i Supply Chain Management Accounting ii THIS PAGE IS INTENTIONALLY LEFT BLANK iii Supply Chain Management Accounting Managing profitability, working capital and asset utilization Simon Templar iv Publisher’s note Every possible effort has been made to ensure that the information contained in this book is accurate at the time of going to press, and the publisher and author cannot accept responsibility for any errors or omissions, however caused No responsibility for loss or damage occasioned to any person acting, or refraining from action, as a result of the material in this publication can be accepted by the editor, the publisher or the author First published in Great Britain and the United States in 2019 by Kogan Page Limited Apart from any fair dealing for the purposes of research or private study, or criticism or review, as permitted under the Copyright, Designs and Patents Act 1988, this publication may only be reproduced, stored or transmitted, in any form or by any means, with the prior permission in writing of the publishers, or in the case of reprographic reproduction in accordance with the terms and licences issued by the CLA Enquiries concerning reproduction outside these terms should be sent to the publishers at the undermentioned addresses: 2nd Floor, 45 Gee Street London EC1V 3RS United Kingdom c/o Martin P Hill Consulting 122 W 27th Street New York, NY 10001 USA 4737/23 Ansari Road Daryaganj New Delhi 110002 India © Simon Templar 2019 The right of Simon Templar to be identified as the author of this work has been asserted by him in accordance with the Copyright, Designs and Patents Act 1988 ISBNs Hardback Paperback Ebook 978 7494 9805 978 7494 7299 978 7494 7300 British Library Cataloguing-in-Publication Data A CIP record for this book is available from the British Library Library of Congress Cataloging-in-Publication Data A CIP record for this book is available from the Library of Congress Typeset by Integra Print production managed by Jellyfish Printed and bound in Great Britain by CPI Group (UK) Ltd, Croydon CR0 4YY v CO N T E N T S Acknowledgements ix 01 Introduction 02 The income statement 2.1 2.2 2.3 2.4 2.5 2.6 2.7 2.8 2.9 2.10 2.11 2.12 2.13 2.14 2.15 2.16 03 Aim and objectives The income statement 10 Revenue 15 Cost of sales 19 Inventory and the income statement 21 Inventory valuation methods 23 Operating expenses 32 Net finance costs 34 Earnings before tax 35 Taxation, earnings after tax, dividends and retained earnings 38 SC management and profitability 39 Summary 42 References 43 Solutions to the activities 44 Study questions 47 Study question solutions 50 The balance sheet 53 3.1 3.2 3.3 3.4 3.5 3.6 3.7 3.8 3.9 Aim and objectives 53 Debits, credits and account types 54 Accounting equation 55 The balance sheet 58 Assets 71 Liabilities 76 Working capital 78 Equity 79 Financial ratios and the balance sheet 80 vi Contents 3.10 3.11 3.12 3.13 3.14 3.15 3.16 04 Cash and working capital management 103 4.1 4.2 4.3 4.4 4.5 4.6 4.7 4.8 4.9 4.10 4.11 05 Aim and objectives 104 The importance of cash in business 104 The cash flow forecast 107 The cash-to-cash cycle 120 The relationship between liquidity and cash flow 125 Supply chain management and supply chain finance 127 Summary 131 References 131 Solutions to the activities 132 Study questions 135 Study question solutions 138 An introduction to depreciation 143 5.1 5.2 5.3 5.4 5.5 5.6 5.7 5.8 5.9 5.10 5.11 5.12 06 Supply chain decisions on the balance sheet 83 Balance sheet case study 85 Summary 90 References 90 Solutions to the activities 91 Study questions 94 Study question solutions 96 Aim and objectives 144 Smoke and mirrors 144 Revenue and capital 145 Depreciation methods 147 Disposal of an asset 154 Depreciation practice in the supply chain 156 Earnings before interest, taxes, depreciation and amortization (EBITDA) 159 Summary 161 References 161 Solutions to the activities 162 Study questions 165 Study question solutions 168 S upply chain management and financial performance 175 6.1 Aim and objectives 