 to this lecture as part of the NPTEL course on Supply Chain Digitization. I am Sushmita Narayan, I am a faculty with IIM Mumbai and this is the session on Supply Chain Design and Operation Strategies. We have already seen up till now what is the linkage of supply chain and design strategies with the corporate strategy as well as other functional strategies. So, that is the part that we have already covered. In this session, I am going to be taking up an interesting topic which is you know not very often linked with operations. This is the interface between operations and finance which is very important for any organization to consider before it implements or designs its operation strategies or the supply chain strategies. In fact, this has implications even for other elements let us say production design R&D as well as marketing human resources and other kinds of strategies that a firm would have, but in particular I am going to be focusing on the interface with operations. Now, in this part also of the session, I am going to be looking at one aspect of finance. Finance is a very vast domain and since this course is focused on supply chain management, I will be picking up one part of finance and giving some kind of a sensitization to our students on one metric in finance which is the return on assets. There are many metrics in finance, there are many elements to financial management, accounting all of these which are very very important to operations management and supply chain management, but as a brief introduction for our students, we will be focusing on just one element which is the return on assets. So, at the end of the session, I would actually encourage students to look at the connection between other elements of financial management, let us say investment banking and all of this to operations because this is becoming a very important topic nowadays called as supply chain finance and a lot of technological advancements have occurred in this space as well such as smart contracting, blockchains so on and so forth. So, when we consider this interface, I am going to pick up a very standard model from financial management, this is called as the DuPont model and I have adapted the DuPont model, this is not having the exact elements of the DuPont model. Let us look at this model first and then try to make sense as to how this is related to operation strategy. The DuPont model is very popularly used in financial analysis and it looks at deriving a set of indicators that depict the performance of the firm. And over here as you can observe, we have at the very left hand side of my screen, we have something called as the return on assets. This is the final metric of interest to us. This metric is being derived from all of these metrics towards the right hand side of the screen. So, at one end, we go in this direction, let us say we go with the top most direction of this particular diagram. On one hand, we have something called as the net profit margin and at the bottom part of the screen, we are looking at the other metric which is called as the asset turnover ratio. The return on assets ROA as it is popularly known or return on net assets is a combination of these two indicators, the net profit margin and the asset turnover ratio. And as you can see here, I have shown that it is the product of these two elements. So, in other words, if we were to say what is the return on assets, this is going to be equal to the net profit margin into the asset turnover ratio. Now, let us take the first half of the screen that is the top part of the screen because this is something that is more easy to understand for someone who is new to finance or someone who is new to operations as well. The net profit margin is a derived indicator in itself. Return on assets is a derived indicator, net profit margin is also a derived indicator. What do I mean by derived indicator? A derived indicator is a metric that is calculated from other indicators. So, it is not measured directly from the occurrence of certain events or through some measurement methods, but it is actually calculated through a mathematical formula. So, that is what is meant by derived indicator. So, the net profit margin return on assets are derived indicators. The net profit margin as we can see is a percentage or a ratio. It is the ratio between the net profit that the firm is going to earn from selling its products or services. It does not matter whether you are selling products or services, you can always capture the net profit versus the sales that it actually was able to you know create or was able to generate within the last financial year of interest to us. So, it is a ratio. So, how much of profit am I actually gaining as a portion of my sales? The profit margin can be less than 100 percent, 1 percent it can be more than 100 percent also, which means that the company is being extremely profitable in terms of its sales that is a possibility that the company is going to consider. The net profit and sales if we were to consider what kind of indicators they are, the net profit is a derived indicator in itself. It is a combination of sales and all the costs that were incurred in trying to sell the product in the market. So, if I were to consider sales, sales is going to be how much I was able to sell that is how much volume into the price of the product. So, let us say the price of the product is 100 rupees and I was able to sell 10000 units of the product, then 100 into 10000 would be the sales that I was able to generate. Now, you can see here I have depicted the mathematical relationship of other terms in terms of minus sign, which means the net profit is sales minus the cost of goods sold, the SGA expenses, interest expenses, taxes so on and so forth. Like I said this is adapted from the DuPont model there could be many other elements as well, which I have not included, but just to give you a primer into the financial performance of the firm I have included a few elements, which are very relevant to our discussion today. So, if I were to consider what is net profit, it sales less the cost of goods sold, less