Learning Curve Case

L E A R N I N G C U R V E S I M U L AT I O NCROSS FUNCTIONAL DEC ISION M A K I N G & B U S I N E S S I M PA C T CASE STUDY enParadigm Knowledge Solutions Learning Curve Case Study Copyright © 2010-2012 enParadigm Knowledge Solutions. All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means — electronic, mechanical, photocopying, recording, or otherwise — without prior written permission from enParadigm Knowledge Solutions. enParadigm Knowledge Solutions, CIIE, IIM New Campus, Vastrapur Ahmedabad – 380015, India Website: www.enparadigm.com Ph: +91 89517 66681 Email: [email protected] Copyright © 2010-2012 enParadigm Knowledge Solutions 1 2 Learning Curve Case Study Table of Contents INTRODUCTION ....................................................................................................................................... 3 Product .................................................................................................................................................... 4 MARKETING............................................................................................................................................. 4 Geographies .................................................................................................................................... 4 Customer Segments ........................................................................................................................ 6 Advertising ...................................................................................................................................... 7 SALES ....................................................................................................................................................... 9 AFTER-SALES ......................................................................................................................................... 10 OPERATIONS ......................................................................................................................................... 11 LOGISTICS .............................................................................................................................................. 11 RESEARCH & DEVELOPMENT ................................................................................................................ 12 HUMAN RESOURCES ............................................................................................................................. 14 Performance Management System .............................................................................................. 14 Workforce Planning ...................................................................................................................... 16 Compensation & Benefits ............................................................................................................. 16 Organizational Effectiveness Initiatives ........................................................................................ 17 FINANCE ................................................................................................................................................ 17 ACCOUNTING ........................................................................................................................................ 19 Balance Sheet ................................................................................................................................ 20 Profit and Loss Statement ............................................................................................................. 23 Cash Flow Statement .................................................................................................................... 24 Copyright © 2010-2012 enParadigm Knowledge Solutions I will be looking at the return on shareholders’ equity investment (ROE) as the definitive measure of your performance vis-a-vis your competitors. You will now be debriefed by the heads of the different departments of the mini robot company. I am expecting you to deliver good profits in the long run to justify our continued investment in the mini robot industry.Learning Curve Case Study 3 INTRODUCTION MEMO From: Mahendra Nath Singhania. You will have to take charge of the company and rebuild it. In other words. the mini robot division. You will do well to remember that being part of the top management team also means that the entire responsibility of ensuring company performance is on you. While the entire mini robot industry may currently be struggling for profitability. with its own top management and financial responsibilities. This is your biggest responsibility to date. Singhania Group Subject: Mini Robot Division Spinoff Hello Top Management Team. You will be briefed on the industry. and the roles that you will step into. We have decided to spin off the mini robot division into a standalone company. Congratulations! You have been selected to head our company’s mini robot division based on the exceptional performance you have exhibited in your career so far. Group Chairman. Copyright © 2010-2012 enParadigm Knowledge Solutions . The Singhania Group is the sole shareholder of this subsidiary company. our marketing plan must take into account the business environment and the moves of our competitors. including us. Asia. However Asia is a fast growing geography. our company has its headquarters in India. and he travels widely across the world to keep in touch with fast changing customer requirements) Our responsibility as a company lies in delivering profits to our shareholders. Though other companies are trying to acquire this technology. Marketing . it is felt that entry barriers are too high for a new entrant to launch within the next few years. North America (NA) has already adopted the new product. We can also decide to enter Latin America Copyright © 2010-2012 enParadigm Knowledge Solutions . unlike North America.He has been with the company for 20 years. Our main export geography. have the technology to manufacture mini robots. our focus has to be on building sustainable competitive advantage over our