Broadening the perspective on supply chain finance
Today, the Supply Chain profession has evolved from a reactive function to managing a strategic supply chain. The days when cost cutting in the supply chain was solely related to comparing the sourcing unit price, are thus definitely over. Completely new visions on supply chain finance are now emerging. Bridging the gap between accounts payable and accounts receivable and Activity-Based Costing (ABC), together with the Total Cost of Ownership (TCO), are the most dominant ones.
In this blog I will examine the two visions mentioned, though I will also explain how you can develop an even broader, strategic perspective.
Focus on payment terms
In the last two years there has been a lot of talk about improving the management of the accounts payable. In other words, the invoices of the suppliers that still need to be paid. In the first instance, manufacturers like to extend the payment terms, since it reduces the need for cash. However, prolonged payment terms are not commercially attractive to the suppliers. Because of the omnipresent supply of cheap credit, a lot of financial institutions stepped into this market. They are advising different models to bridge the gap between the manufacturer’s expectations and those of his suppliers, e.g. by pre-financing the bills to be paid.
Allocating indirect costs with ABC- and TCO-models
Traditional accounting systems were not built to reveal the true profitability of individual customers and individual Stock Keeping Units (SKUs). That has to do with the way they allocate the indirect cost, which is typically quite indelicate. Concepts as ABC and TCO respond to this. The ABC-model refines the indirect costs by looking at the exact cost-drivers and by allocating the indirect costs to individual customers and individual products.
Once the real cost is known, the next step is to get a better understanding of the TCO. Without a doubt, the focus for sourcing decisions broadens based on elements of Total Cost of Ownership. As a rule, companies take into account the costs related to sourcing, receiving, storing, producing and shipping products when calculating the profitability. For example, the way that goods are received from the supplier has an undeniable impact on the costs. Does the supplier deliver in full trucks or in multiple drop shipments? And are the pallets used compatible with the manufacturer’s pallets or are extra handling steps required? Accumulating all of these costs provides a new method for supply managers to make sourcing decisions.
Incorporating the strategic aspect
The work done in the Supply Chain domain about payment terms and ABC- and TCO-models is very valuable. Companies should certainly apply it, though, in my opinion, those visions on supply chain finance are still too limited since they have a pronounced operational focus.
I would recommend to also incorporate a more strategic perspective into the supply chain finance discussion. When reviewing the profitability of a company, organizations need to look at the combination of service (as a driver for the top line), cost (as a driver for the bottom line) and the capital employed (=sum of working capital and the fixed assets), as a measure for the return per dollar invested. I have called this concept the Supply Chain Triangle of service, cost and cash.
The way companies balance the tension between the three sides of the triangle, and thus the way they set up their supply chain strategy, will lead to a different ‘bang-for-your-buck’. And, vice versa, different company strategies – such as operational excellence, product leadership or customer intimacy – will lead to other supply chains.
The CFO and SCM must join forces
Actually, when taking a more strategic approach on the supply chain’s financial metrics, Supply Chain and Finance are two sides of the same coin. Since the financial crisis, the CFO has become more concerned with working capital. The CFO will look for a companion to get the inventory under control, and the most likely candidate will be the Supply Chain manager. Today is therefore the perfect time to broaden the vision on supply chain finance!