Driving value by aligning financial thinking with the physical supply chain.

Aligning finance and supply chain processes is critical for driving business value.   The supply chain has a strong impact on the key financial performance indicators of organisations – earnings, cash, and growth, as well as on organisational risk.

What is the critical link between finance and the physical supply chain?

The critical link between finance and supply chain recognizes the considerable impact supply chain management has on organisational financial performance. 

The supply chain is a strategic process of the business and if managed well will provide a competitive advantage for the organisation through better asset use, increased customer satisfaction, and higher productivity.  This can also be carried to an industry level where it has been suggested that inter-firm competition has been partly replaced by competition between competing supply-chains.  If your organisation is part of an efficient industry supply chain it will gave a competitive advantage over those who are not.

Collaborating with the CFO to improve the supply chain and drive the bottom line

The alignment of financial thinking and the supply chain is critical to organisation performance and is a necessary pre-requisite to streamlining the supply chain.  Non-alignment occurs for a number of reasons some of which are due to the internal dynamics of finance and supply chain functions but often due to the organisational view of the supply chain.  Some factors are:

• The supply chain is seen as a series of tactical functions, mirrored by the accounting system structure.
• Finance is not providing clear conversion values for financial performance trade-offs.
• Supply chain professionals don’t have a strong financial understanding.
• There is no organisation wide view of impact of supply chain decisions and hence no organisation wide targets.
• Unclear Executive level responsibility for the total supply chain management.
• It is unclear how supply chain management relates to strategic imperatives.

Improving alignment between financial thinking and supply chain will require:

• Finance showing Supply chain and the organisation how business processes, activities, and tasks relate to organisational financial performance (cause and effect relationships).
• Use of business intelligence tools that link supply chain management impacts including changing accounting reporting.
• Improving supply chain’s financial acumen.
• Executive (C-level) responsibility for supply chain management
• Alignment of strategic imperatives with supply chain objectives and use value gaps to drive strategic imperatives.
• Inclusion of overall supply chain responsibility on organisational risk within key risk governance processes
• Involvement of the CFO in external collaborative relationships (suppliers, customers)

Finance can assist in streamlining the supply chain.

The key parts of this process have included:

• Mapping the process from end to end to see where supply chain management is impacting financial variables.
• Focus on marginal impacts as well as average impacts (important for growth objectives).
• Compare existing key ratios to industry metrics or terms compliance ratios.
• Focused target ratios for the physical supply chain.
• Work with supply chain to streamline processes using various levers:
  • People (skills, competencies)
  • Technology (information and physical)
  • Contractual adjustments (suppliers, customers)

Efficient supply chain finance to optimise working capital position
Working capital is a resource used by the organisation to generate sales and earnings.  It also acts as a lubricant for the physical supply chain - too little and the physical supply chain risks seizing up (stock-outs, customer and supplier viability).  Too much working capital and the organisation faces higher costs, higher risks, a brake on growth, and a value gap relative to its competitors.  

Why does working capital need a constant focus?

• It is relatively liquid and is turning over regularly.
• Involves several conversions as it makes its way through the organisation.
• It requires management across the organisation through many functions.
• Other participants in the supply chain always want to give you more of it.

Separating the physical supply chain and the financial supply chain

By streamlining end-to-end supply chain processes, organisations can reduce stock, decrease replenishment times from internal and external suppliers, and optimize cash-collection and payment cycles.  The key is to uncover the underlying causes of excess operative working capital within the physical and finance parts of the supply chain.  Working capital is impacted by both the physical supply chain and the financial supply chain and the role of finance can differ between the two.

Physical supply chain

• Primarily impacts on inventory
• Is determined principally physical factors such by the time between transactions, demand variability, lead times, persihibility, geography.
• Includes the physical risk of deterioration – obsolescence, theft, damage.
• Objective is to streamline or speed up the physical flow and reduce physical resources sitting in your business.
• Forecasting, planning, conversion capacity and flexibility, lead times.
• Involves trade-offs with other physical factors such as stock-outs.
• Can produce overall gains for the industry supply chain so collaboration more valuable.

Finance has a key role in ensuring the impacts of the physical supply chain are reported across the organisation in a consistent way on earnings, cash, and risk, and to help drive lower physical working capital.

Financial supply chain

• Primarily impacts on payables and receivables (which are essentially ways that the physical supply chain is financed)
• Is determined by financial arrangements such as the time from transaction to cash settlement.
• Key financial parameters are the cost of capital, processing costs, risk appetite.
• Often appears a zero-sum game across the industry supply chain.
• Objective has been to push more of this on to suppliers and customers.
• Management has focused on terms compliance.
• Collaboration appears to be less prevalent.

Finance has a key role in re-engineering finance processes and determining optimal working capital and includes related functions such as treasury and shared services.

However there are a wide range of possible actions and therefore focus is critical. A realistic plan with clear priorities is the best approach.  An overly ambitious agenda can overstrain internal capabilities and deliver suboptimal results.  Organisations should concentrate on the most promising actions.

Reduce Inventories through streamlining the physical supply chain

By streamlining physical supply chain processes within the company—as well as processes involving suppliers and customers—companies can minimise inventory throughout the value chain.  Including:

• Enhanced forecast accuracy and demand planning
• Advanced delivery and logistics concepts
• Optimised production processes
• Service level adjustments:
• Variance management (product complexity, slow turning products)

Receivable and payables management through streamlining the financial supply chain 

The efficient management of receivables and prepayments received is critical and can yield significant cash potential.

Receivables Collection

Focus in the following areas has produced strong results:

• Invoicing cycle
• Early reminders
• Payment terms
• Payment schedule

Supplier payments

Organisations need to find a more effective, integrated approach to payment arrangements that takes into account all aspects of the customer.  These include attention to:

• Payment cycle
• Avoidance of early payments
• Payment conditions
• Product acceptance conditions
• Automating the payment process

The environment of an economic recovery
The above recommendations will generally apply to businesses regardless of where we are in the economic cycle. However, there are some specific characteristics of the economic recovery that should be taken into account when redefining and improving the financial supply chain:

• The need for minimising cash utilization as organisations return to growth.  Here, it is important to focus on the marginal propensity of the organisation to consume working capital.
• Be wary of patchy recovery amongst customers. The recovery will be patchy and include many false-starts.  Organisations will need to ensure they have effective segmentation and ratings of their customers’ credit positions.
• If it starts raining again, the banks will want their umbrella back.  Organisations need to ensure they focus on reduced working capital rather than resume bank borrowings.