competitors. our home geography. which is nearing maturity. We have seen that customer buying behaviour depends heavily on competition. Only a few companies. to remain profitable in the long run. The robot market has seen a revolution through the introduction of autonomous mini robots which can operate in areas which were hitherto considered inaccessible to robots. Therefore. and a majority of the mini robots there use our technology. MARKETING Mr. Geographies As you all know. Ashish Gupta (Senior Vice President. To fulfil this objective. the Singhania Group.Learning Curve Case Study 4 Product Robots are used to carry out tasks that are repetitive in nature or performed in areas that are hazardous to human life. As of date. Asia. is yet to have the same demand prospects as North America. and customers switch fast if they feel that a competitor is offering them a better deal. This demand will be catered to by us and our competitors in the mini robot industry. the demand from some of the geographies may not be enough to support the overheads that we will have to incur if we enter them early. Besides. Year 1 4180 1585 340 Q1. The sales office maintenance cost has to be incurred every quarter to operate in a region. Year 2 7300 5100 2900 The actual growth rates of these geographies will depend on several parameters and might differ from research projections. We feel that Latin America could be the future engine of growth once North America and Asia slow down. These increase by about 10% quarter on quarter as we delay the entry decision. based on the attributes of the products and services made available in each market. currently a very small geography. The marketing. sales and after-sales plans for each geography should be relevant to the industry situation in that geography. Table 1: Expected Future Quarterly Demand North America Asia Latin America Q1. The main overheads incurred due to presence in geography are the quarterly operating costs of our sales offices. early movers into a region will benefit from lower fixed costs for each quarter. after-sales force and top management mind share will be split among the different Copyright © 2010-2012 enParadigm Knowledge Solutions . Entering / exiting a geography The company does not have a presence in any geography as of now. sales force. We can choose to enter in any combination of the above geographies in the coming quarters. An industry market research team has provided the following demand forecasts for the entire mini robot industry across the three geographies in Table 1. due to the revamp in operations. in the upcoming quarters. but with high growth potential. Therefore. However.5 Learning Curve Case Study (LA). our focus in terms of advertising. They are very particular about ontime delivery of goods. Original equipment manufacturers (OEM) are the largest market segment in volume for mini robots.6 Learning Curve Case Study geographies we enter. They buy mini robots priced between INR 6. Customer segment focus must be a key element in our business strategy to deliver profitability to our shareholders in the long run. we are free to exit it in any future quarter.000. They prefer to use newer versions of mini robots. Though they are the smallest market segment in terms of quantity requirements.000 and INR Copyright © 2010-2012 enParadigm Knowledge Solutions . These services include on-time delivery. Value added resellers (VAR) – They specialize in providing customized solutions to their customers and make several modifications to our mini robots. They generally buy mini robots priced in a range of INR 4. Though the core technology used in the mini robots sold across all segments is the same. but we will lose the advantages gained by early entry. but the whole segment put together constitutes a large share of the market.Original Equipment Manufacturers. and rely little on advertising and sales as they keep themselves highly informed about the various product offerings in the market. Customer Segments There are three customer segments in each of our geographies . Each wholesaler buys only limited quantities.500 and INR 5.000 and INR 8. Value Added Resellers and Wholesalers. advertising and aftersales service support. Once we enter a geography. OEMs are more sensitive to price than the other customer segments. Wholesalers (WHL) – They are players who sell to dealers. The recommended price range to wholesalers is between INR 5. Advertising is also important to them to as it helps generates awareness about mini robots within their customers. they are willing to pay a premium if they get the services they require.500. the services required by each segment are very different. They are always on the lookout for the newest product versions of mini robots in the marketplace. Figure 1: Importance of various attributes to customer segments As the needs of each segment are very different. On the other hand. They do not have a direct relationship with the actual users of our mini robots. Once there is enough brand awareness. Advertising is especially Copyright © 2010-2012 enParadigm Knowledge Solutions . awareness about our brand may not be very high. and hence advertising will be required.Learning Curve Case Study 7 7. Advertising Advertising is an important pre-sales component for us.000. and they prefer older versions of mini robots that are tried and tested. spend on advertising. we can then take a call on how to go about advertising. Hence they are less informed about various product offerings available in the market. In the initial quarters. Figure 1 indicates the importance of different attributes for the 3 customer segments. it will not be possible to satisfy all the segments at the same time. our focus in terms of product offering. if we align the rest of our business functions such as R&D. production & planning based on a key segment. If we try and aggressively sell to all segments. our costs may be rationalized and profits could increase. sales and after-sales may be diluted. Trade Journals and Trade Fairs. Our marketing research team has compiled the relative importance of each medium for the different segments in Figure 2. The additional