a line item.

• Companies present details differently, even call the same item different names.

• Current means in the next cycle.– Current assets will be converted to cash in the

next year.

– Current liabilities will be paid in cash next year.

• Long-term means lasting more than 1 cycle.


23June 24, 2009

Balance Sheet Summary

• Necessary and key to running a business as well as evaluating suppliers and customers.

• As a non-finance professional, don’t be overwhelmed.

• Not necessary to know the last detail until you establish a foundation.

• Regardless of labels and details, a balance sheet is simply:

Cash and equivalentsAccounts receivableInventoryOther current assets

Total current assets

Plant and equipment, netGoodwillOther Intangible assetsOther assets

Total assets

Short-term debtAccounts payableAccrued liabilitiesOther current liabilities

Total current liabilities

Long-term debtOther long-term liabilities

Total liabilities

Stockholders' equity

Total liabilities and equity


24June 24, 2009

Financial Statement Analysis


25June 24, 2009

Financial Performance Metrics

• Formerly, “Financial Ratios”• Relative Basis for Comparison• Thousands of Potential Metrics

– One Number Divided by Another Number– Multiple Permutations and Combinations

• Six Major Categories– Profitability Activity– Liquidity Growth– Leverage Market

• Applicable to Historical Information as well as Plan and Outlook Projections


26June 24, 2009

• Profitability Metrics measure management’s overall effectiveness in generating “profits.”

• Liquidity Metrics measure the firm’s abilities to meet its maturing short-term obligations.

• Leverage Metrics measure the extent to which the firm has been financed by debt.

• Activity Metrics measure how effectively the firm is using its resources.

• Growth measures the firm’s ability to maintain its economic position in the growth of the economy and industry.

• Market Metrics measure the firms’ relationship to the broader Stock Market.

Metric Categories


27June 24, 2009

Financial Performance

Metrics


28June 24, 2009

Net Gross Recurring NetSales Profit Oper Inc Income

Stryker 6,718.2$ Stryker 4,586.8$ Stryker 1,553.9$ Stryker 1,147.8$ Zimmer 4,121.1 Zimmer 3,123.8 Zimmer 1,227.5 Zimmer 848.6 S&N 3,801.0 S&N 2,724.0 S&N 630.0 S&N 377.0 ConMed 646.8 Orthofix 367.7 Arthrocare 53.2 Arthrocare 43.2 Orthofix 519.7 Wright 331.2 ConMed 42.1 Wright 3.2 Wright 465.5 ConMed 312.8 Orthofix 31.0 ConMed (12.5) Arthrocare 307.6 Arthrocare 234.5 Wright 29.1 Nuvasive (27.5) Nuvasive 250.1 Nuvasive 205.8 Nuvasive (27.8) Orthofix (228.6)

2008 Orthopedic Industry Sales & Income Comparison

$- $1,000.0 $2,000.0 $3,000.0 $4,000.0 $5,000.0 $6,000.0 $7,000.0

StrykerZimmer

S&NConMedOrthofixWright

ArthrocareNuvasive

Total sales Gross profit (income)


29June 24, 2009

Simple Income Statement AnalysisStryker Corporation ($ millions)

A. Income Statement B. % of Net Sales C. Annual Growth D. Index Value2006 2007 2008 2006 2007 2008 2007 2008 CAGR* 2006 2007 2008

Net Sales 5,147.2$ 6,000.5$ 6,718.2$ 100.0% 100.0% 100.0% 16.6% 12.0% 14.2% 100.0 116.6 130.5

Costs of Sales 1,616.6 1,865.2 2,131.4 31.4% 31.1% 31.7% 15.4% 14.3% 14.8% 100.0 115.4 131.8

Gross Profit 3,530.6 4,135.3 4,586.8 68.6% 68.9% 68.3% 17.1% 10.9% 14.0% 100.0 117.1 129.9

Operating ExpensesResearch and Development 324.6 375.3 367.8 6.3% 6.3% 5.5% 15.6% 14.3% 14.8% 100.0 115.4 131.8 Selling, General, and Administrative 2,047.0 2,391.5 2,625.1 39.8% 39.9% 39.1% 16.8% 9.8% 13.2% 100.0 116.8 128.2 Intangible Asset Amortization 42.7 41.4 40.0 0.8% 0.7% 0.6% -3.0% -3.4% n/a n/a n/a n/aNon-recurring expenses 52.7 19.8 34.9 1.0% 0.3% 0.5% -62.4% 76.3% n/a n/a n/a n/a Total Operating Expenses 2,467.0 2,828.0 3,067.8 47.9% 47.1% 45.7% 14.6% 8.5% 11.5% 100.0 114.6 124.4

Income Before Interest and Income Taxes 1,063.6 1,307.3 1,519.0 20.7% 21.8% 22.6% 22.9% 16.2% 19.5% 100.0 122.9 142.8 Other Income (Expense) 30.2 62.8 61.2 0.6% 1.0% 0.9% 107.9% -2.5% 42.4% 100.0 207.9 202.6

