Supply Chain Financial Management

Best Practices, Tools, and Applications for Improved Performance

Robert Trent

• Publisher: J. Ross Publishing
• Year: 2015
• Print ISBN: 9781604271164
• eBook ISBN: 9781604277685
• Edition: 1
• Topic: Business
• Subtopic: Operations
• Index: Business

Global competition and stakeholder demands are causing business leaders to seek greater value from their supply chains, and practitioners who think and act more like financial managers. Designed for self-learning, training, and course instruction, this book shows how to apply financial concepts, tools, and techniques to the primary activities of supply chain managers. Supply Chain Financial Management helps readers better understand and manage these activities from a finance perspective and shows how to present the impact of results in financial terms that corporate executives expect. It bridges the divide between supply chain management (SCM) and finance to meet the next level of demands for improved performance and competitive advantage.

UNDERSTANDING SUPPLY CHAIN FINANCIAL MANAGEMENT

Imagine the following scenario, which is based on a true story. After years of trying to convince your colleagues about the value of supply chain management, the day finally arrives when you are invited to make a presentation to your company’s executive committee, including the CEO. And, if all goes well, an invitation to present to the Board of Directors could be on the horizon. This will be your shining moment as you demonstrate, at the highest levels, the accomplishments and importance of supply chain management. Life is going to be good.

While your presentation went well, it was not received with the enthusiasm that you had expected. In fact, despite your best efforts to excite the group about the value of your company’s supply chain efforts, you felt your session came across flat. How could this group not appreciate the significance of improved inventory turns, reduced purchase costs, new longer-term supply contracts, improved forecast accuracy, and a streamlined material releasing system? What is wrong with these people?

Just as men are from Mars and women are from Venus (or so the saying goes), corporate executives and supply chain professionals are also from different planets. The make-up of executive committees and boards of directors includes people who are largely not from the supply chain world. Talking about faster inventory turns probably invokes some mental image of material spinning around in some god-forsaken facility that few in this group have ever visited. To put it bluntly, you entered the lair of a group whose obsession is strategy, corporate-level indicators, and financial results. You, on the other hand, brought to them a world that is more about tactical operations, nonfinancial indicators, and activities instead of accomplishments. Can anyone spell disconnect? Would it not have been better to speak their language?

This chapter begins our journey through the world of supply chain financial management. We first define the terms finance and supply chain management, then present a set of reasons supporting the integration of supply chain management and finance, and identify what finance has to offer supply chain professionals. A discussion of financial statements and financial indicators will help build the knowledge base that underlies this book. The chapter concludes with a case that illustrates the benefits of taking a financial perspective when pursuing supply chain improvements.

WHAT IS FINANCE? WHAT IS SUPPLY CHAIN MANAGEMENT?

Let’s define two major concepts that populate this book—finance and supply chain management. So, what is finance? We can think of finance in terms of a noun and a verb. When we think of finance as a noun, we are referring to a formal entity within the organizational structure—just as marketing, purchasing, and engineering are formal entities. As a functional entity, the finance group or department has the right to perform activities that are central to running any organization. A corporate finance group (a noun) is concerned with activities such as pursuing sound investments, obtaining low-cost credit, allocating funds to pay for liabilities, managing tax obligations, and banking (the verbs).

As a body of knowledge, finance deals with the allocation of assets and liabilities over time—under conditions of certainty and uncertainty. Some refer to finance as the science of money management. Finance also applies various economic theories.¹ One thing that we know for certain is that the body of knowledge that populates finance is well-developed and has evolved over many years.

Supply chain management (SCM) is much less mature, compared with finance. SCM is concerned with the two-way management of some important flows—funds, information, materials, and services. One way to view SCM is in terms of a broad domain with many activities under that domain’s umbrella. These domain activities include purchasing and materials management; demand and supply planning, including forecasting; transportation; distribution; material handling; receiving; some parts of operations and new product development; and inventory management. Without question SCM is still maturing, particularly in terms of financial management and risk management.

Much of what finance concerns itself with is not directly relevant to what we cover in this book. Conversely, finance has developed a host of tools, techniques, and concepts that supply chain professionals can draw upon to enhance their personal expertise, support more effective decision making, and present results in a way that corporate executives understand. Along the way you might even gain the respect and admiration of some important people in your company, which should bode well for your future advancement.

WHY INTEGRATE SUPPLY CHAIN AND FINANCE?

We are going to start this section by making a bold statement—the language of business is finance. If this is the case, and many would argue this to be true, it makes sense to have a working knowledge of that language. One of the main reasons for integrating SCM and finance is to become comfortable with speaking a language that is spoken at the upper echelons of governments, nonprofit organizations, and corporations.

Think about when news services report business results. We typically do not hear that a company increased its inventory turns last quarter. And, if we do hear that inventory turns increased, it is usually as a footnote or a corollary to explain something that was financially related. What we hear about are changes to gross margins, cash flow, and net income; stock buy-backs or sales; and the return on invested capital or assets. Occasionally we hear about market share, which usually excites the marketing people (except when it drops).

Rarely does the focus of these news reports have anything to do with supply chain indicators, even though, as we will see, the supply chain group affects more financial levers than any other group. The time has come to start thinking like a financial manager, not just a cost, supply, and risk manager. Frankly, executive leaders are not going to learn to speak the language of SCM. As you think about your professional development, learn to speak a foreign language called finance.