sales as a result of advertising vary according to the curve shown in Figure 3. Beyond a level. the additional sales from every additional INR 10. Figure 2: Advertising Guidelines Spending more than INR 200.8 Learning Curve Case Study important for wholesalers.000 of ad spend in a quarter decreases.000 in a quarter on any single medium in a geography is not advisable. The relevance of each medium differs from customer segment to customer segment. Impact on Demand Figure 3: Impact of Advertising Advertising Spend Copyright © 2010-2012 enParadigm Knowledge Solutions . There are three different mediums for advertising – Research Journals. as it makes it easier for them to sell to their clients. and arrive at the aggregate market share forecast by adding up the individual forecast numbers. we can expect an average market share in each segment in each geography to start with. This demand will be catered to by all the players in the mini robot industry. Karthikeyan Narain (Senior Vice President. Sales . Since the costs of operating in a geography are very high. when the number of salespeople goes beyond a level. You will have to arrive at a sales forecast for our company based on our business strategy.9 Learning Curve Case Study SALES Mr. However.700 Asia 1. We should ideally have salespeople for each client as the chances of getting orders increase as per the curve shown in Figure 3 below. Table 2: Expected Segment-wise Industry Demand for the next quarter OEM VAR WHL North America 1. with all players having very similar product offerings and capabilities as of date. the additional orders per every new salesperson decrease.100 90 395 140 120 80 Latin America The number of salespeople required per customer segment is also different. we have to carefully choose the geographies we will operate in. He commands a lot of respect among our sales team and is considered an outstanding leader) – Our sales structure is organized geography-wise and then customer segment-wise. taking into account the expected moves of our competitors. As the industry is intensely competitive. The industry market research team has provided the demand forecasts for the three customer segments across the three geographies in Table 2. We recommend that you conduct a bottom-up forecast (for each segment for each geography).He has been with the company for 15 years and has grown through the ranks.500 980 1. Copyright © 2010-2012 enParadigm Knowledge Solutions . rather than getting fixated on an overall market share target and force-fitting sales forecast numbers for each individual segment. Gaurav Rastogi (Senior Vice President. However.He has been in charge of this new division since its inception one year ago. Copyright © 2010-2012 enParadigm Knowledge Solutions . Our current defect rate is 10%. The decrease in demand due to high defect rate can be completely offset by employing after-sales people. The defect rate indicates the percentage of finished goods which have technical defects. we can reduce the defect rate by running successful Quality Improvement research projects. After-Sales . He is from an engineering background and has an experience of 10 years) – Our department provides customer service personnel who help our customers solve problems that arise due to defects in our products. and thus reduce the number of after-sales people required.10 Learning Curve Case Study Impact on Demand Figure 3: Impact of Sales Sales Spend AFTER-SALES Mr. Identifying the root cause of defects is difficult. The cost of production is INR 4. We also have a long term contract with a Chinese vendor. Operations . Kapoor (Senior Vice President. who produces mini robots for us at INR 4. based on data compiled from different market research reports. our goods will be allocated Copyright © 2010-2012 enParadigm Knowledge Solutions . He works under Mr Kapoor and has been in his team since he joined us) – The goods produced at our main plant in China. Roshan (General Manager. CunningFox.He graduated from a premier engineering college and has been with the company for 15 years. If a customer segment is given the 1st priority. North America and Latin America. The mini robots are then shipped to our customers in Asia. The investment required to build a new plant is INR 1. once informed of the availability of the goods. We must make an annual production plan.500.Learning Curve Case Study 11 OPERATIONS Mr.000 units. and was instrumental in shifting the plants to China) – We have a plant in China for manufacturing mini robots. Cunning Fox pays for the transportation costs to our warehouses for goods purchased from it. Logistics has become important with expansion into North America and Latin America. and pay the loading and transportation costs themselves.000 units.000. LOGISTICS Mr. Logistics. Our plants and supply chain are configured in such a manner that we can only sell one version of mini-robots in any quarter. collect them from the warehouses. This will enable us to plan our capacity accordingly. We can add capacity by building new plants with a quarterly capacity of 1. The contract has a technology transfer clause which enables CunningFox to produce to our technology specifications. along with those purchased from CunningFox are stored at external warehouses in China. Goods are made available to customers on the basis of the delivery priority given to each customer segment in each geography.000 and is almost the same for all segments. Plant construction will take one quarter for completion irrespective of the number of plants we want to construct. He has a clear focus on keeping the production costs low.500. with a quarterly capacity of 1. Customers. If we stock out in a quarter to any customer. Value Added Resellers and OEMs scan the market closely for new versions. so that they can then differentiate their offerings to their customers. The warehouses charge an inventory holding cost of INR 50 per unit quarter for any inventory that does not get sold during the quarter. we may not be able to clear the mini robots immediately from the warehouses. by assigning a higher priority to them. There are three types of research projects that can be