Is Your Supply Chain OCF? Part I

Is it? Well, if it’s any good, it’s probably Obsessive Compulsive about Finance, but that’s not what I’m referring to. By OCF, I’m referring to the Operating Cash Flow Metric that some are claiming is the right way to measure supply chain contributions to the organization, and, as such, the measure that should be used in place of EBITDA (Earnings Before Interest Taxes Depreciation and Amortization), ROI (Return On Investment), or ROIC (Return On Invested Capital).

Operating Cash Flow refers to the amount of cash a company generates from the revenues it brings in, excluding costs associated with long-term investment on capital items or investments in securities. The IFRS (International Financial Reporting Standards) defines operation cash flow as cash generated from operations less taxation and interest plus investment income received less dividends. The calculation of cash generated involves determining cash collected from customers and subtracting cash paid to suppliers.

The push for OCF contribution, specifically, the measure of how much additional cash was generated or how much cash payment was avoided, as a measure of supply chain success by a few pundits (including David Schneider) is due to the fact that it is a more accurate measure of how much cash a company has generated (or used) than traditional measures of profitability such as net income or EBIT. (Wikipedia)

The rationale is that other measures are (much) more easily manipulated. For example, a company with numerous fixed assets (factories, equipment, etc.) would have decreased net income due to depreciation, but since depreciation is a non-cash expense, the net income amount is not a true measure of the cash position of the company. In addition, since a company can choose to recognize receivables before the cash is received, traditional balance sheets and resulting EBIT(DA) are also not accurate measurements of the true cash picture. And since companies need cash to run (as pesky people want to be paid), cash flow is often the true measure of company vitality.

OCF allows a company to get a much better grip on its working capital than other measures, and since Supply Chain revolves around working capital, the metric makes sense. So how do you impact it?

Stay Tuned for Part II.