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Ch 5: Financial aspects of logistics and supply chain management

Terms in this set (35)

Part A: Introduction to financial management decision making
Shareholder value
Cost of equity
Free cash flow

Economic value added
Value drivers
Return on investment
Part B: Introduction to cost accounting and calculations for decision-making purposes
Logistics costing and activity-based costing
Marginal costing
Cost-volume-profit analysis
Shareholder value
Shareholder value is determined by the market value of a company's shares.
Investments by shareholders = Equity of the company
Expected return on equity = Cost of Equity

Management can increase the market value by either:
increasing and expediting the projected free cash flow of the company; or
reducing the risk of the company, thereby reducing the cost of equity.
Cost of equity
The return that shareholders require on their investment
Shareholders require compensation for the risk of investing in that company

Ce = Rf + Mrp

Where:
Ce = Cost of Equity
Rf = Risk Free Rate
Mrp = Market Risk Premium

Risk-free rate
Long-term government bond rates
After tax rate

Market risk premium
refer to the average risk of the market
the total expected return from market will vary
refers to the difference between the expected rate of return on the market as a whole that shareholders require and the risk-free rate of return over the same period
The beta factor
return required for an investment in an individual share might be higher or lower than the market return depending on the risk
Analyse individual share's movement relative to market
More volatile → higher the risk
Beta factor represents relative movement
Capital asset pricing model (CAPM)
Model that calculates the return that investors require based on the risk they bear
Ce = Rf + (ß x Mrp)
Free cash flow is the cash flow from operating activities actually available for distribution to the shareholders.
Net Operating Profit after Tax plus any non-cash adjustments shown on the statement of cash flows less investments in working capital and in property, plant and equipment
To increase free cash flow, management needs to:
increase the profit after tax;
decrease the investment in working capital; and
decrease the investment in property, plant and equipment.
Expedite free cash flow
Increase the present value of the discounted free cash
Time value of money


The closer the cash flow is to the present date, the higher the present value
Economic value added (EVA)
Economic value added (EVA) is a residual income measure that subtracts the cost of capital employed from the operating profits generated.

EVA = NOPAT - CCE
Market Value Add (MVA)
MVA = share price x shares issued minus book value of capital employed

In other words: MVA measures the difference between the market value of the firm and the amount of Capital invested.
Value drivers
Revenue
Operating costs
Tax
Working capital
Property, plant and equipment
Revenue
increase the volume of sales / maximise sales

Made difficult by:
Competition in the market (threat of new entrants)
Substitute products
Bargaining power of buyers

How do we retain customers or increase sales?
reliable service
meet customers requirement
Satisfied customers attract other customers and/or place larger orders
Operating costs
All costs
Budgets
Gross margin:
(Revenue less COGS) / Revenue
Net profit:
Gross profit less expenses
Expenses:
Primary Activities
Support Activities
Tax
...
Return on investment
Profit margin
Asset Turnover
Logistics costing and activity-based costing
...
Logistics costing
limitations of financial accounting and reporting?
Activity-based costing (ABC)
Is a refined costing system that assign costs to products (or services) based on the manner a product (or services) "causes" costs / (cost drivers)
ABC process:
Identifying main activities
Allocating cost to activities (cost pools)
Determining cost drivers (causes)
Assigning costs to product/service (usage)
Marginal costing
Only costs & benefits affected by decisions (i.e. Relevant costing)

Special-order decisions
Discontinuation of a department or product
Replacement of equipment
Choice of products where a limiting factor exists
Special-order decisions
Lower than normal price
Once-off orders to fill short-term space capacity

Raw material (5kg @ R14) R70
Labour (2h @ R20) 40
Rental (Apportionment) 35
Packaging 10
Cost of 1 Unit: R155

Capacity 10 000 units
Should they accept once-off order @ R140?
Selling price is below cost price of manufacture!!
Special-order decisions
Only consider costs & benefits that are affected.

Raw material
(5kg @ R14) R70
Labour
Fixed labour - no add costs
Rental
Based on normal capacity
Packaging
Can't be avoided R10

Marginal Cost of 1 Unit: R80
Marginal Benefit R60 (R140 - 80)
Choice of products where a limiting factor exists
Fixed and Variable costs (know the difference!)
Concept of contribution per unit (CU):

CU = sales price per unit minus variable cost per unit

Contribution of each sales unit makes in covering fixed costs
Increasing profit
Section 5.10 - Cost-Volume-Profit Analysis
Choice of products where a limiting factor exists
Limiting- factor decisions:
There may be a factor (resource) that limits the firm activities from satisfying demand for product / services

Step 1: Identify main limiting factor
Step 2: Calc contribution per unit
Step 3: Calc contribution per limiting factor
Step 4: Rank product
Step 5: Calc profit-max production mix
Cost-volume-profit analysis
Effect that changes in variable & fixed costs, sales price and sales volume have on profitability

Reduction sales volume = reduction in profit
CVP assist in determining at what point firm starts making a loss

LM strategies have substantial impact on sales and FC
E.g. Service levels , # and location of warehouses
The Breakeven Point
where total sales and total costs are even and the firm shows neither profit or loss

BEP (in units) = Fixed costs / contribution per unit

BEP (sales value) = number of units X sales price / unit
Units sold increase:
sales revenue ↑
total variable cost & contribution ↑ proportionally.
total fixed costs remains constant

Must sell enough units to earn contribution to cover fixed costs

Sale Price / Unit = R80
Variable costs / unit = R30
Fixed costs / period = R200
Expected sales = 6 units
Contribution / unit = R50 (R80 - 30)
sales revenue ↑
total variable cost & contribution ↑ proportionally.
total fixed costs remains constant

Helpful in determining feasibility of new product/service
if less products will be sold than units required to break even
probably running at loss, not feasible
Margin of safety
Contribution of units above BE units represents Profit
number of units the firm's sales can decrease before incurring a loss (better expressed as a percentage of sales)

= (total sales - breakeven sales)/ total sales X 100%
= (6 units - 4 units) / 6 units x 100% = 33,3%
Sales to achieve a target profit
How many units must we sell to cover fixed cost and required profit?
= (fixed cost + target profit) / contribution per unit
= (R200 + R100) / R50 = 6 units
Change in fixed cost
how many facilities & logistics personnel?
own or outsources transport (paid variable rate)?

will have notable effect on fixed & variable cost composition

In example: If FC increase to R250
BEP requires more units to 5 units (R250/R50)
Increase in losses if fewer or no units are sold
Margin of safety will decrease
Change in variable cost
Increase in VC = reduction in contribution / unit
higher BEP

decelerate the pace at which profit is increased beyond the BEP
Change in selling price
Increase SP = contribution will increase
contribution covering FC & profit at accelerated pace
decreasing effect on sales volume
Price elasticity of products market/demand
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