undertaken by our team. Wholesales prefer older versions that are tried and tested. The customers to whom we failed to deliver will perceive us as unreliable and reduce their orders for the next quarter. Version Enhancement projects are aimed at upgrading the functionalities of our mini robots and to develop the next generation of mini robots. You would know that different segments have different level of interest in the type of R&D that we do.Learning Curve Case Study 12 to that customer before we look at fulfilling orders from any other customer. However if a customer makes a demand for mini robots late in the quarter as a result of the competition failing to meet their supply commitments. this demand will be fulfilled only after the previous orders of other customers are met. Since we plan our production before receiving customer orders. We are right now at Version 1 of our product. The market research studies conducted by our Corporate Marketing team indicate that having a version two levels higher than competition could give us around 20% additional demand in the value added reseller segment. they will reward us by increasing their orders to us in the next quarter. Burman (Chief Scientist. On the other hand. He has improved our technical capabilities and has built a good team in the 10 years that he has been with us) – Our R&D focus has to be specific to the customer segments that we are targeting. R&D. while having a version two levels lower than competition could give us around 20% additional demand in Copyright © 2010-2012 enParadigm Knowledge Solutions . We can avoid stock outs to customers who are more important to us. RESEARCH & DEVELOPMENT Mr. if we are able to supply to our customers the unfulfilled orders of competitors. we lose the unfulfilled demand to our competitors. He has a PhD in Electronics. If the project requires a budget less than what was allocated. INR 40. Only one quality improvement project can be carried out during a quarter.000 . Due to the high costs incurred in carrying out Version Enhancement projects. Automation projects improve the efficiency of our plants by replacing human labour with automated machines. The variable cost of production decreases as a result and the margin on each unit will increase.INR 110. and by reducing wastage. The investments in research projects have to be closer to the upper Copyright © 2010-2012 enParadigm Knowledge Solutions . but will reduce demand for our product. At present our plants have a defect rate of 10%. A successful automation project shall result in all our plants getting upgraded and this will be indicated by the Automation Level of our plants.000. Our Chinese vendor. also produces mini robots of our latest version for us due to the technology transfer agreement. Quality Improvement projects help in reducing the defect rate of our products. Once we successfully complete a project.INR 10. CunningFox.200.000 and INR 8. A maximum of one version enhancement can be carried out in a quarter. Due to the inherent uncertainty of research projects. The variable cost per unit is INR 4. the additional funds shall be utilized for the next project. These repairs are carried out by our after-sales people and hence we can offset the impact on demand by providing our customers with the required number of after-sales people. A successful automation project has a smaller variable cost reduction on higher versions of our mini robots than on lower versions. the costs for each project can only be approximated.000 . Each version enhancement will increase the production cost per unit by INR 100 . the project will be successful. The defect rate indicates the number of mini robots with technical defects for every 100 mini robots sold.000. If the cost of a project is within the budget allocated. as higher versions require more complex machinery to be installed. otherwise additional funds will have to be allocated next quarter. A successful quality improvement project will reduce the defect rate by around 2 percent.Learning Curve Case Study 13 the wholesaler segment.500 . all our inventory would get upgraded to the latest version at no additional cost to us. The automation of our plants can be increased by a maximum of one level in a quarter. and can be off target by as much as 10%. our corporate marketing guidelines specify that we will not be allowed to roll back our offering to previous versions once a project is successful. The initial Version Enhancement.000 respectively. Our plants in China are currently at Automation Level 1.INR 55. which can decrease by around INR 30 . Research Budgets – Research budgets have to be allocated as a part of the decisions for the quarter.INR 50 following each successful automation project. Automation and Quality Improvement projects will require an investment in the range of INR 90. A high defect rate does not result in wastage as the product can be used after adequate repair work. She is a decade old veteran in the Singhania Group. their compensation and performance incentives. and of course. We also try to create a positive and healthy work environment. happiness and satisfaction of the members of the top management team remain high. so that all departments are able to contribute in full towards business decision making. Kavitha Maheshwari (Senior Vice President. and there is no limit to what you can achieve here if you work hard and perform well. Through this exercise. The research budgets required for further projects need to be exponentially increased as we keep improving our products. At the beginning of the following Copyright © 2010-2012 enParadigm Knowledge Solutions . HR . and that of each individual manager in the company. Therefore. how much their contribution is being valued by the rest of the team. and we will need your help to understand how we should go about our R&D investment. HR is expected to resolve the various interpersonal issues that may have cropped up within the leadership team during their work. It has been observed that engagement of managers generally depends on the overall performance of the company. HR has to ensure that the morale. In every quarter. each top manager