Supply chain financial management represents a maturing of the supply chain discipline. Compared with other business disciplines, SCM is relatively young. And, that means it is still evolving. Three areas appear to define the next level of maturation for SCM—the use of big data and data analytics, global risk management, and supply chain financial management. This book is about financial management for the supply chain professional, although finance professionals may appreciate a better understanding of supply chain practices.

Why else should we integrate SCM and finance? Without question, finance is characterized by a sophisticated body of knowledge populated by a diverse set of tools, techniques, and concepts. Some of what resides within that body can be employed directly by supply chain professionals to support better analyses, decision making, and risk management. Throughout this book we are going to borrow selectively from finance (and then use ruthlessly) those tools and techniques.

WHAT FINANCE BRINGS TO THE SUPPLY CHAIN TABLE

Finance is a mature discipline that offers a robust and accepted set of concepts, tools, and techniques. The word robust means that financial concepts, tools, and techniques are applicable across a range of settings. While some of the financial topics presented in this book were not intended to be applied to supply chains, later chapters will demonstrate how to use these techniques in ways Mother Nature never intended.

Besides a robust body of knowledge, what else does finance offer? Finance is perhaps the only corporate entity with the validity to bless the cost savings that supply chain professionals claim they are achieving. This has been an ongoing struggle for most supply chain groups. It is not uncommon for a chief procurement officer (CPO) to claim that her procurement group saved $100 gazillion last year. Upon hearing this, the CEO suspiciously asks how that money mysteriously disappeared? After all, gazillions of dollars did not make it to the bottom line. The CPO then responds that different operating units siphoned off the money before it reached the bottom line, like a river being diverted before it reaches its final destination. The savings never stood a chance! When this scenario occurs, and it occurs more often than we realize, it becomes evident why the CPO not only appreciates what finance has to offer—but, that the CPO needs what finance has to offer.

Finance can also help determine how supply chain initiatives affect corporate performance indicators, although by the end of this book, the reader will also be able to make these determinations. If we better manage inventory and increase inventory turns, how does that affect return on assets (ROA)? If procurement negotiates a major contract that lowers costs of goods sold, how does this affect various financial indicators, including net income? Linking changes (i.e., causes) to specific outcomes (i.e., effects) is something that finance professionals understand well. It is also something we are going to understand.

As we progress through the book, the reader will be exposed to many financial approaches, making reliance on finance personnel less of an issue. Examples include using supplier financial data to predict supplier bankruptcy, using financial investment techniques to evaluate the viability of supply chain projects, gauging the impact of inventory management approaches on working capital, and interpreting the impact of supply chain initiatives on key corporate performance indicators. It is time to transfer some of that finance magic over to the supply chain group.

The bottom line is that the finance community is skillful at managing financial and corporate risk activities. Never doubt that finance people are some of the smarter people in the corporate world (which at times has gotten us into some serious trouble). Unfortunately, finance support is not always available or the finance group may show minimal interest in supporting supply chain activities. The Hackett Group reported that since 2004, the median number of full-time finance department employees has declined by 40% to 71 people for every $1 billion of revenue—down from 119.² There are just some things we are going to have to learn to do for ourselves.

As we progress through this book, keep in mind that certain topics will remain the responsibility of finance. In particular, four areas should remain firmly entrenched in the finance camp. This includes currency and commodity hedging, the calculation of reported corporate performance indicators, the calculation of the inventory carrying cost rate, and the calculation of the corporate hurdle rate. Each of these important topics requires finance support and input.

Some Finance Shortfalls

While, over the years, finance has developed a comprehensive set of tools and techniques, without question there are areas where finance does not offer as much to the supply chain professional. In other words, there are shortcomings regarding the availability or applicability of financial tools and techniques.

Supply chain professionals will have to take the lead when developing certain techniques because these techniques have not been the historical focus of finance or accounting groups. In particular, total cost of ownership (TCO) models, except for capital expenditure models, have never been stressed by the financial community, even though these models rely extensively on financial information. Many of the cost categories embedded in total cost systems have no corresponding financial or accounting category that allows easy data retrieval. TCO modeling is an area where finance and accounting professionals could learn a thing or two from supply chain professionals. Chapter 12 covers TCO systems in depth.

Another shortfall involves calculating the true cost of switching from one supplier to another—or what we call supplier switching costs. Supplier switching costs are not something the finance and accounting community usually think about, even though these costs are often significant. Ideally, an account would ex...

Table of contents

• Cover
• Title
• Copyright
• Dedication
• Table of Contents
• Preface
• About the Author
• WAV™
• Chapter 1 Understanding Supply Chain Financial Management
• Chapter 2 Best Practices in Evaluating and Selecting Suppliers
• Chapter 3 Evaluating and Selecting Suppliers—The Financial Perspective
• Chapter 4 Evaluating and Selecting Suppliers—Applying Financial Techniques
• Chapter 5 Best Practices in Supplier Management and Development
• Chapter 6 Supplier Management and Development—The Financial Perspective
• Chapter 7 Developing Supplier Performance Capabilities—Applying Financial Techniques
• Chapter 8 Best Practices in Managing Supply Chain Costs
• Chapter 9 Managing Costs across the Supply Chain—The Financial Perspective
• Chapter 10 Managing Costs across the Supply Chain—Applying Financial Techniques
• Chapter 11 Best Practices in Worldwide Sourcing
• Chapter 12 Worldwide Sourcing—The Financial Perspective
• Chapter 13 Worldwide Sourcing—Applying Financial Techniques
• Chapter 14 Best Practices in Managing Inventory
• Chapter 15 Managing Inventory —The Financial Perspective
• Chapter 16 Managing Inventory—Applying Financial Techniques