© 2003 Six Sigma Academy0 DFSS Finance Module June, 2003 Tyco Fire & Security.

1© 2003 Six Sigma Academy

DFSS Finance Module

June, 2003

Tyco Fire & Security


Topics

• Financial Statement Basics• Role of Finance – Six Sigma Deployment• Project Charter – Finance Components• Project Approval Process


Section 1

Financial Statement Basics


Balance Sheet (B/S)

• 4th Qtr.• 2 Min remaining• Philadelphia 21, Miami 14• Philadelphia has the ball on Miami’s 40 • 3nd down & 2


Analogous to the score of a football game at any given point in time:


Balance Sheet Example

Convertible Within 1 Yr., or 1 operating cycle

Convertible Within 1 Yr., or 1 operating cycle

BalancesBalances

Payable Within 1 Yr.Payable Within 1 Yr.

As-Of DateAs-Of Date

Assets $M Liabilities & Equity $M

Cash 6,383 A/P 11,182 S/T Investments - S/T Debt 7,719 A/R 7,187 Other Curr. Liab. 731 Inventory 4,716 Other Current Assets 1,479 Tot. Curr. Liab. 19,632

Total Current Assets 19,765 L/T Debt 16,487 Def. L/T Liab -

L/T Investments - Other Liab. 5,505 PP&E 9,970 Goodwill 26,093 Total Liab. 41,624 Intangible Assets 6,563 Other Assets 4,024

Stock Holders Equity 24,791 Total Assets 66,415

Total Liabilities & Equity 66,415

Balance Sheet As Of Sept. 30 2002

HighHigh


What To Look For On The B/S

Assets $M Liabilities & Equity $M

Cash 6,383 A/P 11,182 S/T Investments - S/T Debt 7,719 A/R 7,187 Other Curr. Liab. 731 Inventory 4,716 Other Current Assets 1,479 Tot. Curr. Liab. 19,632

Total Current Assets 19,765 L/T Debt 16,487 Def. L/T Liab -

L/T Investments - Other Liab. 5,505 PP&E 9,970 Goodwill 26,093 Total Liab. 41,624 Intangible Assets 6,563 Other Assets 4,024

Stock Holders Equity 24,791 Total Assets 66,415

Total Liabilities & Equity 66,415

Balance Sheet As Of Sept. 30 2002

PP&E Should Be High (often largest value) for industrial companies.PP&E Should Be High (often largest value) for industrial companies.

Look for Current Liabilities > Current Assets. Indicates company may have productivity & cash challenges.

Look for Current Liabilities > Current Assets. Indicates company may have productivity & cash challenges.

High DebtHigh Debt

Always Look For Trends / Changes Over TimeAlways Look For Trends / Changes Over TimeAlways Look For Trends / Changes Over TimeAlways Look For Trends / Changes Over Time


Income Statementor Profit & Loss Statement (P&L)

X

10 20 30 40 50 40 30 20 10 GG

10 20 30 40 50 40 30 20 10 GG

1. Took Possession on the 17 yard line2. Threw for a 14 yard gain (1st & 10 on the 31)3. Ran for a 3 yard gain (2nd and 7 on the 34)4. Threw for a 18 yard gain (1st and 10 on the 48)5. Sacked, lost 1 yard (2nd and 11 on the 49)6. Ran for 9 yards (3rd and 2 on the 40)

1. 2.3.

4.

5.

5.

Sum Of Gains & Losses Of Individual Plays Translate To Balance SheetSum Of Gains & Losses Of Individual Plays Translate To Balance SheetSum Of Gains & Losses Of Individual Plays Translate To Balance SheetSum Of Gains & Losses Of Individual Plays Translate To Balance Sheet




$M % of Sales

Revenue 35,644 Cost of Revenue 23,081 65%

Gross Profit 12,563 35%

R&D 0%

SG&A (Selling, Gen. & Admin.Exp.) 8,087 23%

Other Expenses (non recurring) 6,055 17%

Operating Income (1,579) -4%

Other Inc./(exp) (155) 0%

EBIT (Earnings Before Int & Tax) (1,734) -5%Tax 258 Interest Exp. 1,078

Net Income From Ops. (3,070) -9%

Income Statement For Year Ending Sept. 30 2002Income Statement Example

Income Statement Reflects Performance For A Income Statement Reflects Performance For A SpecificSpecific Period PeriodIncome Statement Reflects Performance For A Income Statement Reflects Performance For A SpecificSpecific Period Period

