Capstone: Strategy

1

APPRAISING PERFORMANCE AND

STRATEGY MBA600 Week 4

2

COMMONWEALTH OF AUSTRALIA COPYRIGHT REGULATIONS 1969

WARNING THIS MATERIAL HAS BEEN REPRODUCED AND COMMUNICATED TO YOU BY OR ON BEHALF OF KAPLAN BUSINESS SCHOOL PURSUANT TO PART VB OF THE COPYRIGHT ACT 1968 (THE ACT).

THE MATERIAL IN THIS COMMUNICATION MAY BE SUBJECT TO COPYRIGHT UNDER THE ACT. ANY FURTHER REPRODUCTION OR COMMUNICATION OF THIS MATERIAL BY YOU MAY BE THE SUBJECT

OF COPYRIGHT PROTECTION UNDER THE ACT.

DO NOT REMOVE THIS NOTICE.

2

3

WEEK 4 FOCUSES ON THE THIRD LEARNING OBJECTIVE

3. Discuss and translate theory, skills and knowledge into effective management practice.

Other learning objectives Critically assess a diverse range of theories accumulated throughout the Masters’ qualification and the connections that exist between each one.

Acquire advanced knowledge and apply it in real workplace contexts to improve performance and competitive advantage.

Undertake independent research to solve complex business problems.

4

QUICK REVIEW OF KEY CONCEPTS What we learned in Week 3

5

WHAT WE LEARNED LAST

WEEK

Contingency Theory

Strategic fit the consistency of strategy with the firm’s internal environment and industry external environment

Fit is a concept in Contingency Theory There is no single best way of structuring or managing a firm

6

WHAT WE LEARNED LAST

WEEK

Competition strategy and Porter’s Five Forces framework

7

WHAT WE LEARNED LAST

WEEK

Positioning of Competition Strategy

8

WHAT WE WILL LEARN THIS

WEEK

Strategy planning processes related to resources

Capabilities have been discussed in previous weeks

Capital management

Financial stability

Cash flow

9

APPRAISING FINANCIAL STABILITY

Appraising the Effectiveness of current strategy

10

RECALL THE FINANCIAL STATEMENTS

BALANCE SHEET ($ in millions)

ASSETS 2017 2018

LIABILITIES 2017 2018

Current Assets

$761m $707m Current Liabilities

$486m $455m

Fixed Assets

$1,118m $1,035 Long-term Liabilities

$588m $562m

Total Equity $805m $725m

Total Assets

$1,879 $1,742 Total Liabilities and Equity

$1,879m $1,742m

INCOME STATEMENT ($ in millions) 2017 2018

REVENUE $2,262 $1,810

Cost of goods sold $1,655 $1,324

Selling, general and administrative expenses

$327 $262

Depreciation $90 $72

OPERATING INCOME $190 $152

Other income $29 $45

EBIT $219 $197

Interest $49 $44

Taxes $84 $67

NET INCOME $86 $86

Remember: Total Assets = Total Liabilities + Equity

11

APPRAISING PERFORMANCE

STRATEGY PLANNING PROCESS

FINANCIAL RATIO ANALYSIS

MEASURE DESCRIPTION INTERPRETATION

Return on Sales After-tax Profit ÷ Total Sales Percentage of profits earned per dollar of sales revenue

Return on Assets After-tax Profit ÷ Total Assets Percentage of profits earned per dollar of assets

Return on Equity After-tax Profit ÷ Total Equity Percentage of profits earned per dollar of shareholders’ equity

Gross Profit Margin (Total Sales – Cost of Goods) ÷ Total Sales

Percentages of sales dollars retained as operating profit

Net Profit Margin (Total Sales – Total Expenses) ÷ Total Sales

Percentages of sales dollars retained as profit (earnings)

Current Ratio Current Assets ÷ Current Liabilities

Liquidity

12

APPRAISING PERFORMANCE

STRATEGY PLANNING PROCESS

FINANCIAL RATIO ANALYSIS

MEASURE DESCRIPTION INTERPRETATION

Debt to Total Assets Total Debt ÷ Total Assets Proportion of assets that are financed by debt

Debt to Total Equity Total Debt ÷ Total Equity Amount of debt financing as a proportion of total equity

Earnings per Share (After-tax Profit – Preferred Share Dividends) ÷ Common Shares Outstanding

Profit available for distribution to shareholders

Price/Earnings Ratio Market Price per Share ÷ (After-tax Earnings per Share

Indicates anticipated earnings as a multiple of the stock price

Cash Flow per Share (After-tax Profit + Depreciation) ÷ Common Shares Outstanding

Liquidity to fund operations

13

WORKSHOP TIME

How does the financial stability of a firm compare with its competition?

14

CAPABLE MANAGEMENT

OF A FIRM’S FINANCES

WORKSHOP

Perform a financial ratio analysis of the competing firms you selected in Week 2 (30 minutes)

Do a comparative financial analysis across competitors and years

Assess the business risks discovered by your analysis Use your choices of Porter’s 5 Forces, SWOT and PESTLE frameworks

15

DIAGNOSING PERFORMANCE

The ability of a firm to convert its resources to cash

relative to its competitors

16

CURRENT ASSETS Listed on the Income Statement The assets held for sale within the year

LONG-TERM ASSETS Listed on the Balance Sheet The assets that fund the business from year to year

CURRENT LIABILITIES Listed on the Income Statement The funds owed within the year

EQUITY The funds owned by investors in the business

LONG-TERM DEBT Listed on the Balance Sheet The debts the fund the business from year to year

WORKING CAPITAL

CURRENT ASSETS

LONG- TERM

ASSETS EQUITY

CURRENT LIABILITIES

LONG- TERM DEBT

WORKING CAPITAL Cash available to pay expenses when due Current Assets - Current Labilities = Working Capital

CASH FROM WORKING CAPITAL

17

CASH FROM WORKING CAPITAL

Remember Working capital equals current assets minus current liabilities

Important question How quickly can working capital be converted to cash?

