ERP Impact on Stock Price

This part is continued of the previous post about how balance sheet will be affected by ERP project. In this post we will talk about ERP impact on Stock price.

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

ERP Impact on Stock Price

If the integration and improved information of an ERP system results in a better balance sheet and increased profits, these improvements should impact stock price for the company. Although stock price is affected by a variety of factors, the typical effect of improved profits and balance sheet ratios can be estimated. Using the already described example of $10 million manufacturer and typical benefits, and assuming 100,000 shares outstanding and an existing stock price of $30.00 per share, the stock price exhibits the effects of an effective ERP, as figure 1-7-3 shows. With a price/earnings multiplier of six, the stock price for the example company could be increased from $30 to $58.80 per share.

Figure 1-7-3 Calculating the potential stock appreciation

	Before ERP	After ERP
Before tax profit	$500,000.00	$980,000.00
Earnings per share	$ 5.00	$9.80
Current stock price	$30.00	6 * 9.80 = $58.80
Multiplier	6	6

These calculations suggest that ERP systems can lead to significant impacts on financial results, including the balance sheet, income statement, key ratios, and stock price.

ERP Impact on Key Financial Ratios

ERP CHANGE MANAGEMENT

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

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

ERP Impact on Key Financial Ratios

Ration analysis provides another way to look at the impact of an ERP system. Three ratios illustrate the effect---two related to liquidity and one to operating performance.

 

Inventory turnover (Cost of Sales/Inventory). Low inventory turnover can indicate possible overstocking and obsolescence. It may also indicate deeper problems of too much of the wrong kind of inventory, which can create shortages of needed inventory for production and sales. High turnover indicates better liquidity and superior materials management and merchandising. Given the example $10 million company, the current number of inventory turns is 2.5. With a 20 percent inventory reduction, the number of inventory turns increases to 3.1.

 

Days of Receivables (365 * 1/(Sales/Receivables)). This ratio expresses the average time in days that receivables are outstanding. It is a measure of the management of credit and collections. Generally, the greater the number of days outstanding, the greater the probability of delinquencies in accounts receivable. The lower the number of days, the greater the cash availability. With an 18 percent reduction in receivables, the current day's receivable of seventy-three days can be reduced to sixty. This means $356,200 is available for other purposes.

 

Return on Assets (Profit Before Taxes/Total Assets). This ratio measures the effectiveness of management in employing the resources available to it. Several calculations are necessary to determine the return on assets. In this example, the return on assets can be improved from 5.9 to 12.9 by effectively implementing an ERP system.

Performance evaluation based on ratio analysis can also use comparisons between one's own company and similar firms in terms of size and industry. The Annual Statement Studies provide comparative ratios for this purpose. This use of comparative ratio analysis will use the same three ratios for inventory turnover, days receivable, and return on assets. To perform the analysis, you identify the median and upper quartile ratios for firms in the same industry. These roughly correspond to average and good performance. By comparing the ratios with your firm's current performance, you can calculate how much better your company should be performing to be competitive. The same analysis can be performed using the “BenchmarkReport.com” website.

Using the inventory turns ratio for the example $10 million manufacturer, assume the Annual Statement Studies indicate that the median and upper quartile are four and six turns for other firms in the same industry. Average performance of four inventory turns translates into an expected inventory of $1.875 million ($7.5 million divided by four). If the example firm had this ratio, it would have had $1.125 million less in inventory. With inventory carrying costs at 25 percent, this would produce savings of $281,250 each year.

For the days receivable ratio, assume the Annual Statement Studies indicate that sixty and fifty days are the median and upper quartile. The days receivable in the example $10 million manufacturer is currently seventy-three days; an improvement to sixty days would reduce receivables by $356,200 (using a daily sales rate of $27,400 and a thirteen day reduction). This means that cash is available for other purposes.

Note that the return on assets ratio is 5.9 for the example company. Assuming the Annual Statement Studies indicate the return on assets is ten and fifteen for firms in the same industry at the median and upper quartiles, improving the return on assets to equivalent levels would mean increased profits or asset turnover.

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.