Category Archives: Finance

Working Capital Improvement: The View from 30,000 Feet

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.

There has been considerable emphasis in improving working capital among large and small enterprises alike. While the reasons may seem obvious, to state a core objective: unleashing working capital provides more cash for other areas in the business and reduces dependency on credit. According to a recent benchmark by CFO Magazine(c) the working capital metric, DWC – Days Working Capital, of the top-1000 US-based public companies (excluding financial service companies) degraded 8.2% from FY 2008 to FY 2009, the worst degradation in years. Interestingly enough, when reviewing the individual performance of these companies, 464 of these companies actually improved their DWC

The Best are Balanced

Working capital initiatives can seem daunting, but an analysis of the data can lead to some key insights. Using the same data and stack-ranking all 1000 companies by DWC (1 = best improvement, 1000 = most degradation) identifies a trend among the top 25% of companies (Chart 1) who improved DWC by a median of 23%. A deeper analysis of the data on the three sub-metrics which make up DWC — Days Sales Outstanding (DSO), Days Inventory Outstanding (DIO) and Days Payable Outstanding (DPO) yields a further understanding into what drove this performance. A key finding is that 29% of the Top 25% of performers saw improvement in all three sub-metrics: DSO, DIO, and DPO. In other words, their improvement initiatives were not just in one area, they were in all three areas.

Median DWC Improvement from FY08 to FY09
The median DWC of the top 25% of performers improved (dropped) by 23%
Looking further down the rankings at the remaining 75% yielded the following insights: 57% of the bottom 75% saw improvement in NONE of the three DWC sub-metrics.

The conclusion from 30,000 feet: focusing on all three metrics greatly improves the odds of improving DWC. Not focusing on all three? The results are obvious.

Thanks, Sudy for explaining the key to improving working capital is to focus on initiatives that improve the core metrics and not the stupidity I ranted about yesterday.

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I’m Starting to Get Sick of all this Working Capital Management Talk

Ever since the recession hit full swing, it’s been working capital this and working capital that. And I’m getting tired of it. And it’s not because I don’t like working capital management. In theory, when it’s done right, working capital management is worth its weight in gold. The problem is, at most companies, it’s still done very, very wrong, and ends up being the lead weight that drags the company down until it drowns.

Here’s what usually happens. The company starts by:

  • Paying some invoices early to take advantage of favorable currency exchange rates … which is good and the right thing to do, and then it continues by
  • Paying some other invoices early to take advantage of early payment discounts … which is good for the company, but not necessarily good for the supplier. (If it allows the supplier to avoid taking high-interest loans, it’s good. But if the company is just taking advantage of their financial problems, it’s not.)

And it enables these early payments by:

  • Delaying payment to other suppliers … which is not working capital management at all as it risks the suppliers’ ability to deliver and jeopardizes the supply chain.
  • Delaying payment to contractors … which could jeopardize the contractors’ solvency if they’re small and it goes on for too long.
  • Delaying raises and bonuses … which does wonders for employee morale.
  • Delaying expense reimbursements to its employees (from two weeks to four, four weeks to eight) … which is just wrong. Employees aren’t a company’s piggybank.

And then, when there’s no slack left in the system, it:

  • Lays off 10% of the workforce.

And proves it doesn’t know a damn thing. And that’s why I don’t like hearing all this substance-free hype about working capital management.

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A Hitchhiker’s Guide to e-Procurement: Procurement Models

Mostly Harmless, Part XXII

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There are three major procurement models. While they all require the same basic e-Procurement functionality, each model dictates its own e-Procurement requirements and emphasizes certain features and functions above others. This post will address the different models and which features and functions are emphasized by the models.

The first major model is the classic model of decentralized procurement where each business, functional, or geographic unit is responsible for its own purchases. Individual business units are empowered with autonomy and control over their process and design decisions. It allows for quick processes and issue resolution and allows the organization to take advantage of expertise in the local market. However, it does limit an organization’s ability to leverage the corporate spend or to align the business unit objectives with the objectives of the global organization.

If an organization is using a decentralized model, the e-Procurement system will need to be quite flexible as each unit will likely have its own requisition formats, approval processes, purchase order distribution, invoicing, and payment processes. It will have to support multiple workflows, and allow for analyses against multiple budgets. And it will have to meet the different needs of the different units.

The next major model is centralized procurement. In the newer, centralized, model of procurement, all procurement goes through a single centralized model. This has its advantages as it allows the organization to fully leverage corporate spend and drive standardized sourcing processes across the organization. However, it can lead to lost knowledge of local supply markets and consumption patterns, which can result in sub-optimal buys for many regions. It can also increase the risk of maverick spend when the geographically dispersed site managers do not agree with centrally mandated decisions. And it can increase reaction times to unexpected changes in supply or demand.