will have to set the targets for the key performance metric pertaining to his/her department. conflict resolution and consensus building are key elements in ensuring that top management make good decisions.Learning Curve Case Study 14 investment limit to increase the probability of success. HR conducts a leadership engagement survey at the beginning of every quarter to get a pulse on employee morale and fulfilment. and has been the main force behind our talent management efforts across various Singhania Group companies) – The Human Resources Department is a key player in ensuring both the performance of the company. Performance Management System The Singhania Group is a merit based conglomerate. We have identified certain key performance metrics for each department to give you overall guidance on evaluating your performance. The challenging business environment in front of us ensures that all of us will be under pressure to perform. HUMAN RESOURCES Ms. We ensure that responsibilities for carrying out day to day business activities are allocated clearly to the different managers. and the unit cost of outsourcing for the current quarter. of Successful Projects It is the number of research projects attempted in a quarter that have resulted in a change in version. HR Employee Engagement Rating (ESAT) It is the average of engagement ratings given by managers in the employee engagement survey for the quarter Head. Operations Effective Cost per Unit It is the weighted average of the unit cost of inventory of the previous quarter. defect rate or automation level in the next quarter Head.15 Learning Curve Case Study quarter. you will need to check the actual results against the targets set and determine whether you are on the right track. Table 3: Performance Metrics for Heads of Departments Manager Key Performance Metric Explanation CEO % Return on Sales (ROS) It is the ratio of profit after tax (PAT) to the revenue generated by the company in the quarter Head. Finance Interest Coverage Ratio It is the ratio of profit before interest and tax (PBIT) to the interest expenses of the company in the quarter All Functions Return on Equity (ROE) It shows the return to shareholders for the capital that they have invested in the business. R&D No. It is the ratio of the net profit to the total equity held by shareholders in the company Copyright © 2010-2012 enParadigm Knowledge Solutions . MKT & Sales % Market Share By Revenue It is the ratio of revenue of the company to the revenue of the industry as a whole in the quarter Head. The unit cost of inventory for each quarter is the effective cost per unit from the previous quarter Head. The different metrics are given below in Table 3. the unit cost of production for the current quarter. 000 . HR can vary the compensation of salespeople between INR 25. and again reduces our profits. each member of the top management team is entitled to get a quarterly bonus of INR 50. and will not be an expense for your mini robot company. We can hire more talent from the marketplace. Our corporate head office allows a quarterly budget for a maximum of 15 salespeople for OEMs.000 and INR 35. while that for an after-sales person is currently INR 60. Compensation & Benefits The HR function is also responsible for deciding the compensation and benefits that our employees receive. We incur a one-time expense of INR 15. we have to keep an eye on the impact of the same on the profitability of the company. While increasing compensation improves employee morale and productivity. and that of after-sales people between INR 55.000.000. 10 and 15 after-sales people on our rolls in each geography for OEMs. and also retrench them as the need arises. Workforce Planning We will need to ensure adequate staffing to meet the business needs of the organization. Each sales / after-sales person can be allocated to only one customer segment in one geography for a quarter. Having too few people prevents us from fulfilling the needs of the market and making profits. We incur a one-time expense of INR 30. while having too many people increases our fixed overheads. The corporate head office has given us a quarterly budget to have a maximum of 5. Copyright © 2010-2012 enParadigm Knowledge Solutions .Learning Curve Case Study 16 In lieu of our merit based philosophy.000 a quarter.000 for hiring or retrenching an after-sales person. salespeople and after-sales people can be shifted between different customers / geographies in subsequent quarters without any additional cost. However. VARs and WHLs respectively.000 if s/he meets or exceeds his/her respective performance target. This money will be paid out by the Singhania Group. The compensation for a salesperson is currently INR 30.INR 65.000 for hiring or retrenching a salesperson. 10 for value added resellers and 20 for wholesalers in each geography.000 per quarter. The interest we have to pay on a long term loan we have taken will be at the fixed long term interest rate decided when taking the loan. Copyright © 2010-2012 enParadigm Knowledge Solutions . and an amount of INR 200. solvency (sufficient cash for our planned operations. and they might vary from quarter to quarter. The interest for each quarter is calculated by the bank on the outstanding loan amount at the beginning of that quarter. Finance) – The finance department keeps an eye on the key metrics of the company. with the balance 60% coming in the next quarter. Our customers pay us 40% of the money they owe us on the spot. thus enabling us to conduct more business with lesser people. and the balance 45% in the next quarter. as the loan amount is released by the bank only by the end of the quarter. We need to invest an amount of INR 100. Our shareholders expect us to deliver on these metrics. A working capital loan is currently available at a quarterly interest rate of 6%. and will be due for repayment in the next quarter after it is taken. The interest rates are different for the two types of loans. and growth (improvement in key metrics quarter on quarter) of the company. Improving processes within the company increases the productivity level of our employees. the interest for a