Daily Archives: July 31, 2012

Sound, Conventional Financial Management is NOT Good for Supply Chains

And it’s not good from a cost of capital perspective either!

While skimming through Purchasing Insight’s recent white-paper on Supply Chain Finance: A Procurement Strategy (after stumbling upon their recent Supply Chain Leakage post that got them a Sourcing Innovation Thumbs Up, I stumbled on the following paragraph:

By extending payment terms to suppliers (paying them as late as possible) DPO is maximized and by being efficient at collecting from customers (getting the money in as soon as possible), DSO is minimized. This is sound, conventional financial management. It’s all about keeping hold of cash for as long as possible, minimizing the need to borrow and providing an opportunity to earn interest on cash deposits. Poor management of DPO and DSO increases the need to borrow and, in an economic environment where credit is scarcely available to some, borrowing can be very expensive indeed.

It may be sound conventional financial management, but, in reality, maximizing DPO is just another name for screwing your supplier, and all that does is increase your costs while decreasing the overall value you are able to extract from the relationship.

All I can say is that I’m glad the next section went on to say that:

For the procurement community, payment terms can be a double-edged sword. While it’s good to contribute to the reduced cost of working capital by extending payment terms, this doesn’t always support healthy supplier relationships and it can put an inordinate strain on the finances of the supplier, which is in the interests of neither party.

Finally, someone else who realizes that screwing suppliers is a bad thing! (I’ve lost count on how many times I’ve had to rant on this subject over the last six years.) Because, as the white paper goes on to state:

There is another, more compelling reason why the traditional approach to working capital management doesn’t make sense from a procurement point of view. It costs a fortune! The fact is that the traditional, siloed, adversarial approach adopted by most buying organizations toward their suppliers has a huge supply chain cost especially in the current economic climate.

Hear, hear! In order to extract a 0.1% return by holding on to your cash an extra 30 days, you’re risking a rise in costs of 1% to 3% as your supplier passes on their high cost of factoring to you!

However, when trying to improve your working capital practices in such a way that they benefit you and the supplier to take cost out of the entire supply chain, don’t limit yourself to early payment discounts as the sole tool at your disposal. It can be a great tool, as cash strapped suppliers get cash early and you get a better return, but it’s not the only tool. Another option could be to buy the raw materials or components on behalf of your supplier. You might have more leverage with a supplier that you are doing business with on another category and be able to get a better price. A third option, especially in this economy, could be to barter services for better prices. Maybe they need help with their back-office functions. Maybe you have a great relationship with a GPO that could help them and your weight could get them better pricing, or, your technical experts, who recently oversaw the implementation of good back-office accounting and P2P software in your firm could oversee the implementation of the same software in their firm in exchange for free value-added services from them. Be creative. There are many ways to win-win.