Resource threat Most companies go bankrupt because they run out of cash; they cannot pay bills or access more money

18

STATEMENT OF CASH FLOWS

Sources of cash Increase in net working capital

A decrease in liabilities or an increase in assets

Net income after tax

The disposal or revaluation of fixed assets (plant, property, equipment)

Proceeds of loans obtained

Proceeds of shares that were issued

Repayments received on loans previously granted by the company

Uses of cash Decrease in net working capital

Losses to be met by the company

The purchase of fixed assets/investments

The full or partial payment of loans

Granting of loans

Liability for taxes

Dividends paid or proposed

https://corporatefinanceinstitute.com/resources/knowledge/accounting/sources-and-uses-of-funds-statement/

Reports the cash inflow and cash outflow over an accounting period, normally a month or a year

19

CASH CONVERSION

CYCLE

THE DAYS REQUIRED TO CONVERT WORKING CAPITAL

INTO CASH

Days Sales in Inventory: the days taken to sell all inventory during a year

DSI = 365 ÷ (Cost of Sales ÷ Inventory)

Days Sales Outstanding: the days required to collect customer payments after a sale on credit

DSO = 365 ÷ (Net Sales ÷ Accounts Receivable)

Days Payables Outstanding: the days taken to pay supplier invoices

DPO = 365 ÷ (Cost of Sales ÷ Accounts Payable)

Cash Conversion Cycle = DSP + DSI - DPO

Working capital cash comes from inventories plus receivables minus payables

20

RISK OF FINANCIAL

STRESS AND BUSINESS

BANKRUPTCY

Altman’s Z score

Indicates the overall financial health of a firm in a single measure

Altman’s Z score = 1.20 x (Working Capital ÷ Total Assets) + 1.40 x (Retained Earnings ÷ Total Assets) + 3.33 x (Earnings Before Interest and Tax ÷ Total Assets) + 0.60 x (Market Value of Equity ÷ Book Value of Debt) + 0.99 x (Sales ÷ Total Assets)

Scores below 1.8 = likelihood of bankruptcy

Scores above 3.0 = unlikely to go bankrupt

21

WORKSHOP TIME

Positive cash flow is required to fund business growth

22

WORKSHOP

You have three objectives in your competitor assessment (30 minutes)

1. Determine the priorities for resource investment Use the Statement of Cash Flows (in a firm’s annual report); or apply the ‘sources and uses’ table on the previous slide

2. Calculate the Cash Conversion Cycle

3. Summarise the resource base of your firm What is the ability of your firm to fund business growth relative to its competitors?

RESOURCE BASE AND GROWTH

POTENTIAL

HOW ‘COMPETITIVE’ IS THE COMPETITION

STRATEGY?

23

INDUSTRY ANALYSIS

A firm’s ability to fund business growth via equity

and debt, relative to its competitors

24

CAPITAL STRUCTURE OF A FIRM

What is best?

FUNDING TO GROW MORE PROFITS THAN COMPETITORS

One of the most important choices as to the funding operational activities and business growth

The ‘best’ mix of capital depends on the industry The cost of debt is less expensive than equity because it has less risk

Excessive debt increases interest payments, he volatility of profits and bankruptcy risk

‘Companies with consistent cash flows can tolerate a much larger debt load and will have a much higher percentage of debt in their optimal capital structure. Conversely, a company with volatile cash flow will have little debt and a large amount of equity.’ (Investopedia)

25

TYPES OF RISK

BUSINESS risk is a deviation from plan, positive or negative

A negative deviation is a threat A positive deviation is an opportunity

SYSTEMATIC risk affects numerous assets or firms to varying degrees

For example, business cycles and inflation

UNSYSTEMATIC risk affecting a specific group of assets

For example, legislation and ‘acts of god’

26

INVESTMENT ATTRACTIVENESS

CAN A FIRM ATTRACT EQUITY?

ATTRACTING EQUITY INVESTORS

A helpful website is Yahoo Finance! https://au.finance.yahoo.com/ provides free data and charting for global stock exchanges (like the ASX below)

Examine the attractiveness of investment Price-Earnings (P:E) ratio Return on Investment (ROI) Earnings per Share (EPS) Bond Yield

27

WORKSHOP TIME

The attractiveness of a firm to investors (equity and bonds)

28

COMPETITION FOR INVESTMENT

EQUITY AND BONDS

WORKSHOP

Use Yahoo Finance! and other investor websites to investigate the ability to attract investment in your firm and its competitors (30 minutes)

Compare investment attractiveness relative to: Price-Earnings (P:E) ratio Return on Investment (ROI) Earnings per Share (EPS) Bond yield (if available)

29

S e e k h e l p w h e n y o u n e e d i t !

Thank you