Category Archives: Finance

Sunk Costs ARE NOT Underwater Treasure

You’d think it would be painfully obvious that dollars sunk into historical IT investments have nothing in common with chests of Spanish Doubloons on lost underwater wrecks, but given the tendency for most organizations to hang onto their archaic IT systems, one has to wonder. Really, really wonder. Especially when many organizations are still drowning in red ink.

It’s not how much you spent on a system, it’s how much value it’s generating now. Maybe it was worth 1M a year and 2M in integration costs five years ago when it enabled you to streamline operations and shave 5M in the first 2 years, but if you’re still spending a million and not saving a single cent, then it doesn’t matter that you spent 7M — what matters is that you are spending 1M a year with nothing to show for it! Enterprise software prices have dropped considerably over the past decade while functionality has increased exponentially. Today, that Million will get you an end to end e-Sourcing AND e-Procurement suite with some professional spend analysis and category services thrown in (and then some) — a solution that could easily save you millions.

When evaluating your technology solutions, past expenditures should never enter the picture. Only current expenditures should be considered, and only in the ROI calculation. That’s all that matters — the expected return on the current solution vs. the expected return on a new solution. If a new solution has an expected ROI that is greater than the current solution (factoring conversion costs into account and amortizing them over the expected utilization period, which should never be more than a few years), you switch. It’s that simple.

And until you realize this, you’re never going to get the true analytics solutions you need to really cut costs. Remember, as I’ve been saying for years, Business Intelligence (BI) is not analytics. As echoed in this recent article on Analytics by Ritu Jain over in the Supply Chain Digest, a lot of users, industry analysts, and consultants have not fully grasped the difference between business intelligence (BI) and analytics. They continue to consider simplistic query and reporting and OLAP drill-down capabilities to be analytics, thus limiting themselves to traditional BI systems that provide simple alert, monitoring, and dashboard capabilities — and then use the erroneous sunk-cost argument to justify sticking with current systems that just don’t do the job.

And without these modern systems, the company will realize the cost savings potential of true analytical capabilities such as forecasting, data mining, predictive modeling and optimization [that] provide businesses with an understanding of why something is happening, when it can occur again, [and ] what will be the future impact of decisions, so that outcomes can be optimized. So bury your sunk costs in the history ledgers. That’s where they belong.

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Working Capital Improvement: What the “Smart Kids” Do

Today’s guest post is from Sudy Bharadwaj, ex-analyst extraordinaire of the Aberdeen Group, former VP of MindFlow, former CMO of Informance, and, most recently, a star at Inovis.

Analyzing data from CFO Magazine’s “Working Capital Scorecard” (Part I and Part II), and reviewing case studies around the web as well as several interviews, reveals several themes, or habits, common to top performers. Perhaps the most compelling is a holistic view of the business process, change management and technologies deployed.

Business Process

Organizations can simplify the “bookends” of their enterprise business processes and focus on the order-to-cash (DSO — days sales outstanding) and source-to-settle (DPO — days payables outstanding; includes the procure-to-pay) processes. Simply put, focus on your customer processes and your supplier processes to improve these metrics. For DIO (days inventory outstanding), certainly internal processes need to be reviewed (for some enterprises, the manufacturing/production process). However, each external process connects into the manufacturing process, therefore, once optimizing each process has been successful, then organizations can optimize joint processes for further efficiencies. An example of optimizing joint business processes can be connecting your customers to your inventory, thus enabling faster moving inventory, and reducing the need for DIO. Similarly, on the supply-side, provide your suppliers visibility into your inventory and manufacturing requirements and enable the suppliers to replenish the inventory based on services levels.

Change Management

Some organizations are basing performance bonuses on working capital improvement, thus tying personal income to this specific business metric — a smart strategy. Organizations need to continue to think smarter. In several successful working capital initiatives, the sweeping organizational change is making the team pro-active vs. reactive. On the customer side, for example, some organizations (poor performers) do not realize a customer invoice is late until it is past due. By the time the collections team is aware of a specific delay in payment, they are too late — this payment from the customer may not happen for another 60 days. This can be referred to be as a reactive process. Organizations at the top-levels of working capital performance improve DSO by reviewing invoices prior to sending them to the customer. The review goes beyond just formatting and syntax to determine if the invoice matches a customer’s purchase order. In the event the invoice does not match, the collections team is notified and corrective action can be taken before the customer sees the error. By viewing collections within the order-to-cash process as a proactive process, successful enterprises transform the collections team and thus reduce time-to-receipt (payment).

Leverage various technologies

Technology can be double-edged sword. If an enterprise automates the process of manually generating invoices, and the invoices are incorrect 10% of the time, then automating causes the error to happen much faster. Key sets of technologies to leverage are a combination of automation, business process management (BPM) and a workflow-based system. Automation can come in numerous forms from a variety of vendors — from infrastructure providers, B2B integration providers, and providers of e-procurement and e-invoicing solutions to automate the various processes affecting DPO/DSO. Some of these technologies also support varying degrees of BPM, or a stand-alone BPM technology may be deployed, depending on the level of analysis required to analyze any information sent to customers/suppliers. Once such analysis is complete, the workflow-based system can be utilized to route any potential issues to proper personal within the organization.