working capital or a long term loan taken in a quarter is due only in the next quarter. sustainability (new business and repeat business in the long run). Whenever we do not have sufficient cash for a quarter.000 to improve our after-sales process level in a quarter. While all these metrics may be tracked by the finance team. we can borrow from the bank through working capital or long term loans.Learning Curve Case Study 17 Organizational Effectiveness Initiatives We invest in training and development to improve the effectiveness of our people and the company as a whole. It is critical for us to ensure profitability (net profits). investments and financial commitments). In other words. A long term loan will remain on our balance sheet till we pay it back. The role of each function in the company is equally important in the overall performance of the company. For each quarter. Rao (Senior Vice President.000 to improve our sales process level in a quarter. FINANCE Mr. we will have to pay 55% of the money we owe our raw material suppliers on the spot. and hence reduces the dependence on individual capabilities. we have to ensure that all functions in the business consistently follow a well-defined business strategy and work in a holistic manner to ensure that our targets for these metrics are met. 500.18 Learning Curve Case Study There are some financial covenants imposed by the bank on borrowing. as given in Table 4. if the loan amount is INR 2.300.5 8-9 12.000 is at 7%.11 14. As the loan amount increases.5 2-3 8 3-4 8.5 10 . For example. The maximum working capital loan we can avail of in a quarter is INR 1. and hence our long term interest rate also go up. If we run out of cash and have not borrowed from the bank.5 9 .5 4-5 9 5-6 9. the next INR 1. and the maximum long term loan is INR 4.000.5% and the next INR 300.000. The interest rate on long term loans depends on the amount of long term loans we have taken till date.000.000. we will have to go for emergency loans from loan sharks. The interest rate on working capital loans is currently 6%.5 The interest for each quarter is calculated by the bank on the outstanding loan amount at the beginning of that quarter.12 15.000. The bank will not lend us more than INR 12. the risk incurred by the bank increases.000 is at 7. The interest rate slabs for long term loans are as follows Table 4: Interest Rate for Different Loan Amounts (in INR million) Slab (INR Million) Interest Rate 0-1 7 1-2 7.000 is at 8%. The interest rate goes up in slabs.5 6-7 10. then the first INR 1.5 7-8 11.000.5 11 .000.10 13. In other words. Emergency loans come at a premium interest rate of Copyright © 2010-2012 enParadigm Knowledge Solutions .000 as long term loans in total. the interest for a working capital loan or a long term loan taken in a quarter is due only in the next quarter. We pay tax on a quarterly basis. our plants will be depreciated over a period of 20 quarters. The administrative costs also include the hiring / retrenching costs and the investments in sales / after-sales process upgrades. Taxation According to the Income Tax Act. and against our competitors’ performance. and the operating cost of INR 300. This administrative cost for a geography will keep increasing by 10% quarter on quarter as we delay our entry into that geography. ACCOUNTING Mr. Balance Sheet 2. They have to be repaid in the next quarter after they are taken. Financial statements are the records of the various activities performed by a company. while research investment will be amortized over a period of 3 quarters.000 per plant. While a plant will be depreciated from the quarter it is ready for production. Administrative Expenses The quarterly administrative costs associated with our business are factory personnel costs of INR 60. and should be avoided by keeping a buffer of cash reserves. Accounts Department) Welcome! I understand that most of you are not very comfortable with financial statements and accounting terms. Cash Flow Statement Copyright © 2010-2012 enParadigm Knowledge Solutions .Learning Curve Case Study 19 20% per quarter. Shankar (Head. The losses for a quarter cannot be set off against the profits of any other quarter while computing our tax liabilities. Profit and Loss Statement 3. The most commonly used financial statements are: 1. research investments will be amortized once the respective research projects for that investment are successful. before embarking on the new journey. They can be used to compare our company’s performance against its past track record. One of the key challenges faced by the senior leaders from nonfinance backgrounds is being able to interpret financial statements to make prudent business decisions.000 for sales offices in each geography we have a presence in. at a tax rate of 30% on our profit before tax. I will take you through the various sample financial statements so that you can have a good grip on how the big picture looks like. buildings.000 Total Liabilities 0 3. bonds and stocks owned by the company. copyrights. Table 5: Sample Balance Sheet (All figures in INR) Assets Cash Liabilities 1. It is usually computed at the end of every quarter / year. trademarks. Current assets are those assets which can be converted into cash in the short-term. Copyright © 2010-2012 enParadigm Knowledge Solutions .500.000. Tangible assets owned by our company include its production plants. while intangible assets are those such as patents. liabilities and shareholders' equity at a specific point in time.000 Accumulated Depreciation Net Plant 0 1. It shows what the company owns and owes.000 0 1. etc.000 Short Term Loan 0 Gross Research 0 Long Term Loan 0 Accumulated Amortization 0 Net Research 0 Retained Earnings Total Assets 3.000. receivables from our customers. you can have a look a sample balance sheet.000 Assets Our company’s assets are the tangible or intangible resources that it owns which can be used to produce value for itself. finished goods and goods being produced.20 Learning Curve Case Study Balance Sheet The balance sheet is a snapshot of our company's assets.000 Common Stock Accounts Receivable 0 Accounts Payable Inventory 0 Gross