S I M U L A T I O N

M A N A G E M E N T

Week3: Getting it togetherWeek3: Getting it together

1. Situation & Swot Analysis

2. Draft Mission & Vision Statements & Select Growth & Competitive Strategies

3. Formulate “functionally aligned” strategic & tactical decisions…

1. Situation & Swot Analysis

2. Draft Mission & Vision Statements & Select Growth & Competitive Strategies

3. Formulate “functionally aligned” strategic & tactical decisions…

Process of Planning & Evaluating Strategy

Functional Planning:Functional Planning:Marketing Production

R&D, HRFinance

Market Research:Market Research:Situation & SWOTSituation & SWOT

AnalysisAnalysis

Corp. & SBUCorp. & SBUStrategyStrategy::

Mission & VisionGrowth &

Competitive Strategy

PerformancePerformanceAssessment:Assessment:

Success Measures& Financial Ratios

Performance

Assessment

Evaluating Strategy- Step #4:

“SHOW ME

THE

MONEY”

Let’s Examine:

1.Ways to plan & evaluate your financial performance

2.Some Financial Planning guidelines

Financial Proformas & Reports

BalanceBalanceSheetSheet

Financial Financial RatiosRatios

CashCashFlowFlow IncomeIncome

StatementStatement

Shows cash movement in & out of organization

& how much cash is available

Shows cash movement in & out of organization

& how much cash is available

Compares revenues & expenses for the period

Indicates profitability

Compares revenues & expenses for the period

Indicates profitability

http://www.fool.com/school/valuation/howtoreadabalancesheet.htm

What Co. Owns

What Co. Owns

What Co. Owes

What Co. Owes

Who Owns Co.

Who Owns Co.

Provide insights into company’s operations & strategy

Used internally to evaluate performance & set goals

Used externally to make investment decisions

Provide insights into company’s operations & strategy

Used internally to evaluate performance & set goals

Used externally to make investment decisions

Financial Ratios

ROE

ROA

ROS

Asset T/O

P:E

Financial Ratios Answer 5 key

Questions

1) How liquid is your firm?2) How profitable is your Firm?3) How effectively are you utilizing

your assets ?4) How are you financing your assets?5) Are you providing your owners an

adequate return on their investment ?

Your Company’s ratios

as reported annually

in the

Capstone Courier

Financial Guidelines Re: Liquidity

You’ll be left w/less revenue than

anticipated PLUS production &

inventory carrying costs that must be

paid..

IF You Produce a crappy product &/or Your Competitors produce a

better product &/or You produce too much product

Then

You’re left w/less revenue than anticipated and did not plan & allocate enough cash to cover your production & inventory carrying costs....

IF

Then

Big Al arrives -- pays your bills, and leaves you with a loan & a stiff interest payment

•Maintain Adequate working

capital & cash reserves

In order to:

In order to:

•Have realistic/ accurate

sales forecasts

•Avoid a Liquidity Crisis- & “Big AL”

Need to:Need to:

1

2

3

4

Basic Steps of Sales Basic Steps of Sales ForecastingForecasting

BEST CASEBEST CASE

WORST CASEWORST CASE

Your Product/Total Customer survey scores = DemandYour Product/Total Customer survey scores = Demand

•Enter WORSE case- in “your sales forecast” on marketing spreadsheet

•Enter BEST case- in “production schedule” on production spreadsheet

•Spread show up as inventory on proforma BALANCE SHEET

$0.00

In WORSE CASE: You should observe lots of Inventory

& little or no Cash.

In WORSE CASE: You should observe lots of Inventory

& little or no Cash.

Return to Marketing Spreadsheet.

Enter your best case forecast.

Observe that your Balance Sheet will now reflect:

lots of Cash and no Inventory 000

Important Considerations re: BEST-WORST Scenario

Analyses

By adjusting your CASH POSITION according to your WORST CASE estimate– will avoid …

By adjusting your CASH POSITION according to your WORST CASE estimate– will avoid …

$0.00

In WORSE CASE: You will have lots of Inventory

& thus need to drive your cash position to the black…

In WORSE CASE: You will have lots of Inventory

& thus need to drive your cash position to the black…

Liquidity Guidelines

To adjust your cash position -- If you are cash poor,

issue Stock /Bonds ; or if necessary consider a short term loan

If you are cash rich, pay dividends and/or buy back stock.

To adjust your cash position -- If you are cash poor,

issue Stock /Bonds ; or if necessary consider a short term loan

If you are cash rich, pay dividends and/or buy back stock.

Important Considerations re: BEST-WORST Scenario

Analyses

By adjusting production according to BEST CASE estimate– will minimize loss of profit due to Stock-outs

Fixed costs (marketing, R&D, interest

or depreciation) already covered Thus, any additional sales would

only incur variable (production) costs

By adjusting production according to BEST CASE estimate– will minimize loss of profit due to Stock-outs

Fixed costs (marketing, R&D, interest

or depreciation) already covered Thus, any additional sales would

only incur variable (production) costs

For example, 1. If your annual sales

were $120M, in one month you’d sell $10M.

