1. Morgan ManufacturingPresented by:Mark Bundang, B.Scand Mohammed Abdo, B.Eng, M.Eng, PhD, CSSA, PMP
2. Morgan ManufacturingAgenda IntroductionSituation AnalysisConclusion
3. Morgan ManufacturingAgenda IntroductionSituation AnalysisConclusion
4. Morgan ManufacturingKey PlayersMorgan ManufacturingWestwood Inc.Charles Crutchfield Manager of manufacturing operations at Morgan. Primarily concerned with the health of the operating aspects of the business.Edward Drewery Controller for Morgan ManufacturingCompetitor of Morgan Manufacturing
5. Morgan ManufacturingMorgan Manufacturing uses LIFO as its inventory costing method and provides the LIFO reserve.Westwood uses FIFO as its inventory costing method.Events and Facts: Morgan OperationsProductivity ImprovementsFinancial StatementsComparison of Operating PerformanceOver 2006, Morgan Manufacturing implemented significant productivity improvements over Westwood.Morgan feels that these improvements in efficiency should be reflected in the financial statements.Morgan feels that the comparison of 3 key ratios are good indicators of the relative efficiencies between the competitors. Gross Margin Percentage Pre-tax Return on Sales Pre-tax Return on Assets Key Fact
6. Morgan ManufacturingAgenda IntroductionSituation AnalysisConclusion
7. Morgan ManufacturingInventory Costing MethodsEInv = BInv + Purchases – COGS
8. Morgan ManufacturingInventory Costing Methods: FIFO and LIFO
9. Morgan ManufacturingFIFO and LIFO: Goods Available for SaleCurrent year purchasesBeg. Inventory costCOGSFIFO(Pipe) (Bin)LIFO
10. Morgan ManufacturingThe LIFO Reserve: What‘s Left in Inventory ?Current year purchasesBeg. Inventory costEnd. Inventory(Bin)LIFOFIFO(Pipe)Ending Inventory (FIFO)Ending Inventory (LIFO)“LIFO Reserve” = EInvFIFO – EInvLIFO
11. Morgan ManufacturingUsing the LIFO Reserve: Income StatementEInvFIFO = BInvFIFO + Purchases – COGSFIFOEInvLIFO = BInvLIFO + Purchases – COGSLIFOSubtracting these two equations yields:EInvFIFO – EInvLIFO = BInvFIFO–BInvLIFO– (COGSFIFO–COGSLIFO)EInvFIFO– EInvLIFO– (BInvFIFO–BInvLIFO) = COGSLIFO–COGSFIFOEnd LIFO Reserve – Beg. LIFO Reserve = COGSLIFO–COGSFIFO Change in LIFO Reserve = LIFO-FIFO difference in COGS
12. Morgan ManufacturingAccounts Affected by the Inventory Costing MethodIncome StatementCost of Goods SoldIncomeGross MarginChange in LIFO ReserveInventoryRetained EarningsBalance Sheet
13. Morgan ManufacturingKey Parameters to Assess Operating EfficiencyCalculationMeaningRatioGross Margin PercentageHow well is the business’ ability to generate a return at the Gross Profit level. 1Pre-tax Return on Sales (ROS)How well the business is managing its operating expenses.2Pre-tax Return on Assets (ROA)How much income (before taxes) is derived from every 1 dollar in assets.3Inventory TurnoverHow quickly inventory turns over in a given period of time.4Days’ InventoryHow many days needed to turn inventory over completely.5
14. Morgan ManufacturingFinancial Statements: Morgan and WestwoodBased on LIFOBased on FIFO**All figures are in $ millions
15. Morgan ManufacturingInitial Comparison Before LIFO/FIFO ConversionBased on LIFOBased on FIFO2006 Comparison: DifferenceWestwood Inc.Morgan ManufacturingRatio-0.5%45.0%Gross Margin Percentage44.5%1-0.5%15.0%Pre-tax Return on Sales (ROS)14.5%2-0.03%13.39%Pre-tax Return on Assets (ROA)13.36%3+4.6 times6.5 timesInventory Turnover11.1 times4-23.5 days56.4 daysDays’ Inventory32.9 days5
16. Morgan ManufacturingInventoryGross MarginEInvLIFO=$100LIFO Reserve (2006)=$70EInvFIFO=EInvLIFO+ LIFO ReserveEInvFIFO= $170$950(Increase from $890 LIFO amount)Income Before Tax$350(Increase from $290 LIFO amount)Conversion of Accounts from LIFO to FIFOMorgan year endedDecember 31, 2006COGSCOGSFIFO=COGSLIFO+ ΔLIFOResΔLIFORes= - $60COGSFIFO=$1,110 + ($10-$70)COGSFIFO=$1,050LIFO to FIFO Comparison enabled
17. Morgan ManufacturingEffect of Inventory Method: Morgan ManufacturingCOGSGMIBTTaxesLIFO < TaxesFIFOInventoryAssetsR/E**All figures are in $ millions
18. Morgan ManufacturingFinancial Statements: After LIFO to FIFO ConversionCOGSM < COGSWGMM > GMWIBTM > IBTWInvM = InvWAssetsM = AssetsWREM > REW**All figures are in $ millions
19. Morgan ManufacturingComparison After LIFO to FIFO Conversion2006 Comparison: DifferenceWestwood Inc.Morgan ManufacturingRatio+2.5%45.0%Gross Margin Percentage47.5%1+2.5%15.0%Pre-tax Return on Sales (ROS)17.5%2+2.2%13.39%Pre-tax Return on Assets (ROA)15.6%3-0.3 times6.5 timesInventory Turnover6.2 times4+2.5 days56.4 daysDays’ Inventory58.9 days5
20. Morgan ManufacturingProfit After LIFO to FIFO ConversionCalculationMeaningRatioProfit Margin PercentageHow well is the business’ ability to generate profit. 2006 Comparison: DifferenceWestwood Inc.Morgan ManufacturingRatio+1.5%9.0%Profit Margin Percentage10.5%
21. Morgan ManufacturingAgenda IntroductionSituation AnalysisConclusion
22. Morgan ManufacturingConclusion The choice of different inventory methods affects one’s ability to directly compare the financial results of different companies Based on the operating efficiency parameters calculated after conversion of LIFO figures into FIFO, comparison of Morgan Manufacturing ratios to those of Westwood Inc. was made possible. This comparison demonstrates that Morgan Manufacturing’s operations are relatively more efficient than those of Westwood, Inc.
23. Morgan ManufacturingAny questions?