Low – 4%Low – 4%

Six Sigma applied to “Transactional” Business Processes reduces these costs

Six Sigma applied to “Transactional” Business Processes reduces these costs

Six Sigma applied to Operations reduces these costsSix Sigma applied to Operations reduces these costs

Note: F/Y Ends 9/30Note: F/Y Ends 9/30


$M % of Sales

Revenue 35,644 Cost of Revenue 23,081 65%

Gross Profit 12,563 35%

R&D 0%

SG&A (Selling, Gen. & Admin.Exp.) 8,087 23%

Other Expenses (non recurring) 6,055 17%

Operating Income (1,579) -4%

Other Inc./(exp) (155) 0%

EBIT (Earnings Before Int & Tax) (1,734) -5%Tax 258 Interest Exp. 1,078

Net Income From Ops. (3,070) -9%

Income Statement For Year Ending Sept. 30 2002

What To Look For On The P&L

High / Rising COGSHigh / Rising COGS

Key Measures

Always Look For Trends / Changes Over TimeAlways Look For Trends / Changes Over TimeAlways Look For Trends / Changes Over TimeAlways Look For Trends / Changes Over Time

Compare Key Measures To Competition

Compare Key Measures To Competition

Understand what this isUnderstand what this is

Often referred to as “Margin” or “Gross Margin”

Often referred to as “Margin” or “Gross Margin”


Financial Ratios - DSO

Days Sales Outstanding (DSO): Measure of “Collection” effectiveness and a company’s ability to utilize “receivable” assets.

Formula: (A/R / Revenue [for period]) X Days [in period] Calculation: (( 7,187 / 35,644 ) X 365 ) = 73.6

Correct

ed


Financial Ratios – Inventory TurnsInventory Turnover: Appropriateness of Inventory levels. Generally, higher Inventory Turnover is better. IF sales slow down Inventory Turnover will drop. This may indicate the need for corrective action, such as a reduction in production.

Formula: (Cost Of Goods Sold / Average Inventory [(Beg Inv + End Inv) / 2])Calculation: (23,081 / (4,381 + 4716) / 2) = 5.0

Beg. Inv. Conglomerates=6.27, S&P 500=9.91.


Financial Ratios – Asset TurnoverAsset Turnover: Indicates a company’s ability to use assets … convert them to sales and profit. Analogous to the car’s tachometer. The higher the asset turnover the better.

Formula: (Annual Sales / Total Assets)Calculation: (35,644 / 66,415) = 0.54

Conglomerates=0.49, S&P 500=0.93.


Financial Ratios – Employee RatiosEmployee Ratios: Revenue per Employee and Net Income per Employee are used as indicators of productivity. The higher the number the better.

Formula: (Annual Sales / Total # of Employees)Calculation: (35,644,000K / 260K) = 137K

Conglomerates=339K, S&P 500=586K.

Formula: (Net Income / Total # of Employees)Calculation: (-3,070,000K / 260K) = -12K

Conglomerates=36K, S&P 500=70K.


TFS Financial Statements


Standard Cost & VarianceStandard Cost & Variance

From Fixed AssetsFrom Fixed Assets

Earnings Before Interest and TaxesEarnings Before Interest and Taxes

External & Inter-company salesExternal & Inter-company sales


SAB101* = Revenue Recognition

* Staff Accounting Bulletin


Note: EBIT is the first item in the Cash Flow Statement

Note: Increase in these “Assets” is a negative to Cash Flow …

Note: Different types of Cash Flow


Cash Flow, EPS & Multiples

• Cash Flow:• Net Cash Generated/Used During Reporting Period• Leading Indicator• Income + Changes In Operating Assets & Liabilities (Net) + Investment Activities + Financing Activities