2. If a months material & labor costs = $7M, you missed contributing $3M to Net Margin.

3. This would be taxed in the simulation at 35%, so your opportunity cost is a missed $2M in profit.

Financial Ratios 2nd Key Question

1) How liquid is your firm?2) How profitable is your Firm?3) How effectively are you utilizing

your assets ?4) How are you financing your assets?5) Are you providing your owners an

adequate return on their investment ?

Profitability Ratios

Show how profitable company is

ROS---Return on SalesROA—Return on AssetsROE-- Return on Equity

““ROS indicates the percentage of each ROS indicates the percentage of each sales dollar that results in net income.”sales dollar that results in net income.”

Main ratio of ProfitabilityReturn on Sales

Return on Sales =Return on Sales = net profitnet profit

net salesnet sales

net profitnet profit

net salesnet sales

Financial Guidelines:

Profitability

2) How Profitable is your Firm?

ROSROS

Contribution MarginContribution Margin

If your Contribution Margin is below 30%,If your Contribution Margin is below 30%, …..the problem = combination of Marketing (customers hate your products), Production (your labor and material costs are too high), or Pricing (you cut the price too much).

If your ROS is below 5%, but your Net If your ROS is below 5%, but your Net Margin Percentage is above 20%,Margin Percentage is above 20%, ….you either experienced some extraordinary "Other" expense like a write-off on plant you sold, or you are paying too much Interest (If TQM is enabled, you may also have spent heavily on TQM initiatives).

If your Net Margin Percentage is below 20%, If your Net Margin Percentage is below 20%, but Contribution Margin is above 30%,…but Contribution Margin is above 30%,… the problem is heavy expenditures on Depreciation (perhaps you have idle plant) or on SGA (perhaps you are pushing into diminishing returns on your Promo and Sales Budgets).

Financial Ratios 3rd Key Question

1) How liquid is your firm?2) How profitable is your Firm?3) How effectively are you utilizing

your assets ?4) How are you financing your assets?5) Are you providing your owners an

adequate return on their investment ?

Drive Asset Turnover

Reveals how effective assets are at generating sales revenue.

The higher the better= more efficient use of assets

Asset Turnover =sales

assets

sales

assets

$103,777/ $96,043 = 1.08

Firm can generate $1.08 in sales for every $1 assets

Drive- Return on Assets

Return on Assets = =net profit

assets

net profit

assets

““ROA measures company’s ability to use all its assets to generate earnings.”

Financial Ratios 4th Key Question

1) How liquid is your firm?2) How profitable is your Firm?3) How effectively are you utilizing

your assets ?4) How are you financing your assets?5) Are you providing your owners an

adequate return on their investment ?

Assets/Equity – simulation takes owner's perspective.

A Leverage of 3.0 says, "For every $3 of Assets there is $1 of Equity

Leverage     Assets     Debt     Equity

1.0   $1   $0   $1

2.0   $2   $1   $1

3.0   $3   $2   $1

4.0   $4   $3   $1

LEVERAGE:

1.8 to 2.8

OptimalOptimal

Corp assets fin.w/ debt

AAA/AA/A/BBB/… BB & beyond is Junk… B/CCC /CC/C/D = default

AAA/AA/A/BBB/… BB & beyond is Junk… B/CCC /CC/C/D = default

•As your debt-to-assets ratio increases…

•Your short term interest rate increases…

•For each additional .5% increase in interest

•You drop one category

Leverage from lenders’ perspective impacts bond ratings:

Last Key Question

Are you providing your owners an adequate return on their investment

Owners evaluate profits w/ two stat’s:

ROE (Return On Equity) ROE = Profits/Equity = Profits/Assets *

Assets/Equity = ROA * Leverage.

EPS (Earnings Per Share) EPS = Profits/Shares Outstanding

STOCK PRICE Function of:

1.Book Value Equity/ # shares

issued2.Earnings per

Share (wgtg 2-3?) Net Profit/ Shares

3.Dividend Policy (wgtg 5-8?)

Encompasses the 3 main levers used

by mgt to generate return on investors

equity

Profitability * Asset Mgt * Leverage

ROE

DuPont Formula

Return on Equity =Return on Equity =net profitnet profit

equityequity

net profitnet profit

salessales

salessales

assetsassets

assetsassets

equityequityxxxx xxxx

Profitability * Asset Mgt * Leverage

Return on Equity =

net profitnet profit

equityequity

Improve ROE by:Improve ROE by:

1) Increase sales w/out increase costs & expenses

2) Reduce COG or operating expenses

3) Increase sales relative to asset base- either by increasing sales or by reducing company assets

4) Increase use of debt relative to equity-- but only to extent it does not jeopardize firm’s financial position

Improve ROE by:Improve ROE by:

1) Increase sales w/out increase costs & expenses

2) Reduce COG or operating expenses

3) Increase sales relative to asset base- either by increasing sales or by reducing company assets

4) Increase use of debt relative to equity-- but only to extent it does not jeopardize firm’s financial position

