Controlling in the Wood Products Industry

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1 Controlling in the Wood Products Industry SS 2018 Albert Sickl

2 Take aways from Module 3 Reporting, Forecasting, Budgeting Looking back: Reporting of past events Looking ahead: Short-term forecasting & Budgeting Long-term plans and scenarios as tools for the strategist to steer a course between a single forecast and confusion. 2

3 Take home exam 3 1. Define Contribution margin and what can you calculate out of it? 3

4 Gross Sales (Revenues) Module 4 Contribution margin (Deckungsbeitrag): The contribution margin is the amount that remains of our sales after deducting all variable costs. It is used to cover fixed costs and eventually to make profits. Gross Sales - Sales deductions (rebates, cash discounts,..) Net sales - Freight costs, Commissions,.. - Variable Costs. Contribution margin Rebates, CD Energy, Freight Log costs Variable Costs Contribution Margin to cover Fixed costs Can also be expressed as %-age of sales, i.e. a contribution margin of 15% indicates that out of 1Euro sales, 15 cents remain for coverage of fixed costs Contribution margin can also be shown in several steps by allocating fixed costs to articles, article groups, business areas, 4 Spring 2018

5 Take home exam 3 1. Define Contribution margin and what can you calculate out of it? 2. What are the three characteristics of the Break Even Point? 5

6 Gross Sales (Revenues) Module 4 Break-Even Analysis: The break-even point defines the sales volume which is needed to cover all costs, i.e. neither produces a profit nor a loss. Break Even Point means: Profit = 0 Fixed costs = Total contribution margin Revenues = Total costs Rebates, CD Energy, Freight Log costs Variable Costs Total Costs Profitability increase by: Increase of Sales Improvement of Contribution Margin (price increase, reduction of variable costs, improved product mix) Reduction of Fixed costs Fixed costs 6 Spring 2018

7 Take home exam 3 1. Define Contribution margin and what can you calculate out of it? 2. What are the three characteristics of the Break Even Point? 3. Define the components of the Operating Working Capital. 7

8 Working Capital: Delta between current assets and current liabilities. Liquidity indicator: Shows the ability of a company to cover current liabilities out of its current assets. Management approach: Inventories + Accounts receivables - Accounts payables Working Capital Inventories: Finished Goods and Work in Progress Accounts Receivables Accounts Payables Operating Working Capital 8 Lean working capital management means among others: decreased costs (inventory space, ) reduced bad debts Spring 2018 increased cash flow

9 Take home exam 3 1. Define Contribution margin and what can you calculate out of it? 2. What are the three characteristics of the Break Even Point? 3. Define the components of the Operating Working Capital. 4. Looking at each component of the Operating Working Capital: which development is good for the Cash Flow describe them. 9

10 An investment is a long-term usage of financial funds in tangible and intangible objects with the intention to use these objects in achieving company targets. Strategy Investment Financial Investment Real Investment Speculative Long-Term Tangible Intangible 10

11 An investment is characterized through cash flows that start with an outflow of cash and continue with expected cash in- and outflows at later points of time. 11

12 Real Investment Construction / installation investment Running investments Extension / completion investment Alternative investments Repair- and maintenance investments Construction investment: Initial investment when founding a company. 12

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14 Real Investment Construction / installation investment Running investments Extension / completion investment Alternative investments Repair- and maintenance investments Construction investment: Initial investment when founding a company. Running investments: Substitution of an object with an identical one or a bigger maintenance activity. 14

15 Real Investment Construction / installation investment Running investments Extension / completion investment Alternative investments Repair- and maintenance investments Construction investment: Initial investment when founding a company. Running investments: Substitution of an object with an identical one or a bigger maintenance activity. 15

Real Investment Construction / installation investment Running investments Extension / completion investment Alternative investments Repair- and maintenance investments Construction investment:

16 Real Investment Construction / installation investment Running investments Extension / completion investment Alternative investments Repair- and maintenance investments Construction investment: Initial investment when founding a company. Running investments: Substitution of an object with an identical one or a bigger maintenance activity. Extensions: Similar to alternative investments by enlarging, changing or securing existing capacities. 16