• EPS - Earnings Per Share:• Net Income divided by # of shares of stock outstanding• Related (not directly) to company performance and stock price

• Multiples:• P/E Ratio (Stock Price divided by EPS)• A dollar of EPS translates to a significantly higher stock price … indicated by P/E Ratio• A company with a P/E Ratio of 20 means that a dollar improvement might result in a significant ($20)

increase in stock price• P/E and multiples are not guaranteed, or even tightly related, just indicators

Improvements in EPS Are Magnified By P/E RatioImprovements in EPS Are Magnified By P/E RatioImprovements in EPS Are Magnified By P/E RatioImprovements in EPS Are Magnified By P/E Ratio


Summary - Financial Statement Basics

• Balance Sheet• Like the score in the corner of the TV screen,• Tells the balance of accounts (Assets, Liabilities & Equity) as of a specific point in time• Can learn something of the general health of a company

• Income Statement• Like a series of plays,• Shows gains/(losses), and income & expense activity for a certain period of time, such

as a month, quarter or year• Quarters can be added together to make a year (not like B/S)

• Other Important Factors (for this program)• Cash Flow• EPS • P/E Ratio


Role of Finance in a Six Sigma Deployment


Best Practices

• Establish Guidelines & Approach• How to use Financial Analysts in Six Sigma program• Project Cost & Benefits rules

• Engage Finance early• When project in development• Ensure working on right project areas• Should deliver good results• Hard benefits

• Engage Finance often• As project progresses

• Verify results

These Simple Steps Contribute To A Six Sigma Program’s SuccessThese Simple Steps Contribute To A Six Sigma Program’s SuccessThese Simple Steps Contribute To A Six Sigma Program’s SuccessThese Simple Steps Contribute To A Six Sigma Program’s Success


Finance Support

• Project Proposal: high level “sanity check”• The Project Champion completes a Project Charter with high level

estimates of benefit• Finance assists Project Champion or Black Belt in summarizing project

costs and benefits• Questions for Finance to ask

• Are these hard dollar benefits?• Are you measuring the Right factors in the business process?• Are there other possible sources of benefits? A more effective project?

Additional sub-Projects?• Does this opportunity meet the minimum benefit requirements?


• During Project:

• The Black Belt reviews and updates the financial model

• Financial Analyst (FA) reviews/assists as needed

• Questions for Finance to ask:

• How do these estimates compare with the previous estimates?

• Do these benefits look realistic for the proposed improvement?

• How do the savings estimates compare with current budget numbers?

• Is the decision to proceed confirmed?

Finance Support


• Project Completion• Detailed review of benefits to confirm total targeted benefits

• Finance works with Black Belt to validate & verify project results• Questions for Finance to ask

• Did the process improvement take place?• Does the process improvement result in the reported level of savings?• Are appropriate procedures in place to maintain the improvement?

• Ongoing tracking of financial results• Provide support to Project Champion to monitor sustainability of benefits

Finance Support


Finance TeamFinance Team

S ix S ig m a F ina n ce F u nc tion

B u s in ess U n itC o n tro lle r

Profit cente rF inancia l analys t

P rofit cente rF inancia l analys t










B ill B u feD iv is ion a l F in a n ce C h am p ion

M a rk M itch e llE xe cu tive S te e ring C o m m ittee


Business Units (pre Restructuring to Six SBU’s) Controller Ansul Worldwide Den Moraros Anusl US Mike O’Connor Anusl LA Juan Loza Ansul Canada Tony Amoruso EAS Todd tirabassi Video & Access Joe Barbati Europe Manufacturing Tony Carabin Scott H&S Mike Siedler Scott Aviation Nick Koppman TSPW (Simplex) Randy Zomar Graphic Controls Gary Toomey DSC Martin Liddell Singapore Maggie Soh Korea JJ Kang Australia David Bonham


Section 2

DFSS Project Charter


Workbook – Instruction Tab

Note: multiple Tabs in Workbook … 19 of them !

Please read and refer to Instructions, they answer many questions !


Common Data

Common Data Tab – designed to eliminate (reduce) duplicate data entry. Enter data in white cells only.