176 Contents 6.2 6.3 6.4 6.5 6.6 6.7 6.8 6.9 6.10 6.11 6.12 6.13 07 Marginal costing 219 7.1 7.2 7.3 7.4 7.5 7.6 7.7 7.8 7.9 7.10 7.11 08 The role of the supply chain 176 Return on capital employed 178 EBIT percentage and NCA + WC turnover 180 Case study: Qwerty Ltd 184 Supply chain management and ROCE 190 Supply chain management financial ratios 196 EBIT after asset charge (EAC) 201 Summary 202 References 203 Solutions to the activities 204 Study questions 206 Study question solutions 213 Aim and objectives 219 Different types of cost 220 Break-even analysis 225 Limiting factor analysis 230 Inventory valuation 232 Practical applications of marginal costing in supply chains 233 Summary 234 References 234 Solutions to the activities 234 Study questions 238 Study question solutions 241 Absorption costing and variance analysis 247 8.1 8.2 8.3 8.4 8.5 8.6 8.7 8.8 8.9 8.10 8.11 8.12 Aim and objectives 248 The need for full costing 248 Margin vs mark-up 251 Absorption costing 253 Cost units and cost centres 255 Allocation, apportion and absorption 255 Absorption costing case study 269 Standard costing and variance analysis 272 Supply chain implications 277 Summary 279 References 280 Solutions to the activities 280 vii viii Contents 8.13 8.14 09 Contemporary costing methods 293 9.1 9.2 9.3 9.4 9.5 9.6 9.7 9.8 9.9 9.10 10 Study questions 282 Study question solutions 288 Aim and objectives 293 Activity-based costing (ABC) 294 Total cost of ownership 303 Target costing 306 Other contemporary costing methods 311 Summary 311 References 311 Solutions to the activities 313 Study question 316 Study question solution 318 Investment appraisal 321 10.1 10.2 10.3 10.4 10.5 10.6 10.7 10.8 10.9 10.10 10.11 10.12 10.13 10.14 Aim and objectives 322 Revenue and capital expenditure 322 Shareholder value 324 Capital investment appraisal 324 Opportunity cost 326 Case study: warehouse management system upgrade 326 Equivalent annualized cost 340 Practical applications of investment appraisal in supply chains 344 Summary 344 References 345 Discount factor tables 345 Solutions to the activities 349 Study questions 353 Study question solutions 358 Index 371 ix AC K N O W L E D G E M E N T S I would like to acknowledge the support of Julia Swales and Ro’isin Singh from Kogan Page I am grateful to Kaplan Publishing for their permission to use the accounting definitions fromv the CIMA Official Terminology (2005) I would also like to thank Bureau van Dijk for giving me permission to use the finance ratios from their Fame database I acknowledge Cranfield School of Management who have granted permission for me to use examples of my work as a lecturer at Cranfield University I also thank the following organizations who have given their permission for me to use their financial information from their annual report and accounts: ● BASF Group; ●● Deutsche Post DHL Group; ●● Marks and Spencer Group PLC; ●● Nestlé Group; ●● The Procter & Gamble Company. Finally, I would like to thank Carolyn Templar, who has read every single word of the manuscript and for her patience and support during the process of authoring this book 368 Supply Chain Management Accounting The average investment is calculated by dividing the project’s investment by The project with the highest ARR of 18% is Orange, while Green has the lowest percentage of 7%, as illustrated in Table 10.56 Table 10.56 ARR calculations Project Purple Pink Green Orange Profit £m 2.00 1.50 1.00 2.50 Average profit £m 0.50 0.38 0.25 0.63 Average investment £m 3.50 3.50 3.50 3.50 ARR % 14% 11% 7% 18% Answer = D The payback period (PP) is the time taken for the project to recover its initial investment Therefore, we need to calculate for each project its cumulative cash flow When the cumulative cash flow changes from negative to positive it indicates the point in time when the project recovers its initial investment The cumulative cash flows for each project are illustrated in Table 10.57 Let’s focus first on project Green Look at its cumulative cash flow The cash flow