RMG 434 Chapter Notes - Chapter 3: Inventory Turnover, Asset Turnover, Accounts Payable
RMG 434 WEEK 3 CHAPTER 3
SUPPLY CHAIN DRIVERS AND METRICS
● Linking financial measures of firm performance to supply chain performance
● Introduces 3 logistical drivers
○ Facilities
○ Inventory
○ Transportation
■ Used to determine the performance of any supply chain
■ Drivers are used in design, planning and operation of the supply chain
FINANCIAL MEASURES OF PERFORMANCE
● Growing the supply chain surplus is the ultimate goal of the supply chain
○ Premise: increasing the surplus allows for a growth of supply chain profitability which facilitates
an improvement in the financial performance of each member of the supply chain
● From a shareholder perspective, ROE is the main summary measure of a firm’s performance
○ ROE = NET INCOME / AVG. SHAREHOLDER EQUITY
■ ROE measures the return on investment made by a firm’s shareholders, return on assets
(ROA) measures the return earned on each dollar invested by the firm’s assets
○ ROA = EARNINGS BEFORE INTEREST / AVG. TOTAL ASSETS OR
■ NET INCOME + [INTEREST EXPENSE x (1 - TAX RATE)] / AVG. TOTAL ASSETS
○ The difference between ROE and ROA is referred to as RETURN ON FINANCIAL LEVERAGE
(ROFL)
■ ROFL captures the amount of ROE that can be attributed to financial leverage such as
accounts payable and debt
○ An important ratio that defines financial leverage is accounts payable turnover
■ APT = COGS / ACCOUNTS PAYABLE
● A small APT can indicate that an organization was able to use the money it owed
suppliers to finance a considerable fraction of its operations
○ ROA can be written as the product of 2 ratios - profit margin and asset turnover
■ ROA = EARNINGS BEFORE INTEREST / SALES REVNUE x SALES REVENUE / TOTAL ASSETS
= PROFIT MARGIN x ASSET TURNOVER
● Thus, a firm can increase ROA by growing the profit margin and/or increasing the
asset turnover
● Profit margin can be improved by receiving better prices or by reducing the
various expenses incurred
○ Good supply chain management also allows a firm to decrease the
expenses incurred to serve customer demand
● The key components of asset turnover are:
○ Accounts receivable turnover (ART)
○ Inventory turnover (INVT)
○ Property, plant, equipment turnover (PPET)
● ART = SALES REVNUE / ACCOUNTS RECIEVEABLE
● INVT = COGS / INVENTORIES
● PPET = SALES REVENUE / PP&E
● A company can improve its asset turnover by turning its inventory more quickly or using its existing
warehousing and technology infrastructure needed to support a higher level of sales
○ Or decreasing the warehousing and technology infrastructure needed to support the existing
level of sales
■ A company can improve its profit margin by increasing a customer’s willingness to pay
or decreasing operating expense
● Another useful metric is the cash to cash (C2C) cycle which roughly measures the average amount of
time from when cash enters the process as cost to when it returns as collected revenue
○ C2C = -Weeks Payable (1/APT) + WEEKS IN INVENTORY (1/INVT) + WEEKS RECIEVABLE (1/ART)
● 2 financial measures that are not explicitly part of a firm’s financial statements
○ Markdowns
○ Lost sales
■ Markdowns represent the discounts required to convince customers to buy excess
inventory
● Financial statements show only the revenues received from sales not the
revenue that “could have” been received
■ Lost sales represent customer sales that did not materialize because of the absence of
products the customer wanted to buy
● Every lost sale corresponds to product margin that is lost
■ Both markdowns and lost sales reduce net income and arguably represent the biggest
impact of supply chain performance on the financial performance of a firm
● Firms such as Walmart and Zara have achieved strong financial performance in
large part because their supply chains allow a better matching of supply and
demand thereby reducing markdowns and lost sales
DRIVERS OF SUPPLY CHAIN PERFORMANCE
● A supply chains performance in terms of responsiveness and efficiency is based on the interaction
between the following logistical and cross functional drivers of supply chain performance
○ Facilities
○ Inventory
○ Transportation
○ Information
○ Sourcing
○ Pricing
■ The structure of these drivers also affects the financial measures
● The goal is: structure the drivers to achieve the desired level of responsiveness
at the lowest possible cost thus improving the supply chain surplus and the
