Reebok 2013 Annual Report Download - page 123

adidas Group
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2013 Annual Report
Group Management Report – Financial Review
119
2013
Internal Group Management System
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03.1
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Optimisation of non-operating components
Our Group also puts a high priority on the optimisation of non-operating
components such as financial result and taxes, as these items strongly
impact the Group’s cash outflows and therefore the Group’s free cash
flow. Financial expenses are managed centrally by our Group Treasury
department
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SEE TREASURY, P. 135. The Group’s current and future tax
expenditure is optimised globally by our Group Taxes department.
Tight operating working capital management
Due to a comparatively low level of fixed assets required in our business,
the efficiency of the Group’s balance sheet depends to a large degree
on our operating working capital management. Our key metric is
operating working capital as a percentage of net sales. Monitoring
the development of this key metric facilitates the measurement of our
progress in improving the efficiency of our business cycle. We have
significantly enhanced operating working capital management over
recent years through improvement of the Group’s inventories, accounts
receivable and accounts payable.
We strive to proactively manage our inventory levels to meet market
demand and ensure fast replenishment. Inventory ageing is controlled
tightly to reduce inventory obsolescence and to minimise clearance
activities. As a result, stock turn development is the key performance
indicator as it measures the number of times average inventory is sold
during a year, highlighting the efficiency of capital locked up in products.
To optimise capital tied up in accounts receivable, we strive to improve
collection efforts in order to reduce the Days of Sales Outstanding (DSO)
and improve the ageing of accounts receivable. Likewise, we strive to
optimise payment terms with our suppliers to best manage our accounts
payable.
Capital expenditure targeted to maximise future returns
Improving the effectiveness of the Group’s capital expenditure is
another lever to maximise our operating cash flow. We control capital
expenditure with a top-down, bottom-up approach. In a first step,
Group management defines focus areas and an overall investment
budget based on investment requests from various functions of the
organisation. Our operating units then align their initiatives within the
scope of assigned priorities and available budget. We evaluate potential
return on planned investments utilising the net present value method.
Risk is accounted for, adding a risk premium to the cost of capital and
thus reducing our estimated future earnings streams where appropriate.
By means of scenario planning, the sensitivity of investment returns is
tested against changes in initial assumptions. For large investment
projects, timelines and deviations versus budget are monitored on a
monthly basis throughout the course of the project.
The final step of optimising return on investments is our selective
post-mortem reviews, where larger projects in particular are evaluated
and learnings are documented to be available for future capital
expenditure decisions.
M&A activities focus on long-term value
creation potential
We see the vast majority of the Group’s future growth opportunities
coming from our existing portfolio of brands. However, as part of our
commitment to ensuring sustainable profitable development, we
regularly review merger and acquisition (M&A) options that may provide
additional commercial and operational opportunities. Acquisitive growth
focus is primarily related to improving the Group’s positioning within
a certain sports category, strengthening our technology portfolio or
addressing new consumer segments.
Any potential acquisition candidate must correspond with the Group’s
strategic direction. Maximising return on invested capital above the cost
of capital in the long term is a core consideration in our decision-making
process. Of particular importance is evaluating the potential impact
on our Group’s free cash flow. We assess current and future projected
key financial metrics to evaluate a target’s operating profit potential. In
addition, careful consideration is given to potential financing needs and
their impact on the Group’s financial leverage.
Cost of capital metric used to measure
investment potential
Creating value for our shareholders by earning a return on invested
capital above the cost of that capital is a guiding principle of our Group
strategy. We source capital from equity and debt markets. Therefore, we
have a responsibility that our return on capital meets the expectations of
both equity shareholders and creditors. We calculate the cost of capital
utilising the weighted average cost of capital (WACC) formula. This
metric allows us to calculate the minimum required financial returns
of planned capital investments. The cost of equity is computed utilising
the risk-free rate, market risk premium and beta factor. Cost of debt is
calculated using the risk-free rate, credit spread and average tax rate.