changes from negative to positive exactly at the end of year 3; therefore its payback is three years The other three projects change from negative to positive between years and 3, but we need to find the project that has a payback period of 2.75 years To find the exact PP, we an apportionment by taking the amount outstanding at the end of year and dividing it by the cash received in year In the case of project Pink, at the end of year £1.5m is needed to recover the initial investment, and in year the forecast cash flow received is £2.0m To calculate the point when the sign changes, we now divide £1.5m by £2.0m, which equals 0.75 Therefore, project Pink will have a PP of 2.75 years, or years 274 days approximately It is important to point out that in the PP calculation, we assume that the cash flows are a straight line over time; we assume that the forecast cash flow is the same for every day in a specific year, which in practice is not the case Therefore, the project that has a payback period of 2.75 years is Pink Answer = C –3.5 –1.0 1.0 3.5 2.5 2.0 1.0 2.0 Total PP = 2.50 years 2.0 –7.0 –7.0 Year Pink Pink 1.5 0.5 –1.5 –4.0 –7.0 PP = 2.75 years 1.5 1.0 2.0 2.5 3.0 –7.0 Cash Cumulative flows Cumulative £m £m £m Purple Cash flows £m Project Purple Table 10.57 Payback period calculations 1.0 0.0 –1.5 –4.0 –7.0 Cumulative £m Green PP = 3.00 years 1.0 1.0 1.5 2.5 3.0 –7.0 Cash flows £m Green 2.5 1.0 –1.0 –4.0 –7.0 Cumulative £m Orange PP = 2.50 years 2.5 1.5 2.0 3.0 3.0 –7.0 Cash flows £m Orange 369 370 Supply Chain Management Accounting To calculate the project’s net present value (NPV), we need to calculate the present value for each year We this by multiplying the cash flow for each year by it relevant discount factor for that year Let’s take year for project Purple Its cash flow is £3.5m, the discount factor at 10% for that year is 0.9091; we multiply them to derive the present value of £3.1819 We the same present value calculation for every year, even year 0, and then add them all together to arrive at the NPV for the project, as illustrated in Table 10.58 for project Purple Purple’s NPV using the company’s test discount rate of 10% will be £0.4335m Purple’s NPV is positive when a 10% discount rate is adopted; therefore, the project’s returns are greater than the cost of capital (opportunity cost) and should be accepted Answer = C Table 10.58 Project Purple NPV calculation Project Purple Discount factor Present value Cash flows £m 10% £m –7.0 1.0000 –7.0000 3.5 0.9091 3.1819 2.5 0.8264 2.0660 2.0 0.7513 1.5026 1.0 0.6830 0.6830 Total 2.0 0.4335 Year The internal rate of return (IRR) is the discount rate that will result in an NPV of zero When the test discount rate is 15%, Purple has a negative NPV of –£0.177m; however, when the test discount rate is 10%, the project has a positive NPV of £0.4335m The IRR will be located somewhere between 10% and 15% The following formula, which is an apportionment, will be used to approximate the IRR: £0.4335m 10% + 5% * = 13.55% £0.4335m− − £0.177 Answer = B 371 INDEX absorption costing 247–80 absorption of indirect costs 255–56, 265–69 allocation of indirect costs 255–57 apportionment of indirect costs 255–56, 257–63 case study 269–72 cost centres 255 cost units 255 direct costs 253–54 distribution of indirect costs 255–72 indirect costs 253–54, 255–72 margin vs mark-up 251–52 need for full costing 248–50 standard costing and 272–77 supply chain implications 277–79 account types in business 54–55 accountancy, variations in terminology accounting equation 55–58 accounting period 10 accounting rate of return 327–28 accruals basis of accounting 147 acid test ratio (quick ratio) 80–82, 198, 199 activity-based costing 294–303, 312 case study 296–301 annualized cost 340–43 approved payables finance 127–29 asset account 54–55 asset utilization ratios 197, 199 assets 71–76 disposal of 154–56 average cost (AVCO) inventory valuation 23–32 average inventory 20–21 balance sheet 53–90 account types 54–55 accounting equation 55–58 assets 71–76 case