the expenses in SGA, less interest expenses, taxes so on and so forth. What is cost of goods sold? The cost of goods sold refers to the cost of all the activities that were carried out in producing and selling the product in the marketplace. And this would typically include you know what was the cost of purchase that is how much did you spend in terms of procuring raw materials for the product. Let us say we were making 10000 units of the product, we could be looking at every unit of the product incurring some kind of cost. The cost of manufacturing could be related to the cost of purchase and in the cost of purchase we would be looking at how much cost was incurred in paying a vendor for that particular unit of product that could be one part of the cost of goods sold. The other part of cost of goods sold would be related to what was the cost incurred in creating this product right. So, let us say you were carrying out manufacturing, there would be some kind of labor who is going to be utilized in order to make the product. They may be packaging the product, cleaning the product, they could be involved in setting up the equipment for manufacturing, they could be involved in moving the material within the warehouse, they could be involved in many activities that are related to creating this product in the form of a final finished goods. This is all part of cost of goods sold and as you can see it is directly related to the activity of producing and distributing the product. The other expenses that could be incurred are what we call as SGA, interest expenses, taxes so on and so forth. The SGA expenses in particular are what we call as sales, general and administrative expenses. Now, what do we mean by this? These are expenses related to the process which is not directly linked to the manufacturing of the product alright. So, it could be related to the advertisement cost of you know promoting this product in the marketplace. Administrative expenses, let us say you are having staff or employees in your organization, they are not necessarily working on the shop floor, but they could be related to the IT systems, they could be managing the infrastructure in your facility, they could be managing let us say customer relations, they are not directly related to the manufacturing process of the product. We will have wages to be paid to such employees as well, but they are not directly related to the cost of goods sold, they are not related to the cost of manufacturing the product. So, these are the expenses are the apart from the expenses incurred in making the product. Similarly, upon these expenses you could have also interest expenses, you can have taxes that need to be paid over your income so on and so forth. Now, all of these aspects are going to be deducted or all these elements are actually going to be deducted from the revenue that you make. So, you can see it is not going to be very easy for a company to be profitable because it owes money to a lot of other entities right. It owes money to its vendors when it is purchasing, it owes money to its employees, it owes money to the bank, it owes money to the government and all of these elements are going to deduct the kind of value that the firm can actually derive from selling the product. So, naturally if a firm is interested in functioning within a marketplace it would try to achieve more profitability as much as possible right. So, this part is going to feed into what we call as the net profit margin. So, a firm would like to increase its net profit margin as much as possible in order to function within the marketplace in order to exist within the marketplace. On the other hand at the bottom part of this slide as you can see I have considered what is called as the asset turnover ratio. The asset turnover ratio is also a derived indicator and remember I have said what is a derived indicator it is a metric that is going to be calculated by combining other metrics right through some kind of mathematical operation. So, in this case the asset turnover ratio is the ratio between the sales as a value. So, we are talking about sales as rupee value or dollar value versus total assets that the firm is going to have again in dollar or rupee value. So, it is a ratio. So, as you can see here the net profit margin is also a ratio the asset turnover ratio is also a fraction and this derived indicator is going to again consider the sales the same sales that we considered in the net profit margin and here interestingly it is looking at a different kind of metric which is called as total assets. Now, what do we mean by total assets? Total assets are all that the firm is going to use in order to generate that product and sell that product. What does it use? What are some of the assets that the firm is going to have that it is going to use in order to sell and this will be physically visible right this is physically visible to you. So, among these total assets we have two types of assets that are very common the first one is current assets and the second one is fixed assets. As you can observe over here current assets is also going to be derived from other metrics whereas, fixed asset is the final indicator over here which means we can directly measure it from the value of assets that we own. Now, what is the difference between fixed assets and current assets? Fixed assets and I can explain this with an example fixed assets refer to the equipment that we have manufacturing equipment, the you know the plants that we own the factories that we own the facilities that we own it could also relate to the fleet of vehicles that we own right. Now, these assets are part of our capital expenditure we are going to purchase these assets and we cannot very easily sell these assets right because once we purchase them it is going to take a long time for them to again get sold in the market. It takes a while to purchase these assets it is also going to take a while to sell these assets. So, you cannot generate revenues very easily from these kinds of assets. So, over a period of time they are fixed they are going to be fixed and they are not