Canon 2004 Annual Report Download - page 35

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Canon intends to continue to pursue further shortening of
product development lead times and reductions in production
costs.
Operating profit ratio (ratio of operating profit to net sales)
and research and development (“R&D”) expense to net sales
ratio are considered by Canon to be KPI. Canon is focusing on
two areas for improvement. On one hand, Canon strives to
control and reduce its selling, general and administrative
expenses. On the other hand, Canon’s R&D policy is designed
to maintain a high level of spending in core technology in
order to sustain Canon’s leading position in its current fields of
business, and to explore possibilities in other markets. Canon
believes such investments will be the basis for future success in
its business and operations.
Cash Flow Management
Canon also places significant emphasis on cash flow
management. The following are the KPI relating to cash flow
management that management believes to be important.
Inventory turnover within days is a KPI because it is a
measure of supply-chain management efficiency. Inventories
have inherent risks of becoming obsolete, deteriorating or
otherwise decreasing in value significantly, which may
adversely affect Canon’s operating results. To mitigate these
risks, management believes that it is important to continue
reducing inventories and shorten production lead times in
order to achieve early recovery of related product expenses by
strengthening supply-chain management.
Canon’s management seeks to meet its liquidity and
capital requirements primarily with cash flow from operations
and also seeks debt-free operations. For a manufacturing
company such as Canon, the process for realizing profit on
any endeavor can be lengthy, involving as it does R&D,
manufacturing, and sales activities. Management, therefore,
believes that it is important to have sufficient financial
strength so that it does not have to rely on external funding.
Canon has continued to reduce its reliance on external
funding for capital investments in favor of generating the
necessary funds from its own operations.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The consolidated financial statements are prepared in
accordance with accounting principles generally accepted in
the United States of America, and based on the selection and
application of significant accounting policies, which require
management to make significant estimates and assumptions.
Canon believes that the following are some of the more
critical judgment areas in the application of its accounting
policies that currently affect its financial condition and results
of operations.
Revenue recognition
Canon generates revenue principally through the sale of
consumer products, equipment, supplies, and related services
under separate contractual arrangements. Canon recognizes
revenue when persuasive evidence of an arrangement exists,
delivery has occurred and title and risk of loss have been
transferred to the customer, the sales price is fixed or
determinable, and collectibility is probable.
For arrangements with multiple elements, which may
include any combination of equipment, installation and
maintenance, Canon allocates revenue to each element based
on its relative fair value if such element meets the criteria for
treatment as a separate unit of accounting as prescribed in the
Emerging Issues Task Force Issue 00-21 (“EITF 00-21”),
“Revenue Arrangements with Multiple Deliverables.”
Otherwise, revenue is deferred until the undelivered elements
are fulfilled as a single unit of accounting.
Revenue from sales of consumer products including office
imaging products, computer peripherals, business information
products and cameras is recognized upon shipment or
delivery, depending upon when title and risk of loss transfer to
the customer.
Revenue from sales of optical equipment such as steppers
and aligners sold with customer acceptance provisions related
to their functionality is recognized when the equipment is
installed at the customer site and the specific criteria of the
equipment functionality are successfully tested and
demonstrated by Canon. Service revenue is derived primarily
from maintenance contracts on equipment sold to customers
and is recognized over the term of the contract.
Most office imaging products are sold with service
maintenance contracts for which the customer typically pays a
base service fee plus a variable amount based on usage.
Revenue from these service maintenance contracts are
recognized as services are provided.
KEY PERFORMANCE INDICATORS 2004 2003 2002 2001
Net sales (Millions of yen) ¥3,467,853 ¥3,198,072 ¥ 2,940,128 ¥ 2,907,573
Gross profit to net sales ratio 49.4% 50.3% 47.6% 44.0%
R&D expense to net sales ratio 7.9% 8.1% 7.9% 7.5%
Operating profit to net sales ratio 15.7% 14.2% 11.8% 9.7%
Inventory turnover within days 49 days 49 days 51 days 57 days
Debt to total assets ratio 1.1% 3.1% 5.0% 10.4%
Note: Inventory turnover within days; Inventory divided by net sales for the previous six months, multiplied by 182.5.