firm’s financial performance
● Facilities
○ Actual physical locations in the supply chain network where product is stored, assembled,
fabricated
○ 2 major types of facilities are production sites and storage sites
○ Decisions regarding the role, location, capacity and flexibility of facilities have a significant
impact on the supply chains performance
● Inventory
○ Encompasses all raw materials, WIP, and finished goods within a supply chain
○ Inventory belonging to a firm → assets
○ Changing inventory policies can dramatically alter the supply chains efficiency and
responsiveness
● Transportation
○ Entails moving inventory from point to point in the supply chain
○ Can take the form of many modes and routes each with its own performance characteristics
■ Transportation choices have a large impact on supply chain responsiveness and
efficiency
○ Outbound transportation costs of shipping to the customer are typically included in selling,
general and administrative expense whereas inbound transportation costs are typically
included in COGS
● Information
○ Consists of data and analysis concerning facilities, inventory, transportation, costs, prices and
customers throughout the supply chain
○ Information is potentially the biggest driver of performance in the supply chain because it
directly affects each of the other drivers
■ Presents management with the opportunity to make supply chains more responsive and
more efficient
● Sourcing
○ The choice of who will perform a particular supply chain activity, such as production, storage,
transportation or the management of information
○ At the strategic level these decisions determine what functions a firm will perform and what
functions will be outsourced
■ Sourcing decisions affect both the responsiveness and the efficiency of a supply chain
○ Sourcing costs show up in COGS and monies owed to the suppliers are recorded under accounts
payable
● Pricing
○ Determines how much a firm will charge for the goods and services that it makes available in
the supply chain
○ Pricing affects the behavior of the buyer of the good or service thus affecting demand and
supply chain performance
○ Any change in pricing affects revenues directly but could also affect costs based on the impact
of this change on the other drivers
● Defining these drivers attempts to delineate logistics and supply chain management
○ SCM includes the use of logistical and cross functional drivers to increase the supply chain
surplus
○ Cross functional drivers have become increasingly important in raising the supply chain surplus
in recent years
■ Although logistics remains a major part, SCM is increasingly becoming focused on 3
cross functional drivers
○ Important to realize that these drivers do not act independently but interact to determine the
overall supply chain performance
■ Good supply chain design and operation recognize this interaction and make the
appropriate tradeoffs to deliver the desired level of responsiveness
FRAMEWORK FOR STRUCTURING DRIVERS
Document Summary
Linking financial measures of firm performance to supply chain performance. Used to determine the performance of any supply chain. Drivers are used in design, planning and operation of the supply chain. Growing the supply chain surplus is the ultimate goal of the supply chain. Premise: increasing the surplus allows for a growth of supply chain profitability which facilitates an improvement in the financial performance of each member of the supply chain. F(cid:396)o(cid:373) a sha(cid:396)eholde(cid:396) pe(cid:396)spe(cid:272)ti(cid:448)e, roe is the (cid:373)ai(cid:374) su(cid:373)(cid:373)a(cid:396)(cid:455) (cid:373)easu(cid:396)e of a fi(cid:396)(cid:373)"s pe(cid:396)fo(cid:396)(cid:373)a(cid:374)(cid:272)e. Roe (cid:373)easu(cid:396)es the (cid:396)etu(cid:396)(cid:374) o(cid:374) i(cid:374)(cid:448)est(cid:373)e(cid:374)t (cid:373)ade (cid:271)(cid:455) a fi(cid:396)(cid:373)"s sha(cid:396)eholde(cid:396)s, (cid:396)etu(cid:396)(cid:374) o(cid:374) assets (cid:894)roa(cid:895) (cid:373)easu(cid:396)es the (cid:396)etu(cid:396)(cid:374) ea(cid:396)(cid:374)ed o(cid:374) ea(cid:272)h dolla(cid:396) i(cid:374)(cid:448)ested (cid:271)(cid:455) the fi(cid:396)(cid:373)"s assets. Roa = earnings before interest / avg. Net income + [interest expense x (1 - tax rate)] / avg. The difference between roe and roa is referred to as return on financial leverage (rofl)