going to directly convert to cash through a sale. Fixed assets are typically used in order to generate the product or services that we offer to the customer. So, I am going to use the plant or I am going to use the equipment in the plant in order to manufacture the product, but the plant itself is not going to be sold as the product the equipment itself is not going to be sold as the product. So, in a sense the fixed assets are supporting our process of production or manufacturing in this case. Similarly, I would be using my vehicles in order to transport the product from point A to point B. Again I am not selling the vehicle I am selling the product. So, the fixed asset which is my vehicle is going to help me in selling this product by the means of transporting it to the point of sale. Now, on the other hand we have current assets. So, if we look at current assets it is again as I mentioned it is derived from a few indicators one of them is inventory very very important within the supply chain which is the inventory and this refers to the inventory or the stock of materials that is going to be either sold as the product or that which is going to be used in directly making the product. So, the inventory in the in in terms of let us say the finished good itself right it could be that shampoo bottle that you created with the shampoo or it could be inventory in the form of work in process inventory. For example, the dyes the chemicals that are used to make the shampoo the bottle itself which is all work in process the plastic which is used to make the product that is also in process as you can see ultimately this is going to be sold to the customer and it is going to generate sales. In other words this particular product should be or can be easily liquidated or sold within the market in return for money much faster than let us say the fixed assets that I have right. So, within the year typically I should expect to sell this product within the market and gain revenues from this. So, this is what we call as current assets because it can be sold in the market and we can quickly generate money from this specifically cash right. We also have something called as receivables. Now as you can think of if you are a retail consumer that is you are someone who has gone to purchase the shampoo bottle in the market you are going to pay money to your grocer or you are going to pay money to the retail chain almost immediately in order to purchase the product. Very rarely unless you have very good terms and conditions with your grocer who is your you know who is someone who you have known for a while you might even take products from your grocer on credit. In the sense you might tell him that I will pay back the money for this after a week or after 10 days. In such a case you have created a system of credit with your grocer and you owe money to your grocer and your grocer who has sold the product to you expects receivables of sales equivalent money or revenue from you. This is going to be much more common in a B to B setting that is business to business setting rather than a B to C setting and it is going to be very commonly observed in these settings because you have regular business or operations happening between companies within a supply chain. So, you are continuously going to be selling products and trading them or selling them in the marketplace further so on and so forth. You are continuously going to be purchasing raw materials converting them into some kind of a product. So, it does not make sense for you to have immediate financial transactions, but in you might want to take the option of paying back your supplier or your vendor after a period of in time. This is what we say purchasing on credit and you are going to owe money to your vendor in such a case and your vendor is going to expect receivables from you. The receivables also can be converted into cash equivalents through the process of liquidation and hence this is also considered as a current assets. We also have current assets in the form of cash and other current assets. So, this is already liquid assets that we are going to have and all of these current assets are very important because of the nature of liquidation. We can use these assets in order to finance our day to day operations as a firm. So, if you have to pay wages to your employees or if you have to let us say pay small vendors, you would be using the cash that you generate from these operations in order to finance all of the other activities that you have as a firm. So, having current assets is actually very, very important in order to keep the machinery going as we say. On the other hand fixed assets are very important because they are going to help generate the revenue that we want. The total assets is the sum of these current assets and fixed assets. Now, let us look at the nature of the asset turnover ratio. The asset turnover ratio shows us that it is the ratio between sales and total assets. So, in other words if we wanted to look at what is the desired direction for the asset turnover ratio, I would want it to be high as high as possible right. There could be limitations, but I would want it to be as high as possible. What does that mean? I do not want to have excess assets such as machinery, equipment or inventory in my organization because that would mean I am not selling the product itself right or I am not generating enough revenues. I would want to have just enough assets that can help me generate a high amount of sales. So, in other words if I were to consider the net profit margin, I would want this to be as high as possible. If I were to consider the asset turnover ratio, I would want this also to be as high as possible. Particularly if I were to again focus on the asset turnover ratio, we want to generate as much sales as possible from the assets that we have. We want to utilize them to the best extent possible. We do not want to have anything in excess which is not sold. We want to be able to utilize all our facilities, else we would be very inefficient in using our resources right. So, considering all of this, we are going to see