Success Measures

Cumulative Profits Ending Market Share ROS Asset Turnovers ROA ROE Ending Stock Price Market Capitalization (Ave # Shares) * (Closing

Price)

Performance Measures- Defined Performance Measures-Dynamics

• Select Success Measures & Determine Relative Weightings

• Need to enter weightings – prior to round-1

• Select Success Measures & Determine Relative Weightings

• Need to enter weightings – prior to round-1

Diff Strategies Play into Different Success Measures

Profit MS SP & MC

ROEpf/e

ROSpf/s

ATs/a

ROApf/a

BCLL=2-3

X X X X

Cost- Niche & PLC

X X X

B-Diff L=1.5-2

X X X X

Niche-PLCDiff

X X X X

Cost Strategy = higher leverage/more

investment/ more assets/more debt/ le

ss

equity

Cost Strategy = higher leverage/more

investment/ more assets/more debt/ le

ss

equity

Differentiation Strategy =lower

leverage/less investment/ less assets

Differentiation Strategy =lower

leverage/less investment/ less assets All Segments= more sales & thus enable

greater Cum. profit & overall market share

All Segments= more sales & thus enable greater Cum. profit & overall market share

Focused

Strategies should

operate more

effectively &

have overall less

sales

Focused

Strategies should

operate more

effectively &

have overall less

sales

It is important to look at the means used to achieve outcomes …. not just focus on the outcomes themselves

To only focus on traditional financial accounting measures (such as

ROA, ROE, EPS) …..does not give mgt the whole picture….

M A R K E T I N G

M A N A G E M E N T Performance needs to be judged thru mix of both financial & non-financial measures….

As some nonnon--financialfinancial measures are driversdrivers of financial outcomes

Performance needs to be judged thru mix of both financial & non-financial measures….

As some nonnon--financialfinancial measures are driversdrivers of financial outcomes

M A R K E T I N G

M A N A G E M E N T

Management benefits from a multi-dimensional perspective which includes not only financial– but customer, internal & organizational learning/improvement perspectives as well…

Management benefits from a multi-dimensional perspective which includes not only financial– but customer, internal & organizational learning/improvement perspectives as well…

M A R K E T I N G

M A N A G E M E N T

The Logic

"If we succeed, how will we look to our

shareholders?”

Financial Perspective

"To achieve my vision, how must I look to my

customers?”

Customer Perspective

"To satisfy my customers, at which processes must excel?”

Internal Perspective

"To achieve my vision, how must my organization learn

and improve?”

Organization Learning

STRATEGY

M A R K E T I N G

M A N A G E M E N T

What is measured gets noticed

What is noticed gets acted on

What is acted on

gets improved

Today …

~ 70% of Fortune 1,000 companies utilize a Balanced Balanced ScorecardScorecard to help manage performance—

because…..

Today …

~ 70% of Fortune 1,000 companies utilize a Balanced Balanced ScorecardScorecard to help manage performance—

because…..

M A R K E T I N G

M A N A G E M E N T

Basic Scorecard Terminology(Southwest Airlines Example)

Objectives

• Fast ground turnaround

Objectives:What the

strategy is trying to achieve

Targets

• 30 Minutes• 90%

TargetsThe level of

performance or rate of

improvement needed

• Cycle time optimization

InitiativesKey action programs

required to achieve targets

InitiativesMeasures

• On Ground Time

• On-Time Departure

MeasuresHow

performance is measured

against objectives

Strategic Theme: Operating Efficiency

Profits and RONAFinancial

Learning

Ground crew alignment

Lowest prices

Fewer planes

Customer

Internal

Fast ground turnaround

Strategy Map

On-time Service

Attract & Retain More Customers

Grow Revenues

M A R K E T I N G

M A N A G E M E N T

• % Ground crew trained

• % Ground crew stockholders

A Complete Scorecard is a Program for Action

Objectives Measures

• # Customers• FAA On Time

Arrival Rating• Market Survey

• On Ground Time

• On-Time Departure

Strategic Theme:Operating Efficiency

Initiatives

• Cycle time optimization

• Ground crew training

• ESOP

•Customer loyalty program• Quality management

Targets

•30% +/yr

•20%

•5% • 12% growth• Ranked #1• Ranked #1

• 30 Minutes• 90%

• yr. 1 70%yr. 3 90%yr. 5 100%

• Profitability

• Grow Revenues

• Fewer planes

• More Customers

• Flight is on -time

• Lowest prices

• Fast ground turnaround

• Ground crew alignment

Strategic Theme:

Operations ExcellenceProfits and

RONAFinancial

Learning

Ground crew alignment

Fewer planes

Customer

Internal

Fast ground turnaround

Attract & Retain More Customers

Grow Revenues

Lowest prices

On-time Service

M A R K E T I N G

M A N A G E M E N T

Capstone's Balanced Scorecard Capstone's Balanced Scorecard

M A R K E T I N G

M A N A G E M E N T

Your Business

Plan

BizPlan: Format & Contents- Guide