study 85–90 components 70–71 date of preparation 53 definition 53, 58 different formats 58–69 equity 79 financial ratios and 198 financial ratios derived from 80–82 liabilities 76–77 net current assets 78 net current liabilities 78 Type format 59–63 Type format 59–60, 63–66 Type format 59–60, 66–69 working capital 78–79 balance sheet forecast 117–18 BASF Group acid-test ratio 126 current ratio 126 depreciation policy 157 inventory valuation policy 31 liquidity ratios 81 operating expenses 32–34 total assets 74 working capital calculation 78 bill of materials 223 break-even analysis 225–29 formula method 227–29 graphical method 225–27 Cameron, David 127, 131 capital expenditure 145–47, 322–23 capital investment appraisal 324–25 cash, importance for business and organizations 103 cash flow generators and consumers 107 impact of supply chain activities 105, 107 importance in business 104 metaphors for 103 relationship to liquidity 125–27 cash flow forecast 107–19 case study 108–19 cash flow statement 105–07 372 Index cash-to-cash cycle 120–25 contemporary costing methods 293–311 activity-based costing 294–301, 312 supply chain costing road map 311, 312 target costing 306–10, 312 total cost of ownership 304–06, 312 cost–benefit analysis 327 cost centres 255 cost elements as a percentage of revenue 12 cost of sales 19–21 cost of sales as percentage of revenue 20–21 cost reduction, supply chain initiatives 191–96 cost to serve method 312 cost units 255 costing see absorption costing; contemporary costing methods; marginal costing credit accounts 54–55 cross-docking 85 current assets 71, 74–75 current liabilities 77 current ratio 81–82, 198, 199 debits accounts 54–55 depreciable amount 148 depreciation 143–61 accruals basis of accounting 147 capital expenditure 145–47 definition 143–45 effect on the financial statements 147–54 impact on EBIT 159–60 matching convention 147 net book value (NBV) 148–54, 155 non-current asset register 158 profit calculation and 145 relevance to supply chain assets 143 revenue expenditure 145–47 useful life of an asset 144–45 depreciation methods 147–54 changing depreciation policy 155–56 choice of method 147–48 comparison of the different methods 152–54 disposal of an asset 154–56 impact on EBITDA 156, 159–60 practice in the supply chain 156–58 reducing balance method 147–48, 149–50, 152–54 straight line method 148–49, 152–54 sum of the digits method 147–48, 150–51, 152–54 Deutsche Post DHL Group acid-test ratio 126 balance sheet components 71–75, 76–77 current ratio 126 depreciation policy 157 EBIT 35–38 equity 79 inventory valuation policy 31 liquidity ratios 81 net finance costs 34–35 operating expenses 32, 33 reporting example 16–17 total assets 74 use of EAC (EBIT after asset charge) 202 working capital calculation 78 direct costs 253–54 direct product profitability method 312 discounted payback period 334–35 double-entry accounting 10, 54–55 dynamic discounting 129–31 EAC (EBIT after asset charge) 201–02 earnings after tax (EAT) 11, 198 earnings before interest and taxes see EBIT earnings before interest, taxes, depreciation and amortization see EBITDA earnings before tax 11 EBIT 11, 197–98 definition 159 impact of depreciation 159–60 ROCE calculation 178–80 EBIT after asset charge (EAC) 201–02 EBIT margin 36–38, 159–60 EBITDA 198–99 definition 159 impact of depreciation 156, 159–60 EBITDA margin 35–38, 159–60 economic order quantity (EOQ) model 278 electronic data interchange (EDI) 84 Engineering and Physical Sciences Research Council (EPSRC) equity 79 equity account 54–55 equivalent annualized cost (EAC) 340–43 expenditure capital expenditure 145–47 revenue expenditure 145–47 expenditure account 54–55 finance see supply chain finance financial performance and the supply chain 175–203 influential supply chain issues managing the flows in the supply chain 177–78 return on capital employed (ROCE) 178–84 ROCE case study 184–90 role of the supply chain 176–78 Index financial ratios derived from the balance sheet 80–82 supply chain management and 