Plant 3.500. equipment etc. and financial assets such as cash. as well as the amount invested by the shareholders.000. its inventory of raw material. receivables from customers.500. short-term investments which are expected to be redeemed within a year. In Table 5 below. intellectual property. inventory. Current assets include cash. Those assets that are not directly consumed during the business of the firm. are depreciated. trademarks. Accumulated depreciation on an asset is the total depreciation on that asset from its initial acquisition onwards. etc are fixed assets. the difference between amount paid for the asset. Fixed assets are those which assets which cannot easily be converted into cash in the shortterm (perhaps a period of 1 year. The cost of an asset so allocated as depreciation. and amount expected to be received on disposal of the asset. is allocated as a cost to the company in such a manner that it is equally split over the useful life of the asset. Annual depreciation expense = (Gross value of asset – expected disposable value) / useful life in years Your company’s investment in plant and research will be depreciated based on the cost paid for each investment and the quarter in which you invest. copyrights. Depreciation If you look closely at the asset side of the balance sheet. property. patents. is the difference between the total amount paid for the asset and the total amount expected to be received when it is disposed by the company. such as investments in research. Net value of a depreciable asset = Gross value of asset – accumulated depreciation on asset Amortization You would also have noticed a term called accumulated amortization. such as our plant etc. In this method. Copyright © 2010-2012 enParadigm Knowledge Solutions . you will see notice a term called accumulated depreciation. intellectual property etc. or 1 operating cycle).  Inventory represents the value of the unsold goods that we have at the end of each quarter / year. One of the accounting methods used for depreciation is straightline depreciation. equipment. Our company’s plant.Learning Curve Case Study 21  Accounts Receivable represents the outstanding payments due from customers of our company for the products and / or services that we have already provided them with. Depreciation is an accounting term that represents the cost of using long term assets over a specific period of time such as a quarter or a year. Amortization is the equivalent of depreciation for intangible assets of our company. etc. Long term liabilities are those liabilities which are not expected to be discharged in a year’s time. its lenders or banks. Retained earnings can also be defined as the sum of profits / losses over the entire period of your company’s existence. any liability that our company incurs to an external agent will also result in the creation of an equivalent asset for the company. it results in the company getting cash of INR Copyright © 2010-2012 enParadigm Knowledge Solutions . Net value of an amortizable asset = Gross value of asset – accumulated amortization on asset Liabilities Our company’s liabilities represent what it owes to the external world. I will introduce you to the accounting equation. pension obligations etc.000. which is the capital invested into the company by its shareholders in return for shares. Assets = Liabilities + Shareholders’ equity In simple words. For example. long term leases. The accounting equation provides the mathematical structure of the balance sheet.Learning Curve Case Study 22 Annual amortization expense = (Gross value of intangible asset – expected disposable value) / useful life in years Accumulated amortization on an intangible asset is of course. Accounting Equation Now that you have come this far.  Short term loan repayments are those payments for which payment is due within the next one year. Shareholders’ equity represents the benefit that shareholders of a company gain by virtue of their stake in the company. They include long term loans.  Accounts payable is the balance payment due to your suppliers against the raw materials for your products. if a bank gives a loan of INR 1. such as its suppliers. the total amortization on that asset from its initial acquisition onwards. Shareholders’ equity is comprised of common stock. which is the value created / destroyed by the company for its shareholders by virtue of its existence over time.000 to our company (liability). and retained earnings. Current liabilities are those which are expected to be paid off in the next year or operating cycle. 000 (4.000) After-sales cost (125.000 (asset).000 Revenue consists of the total sales revenue for the period.23 Learning Curve Case Study 1.000) General & Admin expenses (420.000) (100.000.usually a quarter or a year. you can have a look at a sample Profit and Loss Statement for a quarter. Profit and Loss Statement The profit and loss statement summarizes the revenues and expenses incurred by our company during a specific period of time .000 66. Copyright © 2010-2012 enParadigm Knowledge Solutions .000.000) Advertising cost 0 Sales cost (100.000.000.000.000 154. If our shareholders decide to increase the capital invested in the company by INR 2.000) Profit before interest and tax 220.000 Research Amortization 0 Inventory holding cost 0 Marketing Research cost (35. then it again results in the company getting cash of INR 2.000 Interest Cost Profit before tax Tax Profit after Tax  0 220.000) 900.000. In Table 6 below. Table 6: Sample Profit and Loss Statement Head Revenue Variable cost of goods sold Plant Depreciation Gross margin Amount (INR) 5.000.  Advertising cost is the total amount spent on advertising for a quarter or year. along with the wages for factory personnel cost. and labor to operate the space. security. It includes electricity charges. plant depreciation etc. plant maintenance. COGS = Variable cost of goods sold + Plant Depreciation  Depreciation in each quarter is shown as an expense in the profit and loss statement. the variable cost of goods sold consists of the direct costs involved in the production of goods such as the raw material cost.  