17 Post completion audit, Project name Mill, division

18 Executive summary Describing the key outcome of the investment project regarding Safety in project (number of TRIs and LTAs) Achievement of set financial, operational, quality and e.g. environmental objectives Investment cost accuracy Project schedule accuracy Investment profitability Safety TARGET ACTUAL Number of TRI and LTA 0/0 TRI/LTA TRI & LTA/million working hrs 0/0 TRI/LTA Profitability targets Payback period (years) IRR (%) NPV (MEUR) EBITDA improvement (year) ROOC of project (year) TARGET (approval letter) ACTUAL (latest estimate) Operational targets TARGET ACTUAL Specify parameter & unit (e.g. production output, efficiency, quality) Parameter Parameter Parameter Project cost and schedule accuracy Investment cost (MEUR) TARGET ACTUAL Start-up (date) 18 PCA template April 2017

19 Investmentcalculation Methods Static Methods Dynamic Methods 1) Cost comparison 1) Net present value 2) Profit comparison 2) Dynamic payback period 3) Comparison of profitability 3) Internal rate of return 4) Static payback period 19

20 Example 1: Kostenvergleichsrechnung / Cost comparison calculation Available own funds: EUR Cost of capital: Equity: 5% p.a. Debt: 9% p.a. Alternative A Alternative B Acquisition value Income from asset disposal Useful life (years) 4 5 Production p.a pieces pieces Insurance / year Personnel costs / piece 6 5 Material costs / piece

21 Example 1: Kostenvergleichsrechnung / Cost comparison calculation An investment is absolutely advantageous if its costs are lower than the non-investment alternative. An investment is relatively advantageous if its cost are lower than other investment alternatives. 21 Relatively easy to perform Reliability for estimates in the future in reality not fully given Differences in costs over time are not taken into account (averages used) Only total costs taken for decisions. Capacity utilization of investment alternatives and differentiation between fixed and variable costs not included in the calculation Income has to be identical

22 Example 2: Gewinnvergleichsrechnung / Profit comparison calculation Alternative A Alternative B Sales / piece 13,0 13,5 Acquisition value Income from asset disposal Useful life (years) 4 5 Production Insurance / year Personnel costs / piece 6 5 Material costs / piece

23 Example 2: Gewinnvergleichsrechnung / Profit comparison calculation An investment is absolutely advantageous if its profit is bigger than zero. An investment is relatively advantageous if its profit is bigger than all other investment alternatives. Different income of the alternatives taken into account Problem if no income is attributed to an investment object Otherwise similar to cost comparison calculation 23

24 Example 3: Rentabilitätsrechnung / Profitability calculation Alternative A Alternative B Sales / piece 13,0 13,5 Acquisition value Income from asset disposal Useful life (years) 4 5 Production Insurance / year Personnel costs / piece 6 5 Material costs / piece

25 Example 3: Rentabilitätsrechnung / Profitability calculation An investment is absolutely advantageous if its profitability is higher than a defined minimum profitability. An investment is relatively advantageous if its profitability is higher than all other investment alternatives. Income of the alternatives taken into account Profitability = Profit in relation to capital employed Problem if investments have different capital needs comparison difficult (similar additional investments needed for comparison). 25

26 Example 4: Statische Amortisationsrechnung / Static payback period calculation Durchschnittsmethode / Average method Kumulationsmethode / Accumulation method Sales [pieces] Alternative A Alternative B Year Year Year Year Year

27 Example 4: Statische Amortisationsrechnung / Static payback period calculation An investment is absolutely advantageous if its payback period is shorter than a defined milestone. An investment is relatively advantageous if its payback period is shorter than all other investment alternatives. Payback period of an investment is the amount of time in which the capital used will be earned through average income Does not show effects after the end of the payback period Indicates in addition to other models the risk of the other alternatives 27

28 Example 5: Kapitalwertmethode / Net present value A dollar today is more than a dollar tomorrow (because the dollar today can be invested to start earning interest immediately) Discount factor = 1/(1+r) Present value (PV) = C1* 1/(1+r) Net present value (NPV) = C0 + C1/(1+r) A safe dollar is worth more than a risky one 28 Net present value rule: Accept investments that have positive net present values (difference between the discounted value of the future income and the amount of the initial investment)! Rate of return rule: Accept investments that offer rates of return in excess of their opportunity costs of capital!