that the right hand side is going to require a lot of focus if we wanted to really improve the left hand side, which is the return on assets. Now, how do we go about doing this? As you can see on the very right hand side, these are not necessarily derived indicators. There may be further demarcations possible or further derivations possible, but a lot of it let us say for example inventory can be directly measured from what is visible in the shop floor or visible within the factory. So, what are the implications that we can think about when we are looking at such indicators for operation strategies? Let us say we were to consider sales or we were to consider the cost of goods sold. We would want to reduce our cost of input, we would want to reduce labor costs. If I were to consider my expenses, I would want to reduce advertising costs, I would want to reduce distribution costs. If I were to consider let us say taxes for example, I may make a choice of materials or locations which can provide me tax benefits right. So, I might want to locate my manufacturing facility let us say in an ACZ where I am going to get some benefits of taxes that are going to be on the lower side. If I were to consider let us say inventory, I would not want to have too much inventory. Remember inventory is required, receivables are required, cash and other current assets are required because they help us in day to day operations, but we do not want too much of it because then it would indicate that a large amount of investment is held up within the organization and not getting sold. It is not a very efficient way of functioning. And I would want to improve the speed of cash to cash cycles. In other words, how fast can I generate cash from my operations? I would want to increase the inventory turnover that is quickly move the inventory from my facility to the consumer sell the inventory. And if I were to consider the fixed assets, I would want to first of all improve my asset utilization. Let us say if I am having 4 or 5 equipment or machinery that are used for production, I would want that they are going to be utilized to the best extent possible because that would indicate that I am also generating a large amount of production which can be sold in the market. If the assets are very expensive and this is very common, I might actually choose to outsource. So, I might even think of getting rid of this entirely by going for outsourcing. As you can see here, all of these elements are looking at reducing cost, reducing inventory, reducing asset so on and so forth with the requirement or with the hope that we are going to improve the financial performance of the firm. Only the element let us say sales is something that we would want to increase as much as possible. So, if we were to increase sales, I would look at promotional strategies. I would want to promote the product more in the market place which would again figure in the advertising expenses that I am going to incur. So, we can see over here that these elements are actually going to be interrelated in some way or the other. So, the supply chain and operation strategy that needs to pick up that needs to be picked up has to keep in mind that there is an interaction between these elements. They are not independent of each other, working on one part is going to impact the other as well. So, in summary if we were to look at this interface between operations and finance, specifically focusing on return on assets, we can actually design a strategy with the understanding as to how it is going to impact the financial performance. Let us say for example, financial performance is return on assets. The higher is the profit margin, the higher is the asset turnover ratio, we can expect higher return on assets. But one of the main things that we need to keep in mind is that when we try to apply a strategy and let us say attempt to manage one lever, it could impact other levers as well within our system. So, this is the basic interface between operations and finance that we need to consider when we are going to choose or design any operations or supply chain strategy. Note that you know the return on assets is just one indicator, there could be several other indicators of interest with more nuanced implications for the operation strategy, let us say quick ratios on and so forth. And hence it always makes sense for us to not focus on just one indicator, but look at a variety of indicators and then make a decision as to what kind of strategy we need to pick up. So, we were looking at the interface between operations and finance and how this has implications for supply chain and operation strategy using an adaptation of the DuPont model. Let us see whether there are any examples that can help us understand this better. So, this is an example that I have picked up which is very relevant to what we see today with same day delivery, 10 minute delivery becoming very commonplace in e-commerce. When we have to carry out a lot of deliveries on a continuous basis, the cost of operations are going to be high because you are going to make several trips, you are going to make several deliveries. So, manpower is going to be used for delivering, for selling the product to the end customer. But what do we see as a problem? One of the issues that we observe particularly in India when it comes to the transportation sector is that a huge part of costs in logistics are accounted by transportation costs. Nearly 50 percent or more of logistics costs comes from transportation with the other costs coming through from warehousing and other activities. In fact, this is specifically the case because in India most of the transportation is via road, via truck, via other vehicles. And why this cost is such a large component of logistics cost is also because that most of the transportation cost is accounted by fuel cost, diesel cost, petrol cost so on and so forth. So, it is expensive to actually transfer or transport products in the Indian marketplace. A lot of activities have been taken up by the government in order to reduce these costs. For example, the PM Gatishakti you