All amounts in US$ except where noted.Cost & Price inflation/(deflation)


Project Authorisation

Project Authorisation Tab – Captures basic project information … used to summarize project financials and present to management for approval.

All amounts in US$ except where noted.


Project CostDetailed Project Cost Tab – Enter project cost.



Capital

Capital Tab – Enter Capital requirements for project.


Use one row for each asset (or category of assets)

Enter Cost & useful life … depreciation expense will be calculated.


Summarized Cost

Summarized Cost Tab – This Worksheet summarizes all of the cost for the project. This is for your information. No data entry is required on this form.


Product Sales

Product Sales Tab – This Worksheet captures expected sales volumes, standard cost & related information.

Use one row for each part number or product/system bundle.

Maximum, typical dealer discount or interc-ompany price.


Pull-Through Product

Product Sales Tab – Similar to the “Product Sales Tab, this Worksheet captures expected sales volumes, standard cost & related information for “Pull-Through products”… additional products that will be sold as a result of this project.


Displaced Products

Product Sales Tab – Similar to the “Product Sales Tab, this Worksheet captures expected reduction in sales volumes, standard cost & related information for products that will be negatively impacted (replaced) by this project.


ROI

ROI Tab – This worksheet summarizes the project’s Return On Investment for you review. No data entry is required.


ROI Graph


Sensitivity Notes


Timing Sensitivity

Sensitivity Pages: Assumptions are made (see red text in cell comments). If assumptions are valid, no input is required on these pages. The white cells will calculate and populate based on the stated assumptions.

If adjustments are required, edit the values in the white cells.


Development Cost Sensitivity




Product Cost Sensitivity




Quality Sensitivity




Cost Analysis


Milestone Review

Complete Columns A & B prior to submission of the Project Authorisation Pack

Complete monthly as part of the monthly reporting procedures.

Complete column C at the completion of milestones


Change Control

Use this sheet to document changes to project


• Project Charter Approval Process

Section 3

DFSS Project Approval Process


TSP Interim Project Approval Process

Project ConsiderationBB initiates Six Sigma ProjectCharter with PC

Collects Data Refines Problem

Statement & Objective Collects Financial Data

Are there Additional Variables tofactor into the definition?

Decision by PC & BB

BB & PC ReviewFinancial Benefits with

Local/Site FA

APPROVED?

NO

BB & PC ReviewProject Charter & Benefits

with ES

YES

APPROVED?NO

APPROVED?

NO

TSP FinancialChampion Logs

financial benefit forBusiness Unit

TSP DeploymentChampion(s) Reviews

Projects(Periodic Reviews with

TSP Six SigmaSteering Committee)

Forward Project Charter to TSPDeployment Champion(s)

- DMAIC- DFSS

TSP DeploymentChampion(s) RegisterProject Charter in TSP

Project Database

TSP DeploymentChampion(s) ReviewProject Charter with

TSP FinancialChampion

CONTINUE?

Project Status / Review until Project Closure.

Appropriate Budgets Adjusted / Reported

NO

YES

YES

NO

LEGEND:BB = Black BeltPC = Project ChampionFA = Financial AnalystES = Executive Sponsor

YES

YES

START

FINISH

1. Local Approval1. Local Approval

2. Champion Approval

(Clive, Jeff & Bill)

2. Champion Approval

(Clive, Jeff & Bill)

3. Steering Committee

3. Steering Committee


• Project Charter Approval Process

Definitions / Reference


Accounting Terms Used – P&L

• Revenue – Sales of products, rendering of services and earnings from interest, dividends, lease income and royalties.• Cost of Revenue – AKA COGS or Cost of Goods Sold, or Cost of Sales. Direct material, labor & factory overhead

associated with making or producing goods or services.• Gross Profit – Revenue less Cost Of Revenue. Key indicator of product line performance before Corporate

expenses are applied.• R&D – Research and Development cost.• SG&A – Selling, General & Administrative cost. Examples: Legal, Finance, HR, Lease cost not directly associated

