Category Archives: Finance

Is It All About the P&L?

In a recent editorial piece over on Supply Chain Digest, the Editorial Staff asks if Procurement and Finance [can] Get on the Same Page in Measuring Savings from Supply Management Improvements. The article notes that a major challenge to this effort is the fact that procurement and financial managers are often talking a somewhat different scorebook. While procurement managers focus on savings as cash improvement, finance types tend to focus on profit and loss, and accrue all the while.

However, according to the article, the two don’t have to be fully reconciled for both departments to find common ground. All that is required is a common calculation that both departments can accept. According to the article, this calculation is:

Savings = Secured P&L + Deferred P&L + Mitigated P&L

where

Secured P&L = savings where favourable terms of purchase are acquired through changes in pricing, mix, demand, or quality

Deferred P&L = measure of the benefit delivered to the balance sheet for the current financial period (through capital purchases or pre-payment scenarios, for example)

Mitigated P&L = savings that come from agreements in which favourable terms of purchase are retained (cost avoidance)

Simplified:

Savings = Cost Reduction + Balance Sheet Improvement + Cost Avoidance

This is a good calculation, but I’m not sure balance sheet improvement captures all of the benefit supply management can bring. Is risk reduction (and minimized disruption costs) captured on the balance sheet? Is working capital optimization captured on the balance sheet? (And is procurement credited for reduced finance charges?) Simply put, the value of good Supply Management is:

Value = Cost Reduction + Cost Avoidance + Profit Improvement

where

Profit Improvement = Working Capital Improvement + Risk Mitigation + Capital Acquisitions + Market Share Improvement + ….

What Effect Will The Proposed UK VAT Increase Have On Your Supply Chain?

A recent article over on BBC news discusses yesterday’s VAT increase from 17.5% to 20% and how it is going to cost the average UK family £7.50 a week, or about £389 and how it’s going to hit living standards, hinder economic growth, cost thousands of jobs, and make it even harder for families to make ends meet when they are already feeling squeezed. I have to agree with these points, especially when PayScale UK reports the average office administrator as making only £16,150 a year, the average retail store manager as making only £21,477 a year, and the average designer a mere £20,006 a year (which is not much more than the median income of £16,400 a year). For these people, that’s another 1.8% to 2.4% of their annual salary lost to taxes. These people already lose at least 36% of their income to taxes (as per howitends.co.uk) through Tax and Personal Insurance Contributions. When you also consider that the average property tax equals almost 7% of their income, and add this new tax, the average UK citizen is now losing about 45% of their income to taxes — quite a burden in these tough economic times.

But the story doesn’t stop here. In many sectors, such as logistics and (grocery) retail, profit margins in a good year now sit at 3% to 5%. What is a 2.5% tax increase going to do to these business? Especially if, after having one or two bad years of barely breaking even, the profit margin is currently sitting between 0% and 1%? At the very least, you’re going to see jobs disappear. In the worst case, this is going to force more closures, which is going to be very disruptive at home and across the globe for certain multi-nationals. I have to agree with Labour leader Ed Miliband on this one — it’s the wrong tax at the wrong time. In most countries, the private sector is the only chance they have of getting out of the recession. If the private sector is taxed out of business, then there’s no way the country is going to recover (especially in the UK which has a long history of the public sector moving at a snail’s pace).

Should Private Equity Firms Get Into Supply Chain Finance?

I was recently asked what role the banks have in Supply Chain Finance (SCF), which I found to be a bit of an odd question as the role the banks should play in SCF has been well known for a long time. Quite simply, they should be lending more money to the supply chain, doing more financing on receivables, and be supporting the business that make and ship the products we all use everyday. However, instead of playing the long term game (and investing into these business which are pretty much guaranteed to make a return as long as we need to eat, clothe ourselves, and be entertained), they chose to dump money into high-risk mortgages, facilitate the hedge fund madness, and encourage high-risk start-ups during the boom in pursuit of high rewards that are not sustainable in the long term [even if they materialize in the first place].

As a result, they banks are almost broke (and Basel III is probably going to initiate another wave of bank failures, to add to the 139 that had been shut down in the US in 2010 as of October 21 [source: Reuters], because it’s coming into effect too late — the banks have already dug the graves Basel III is trying to prevent) and have turned the taps off completely even if you’re profitable, sustainable, and have been in business for fifty years. Even though the “trade banks [could] strengthen customer relationships” (as per a white-paper published by CGI back in 2007), they have pretty much chosen to turn their backs on their customers when their customers need them most.

As a result, we’ve seen the emergence of trade finance companies, including The Receivables Exchange, which offers a business quick receivables financing from public and private lenders willing to offer receivables financing at the requested rates and/or willing to participate in a reverse auction for the business, and Orbian, which purchases receivables from suppliers in exchange for non-recourse cash for the full invoice value at rates based on the buyer’s credit, which have emerged in an attempt to fill the void. However, these solutions are few and far between and have limited cash reserves as they have not gained wide-spread adoption with either banks or investors. As a result, they cannot come close to serving the true global market demand for trade finance [even though they are being under-utilized by companies hoping to be saved by the banks that abandoned them].