29 Example 5: Kapitalwertmethode / Net present value Value cash flows in several periods: PV = C1/(1+r1)+C2/(1+r2)^2+ NPV = C0 + PV A dollar tomorrow cannot be worth less than a dollar the day after tomorrow! 29

30 Example 5: Kapitalwertmethode / Net present value Alternative A Alternative B Year Year Year Year Year

31 Example 6: Dynamische Amortisationsrechnung / Dynamic payback period calculation An investment is absolutely advantageous if its payback period is shorter than a defined milestone. An investment is relatively advantageous if its payback period is shorter than all other investment alternatives. Payback period of an investment is the amount of time in which the capital used will be earned through average income Does not show effects after the end of the payback period Indicates in addition to other models the risk of the other alternatives Indicates a benchmark for the lifetime of the investment 31 Amortization = t* + PV(t*) / ( PV(t*) PV(t*+1) ) t*.. Year with last accumulated negative present value

32 Example 6: Dynamische Amortisationsrechnung / Dynamic payback period calculation Alternative A Alternative B Year Year Year Year Year Year

33 Example 7: Interne Zinssatzmethode / Internal Rate of Return The internal rate of return is defined as the rate of discount which makes NPV = 0. Internal rate of return rule is to accept an investment project if the opportunity cost of capital is less than the internal rate of return! The investment is absolutely advantageous if the IRR is bigger than all other investment alternatives. IRR = i(+) + [ NPV(+) * ( i(-) i(+) )] / ( NPV(+) NPV(-) ) 33

34 Example 7: Interne Zinssatzmethode / Internal Rate of Return Alternative A Alternative B Year Year Year Year Year Year

35 Example 8: Why Net Present Value leads to better investment decisions than other criteria: WACC 10% Alternative A Alternative B Alternative C Year Year Year Year

36 Example 8: Why Net Present Value leads to better investment decisions than other criteria: NPV versus Discounted payback rule Alternative A Alternative B Alternative C Cash Flow discounted CF accumulated Cash Flow discounted CF accumulated Cash Flow discounted CF accumulated Year Year Year Year Payback (Years) 2,30 1,98 1,66 NPV (10%) The discounted payback rule does not take any cash flows after the cutoff date into account! The static payback rule additionally gives equal weight to all cash flows before the cutoff date! 36 Brearly R.; Myers S.; Principles of corporate finance; 6th edition; 2000

37 Example 9: Why Net Present Value leads to better investment decisions than other criteria: WACC 10% Alternative A Alternative B Year Year

38 Example 9: Why Net Present Value leads to better investment decisions than other criteria: NPV versus Internal Rate of Return (1) Alternative A Alternative B Cash Flow discounted CF accumulated Cash Flow discounted CF accumulated Year Year Internal Rate of Return (%) 102,25% 86,14% NPV (10%) The Internal Rate of Return is unreliable in ranking projects of different scale! 38 Brearly R.; Myers S.; Principles of corporate finance; 6th edition; 2000

39 Example 10: Why Net Present Value leads to better investment decisions than other criteria: WACC 10% Alternative A Alternative B Year Year Year Year Year Year

40 Example 10: Why Net Present Value leads to better investment decisions than other criteria: Alternative A Alternative B Cash Flow discounted CF accumulated Cash Flow discounted CF accumulated Year Year Year Year Year Year Internal Rate of Return (%) 37,71% 32,27% NPV (10%) The Internal Rate of Return is unreliable in ranking projects which offer different patterns of cash flow over time! The IRR is misleading as the total cash inflow of alternative B is larger but tends to occur later. 40 Brearly R.; Myers S.; Principles of corporate finance; 6th edition; 2000

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Controlling in the Wood Products Industry

Controlling in the Wood Products Industry SS 2015 Albert Sickl Take-aways from Module 3 Reporting, Forecasting, Budgeting Looking back: Reporting of past events Looking ahead: Short-term forecasting &