Income Before Income Taxes 1,093.8 1,370.1 1,580.2 21.3% 22.8% 23.5% 25.3% 15.3% 20.2% 100.0 125.3 144.5 Provision for Income Taxes 322.4 383.4 432.4 6.3% 6.4% 6.4% 18.9% 12.8% 15.8% 100.0 118.9 134.1

Income before Accounting Change 771.4 986.7 1,147.8 15.0% 16.4% 17.1% 27.9% 16.3% 22.0% 100.0 127.9 148.8 Discountinued Operations 6.3 30.7 - 0.1% 0.5% 0.0% n/a n/a n/a n/a n/a n/a

Net Income 777.7$ 1,017.4$ 1,147.8$ 15.1% 17.0% 17.1% 30.8% 12.8% 21.5% 100.0 130.8 147.6

*CAGR: Compound Annual Growth Rate from 2006 to 2008. It is calculated as: (Value2008 / Value2006)2 - 1


30June 24, 2009

Industry Profitability Analysis


Total revenue 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%

Cost of products sold 26.5% 51.6% 17.7% 29.2% 28.3% 31.7% 28.9% 24.2%

Gross profit (income) 73.5% 48.4% 82.3% 70.8% 71.7% 68.3% 71.1% 75.8%

Research and development 8.4% 4.7% 10.4% 5.9% 4.0% 5.5% 7.2% 4.7%Selling, general and administrative 46.1% 36.3% 74.7% 55.6% 51.1% 39.1% 56.2% 41.3%Other expense (income) - recurring 2.3% 0.8% 8.4% 3.3% 0.0% 0.6% 1.6% 0.0%

Operating profit (loss) - recurring 16.7% 6.5% -11.1% 6.0% 16.6% 23.1% 6.3% 29.8%

Other operating expenses - extraordinary 0.0% 7.2% 0.0% 55.4% 0.0% 0.5% 1.4% 3.3%

Operating profit (loss) 16.7% -0.7% -11.1% -49.4% 16.6% 22.6% 4.8% 26.4%

Interest and other, net 0.7% 3.1% 0.1% -7.3% 1.7% -0.9% 0.2% 0.8%

Earnings before income taxes 17.4% -3.8% -11.0% -56.8% 14.8% 23.5% 4.6% 27.2%

Provision for (benefit from) income taxes 3.8% -1.8% 0.0% -12.8% 4.9% 6.4% 4.0% 6.6%Other (income) expense, net 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0%

Net earnings 13.5% -1.9% -11.0% -44.0% 9.9% 17.1% 0.7% 20.6%


31June 24, 2009

Profitability


Net margin 13.5% -1.9% -11.0% -44.0% 9.9% 17.1% 0.7% 20.6%Pre-tax margin 17.4% -3.8% -11.0% -56.8% 14.8% 23.5% 4.6% 27.2%Operating margin 16.7% 6.5% -11.1% 6.0% 16.6% 23.1% 6.3% 29.8%Gross margin 73.5% 48.4% 82.3% 70.8% 71.7% 68.3% 71.1% 75.8%

Return on assets 9.6% -1.4% -5.6% -40.7% 8.4% 15.1% 0.5% 11.7%Return on net assets 10.6% -1.5% -6.2% -46.5% 10.2% 18.6% 0.5% 13.1%Return on equity 12.7% -2.5% -14.7% -113.1% 22.2% 21.2% 0.8% 15.0%

Financial Performance Metric Calculation Strength

ProfitabilityNet Margin Net Income / Sales HigherPre-Tax Margin Pre-Tax Income / Sales HigherOperating Margin Operating Income / Sales HigherGross Margin (Sales - Cost of Goods Sold) / Sales Higher

Return on Assets Net Income / Assets HigherReturn on Net Assets Net Income / (Assets - Non Interest Bearing Current Liabilities) HigherReturn on Equity Net Income / Equity Higher


32June 24, 2009

Liquidity


Current ratio 4.51 3.61 6.64 3.66 2.05 3.41 6.34 2.83 Working capital ($ millions) 148.3$ 201.7$ 256.5$ 199.6$ 1,017.0$ 3,517.2$ 401.5$ 1,407.5$ Quick ratio 3.05 1.47 5.12 2.45 1.14 2.75 4.00 1.62 Cash ratio 1.03 0.15 3.91 0.34 0.15 1.50 1.93 0.28


LiquidityCurrent Ratio Current Assets / Current Liabilities HigherNet Working Capital Current Assets - Current Liabilities HigherQuick Ratio (Current Assets - Inventories) / Current Liabilities HigherCash Ratio Cash / Current Liabilities Higher


33June 24, 2009

Leverage


LeverageDebt to Equity Liabilities / Equity LowerCurrent Debt to Equity Current Liabilities / Equity LowerLong-Term Debt to Equity Long-Term Liabilities / Equity Lower

