Supply chain management accounting managing profitability, working capital and asset utilization

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