know initiative which has been taken up building up of infrastructure such as roads, rail so on and so forth in trying to reduce these costs to a large extent. However, the dependence on fuel cost is something which is more external to the infrastructure aspects in the country. So, what have companies now started looking at? One of the recent technological advancements that has happened is the electric vehicles and their use for transportation, particularly in last mile delivery. Electric vehicles can lower the cost of operations provided their energy source is not fueling. Which means when you are looking at operating the electric vehicle, it is going to be functioning with the help of a battery. And that battery is going to be charged through renewable energy sources for let us say solar energy so on and so forth. If it is not dependent on conventional fuel sources, electric vehicle cost of operation is actually much lesser than using your typical motorcycle which is fuel dependent. So, a lot of companies that we are seeing in last mile delivery let us say in the food sector, food delivery or in the grocery sector have started adopting the electric vehicles as they have the potential to lower the cost of operation and remember this is an important component for improving the return on assets. Similarly, another example that I have is the concept of asset light. In India, like I mentioned the cost of transportation are quite high, cost of logistics are quite high for an independent organization to pursue. So, what do they do? They outsource their operations to third party logistics providers and we have several third party logistics providers who have come up in the marketplace in the last decade or so. And these third party logistics providers themselves are functioning on asset light models in the sense they are also not necessarily owning their own vehicles for transportation. For example, they would also further outsource transportation to service providers who have vehicles whether it is for long distance travel, line hall or whether it is for last mile delivery. What the third party logistics provider would do is aggregate volumes of business from different clients and pass it on to the transportation service provider and gain the benefits through the economies of scale or the large volumes that he brings to the transportation service provider and pass these cost savings to the manufacturer or to other clients that he or she has. So, this is an example where we see that companies are actually trying to get rid of unnecessary assets within their system. Finally, the focus of our course which is on supply chain digitization, we are seeing a vast amount of adoption of digital transformation in operations, particularly in information processing we observe this quite a bit. A huge amount of time can be wasted gathering information pertaining to orders pertaining to quantity so on and so forth. A large part of this can actually be automated with the help of very simple tools and technologies. For example, the very purpose of emailing and e-commerce systems is to reduce any kind of manual interaction between companies or between individuals and through certain automation procedures we can actually even reduce any kind of manual interventions even in sending out emails. Emails can also be automated e-commerce systems can have proper order management systems in which a seller and a buyer can interact with each other and negotiate terms and conditions without too much of interaction. This has the potential to reduce unnecessary administrative expenses or documentation expenses that would be there. Another interesting strategy that a company would look at particularly let us say in e-commerce is trying to improve the inventory turnover by ensuring that there is huge amount of footfall of the client let us say the consumer on their website. So, you would have noticed this as someone who purchases online that the e-commerce website or the applications are always trying to improve the way in which navigation is carried out for the consumer. All with the intention that the consumer quickly makes selection of the products, makes the payment and leaves the website or goes on to purchase more products. By cleverly designing the website and the application the firm can actually ensure that the customer quickly purchases products. So, the sales goes up and by doing so the inventory is going to get moved out quickly from warehouses and fulfillment centers within the system. So, this improves the inventory turnover and reduces the presence of large amounts of inventory within the system. So, we can see here something as simple as a digital transformation can actually have far reaching implications on the cost incurred by the firm and hence can have implications for the financial performance of the firm as well. These are all very interesting examples that we are seeing and as I mentioned there could be many other financial metrics that can provide us a better understanding of operations. Thus when we are looking at choosing operating strategies or supply chain strategies we should not limit ourselves only to return on asset or a metric like return on asset, but also look at other metrics which could be of interest to us and there are several examples of this in place as well. So, thank you very much for this session. I hope you gain some kind of an understanding as to how operations and finance are actually linked and what are some of the relevant examples that we can pick up from industry as we see today and how they are trying to work towards designing operation strategies that can help showcase better financial performance. Better financial performance of the firm will attract investors and stakeholders who are interested in being shareholders in the firm and hence it is a very important endeavor for any firm to look at designing operating strategies that can help improve its financial performance as well. So, with this I end the session on the interface between operations and finance as a discussion of supply chain strategy or operations strategy. Thank you very much.