Financial Leverage Assets / Equity LowerCapitalization Ratio Interest Bearing Debt / (Interest Bearing Debt + Equity) LowerLong-Term Capitalization Ratio Long-Term Interest Bearing Debt / (Interest Bearing Debt + Equity) LowerInterest Coverage Earnings Before Interest and Tax / Interest Expense Higher


Debt to Equity 32.2% 77.0% 159.8% 177.7% 165.3% 40.6% 68.1% 28.1%Current Debt to Equity 12.4% 15.3% 24.3% 37.1% 57.0% 27.0% 18.3% 13.6%Long-Term Debt to Equity 19.8% 61.7% 135.6% 140.6% 108.4% 13.6% 49.9% 14.5%

Financial Leverage 1.322 1.770 2.598 2.777 2.653 1.406 1.681 1.281 Capitalization Ratio 15.0% 30.6% 55.1% 58.3% 47.3% 0.4% 32.7% 7.5%Long-Term Capitalization Ratio 15.0% 30.2% 55.1% 57.2% 42.1% 0.0% 32.7% 7.5%Interest Coverage 53.20 2.20 n/a 1.53 8.87 n/a 13.86 n/a


34June 24, 2009

ActivityFinancial Performance Metric Calculation Strength

ActivityTotal Asset Turnover Sales / Total Assets HigherFixed Asset Turnover Sales / Net Plant, Property, & Equipment HigherCurrent Asset Turnover Sales / Current Assets Higher

Accounts Receivable Turnover Sales / Accounts Receivable HigherAverage Collection Period 365 days / Accounts Receivable Turnover LowerInventory Turnover Cost of Goods Sold / Inventory HigherInventory Days Outstanding 365 days / Inventory Turnover Lower


Total Asset Turnover 0.71 0.72 0.51 0.93 0.84 0.88 0.67 0.57 Fixed Asset Turnover 1.23 1.05 1.35 1.81 1.51 2.56 2.16 0.81 Current Asset Turnover 1.68 2.32 0.83 1.89 1.91 1.35 0.98 1.89

Accounts Receivable Turnover 4.57 8.02 4.85 4.69 3.96 5.95 4.56 5.62 Average Collection Period 79.93 45.48 75.31 77.75 92.28 61.37 79.98 64.90 Inventory Turnover 1.37 2.02 0.64 1.67 1.23 2.24 0.76 1.07 Inventory Days Outstanding 265.89 180.31 567.69 219.00 297.90 163.15 478.60 339.75


35June 24, 2009

Performance Metrics Summary


LiquidityCurrent Ratio Current Assets / Current Liabilities HigherNet Working Capital Current Assets - Current Liabilities HigherQuick Ratio (Current Assets - Inventories) / Current Liabilities HigherCash Ratio Cash / Current Liabilities Higher

ActivityTotal Asset Turnover Sales / Total Assets HigherFixed Asset Turnover Sales / Net Plant, Property, & Equipment HigherCurrent Asset Turnover Sales / Current Assets Higher

Accounts Receivable Turnover Sales / Accounts Receivable HigherAverage Collection Period 365 days / Accounts Receivable Turnover LowerInventory Turnover Cost of Goods Sold / Inventory HigherInventory Days Outstanding 365 days / Inventory Turnover Lower

LeverageDebt to Equity Liabilities / Equity LowerCurrent Debt to Equity Current Liabilities / Equity LowerLong-Term Debt to Equity Long-Term Liabilities / Equity Lower

Financial Leverage Assets / Equity LowerCapitalization Ratio Interest Bearing Debt / (Interest Bearing Debt + Equity)LowerLong-Term Capitalization Ratio Long-Term Interest Bearing Debt / (Interest Bearing Debt + Equity)LowerInterest Coverage Earnings Before Interest and Tax / Interest Expense Higher

ProfitabilityNet Margin Net Income / Sales HigherPre-Tax Margin Pre-Tax Income / Sales HigherOperating Margin Operating Income / Sales HigherGross Margin (Sales - Cost of Goods Sold) / Sales Higher

Return on Assets Net Income / Assets HigherReturn on Net Assets Net Income / (Assets - Non Interest Bearing Current Liabilities)HigherReturn on Equity Net Income / Equity Higher

MarketMarket Capitalization Stock Price Per Share * Shares Outstanding HigherPrice/Earnings Stock Price Per Share / Earnings Per Share HigherMarket to Book Market Value / Book Value HigherShareholder Returns (Capital Appreciation + Dividends) / Beginning Stock PriceHigherDividend Yield Dividend Per Share / Beginning Stock Price Higher


36June 24, 2009

DuPont Ratio AnalysisA systematic ordering of metrics for comprehensive

company analysis.

