Monday, September 1, 2008

How should balance sheet be affected by this project?

ERP CHANGE MANAGEMENT


If you are new with this web log we request you to read preface first.


This part is about the messages on how balance sheet will be affected by ERP project. As we have mentioned before you have to disseminate the messages to all of the related people.


A_1-6 what is the timetable to implement ERP?

Project scheduling and selected systems for implementation should be announced to departments.


A_1-7 how should balance sheet be affected by this project?

Benefits from improved business processes and improved information provided by an ERP system can directly affect the balance sheet of a company. You have to show affect of the project in the balance sheet and show the decision-makers how this project could be valuable for the company. So you should prepare your company balance sheet as shown in the following example and use it properly in your meetings, communications etc.

(We have used following example with the permission of Dr. Scott Hamilton)

To illustrate this impact, a simplified balance sheet is shown in figure 1-7-1 for a typical manufacturer with annual revenue of $10 million. The biggest impacts will be on inventory and accounts receivable.

In the example, the company has $3 million in inventory and $2 million in outstanding accounts receivable. Based on prior research concerning industry averages for improvements, implementation of an ERP system can lead to a 20 percent inventory reduction and an 18 percent receivables reduction.

Figure A_1-7-1 Summarized balance sheet for a typical $10 million firm


Typical


Current

Improvement

Benefit

Current assets




Cash and other

500,000



Accounts receivable

2,000,000

18%

356,200

Inventory

3,000,000

20%

600,000

Fixed assets

3,000,000



Total assets

$8,500,000


$956,200

Current liabilities

xxx,xxx



Non current liabilities

xxx,xxx



Stockholder's equity

xxx,xxx



Total liabilities and equity

xxx,xxx



Inventory Reduction. A 20 percent inventory reduction results in $600,000 less inventory. Improved purchasing practices (that result in reduced material costs) could lower this number even more.

Accounts Receivable. Current accounts receivable represent seventy-three days of outstanding receivables. An 18 percent reduction (to sixty days' receivables) results in $356,200 of additional cash available for other uses.

ERP Benefits on the Income Statement

A simplified, summary income statement for the same $10 million manufacturer is shown in figure 1-7-2. For many manufacturers, the cost of sales ranges from 65 to 75 percent of sales (the example will use 75 percent). Using industry averages for each major benefit, the improved business processes and associated information system almost double the current pretax income.

Inventory Reduction. A 20 percent reduction in the current inventory of $3 million results in ongoing benefits of lower inventory carrying charges. Using a carrying cost of 25 percent results in $150,000 in lower carrying charges each year, identified here as part of the administrative expenses.

Material Cost Reductions. A 5 percent reduction in material costs because of improved purchasing practices results in annual savings of $225,000.

Labor Cost Reductions. A 10 percent reduction in labor costs because of less overtime and improved productivity results in annual savings of $100,000.

Increased Sales. Improvements in customer service typically lead to a 10 percent sales increase; this is not shown in figure 3.1.

Annual benefits totaling $475,000 in this example almost equals the current pretax income of $500,000.

Figure 1-7-2 Summarized income statement for a typical $10 million firm



Typical


Current

Improvement

Benefit

Sales

$10,000,000

10%


Cost of sales

7,500,000



Material

4,500,000

60%

Labor

1,000,000

13%

Overhead

2,000,000

27%

5%

$225,000

10%

$100,000



Administrative expenses

2,000,000


$150,000

Pretax income

$ 500,000


$475,000


This part will be continued in next post.