with product.• Other Expenses – Expenses not accounted for in one of the accounts above. e.g. rental expense, royalties, F/X.• Operating Income – Gross Profit less R&D, SG&A, and Other Expenses. Indicates profitability from operations

before the application of financial related items (interest, dividends, etc.)• Interest Expense – Amount charged by borrowers for use of funds.• EBIT –Earnings Before Interest & Taxes. This is a key measure found of all Income Statements. • Tax – Amount of income (Federal, State & Local) tax charged against income for the current period.• Minority Interest – Income/(Loss) from investment holdings outside of the consolidated group (less than 100%

ownership).• Effect of Accounting Changes – Changes resulting in a change in Accounting Methods. Such as, change in

depreciation method, merger/divesture of companies.• Net Income – Final Income/(Loss) for the period after all adjustment to income have been applied. The “Bottom Line”• P&L – Profit & Loss Statement. AKA Income Statement.


Accounting Terms Used – B/S

• Asset – An economic resource that is expected to provide future benefit to the business entity..

• Cash – Usually this account is cash and cash equivalents. Cash on hand and cash on deposit.

• S/T Investments – Funds placed in securities that are expected to be held for less than one year. Examples: Money Market funds, options.

• A/R – Accounts Receivable. Amounts owed to the company for goods or services purchased by customers. Amounts that have been billed (invoiced), but not yet paid.

• Inventory – Merchandise or supplies on had or in transit at a particular point in time. Three kinds: Raw Materials, Work In Process (WIP) and Finished Goods.

• Other Current Assets – Other assets not categorized with a useful life of one year or less. e.g. prepaid interest, tax, rent.

• Total Current Assets – Assets having a useful life of one year or less. Sum of all items above.

• Long-Term Investment – Amounts invested with an expected maturity of more than one year.

• PP&E – Property,Plant & Equipment. Fixed assets used in business operations including land & buildings. Value shown is book value of assets (original cost less accumulated depreciation).

• Goodwill – In general, Goodwill is the amount paid for a company in excess of the net assets (assets, less liabilities).

• Intangible Assets – Value of assets without a physical presence (patents, trademarks, franchise).

• Other Assets – The value of all other assets not categorized above. e.g. assets of discont. Ops., L/T prepaid assets.

• A/P – Accounts Payable. Obligations to pay suppliers for goods and services acquired.

• S/T Debt – Short-Term Debt. Money payable to debtor within one year. e.g. notes payable, Commercial paper.

• Other Current Liabilities – Other obligations payable within one year. e.g. current taxes, royalties, litigation, etc.

• L/T Debt – Long-Term Debt. Monies owed for a period exceeding one year. Examples: Bonds and Long Term Notes Payable.

• Def. L/T Liab. –Deferred Long Term Liabilities. Debt where the payment made is postponed beyond the present date. E.g. deferred inter-company profit in inventory, capital lease obligations.

• Other Liab. – Other Liabilities• Stock Holders Equity – Ownership interest of stockholders in

the corporation. The difference between Total Assets and Total Liabilities.


Accounting Terms Ratios and Key Performance Measures

Working Capital – A measure of a company’s liquidity. Current assets less current liabilities.

Working Capital Turns – Sales divided by average working capital. Reflects an organizations’ effectiveness to use working capital to obtain revenue.

Inventory Turns – COGS divided by average inventory ((beg inv + end inv)/2). Low turnover may be an indication of overstocking, obsolescence or deficiencies in marketing.

P/E Ratio – Price Earnings Ratio – Market Price Per Share divided by Earnings Per Share. Used in evaluating investment possibility in the company. A steady decrease in P/RE Ration indicates a decrease in investor confidence.

EPS – Earnings Per Share. Net Income less Preferred Dividend divided by Weighted Average Common Stock Outstanding. Profit accruing to stock holders for each share held.

Gross Margin Ratio – Gross Margin divided by Sales. Profitability effectiveness of company’s product lines (before fixed expenses).

Profit Ratio – AKA EBIT %. Income Before Interest & Taxes divided by Sales. Indicates profitability of company including fixed expenses.

© 2003 Six Sigma Academy0 DFSS Finance Module June, 2003 Tyco Fire & Security.

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