1. Pre-Tax Margin X After Tax Retention = Net Margin

Pre-Tax Income Net IncomeSales Sales

2. Net Margin X Asset Turnover = Return on Assets

Net Income Sales Net IncomeSales Total Assets Total Assets

3. Return on Assets X Financial Leverage = Return on Equity

Net Income Total Assets Net IncomeTotal Assets Equity Equity

=

=

=

X

X

X

( 1- Tax Rate)


37June 24, 2009

Pre-Tax After-Tax Net Asset Return on Financial Return onMargin Retention Margin Turnover Assets Leverage Equity

Arthrocare 17.4% 0.780 13.5% 0.709 9.6% 1.322 12.7%ConMed -3.8% 0.512 -1.9% 0.723 -1.4% 1.770 -2.5%Nuvasive -11.0% 1.000 -11.0% 0.513 -5.6% 2.598 -14.7%Orthofix -56.8% 0.775 -44.0% 0.926 -40.7% 2.777 -113.1%

Smith & Nephew 14.8% 0.668 9.9% 0.843 8.4% 2.653 22.2%Stryker 23.5% 0.726 17.1% 0.884 15.1% 1.406 21.2%Wright 4.6% 0.148 0.7% 0.673 0.5% 1.681 0.8%Zimmer 27.2% 0.756 20.6% 0.569 11.7% 1.281 15.0%

2008 Orthopedic IndustryDuPont Ratio Analysis


38June 24, 2009

Performance Monitoring - 2008 Stryker Return on Assets($ millions)

Hypothetical Application Performance Metric Responsibility All values are directional for illustration Objective Target Primary Secondary

Sales Sales Sales growth 11.96% Marketing Sales6,718.2$ $6,718.2

Labor % of sales 16.94% Plant VP,minus $1,138.2 Manager Production

plus

COGS Material % of sales 6.24% Plant VP,1,783.8$ $419.1 Manager Production

plus

Overhead % of sales 3.37% Plant VP,minus $226.5 Manager Production

Dep & Amt Dep & Amt Depreciation and Controller Engineer$387.6 $387.6 Amortization Schedule

R&D R&D % of sales 5.47% VP, R&D Marketing$367.8 $367.8

Net Inc$1,147.8 Marketing % of sales 20.88% Brands Marketing

minus $1,403.0 ManagerNet plus

Margin divided by SG&A Selling % of sales 13.16% Sales Marketing17.08% $2,660.0 $883.9

plus

plus Adm & Res % of sales 5.55% All Admin All ViceSales $373.1 Managers Presidents

Other Inc Other Inc Interest Rates 5%/2.2% Treasurer CFO$61.2 $61.2

6,718.2$ minus

Taxes Taxes Tax rate 27.40% Tax CFO$432.4 $432.4 Department

ROA multiplied by

15.10% Cash Dollar amount 2,195.6$ Treasurer CFOSales $2,195.66,718.2$ plus

Receivables Days outstand. 61.37 A/R MarketingCurrent $1,129.5 Manager

Turnover divided by Assets plus

0.884 4,979.3$ Inventory Days outstand. 163.15 Inventory Production$952.7 Manager

Total plus

Assets plus Other CA Dollar amount 701.5$ Controller CFO7,603.3$ $701.5

NPPE NPPE Dollar amount 963.8$ Engineer Controller963.8$ $963.8

plus Goodwill Dollar amount 567.5$ Controller CFOOther $567.5Assets plus

$1,660.2 OtherAssets Dollar amount 1,092.7$ Controller CFO

$1,092.7


39June 24, 2009

Unidentified Companies1 2 3 4 5 6 7 8

% of SalesCost of goods sold 19.2% 27.2% 82.1% 77.0% 42.5% 75.5% 31.7% 0.0%Operating expense 43.6% 68.4% 12.7% 15.4% 41.0% 18.9% 45.1% 87.3%

% of AssetsCash 32.5% 6.1% 31.5% 9.0% 5.2% 4.5% 9.2% 2.4%Accounts receivable 18.7% 0.0% 17.9% 14.9% 5.3% 2.4% 14.9% 1.6%Inventory 1.4% 0.7% 6.5% 7.0% 51.6% 21.1% 12.5% 0.6%Current assets 59.4% 14.6% 76.0% 45.6% 66.0% 30.0% 65.5% 5.9%Plant, property and equipment, net 8.6% 78.5% 8.6% 9.6% 23.9% 56.8% 12.7% 84.3%Current liabilities 41.1% 19.1% 56.1% 46.7% 19.4% 33.9% 19.2% 16.2%Interest bearing debt 0.0% 30.2% 7.6% 15.8% 22.8% 25.8% 0.3% 42.6%Equity 49.8% 48.1% 16.1% 34.4% 51.2% 39.9% 71.1% 41.3%