Profit before Interest and Tax (PBIT) consists of revenue less the above expenses. raw material cost.  Inventory holding cost is the cost of storing inventory at warehouses for a quarter or year. interest on money invested in the inventory and space.  Interest cost is the sum of the interest on short term loans. Another major cost is cash held down in the form of inventory.  Tax is calculated as a percentage (tax rate) of PBT. insurance.  Profit before tax (PBT) is derived by deducting interest from PBIT.  Sales cost reflects the salary payment to the sales force over a quarter or year.Learning Curve Case Study  24 Cost of Goods Sold (COGS) comprises of all the costs that are associated directly with production.  After-sales cost consists of the salary payment to the after-sales people for a quarter or year. Depreciation is a notional expense that does not result in a cash outflow for our company. Cash Flow Statement It shows all cash inflows and cash outflows our company incurs during the course of its Copyright © 2010-2012 enParadigm Knowledge Solutions . Inventory holding costs include rent for the required space. long term loans and emergency loans. For our company. materials. labor cost.  Other fixed costs represents the total cost of running operations in each geography. equipment. and other direct expenses. This is the profit available for company shareholders after all expenses are met. It can also be termed as net profit.  Profit after Tax (PAT) is PBT less tax. 000 Net change in cash 208.000 Increase (Decrease) in long term loans 100.708.000 Decrease (Increase) in Accounts Receivable (848. and to keep a tab on the short term viability our company.000) Cash flow from investing activities (100.000) Increase (Decrease) in short term loans 100.500. The cash flows resulting from the activities of our company can be divided into three categories.000 Opening cash balance 1. investments and financing activities.000 Cash flow from operating activities 108.000 Add (Less) Investment in Plant 0 Add (Less) Investment in Research (100.000 Closing cash balance 1. The cash flow statement is used to analyze how the cash position of our company has changed from previous year.000 Cash flow from financing activities 200.25 Learning Curve Case Study operations.  Cash flow from operating activities  Cash flow from investing activities  Cash flow from financing activities Table 7 below shows how a hypothetical cash flow statement for a company could look like Table 7: Hypothetical Cash Flow Loss Statement Head Amount (INR) Profit After Tax 154.000 Add: Depreciation & Amortization 100.000) Decrease (Increase) in Inventory 0 Increase (Decrease) in Accounts Payable 702.000 Copyright © 2010-2012 enParadigm Knowledge Solutions . during a specific period of time – usually a quarter or year.  Change in Accounts Payable – If the accounts payable of a quarter is higher than the accounts payable of the previous quarter.Learning Curve Case Study 26 Cash flow from operating activities  Profit After Tax (PAT) – The PAT is taken from the Profit And Loss Statement. it results in an outflow of cash for our company The net change in cash due to the above heads consists of the cash flow from investing activities.  Change in Inventory – If our inventory in the current quarter is higher than that of the previous quarter. and there is a net outflow of cash for the company. it results in a net inflow of cash for our company and hence has a positive effective on our cash balance. We start from this figure. it results in a net outflow of cash for our company and hence has a negative effective on our cash balance.If the net investment in research is positive. The net change in cash due to the above heads consists of the cash flow from operating activities. they are added to the net profit of the company  Change in Accounts Receivable – If the accounts receivable of a quarter is higher than the accounts receivable of the previous quarter. our cash has been sucked up for the excess inventory.  Depreciation & Amortization – As depreciation and amortization are notional expenses. Cash flow from investing activities  Investment in Plant – If the net investment in production plants is positive. to arrive at the actual change in the cash balance of our company during the period. Cash flow from financing activities  Change in short term loans – If the short term loan outstanding in the current Copyright © 2010-2012 enParadigm Knowledge Solutions . and do not result in any real outflow of cash. it results in an outflow of cash for our company  Investment in Research . and make the necessary adjustments for inflow and outflow of cash in the period that are not reflected in the Profit And Loss Statement. The closing cash balance at the end of a quarter or year is obtained by adding the net change in cash to the opening cash balance at the beginning of the quarter / year. but effective check to see whether the accounting has been done properly. it results in an inflow of cash for our company  Change in long term loans . cash flow from investing activities and cash flow from financing activities.Learning Curve Case Study 27 quarter is greater than those in the previous quarter. This is a simple. it results in an inflow of cash for our company The net change in cash due to the above heads consists of the cash flow from financing activities.If the long term loan outstanding in the current quarter is greater than those in the previous quarter. Net Change in Cash It is the sum of the cash flow from operating activities. Copyright © 2010-2012 enParadigm Knowledge Solutions . Note: The closing cash balance in the cash flow statement must obviously be the same figure as that shown in the Cash head of our balance sheet for the same date. Learning Curve Case Study Copyright © 2010-2012 enParadigm Knowledge Solutions 2 . 3 Learning Curve Case Study enParadigm Knowledge Solutions. photocopying.com Ph: +91 89517 66681 Email: talktous@enparadigm. stored in a retrieval system. IIM New Campus. CIIE. Copyright © 2010-2012 enParadigm Knowledge Solutions .com Copyright © 2010-2012 enParadigm Knowledge Solutions. 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