However, private equity companies generally have lots of cash on hand, which they typically use to buy troubled companies with solid products or services that can meet a substantiated market demand and turn a profit. Then, when the companies turn a profit, they take dividends to add to their cash pool or take them public for a profit. What if instead of buying a company, they bought trade finance institutions and/or created new ones? Considering that private equity firms currently sit atop an estimated 500 Billion (as per an article from July 2010 in economy watch titled “economy business and finance news/what depression private equity firms have too much money 01 07”), they could make a significant impact on global trade as this could (if converted to liquid assets) theoretically finance 20% of global trade if net terms, and payback, was 60 days or less (assuming annual merchandise exports are still hovering around the 15 Trillion globally).

What do you think? Should Private Equity get into the SCF arena? While they may only control assets less than 1/10th of the assets collectively controlled by the US banks, most of their assets are not at risk and leveragable. And they are generally much better managed.

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Should You Really Care About the Finance Classification Hierarchy?

A recent article in CPO Agenda on “a meeting of the minds” that discussed the need for Procurement and Finance to establish a common framework put forward five suggestions on what an organization can do to make it happen. Four of the suggestions were really great, but the last one, which said that Procurement and Finance should “establish common organization and spend classification hierarchies in spend analytic and value-tracking pipeline tools” has me scratching my head.

If the article had suggested that Procurement and Finance should establish a common reference classification hierarchy that Procurement could map too, that would be different, but instead the article says that “the spend analytics programme and value-tracking pipeline should share a common organization and spend classification framework“. There are two problems with this logic.

First, there is the built-in fallacy that one spend cube is enough. It’s not. You need a spend cube for AP data, a spend cube for Invoice data, a spend cube for utilization data, etc. You need a spend cube, and an appropriate hierarchy, for everything you can think of analyzing. The real savings in spend analysis doesn’t come from analyzing canned reports — it comes from having a hunch, analyzing the data, and walking away with either a savings opportunity or a better informed hunch as to where the savings opportunity truly lies. A true spend analysis system lets the user build new cubes and hierarchies at will, because, otherwise, data analysis is avoided and savings go unrealized.

Secondly, the hierarchy most appropriate to Finance and the financial and tax reporting they need to do is often the least appropriate hierarchy for Procurement and the spend analysis it needs to do. As a result, a compromise isn’t going to help either party. It’s just going to create a common language that Finance can use to explain why it now takes them 50% longer to do reporting and that Procurement can use to explain why they can’t find any savings opportunities.

The answer is to define a common reference classification that each side can map too after they performed their analysis and created their reports. After all, ETL Tools are a dime a dozen these days, and most good spend analysis or BI tools come with one or more built in. As a result, such mappings can be easily automated to occur automatically on a fixed interval or after analysis is completed and each department can then view the hierarchy in a manner that makes sense to them. No need for unproductive compromises.

However, as mentioned at the start of the post, the other four suggestions are good. To develop a common language:

  • Establish a savings framework (and definitions),
  • define and implement a disciplined engagement model,
  • produce timely, consistent, and accurate reporting, and
  • capture opportunities created for profit improvement.

Check out “a meeting of the minds” for more details.

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Capital Costs are Going Up. Can Your Supply Chain Handle It?

The McKinsey Quarterly just published a great article on “how the growth of emerging markets will strain global finance” (registration required) that should be read by every CPO who doesn’t work for a mega-corporation with a large cash balance. The article will help them understand what’s keeping the CFO up at night and why the CFO, who already has to deal with Basel III, might be afraid to invest in long-term capital projects (or, at the very least, have difficulty committing the capital).

The article points out that when you combine low savings rates in developed economies, decreasing savings rates in the more mature emerging economies, the increasing expenditures required to support the aging population in developed countries (that will further reduce savings), and the growing need for capital-intensive investments in infrastructure in the new emerging economies, in less than 20 years there will be a significantly greater need for investment in the global marketplace than there will be investment dollars available. When you combine this increasing demand for capital with the looming threat of increased inflation, and factor in the increased risks associated with short-term funding, it quickly becomes clear that interest rates have no where to go but up, especially since these rates are now at their 30-year lows. At the very least they will return to their 40-year average (which is about 150 basis points above current rates), but they could rise even higher.

As a result, capital for supply chain infrastructure investments could soon be in short supply. This means that if your supply chain is aging and needs significant infrastructure upgrades in terms of facilities or vehicles, the last thing you want to do right now is extend end-of-life (planning) too far into the future if a costly upgrade is inevitable. At the very least you want to start planning and analyzing different upgrade cost scenarios that factor in different (potential) costs of capital so that you’ll know how much capital the supply chain upgrades are going to require and at what point it becomes too expensive. Then you will be in a good position to work on securing the capital before it’s too late.

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