DuPont AnalysisNet margin 29.3% 2.3% 4.1% 7.2% 7.7% 3.3% 17.1% 8.8%Total asset turnover 0.83 1.80 2.31 1.03 0.92 2.48 0.88 0.40Return on assets 24.3% 4.1% 9.4% 7.3% 7.1% 8.2% 15.1% 3.5%Financial leverage 2.01 2.08 6.20 2.91 1.95 2.50 1.41 2.42Return on equity 48.7% 8.5% 58.0% 21.4% 13.9% 20.5% 21.2% 8.4%

Other metricsCurrent ratio 1.45 0.76 1.36 0.98 3.40 0.88 3.41 0.37A/R Days outstanding 82.09 n/a 28.26 53.10 20.99 3.51 61.37 15.16Inventory days outstanding 31.00 5.53 12.46 32.10 481.20 41.14 163.15 n/a

Column #Please identify which company Dellmatches which column. HPWrite the number of the column Microsoftaside of the appropriate company. PF Chang

Royal CarribeanStrykerTiffanyWalmart


40June 24, 2009

Application of Company Specific Financial

Statement Analysis for Suppliers and Customers


41June 24, 2009

Required Analytical Steps

• Gather appropriate financial information– Annual and quarterly reports

– 10-Ks and 8-Ks

• Prepare an analytical page

• Evaluate directional changes – trend analysis

• This is only the first step!

• This begins the analysis from a finance person’s perspective.


42June 24, 2009

Data Gathering – Stryker Illustration($ millions)

2004 2005 2006 2007 2008

Sales 4,017.4$ 4,608.9$ 5,147.2$ 6,000.5$ 6,718.2$ Cost of goods sold 1,303.8 1,489.2 1,616.2 1,865.2 2,131.4 Operating income - recurring 798.7 948.0 1,116.3 1,327.1 1,553.9 Operating income 677.9 932.1 1,063.6 1,307.3 1,519.0 Pre-tax income 675.0 937.0 1,093.8 1,370.1 1,580.2 Net income 440.0 643.6 777.7 1,017.4 1,147.8

Cash and equivalents 349.4 1,056.5 1,414.8 2,410.8 2,195.6 Accounts receivable 751.1 770.3 907.0 1,030.7 1,129.5 Inventory 552.5 563.5 677.6 796.2 952.7 Current assets 2,142.6 2,870.1 3,534.3 4,904.9 4,979.3 Total assets 4,120.0 4,992.5 5,873.8 7,354.0 7,603.3

Equity 2,788.2 3,300.2 4,191.0 5,378.5 5,406.7 Interest bearing debt 10.0 231.6 14.8 16.8 20.5 Current liabilities 1,113.5 1,248.8 1,351.5 991.6 963.8


43June 24, 2009

Data Analysis – Stryker IllustrationTrend Analysis

2004 2005 2006 2007 2008 Long-term Short-termDuPont Analysis

Net margin 11.0% 14.0% 15.1% 17.0% 17.1% + +X Asset turnover 0.98 0.92 0.88 0.82 0.88 - += Return on assets 10.7% 12.9% 13.2% 13.8% 15.1% + +X Financial leverage 1.478 1.513 1.402 1.367 1.406 + or - + or -= Return on equity 15.8% 19.5% 18.6% 18.9% 21.2% + +

ProfitabilityNet margin 11.0% 14.0% 15.1% 17.0% 17.1% + +Pre-tax margin 16.8% 20.3% 21.3% 22.8% 23.5% + +Operating margin 16.9% 20.2% 20.7% 21.8% 22.6% + +Operating margin - recurring 19.9% 20.6% 21.7% 22.1% 23.1% + +Gross margin 67.5% 67.7% 68.6% 68.9% 68.3% + -

Return on assets 10.7% 12.9% 13.2% 13.8% 15.1% + +Return on equity 15.8% 19.5% 18.6% 18.9% 21.2% + +

GrowthAnnual growth: Sales 18.1% 14.7% 11.7% 16.6% 12.0% - -Annual growth: Gross income 19.5% 15.0% 13.2% 17.1% 10.9% - -Annual growth: Oper inc recurring 29.6% 18.7% 17.8% 18.9% 17.1% - -Annual growth: Net income 1.3% 46.3% 20.8% 30.8% 12.8% + -

LiquidityCurrent ratio 1.92 2.30 2.62 4.95 5.17 + +Working capital ($ millions) 1,029.1$ 1,621.3$ 2,182.8$ 3,913.3$ 4,015.5$ + +Quick ratio 1.43 1.85 2.11 4.14 4.18 + +Cash ratio 0.31 0.85 1.05 2.43 2.28 + -

LeverageDebt to equity 47.8% 51.3% 40.2% 36.7% 40.6% + or - + or -Financial leverage 1.478 1.513 1.402 1.367 1.406 + or - + or -Capitalization ratio 0.4% 6.6% 0.4% 0.3% 0.4% + or - + or -

ActivityTotal asset turnover 0.98 0.92 0.88 0.82 0.88 - +Fixed asset turnover 2.03 2.17 2.20 2.45 2.56 + +Current asset turnover 1.88 1.61 1.46 1.22 1.35 - +

Accounts receivable turnover 5.35 5.98 5.67 5.82 5.95 + +Average collection period 68.24 61.00 64.32 62.70 61.37 + +Inventory turnover 2.36 2.64 2.39 2.34 2.24 - -Inventory days outstanding 154.67 138.11 153.03 155.81 163.15 - -

Also compare to competitors

over time.


