The current economic downturn (and anticipated upturn) requires supply and procurement (S&P) professionals to be knowledgeable in the financial supply chain (FSC) aspects of procurement, especially suppliers’ financial supply chain health.
The largest custodian of the company’s wealth is the procurement supply chain. For most companies, over 50 percent of sales revenue is expended to buy materials and services from external suppliers. Not only is it the largest user of funds, but the supply chain has the longest lead time in the order-to-cash cycle; often, the initial expenditures are made substantially before the order is received. Thus, we in procurement and supply are part of and responsible for the FSC.
The management of cash flows is also a key part of our job. In the past, we did a poor or incomplete job of optimizing cash flows. Fortunately, from a competitive standpoint, most companies were burdened with the same poor quality, demand forecasting limitations, inefficient distribution, and lack of supply chain information visibility into financial issues. They all used the same strategy to compensate for these problems and hedge against uncertain demand: excess inventory, excess capacity, excess labor, and, especially, excess working capital. The cost of capital was low (5 to 10 percent), so money was cheap. In other words, companies relied on the float of excess working capital—a lot of it—to compensate for inadequate cash management, and few cared about the consequences.
These problems still plague almost every global company today, regardless of industry. Moreover, until the FSC is optimized, enterprises will continue to use an expensive hedge against the uncertainty of demand and out-of-control cash management, requiring “excess” working capital. The cost of this excess working capital is no longer sustainable in a global competitive market.
How do we directly impact the FSC? Consider:
- Using the economic value of consignment agreements.
- Reducing supplier lead times so that less inventory is held.
- Optimizing minimum order sizes from suppliers and reducing safety stock levels.
- Measuring sellers’ management of inventory, using the same standards that are used to measure your use of inventory.
- Managing payables between you and the supplier, not as a penalty to suppliers, but to achieve the lowest overall economic total cost of ownership (TCO).
Remember, you eventually pay all suppliers’ costs, so the question is: how can we both achieve economic value? Who pays the lowest cost for capital or cost of inventory, you or supplier? Should that party carry the receivables or inventory? This is not an opportunity to pass my problems on to my suppliers.
Finally, measure your performance and the ability to forecast and stabilize external cost by utilizing purchase price variance (PPV) as an effective S&P management tool. Unless S&P contributions and savings can be expressed in financial terms, they lack credibility with senior management.
CPOs and CFOs can extend the lessons learned from the physical supply chains by facilitating communication and collaboration across buyers, sellers, carriers, and financial institutions. The artificial barriers that separated supply from finance are no longer effective. Our job must include cash flow management, and that job is not done until everyone gets paid and cash flow is optimized for us and the supplier.