Supply Chain Vector [Electronic resources] : Methods for Linking the Execution of Global Business Models With Financial Performance نسخه متنی

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Supply Chain Vector [Electronic resources] : Methods for Linking the Execution of Global Business Models With Financial Performance - نسخه متنی

Daniel L. Gardner

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Cash Flow From Financing Activities

Of the three sections of the CFS, financing activities certainly seems the least related to tactical supply chain execution. To refute this line of thought, however, one can revisit the situation at General Motors in 1920. In order to ramp up for anticipated production, the finance people at GM made an additional stock offering to support the purchase of raw materials. This is not an unusual practice, but when the auto market went south and GM had no revenues, management then had to go to the banks for short-term notes to pay suppliers. Although a difficult situation for any company to find itself in, the scenario has repeated itself dozens if not hundreds of times since the early days of industrialization. Unfortunately, knowledge of the past does not necessarily guarantee that it will not be repeated, and NikoTech falls into the same quagmire in Y2. The company's financing activities are summarized in Table 16.3.

Table 16.3: NikoTech Cash Flow Statement Financing Activities

in Millions

Financing Activities

Issuance of Long-Term Notes


Cash from Financing Activities


With both earnings and the NikoTech stock price down in Y2, its sources of financing were somewhat limited. Also, the decision to invest $60 million in plant and equipment put pressure on the company's delicate position, compelling it to issue an equivalent amount in long-term notes. Although shown as a source of cash on the Y2 CFS, the problem with any debt is that it has to be paid back, installments of which (principal and interest) inconveniently find their way to the income statement.

When debt is acquired in less than ideal circumstances, the conditions under which the notes are secured will also be less than optimal. In this case, NikoTech had to offer the notes at a percentage higher than it would have had its net income been healthier.

The three sections analyzed in the CFS combine to form what is known as free cash flow. Defined as the amount of cash available to a company after all operational and strategic sources/uses of cash have been accounted for, free cash flow is the oxygen that keeps an organization breathing. As noted on the CFS, NikoTech experienced a net decrease in cash of $177 million, dragging down its cash on the balance sheet from $264 million in Y1 to $87 million in Y2. This event speaks once again to the impact on measures like working capital, return on total assets - virtually any measure that includes current assets in its denominator.

The fact that cash decreased while other current assets increased creates a false sense of improvement in these ratios, a situation that may partially mask more critical issues. Surely a company does not want to have too much tied up in cash, but to deplete this number as a result of poor operating results or bad strategic decisions is even less desirable.

When one considers the number of ratios available to management teams, it should not be difficult to select a handful of tools that put performance in the "supply chain vector" that has been the central theme of this book. Without going overboard, analysts must choose metrics that not only produce reliable figures but also help to reveal the underlying causes of perplexing numbers. Without question, management must include calculations such as return on investment, working capital, the operating cycle and the cash-to-cash cycle. However, much like the way in which the DuPont formula synthesizes net income with asset utilization, other ratios must be found that continue this process of cross-pollination.

Because of its all-encompassing treatment of net income, depreciation, changes in working capital and investing and financing activities in the same report, the CFS is a good place to look for ratios that continue this process of vectorization. Wall Street's obsession with short-term performance and the impact that earnings and changes in working capital have on free cash flow make the search for relevant ratios that much easier.

Of all the sources of financial information, cash flow from operating activities is the most relevant in measuring the short-term performance of net income versus investments in current assets. While the return on investment formula measures earnings compared with total asset value, the ratio of cash flow from operating activities to net income measures earnings against how well a company manages inventories, collects on debt and pays its bills. This ratio makes a powerful argument: net income is great, but if inventories are not managed, money cannot be collected and there is no cash to pay bills, the entire exercise will be for naught. Calculation of NikoTech's cash from operating activities to net income ratio sheds new and revealing light on an age-old dilemma. The formula reads:

Cash flow from operating activities/Net income

Intuitively speaking, a high quotient is desired for this ratio as it depicts a company whose earnings are backed up by cash. Reporting net income is one thing; getting the funds from customers is another story entirely. Results for NikoTech in Y2 were

($192 million)/$12.6 million = (15.23)

If there is any residual doubt as to the grave state of affairs at NikoTech, the cash flow from operating activities to net income ratio should erase it. True, the ratio is high, but the idea is to have a high ratio that is also positive. With a negative ratio of 15.23, this calculation reveals that for every dollar in net income that NikoTech generates, it can expect a negative cash flow of $15.23. Another variation on the same theme is that all the net income in the world is not going to do NikoTech a bit of good until it squares away its current assets.

In fact, even if the company tripled earnings, it would still have an operating activities ratio of ($5). Unless this trend is reversed, NikoTech will continue down the path of cash consumption to the point where it will run out of money and be unable to find a financial institution willing to bail it out.

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