44June 24, 2009

Supply Chain Finance


45June 24, 2009

Working Capital Policy

• In total, Current Assets less Current Liabilities

• Operationally– Inventories– Accounts Receivable– Accounts Payable

• Financial Goal is to Minimize Working Capital Investment without Impacting Operations

• Driven by Operations for Strategic Purpose


46June 24, 2009

Figure 1

Stryker: Operating and Cash Cycles2008

Operating Cycle (224 days)

Days to Pay Accts Pay

Inventory on Hand (163 days) Accts Rec Collection (61 days)

Cash Cycle (177 days)(47 days)


47June 24, 2009

Turnovers and Days Outstanding Operating and Cash CyclesOrthopedic Industry Orthopedic Industry - 2008 Days Outstanding

2008 Turnovers 2008 Days Outstanding Receivables Inventory Payables Receivables Inventory Payables

Arthro Care 4.40 1.37 5.34 83.0 266.1 68.4ConMed 7.69 2.25 10.03 47.5 162.3 36.4NuVasive 4.84 0.64 1.66 75.3 567.1 219.4Orthofix 4.69 1.67 6.85 77.8 218.9 53.3

Smith & Nephew 3.96 1.23 1.77 92.3 297.9 205.7Stryker 5.95 2.24 7.77 61.4 163.1 47.0Wright Medical 4.56 0.76 8.46 80.0 478.2 43.1Zimmer Holdings 5.62 1.07 5.35 64.9 339.7 68.2

Average 5.21 1.40 5.90 72.8 311.7 92.7

Johnson & Johnson 6.56 3.66 2.47 55.6 99.6 147.9

Symmetry 8.01 5.29 12.00 45.6 69.0 30.4Owens & Minor 13.89 9.61 12.72 26.3 38.0 28.7


48June 24, 2009

Operating and Cash CyclesOrthopedic Industry - 2008 Days Outstanding

Accounts Operating Accounts Cash Receivables Inventory Cycle Payables Cycle

Arthro Care 83.0 266.1 349.1 68.4 280.7ConMed 47.5 162.3 209.8 36.4 173.3NuVasive 75.3 567.1 642.5 219.4 423.0Orthofix 77.8 218.9 296.7 53.3 243.5

Smith & Nephew 92.3 297.9 390.2 205.7 184.5Stryker 61.4 163.1 224.5 47.0 177.5Wright Medical 80.0 478.2 558.2 43.1 515.1Zimmer Holdings 64.9 339.7 404.6 68.2 336.4

Average 72.8 311.7 384.5 92.7 291.8

Johnson & Johnson 55.6 99.6 155.2 147.9 7.3

Symmetry 45.6 69.0 114.6 30.4 84.2Owens & Minor 26.3 38.0 64.3 28.7 35.6


49June 24, 2009

Stryker's Operating Investment at J&J Days Outstanding

2008Stryker J&J More (less) Actual At J&J Days More (less)

Days outstanding: (1) Inventory 163.1 99.6 63.5 952.7$ 581.8$ 370.9$ (2) Accounts receivable 61.4 55.6 5.8 1,129.5 1,022.8 106.7 Operating cycle 224.5 155.2

Gross Operating Working Capital Investment 2,082.2 1,604.6 477.6

(3) Accounts payable 47.0 147.9 100.9 274.3 863.2 588.9 Cash cycle 177.5 7.3

Net Operating Working Capital Investment 1,807.9$ 741.4$ 1,066.5$

Days of Investment Stryker Investment ($ Millions)


50June 24, 2009

Table 42008 Industry Comparison of

Inventory Management Savings Opportunities (or Realized)($ millions)

Equivalent Inventory Management Savings Opportunity (Realized) 1-Day 8-Co Average Best 8-Co DOS J&J DOS Savings 2006 DOS DOS 311.7 162.3 99.6

Arthro Care 0.232$ ($1.3) ($10.6) $24.1 $38.7ConMed 0.986 (3.4) (147.3) 0.0 61.8NuVasive 0.121 25.4 31.0 49.1 56.7Orthofix 0.416 (23.1) (38.6) 23.6 49.7

Smith & Nephew 2.951 12.1 (40.7) 400.1 585.1Stryker 5.839 59.3 (867.4) 5.0 371.0Wright Medical 0.368 57.0 61.3 116.3 139.4Zimmer Holdings 2.732 112.3 76.7 484.9 656.1

Total 13.646 243.0 (777.8) 1,079.1 1,858.0Total - Savings - (27.9) (1,104.6) 0.0 0.0Total - Opportunity - 266.1 169.0 1,079.1 1,858.0

Johson & Johnson 50.715 (958.5) (10,755.4) 2,644.8 0.0

Symmetry 0.885 4.4 27.5 NA 27.5 *Owens & Minor 17.879 (208.2) 0.0 NA 0.0

DOS: Days Outstanding

* For Symmetry Medical, the days outstanding comparisons use Owens & Minor instead of J&J.