196–201 financial statement forecasts 107–19 financial statements, impact of inventory 21–22 financial structure ratios 197, 200 first in first out (FIFO) inventory valuation 23–32 fixed asset register 149 fixed costs 220–22, 223 forecast financial statements 107–19 Forrester, Jay W 178 full costing see absorption costing gearing ratio 197, 198, 200 Global Supply Chain Finance Forum 127 gross margin 11, 35–38, 159–60, 198 income account 54–55 income statement account types 54–55 accounting period 10 cost elements as a percentage of revenue 12 cost of sales 19–21 definition 10 earnings before tax 35–38 financial ratios and 198 impact of inventory 21–22 inventory valuation methods 23–32 net finance costs 34–35 operating expenses 32–34 Procter & Gamble example 13–14 profit calculations 10–11 profitability ratios 11 revenue 15–19 taxation 38 variations in accountancy terminology income statement forecast 115, 116 index numbers (indices), use and construction of 17–18 indirect costs 253–54 distribution of 255–72 intangible non-current assets 71–73, 74 internal rate of return (IRR) 335–38 inventory average inventory 20–21 impact on financial statements 21–22 inventory turnover ratio 20–21 net realizable value (NRV) 21–22 inventory reduction, supply chain initiatives 84–85 inventory turnover ratio 20–21 inventory valuation 20–21 absorption costing and 279 marginal costing and 232–33 methods 23–32 investment appraisal 321–45 accounting rate of return 327–28 capital expenditure 322–23 capital investment appraisal 324–25 case study (warehouse management system upgrade) 326–39 cost–benefit analysis 327 discounted payback period 334–35 equivalent annualized cost (EAC) 340–43 internal rate of return (IRR) 335–38 net present value 330–33 opportunity cost 326 payback period 328–30 practical applications in supply chains 344 revenue expenditure 322–23 shareholder value 324 weighted average cost of capital (WACC) 334 J Sainsbury plc liquidity ratios 81 working capital calculation 78 just-in-time working 85 last in first out (LIFO) inventory valuation 23–32 liabilities 76–77 liability account 54–55 limiting factor analysis 230–31 liquidity, relationship to cash flow 125–27 liquidity ratios 81–82, 197, 199 make-or-buy decision, impact of distribution of costs 278 marginal costing 219–34 break-even analysis 225–29 fixed costs 220–22, 223 inventory valuation 232–33 limiting factor analysis 230–31 marginal costs 225 see also variable costs practical applications in supply chains 233 stepped fixed cost 221–22 strengths and weaknesses 233 total cost 225 types of cost 220–25 variable costs 222–24, 225 373 374 Index marginal costs 225 see also variable costs mark-down calculation 251 mark-up, profit margin and 251–52 Marks & Spencer Group plc acid-test ratio 126 balance sheet format 59–69 cash flow statement 105–06 cash-to-cash cycle 121–23 current assets 75 current ratio 126 definition of net realizable value (NRV) 21–22 definition of revenue 15 depreciation policy 157 equity 79 inventory levels and the supply chain 85 inventory valuation 20–21 inventory valuation policy 31 liquidity ratios 81, 82 operating expenses 32–33 review of supply chain and logistics 19 supply chain initiatives 42, 194–96 total assets 74 working capital calculation 78 working capital ratios 121–23 matching convention 10, 147 Nestlé Group acid-test ratio 126 current ratio 126 definition of revenue 15 depreciation policy 158 inventory valuation policy 24, 28, 31 liquidity ratios 81 revenue index example 17–18 total assets 74 working capital calculation 78 net book value (NBV) 148–54, 155 net current assets 78 net current liabilities 78 net finance costs 34–35 net present value 320–33 net realizable value (NRV) 21–22 Next plc profitability ratios 36, 37–38 revenue index example 18 non-current asset register 158 non-current assets 71–74 non-current liabilities 76 Norman, Archie 85 operating expenses 32–34 operating margin 11 opportunity cost 326 outsourcing 83 payback period 328–30 Porter’s value chain 39–42 Procter & Gamble Company