Conclusion

The high performers in working capital, as measured by days working capital (DWC), improve the DWC by being pro-active vs. re-active in the various business processes which can directly impact this metric and it’s sub-metrics (DPO/DIO/DSO). However, the improvement is not accomplished by just addressing a single facet — process, technology or people, the improvement occurs by addresses all three facets simultaneously. Addressing all three facets enables the proactive management of the business processes, which contribute to improvement of working capital.

Thanks, Sudy.

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Health Care Costs, Working Capital Improvement and Supply Management in the Same Sentence?

Today’s guest post is from Sudy Bharadwaj, ex-analyst extraordinaire of the Aberdeen Group, former VP of MindFlow, former CMO of Informance, and, most recently, a star at Inovis.

A previous post showed that top performing companies among the US-headquartered 1000 companies, as measured by Days Working Capital (DWC) improvement, focus on all three sub-metrics of DWC:

  • DSO – Days Sales Outstanding
  • DIO – Days Inventory Out Standing
  • DPO – Days Payables Outstanding

The data, as compiled, analyzed and reported by CFO Magazine(c)also performs an analysis on the above metrics by industry sector. The top culprits, or bottom three performers, as per Table 1, were in Healthcare Equipment and Supplies, Biotechnology, and Life Sciences Tools and Services. Two other sectors, Pharmaceuticals and Health Care Technology were in the bottom third percentile of all 59 industry sectors (GICS Industry Level). All these industries can be classified as health related industries (HRI).

Table 1: Days Working Capital by Industry Sector

Causes

While many enterprises are different, thus requiring customized initiatives to improve working capital performance, a detailed look into the three sub-metrics yields the fact that HRI sub-sectors (other than pharmaceuticals) fall in the bottom third percentile of all industries in DPO, Table 2.

Table 2: Days Payables Outstanding by Industry Sector

To sum it up, HRI organizations, on average, pay suppliers much quicker than the average of all sectors — in some cases more than twice as fast as the overall average. The question can be asked: “why do these organizations pay their suppliers/sub-contractors so quickly”? Based on the very nature of HRI — highly proprietary and cutting edge products, and based on reviewing detailed SEC filings, the following conclusions can be made:

  • Some strategic materials are sole sourced,
  • Outsourced R&D (including clinical trials) and,
  • A reliance on favorable fluctuations in the strength of the US dollar

One can surmise that suppliers to HRI are very strategic and hold strong leverage to their HRI customers.

All point to the fact that this sector, perhaps like no other requires strong and senior-level attention to supply management initiatives.

Conclusion

One can conclude that in HRI, the suppliers hold the leverage in these relationships, which means it is paramount for HRI organizations to proactively approach supply-management in a collaborative manner that encourages mutual benefit. Of the various known strategies, two come to mind:

Leverage early-payment discounts: This strategy may already be occurring. HRI finance teams must perform a cost-benefit analysis to determine if taking advantage of early-payment discounts yields stronger returns vs. freeing up working capital.

Supply-Chain Finance: Potentially the best strategy since neither organization’s working capital is adversely affected. Again, a cost-benefit analysis must be performed to determine if any new finance charges yield stronger returns.

In general, enterprises in the HRI sector may wish to address the question:

How Do We Improve Each Other’s Working Capital Without Adversely Affecting Other Financials?

Thanks, Sudy.

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Is a 45,000 fine in your future?

Any UK organization with half-hourly metered electricity that used more than 6,000 MWh in 2008 that does not register for the UK-wide CRC Energy Efficiency Scheme before September 30, 2010 could be fined as much as £45,000!

Previously known simply as the Carbon Reduction Commitment, the CRC Energy Efficiency Scheme is an emissions trading scheme introduced by the UK government to cut greenhouse gases by 1.2 million tonnes of carbon per year by 2020. Organizations are now required to monitor their emissions, and if they exceed this threshold, they need to purchase allowances to emit additional tonnes of CO2 or face a hefty fine.

The government estimates that as many as 5,000 organizations exceed the threshold, but only 1,229 have registered to date. Eligible private and public sector organizations that don’t meet the registration deadline will be immediately fined £5,000 plus an additional £500 penalty for every subsequent working day the company fails to register, to a maximum of 80 days. Is your company one of the roughly 3,800 that hasn’t registered yet? Are you sure?

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Spreadsheets Will Cost You Billions

I’ve told you many times that spreadsheets, the cockroaches of the workplace, can cost you billions, but I’m not sure that you’ve been listening. So I’m going to remind you of two situations where poor spreadsheets literally cost a company billions. As per this classic article in CIO on eight of the worst spreadsheet blunders ever:

Fidelity Loses $2.6 Billion

In January 1995, an accountant omitted the minus sign on a net capital loss of $1.3 Billion when transcribing the net realized gain from the funds financial records from one spreadsheet to another. As a result, they estimated that they would make a $4.32/share distribution, a number that was off by $2.6 Billion. Needless to say the shareholders weren’t happy when the truth was discovered.

Fannie Mae and it’s $1.13 Billion “Honest” Mistake

In a news release back in October 2003, Fannie Mae stated that a review of the third-quarter financials revealed a $1.136 Billion error in total shareholder equity as there were honest mistakes made in a spreadsheet used in the implementation of a new accounting standard.

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