51June 24, 2009

2008 Orthopedic Industry Review

Operating and Cash Cycle Opportunity (Realized) Savings

Operating CashCycle Cycle

Using 2006 as the standard $ 239.8 $ 314.7 Using the 8-company industry average (1,055.6) (974.8)Using the best of the 8 companies DOS 2,632.1 3,466.8 Using J&J as the standard 2,156.3 3,966.6

($millions)


52June 24, 2009

Corporate Investment Analysis:

Investment in the Supply Chain


53June 24, 2009

Back Ground for Investment Analysis

• Tool Box– Time Value of Money– Capital Evaluation Techniques

• Advanced Discussions– Determining Cash Flows– Developing an Appropriate Required Rate of Return


54June 24, 2009

Overview of Investment Process

• Projected Future Cash Flows• Major Techniques

– Pay Back Period– Net Present Value– Internal Rate of Return– Terminal Rate of Return

• Subject to Hurdle Rate– Cost of Capital


55June 24, 2009

Applications of Investment Analysis• Capital Expenditure Analysis

– Investments in Equipment– Investments in Plants

• Major Operating Decisions– Advertising Campaigns– Research and Development

• New Product Introduction

• Information Technology

• Mergers and Acquisitions– External Acquisition Targets– Divisional Valuation

• Using Internal Strategic Plans

– Divestiture Analysis


56June 24, 2009

Overview of a SuccessfulCapital Program

• Four Phases– Planning– Project / Capital Evaluation (CAR)– Status Reporting– Post-Completion Review

• Facilitates Discussion Related to Business Objectives

• Creates Up-Front “Buy-In”• Requires Successful Implementation


57June 24, 2009

Capital Evaluation Techniques

• Pay Back Period (PBP)– The number of years required to return

the original investment.

• Net Present Value (NPV)– Present value of future cash flows,

discounted at an appropriate cost of capital or hurdle rate, less the cost of the investment.


58June 24, 2009

Hypothetical Projects


59June 24, 2009

Pay Back Period


60June 24, 2009

Net Present Value

Present Value 10% Discount Future Value

Year 0 Year 1 Year 2 Year 3

$273 $300165 $200

75 $100$513

$400 Investment (Yr 0)

$113 Net Present Value


61June 24, 2009

Present Value 10% Return Future Value


$100 $110 $121 $133.10

Present Value 20% Return Future Value


$100 $120 $144 $172.80

Future Value of a Single Sum:Graphical


62June 24, 2009

FV = PV ( 1 + r ) N

Where: FV = Future ValuePV = Present Value = $100r = Return = .10N = Number of Years = 3

FV = $100 ( 1 + .10 ) 3

= $100 ( 1.3310)= $133.10

Future Value of a Single Sum:Equation


63June 24, 2009

PV = FV / ( 1 + r ) N

Where: PV = Present ValueFV = Future Value = $100r = Return = .10N = Number of Years = 3

PV = $100 / ( 1 + .10 ) 3

= $100 / ( 1.3310)= $75.13

Present Value of a Single Sum:Equation


64June 24, 2009

Time Value of Money – Present Value of Cash Flow

N PV = CFt / ( 1 + r ) t t=1

Where: PV = Present Value CF = Cash Flow r = Return = 0.10 N = Number of Years = 3 t = Time Period

FV = $300 /( 1 + .10 ) 1 + $200 / ( 1 + .10 ) 2 + $100 / ( 1 + .10 ) 3 = $273 + $165 + $75 = $513


65June 24, 2009

Net Present Value (Part 2)

A PROJ ECTS B

$ 273 Present Value of Year 1 Cash Flow $ 91 165 Present Value of Year 2 Cash Flow 165

75 Present Value of Year 3 Cash Flow 225

$ 513 Total Present Value Cash Flow $ 481 400 Less: Investment (Year 0) 400

$ 113 Net Present Value (10%) $ 81

$ 47 NET PRESENT VALUE 20% DISCOUNT RATE

$ (4)

NET PRESENT VALUE (10% DISCOUNT RATE)


66June 24, 2009

Analysis and Computation of Project Cash Flow: Project B

Year 1 Year 2 Year 3Project Income: Sales $ 1,000 $ 1,300 $ 1,300 Expenses (Excluding Depreciation) 850 950 950 Operating Income $ 150 $ 350 $ 350 Depreciation 100 100 100 Pre-tax Income $ 50 $ 250 $ 250 Taxes 25 125 125 Net Income $ 25 $ 125 $ 125

Project Cash Flow: Net Income $ 25 $ 125 $ 125 Depreciation 100 100 100 Additional Working Capital (25) (25) 50 After-tax Salvage Value - - 25 Total Cash Flow $ 100 $ 200 $ 300


67June 24, 2009

New Software Acquisition

• $75,000 Software Expense• Immediately Reduces Working Capital

by $225,000• Should you make the investment?