acid-test ratio 126 cost of sales 21 current ratio 126 depreciation policy 158 importance of the supply chain 178 income statement example 13–14 inventory valuation policy 28, 32 liquidity ratios 81 operating expenses 32, 33 supply chain initiatives 194 total assets 74 working capital calculation 78 productivity ratios 197, 200 profit, alternative terms in the income statement 9 profit and loss account (P&L) see income statement profit before interest and tax (PBIT) profit margin, mark-up and 251–52 profitability impact of distribution of costs 279 impact of SC management 39–42 profitability ratios 11, 36, 37–38, 197, 198–99 forecasting 107–19 quick ratio (acid-test ratio) 80–82, 198, 199 reducing balance method of depreciation 147–48, 149–50, 152–54 retained earnings 11 return on capital employed see ROCE revenue 15–19 definitions 15 Deutsche Post DHL Group reporting example 16–17 indices (index numbers) 17–18 reporting 16–17 revenue expenditure 145–47, 322–33 reverse factoring 127–29 ROCE (return on capital employed) 9, 119, 178–84, 197–98 supply chain initiatives 190–96 supply chain initiatives (case study) 184–90 ROE (return on equity) 199 ROS (return on sales) ROTA (return on total assets) 198 running costs see variable costs sales alternative terms in the income statement 9 supply chain initiatives 191 Index SCOR activities 311 shareholder value 324 standard costing 272–77 supply chain implications 277–79 variance analysis 273–77 standardized components 85 standing costs see fixed costs statement of financial provision see balance sheet stepped fixed cost 221–22 straight line method of depreciation 147–49, 152–54 sum of the digits method of depreciation 147–48, 150–51, 152–54 supply chain decisions impact on profitability 39–42 impact on the balance sheet 83–85 issues which may have financial impacts 6 supply chain finance 127–31 approved payables finance 127–28 definition 127 dynamic discounting 129–31 reverse factoring 127–29 Supply Chain Finance Community supply chain initiatives cost reduction 191–96 effect on ROCE 190–96 effect on ROCE (case study) 184–90 inventory reduction 84–85 potential to enhance profitability 39–42 sales 191 tangible non-current asset reduction 83 tangible non-current assets 71–72, 73–74 reduction initiatives 83 target costing 306–10, 312 case study 307–10 taxation 38 tax-efficient SC management (TESCM) 38 terminology, variations in accountancy Tesco plc liquidity ratios 81, 82 working capital calculation 79 third-party logistics providers (3PL) 108 throughput accounting 312 total cost 225 total cost of ownership method 303–06, 312 case study 304–06 transfer pricing, absorption costing and 278 Unilever cash-to-cash cycle 123–24 current ratio 125–26 liquidity ratios 125–26 working capital ratios 123–24 value chain (Porter) 39–42, 191–94 variable costs 222–24, 225 variance analysis, standard costing and 273–77 vendor-managed inventory (VMI) 85, 108 weighted average cost of capital (WACC) 334 weighted average method 24, 28 Wm Morrison Supermarkets plc liquidity ratios 81 working capital calculation 79 working capital 78–79 working capital cycle 120–25 working capital ratios 197, 199 375 376 THIS PAGE IS INTENTIONALLY LEFT BLANK 377 THIS PAGE IS INTENTIONALLY LEFT BLANK 378 THIS PAGE IS INTENTIONALLY LEFT BLANK 379 THIS PAGE IS INTENTIONALLY LEFT BLANK 380 THIS PAGE IS INTENTIONALLY LEFT BLANK 381 THIS PAGE IS INTENTIONALLY LEFT BLANK 382 THIS PAGE IS INTENTIONALLY LEFT BLANK ...i Supply Chain Management Accounting ii THIS PAGE IS INTENTIONALLY LEFT BLANK iii Supply Chain Management Accounting Managing profitability, working capital and asset utilization Simon... role of the supply chain 176 Return on capital employed 178 EBIT percentage and NCA + WC turnover 180 Case study: Qwerty Ltd 184 Supply chain management and ROCE 190 Supply chain management. .. activities and study questions with worked solutions Supply Chain Management Accounting Supply chain issues and financial performance Table 1.1 illustrates the typical supply chain management