Canon 2005 Annual Report Download - page 39

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to sustain Canon’s leading position in its current fields of busi-
ness, 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 manage-
ment. The following are the KPIs relating to cash flow manage-
ment that management believes to be important.
Inventory turnover within days is a KPI because it is a mea-
sure 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, manage-
ment believes that it is important to continue reducing invento-
ries and shortening 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.
Stockholders’ equity to total assets ratio (ratio of total
stockholders’ equity to total assets) is another KPI for Canon.
Canon believes the stockholders’ equity to total assets ratio
measures its long-term viability. Canon believes that a high or
increasing stockholders’ equity ratio usually indicates that
Canon has a good, or improving ability to fund debt obliga-
tions and other unexpected expenses, which means in the
long-term that Canon is better able to maintain a high level of
stable investments for its future operations and development.
As Canon puts a strong emphasis on its research and develop-
ment activities, management believes that it is important to
maintain a stable financial base and, accordingly, a high level
of stockholders’ equity to total assets ratio.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The consolidated financial statements are prepared in accor-
dance with U.S. generally accepted accounting principles, and
based on the selection and application of significant account-
ing 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 con-
dition and results of operations.
Revenue Recognition
Canon generates revenue principally through the sale of con-
sumer 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 col-
lectibility is probable.
For arrangements with multiple elements, which may
include any combination of equipment, installation and mainte-
nance, Canon allocates revenue to each element based on its
relative fair value if such element meets the criteria for treat-
ment as a separate unit of accounting as prescribed in the
Emerging Issues Task Force Issue No. 00-21 (“EITF 00-21”),
“Revenue Arrangements with Multiple Deliverables.” Other-
wise, revenue is deferred until the undelivered elements are ful-
filled 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 demon-
strated 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 mainte-
nance contracts for which the customer typically pays a base
service fee plus a variable amount based on usage. Revenue
from these service maintenance contracts is recognized as
KEY PERFORMANCE INDICATORS 2005 2004 2003 2002 2001
Net sales (Millions of yen) ¥3,754,191 ¥3,467,853 ¥3,198,072 ¥2,940,128 ¥2,907,573
Gross profit to net sales ratio 48.5% 49.4% 50.3% 47.6% 44.0%
R&D expense to net sales ratio 7.6% 7.9% 8.1% 7.9% 7.5%
Operating profit to net sales ratio 15.5% 15.7% 14.2% 11.8% 9.7%
Inventory turnover within days 47 days 49 days 49 days 51 days 57 days
Debt to total assets ratio 0.8% 1.1% 3.1% 5.0% 10.4%
Stockholders’ equity to total assets ratio 64.4% 61.6% 58.6% 54.1% 51.3%
Note: Inventory turnover within days; Inventory divided by net sales for the previous six months, multiplied by 182.5.