68June 24, 2009

Cash Flow for Investment Analysis


69June 24, 2009

Determining Cash Flows

• Foundation for Capital Investment Analysis

• Determining Relevant Cash Flows– Incremental after-tax investment and

resulting after-tax cash inflows projected in a capital analysis.

• Determining Incremental Cash Flows– Additional cash flows - outflows or inflows -

expected to result from a project.


70June 24, 2009

Cash Flow Components

• Initial Investment– Relevant cash out flow (or investment) at the

beginning of the investment proposal.

• Operating Cash Flows– Relevant, after-tax, incremental cash inflows

or outflows from the project throughout its life.

• Terminal Cash Flow– After-tax, non-operating cash flow occurring in

the final year of the project.


71June 24, 2009

Steps for Capital Investment Analysis

1. Estimate the initial investment

2. Determine annual incremental cash flow

3. Project the terminal cash flow or expected salvage value

4. Find the present value of the future cash flows

5. Determine the net present value.


72June 24, 2009

Chocolate Confections Corporation Case

• Evaluation of Human Resource Software System (Human Assets)

• Illustration of Capital Investment Analysis Framework Applied to Information Technology (Software) Decisions

• Become Discerning when Determining Cash Flows


73June 24, 2009

Major Identified Savings

• It was estimated that the system would save each manager half an hour a week. With 600 cost-center managers at an average annual compensation of $100,000 (including benefits and bonuses), the annual savings were estimated to be $750,000 (600 $100,000 0.5/40.0).

• Similarly, annual savings of $500,000 were estimated for 50 HR managers and professionals with an average annual compensation of $50,000, whose time savings were estimated to be eight hours a week.

• It was estimated that a total reduction of six staff members could be achieved. This reduction would result from the process re-engineering that CCC would conduct after successfully installing the HumanAssets system. Based on an average annual total compensation package (pay and benefits) of $45,000 per employee, the total savings associated with staff reductions would be $270,000 a year.


74June 24, 2009

Software Analysis Case2001 2002 2003 2004 2005 2006

Year 0 Year 1 Year 2 Year 3 Year 4 Year 5

- $750,000 $787,500 $826,875 $868,219 $911,630 - 500,000 525,000 551,250 578,813 607,754

- 270,000 283,500 297,675 312,559 328,187 - 130,000 136,500 143,325 150,491 158,016

- 325,000 341,250 358,313 376,229 395,040

- 1,975,000 2,073,750 2,177,438 2,286,311 2,400,627

- -139,200 -146,160 -150,545 -155,061 -159,713 - -50,000 - - - - - -55,000 -60,000 - - - - -208,000 -86,000 -88,580 -91,237 -93,974

- -452,200 -292,160 -239,125 -246,298 -253,687

- -535,133 -535,133 -535,134 - -

- 987,667 1,246,457 1,403,179 2,040,013 2,146,940 - -395,067 -498,583 -561,272 -816,005 -858,776

- 592,600 747,874 841,907 1,224,008 1,288,164

- 535,133 535,133 535,134 - - (0) (0) (0) (0) (0) (0)

($1,605,400) - - - - -

($1,605,400) $1,127,733 $1,283,007 $1,377,041 $1,224,008 $1,288,164

$2,694,278 38.8%71.0%

1.37 years($1,605,400)

Cost reductionCost-center manager process savingsHR manager/professional savingsStaff reductionsInformation-systems charge-backsFlexible-benefits administration

Total estimated savings

Additional Maintenance contractsConsultingImplementation teamInformation-systems charge-backs

Total implementation/ongoing expenditures

Depreciation & amortization

Pretax incremental operating incomeIncome taxes @ 40%

After-tax incremental operating income

+ Depreciation & amortization- Net working-capital investment (recovery)- Direct investment (recovery)

Operating cash flow

Net present value - 14%Modified internal rate of return - 14%Internal rate of returnPayback periodMaximum cash exposure


75June 24, 2009

Agenda

• Financial Statements as a Business Tool• Financial Statement Analysis

– Managing your business– Reviewing competitors – Evaluating customers– Analyzing suppliers

• Overview of Supply Chain Finance• Evaluating Investments


76June 24, 2009

Wrap Up and Summary

Thank You!

Samuel C. Weaver, [email protected]

supply chain finance: fundamentals for supply chain professionals

Documents

sharedetailed income

net income

millionsincome statement

income generation

business acquisitionwhen

different measures of

businessget assets

total net assets