If the organization is using a centralized model, the e-Procurement system will need to be scalable and high performance as the global organization will be using a centralized instance and a centralized data store. It will need very good fine-grained roles management as there will be hundreds, or thousands, of users, who will not only have different roles, but different levels of access to the system and the data contained within. (A manager might only be allowed to see activity from her team in her local unit.) And it will need fine-grained data classification capabilities to support unit-based analysis, which could be built-in or through an external tool.

The final major model is a hybrid procurement model known as center-led procurement. In a center-led model, a procurement center of excellence (COE) focusses on corporate supply chain strategies and strategic commodities, best practices, and knowledge sharing while leaving tactical buys and tactical execution to the individual business units. It was designed to give an organization the best of both the centralized and decentralized worlds with as few disadvantages as possible.

If the organization is using a center-led model, the e-Procurement solution needs to be extremely flexible, scalable, and robust as it will need to support distributed instances with different workflows for each business unit for decentralized purchases as well as a centralized instance with a single master workflow for centralized instances. Role management and security will need to be extremely fine grained as users could have different permissions depending upon whether the spend is centralized or distributed. And data management will have to be fairly intelligent as some spend will be centralized while other spend is distributed.

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ROI, ROIC, ROCE, and … ROSMA?

The key to a rising CPO’s success is the often the ability to talk shop with the CFO and explain the advantages of supply chain management in terms that the CFO can understand. It’s often the quickest way to a seat at the boardroom table. Traditionally, this has come down to the ability to provide the CFO with the ROI (Return on Investment), the ROIC (Return on Invested Capital), and the ROE (Return on Equity) of every investment. This is because ROI measures the efficiency of investment, the ROIC measures the company’s efficiency at allocating the capital under its control to profitable investments, and the ROE measures the profitability of the investment. But will CPOs soon have to add another measure to their financial lexicon?

Near the end of A.T. Kearney’s “Higher Visibility, Greater Expectations” that chronicled the results of their recent Indirect Procurement study, they discuss their new approach to translate the business case into a language more recognizable to finance executives which revolves around their new ROSMA (Return on Supply Management Assets) metric. Now, it sounds good … because what could be better than a financial metric (which gets a CFO excited) specifically designed to showcase the performance of supply management … but does it deliver?

Breaking it down, A.T. Kearney defines ROSMA(c) as financial results delivered / invested supply management assets where the financial results are the product of spend coverage, velocity, category yields, and compliance plus the net extended benefits and the invested supply management assets are the sum of period costs and structural investments. This sounds logical, and when you consider that twenty different factors go into the calculation of the financial results and that twelve different factors go into the calculation of the invested supply management assets, it sounds complete, but it is sound. And more importantly, will CFOs bite?

To answer this question, I’ve invited Robert Rudzki, SI’s resident expert on supply chain finance (and [co-]author of Beat the Odds: Avoid Corporate Death and Build a Resilient Enterprise, On-Demand Supply Management, and the supply management best seller Straight to the Bottom Line), to chime in. This is what he had to say:

AT Kearney’s ROSMA(c) framework offers another tool to connect the supply management function with its colleagues in the financial function. As a former practitioner with a dual background in finance and supply management, I appreciate the applicability of the concept. I do have a few specific questions; for example, does “supply management assets” include the assets participating from other functions outside of supply management? If so, then ROSMA(c) appears to be a comprehensive framework that can withstand the scrutiny of the toughest bean counters.

 

The more fundamental question however is this: do we really need a another framework, or do we just need to do a better job connecting to the financial metrics that are already being used by the CEO and CFO to manage the business?

 

In our experience, CPOs can dramatically improve their internal credibility with the executive staff by relating their proposed agenda (including the need to transform supply management) to the metrics that the senior staff and the Board of Directors already monitor. Such key metrics as ROIC / ROE / RONA (Return on Net Assets), cash flow and EPS (Earnings Per Share), are highly visible and relevant metrics. Rather than introduce a new metric, we have generally found it to be more productive — and quicker at achieving credibility — to relate the proposed CPO agenda directly to the particular metrics currently in use by the company’s senior management.

Thanks, Bob!

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A Hitchhiker’s Guide to e-Procurement: Costing a Solution

Mostly Harmless, Part XXI

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Every solution costs more than the sticker price. But how much more? In this post, we’ll outline how to cost the various solutions as well as a methodology for calculating the expected value.

First of all there’s the cost of the license, which can be significant. If the system is enterprise, and especially if it’s an installed solution, this can be a very significant up-front cost in the six figure range. Then there’s the maintenance, which is required for support and mandatory for some solutions, and built into the price of on-demand/SaaS solutions. This can be as high as 22% a year for some solutions. Then there’s the installation and integration costs. Even a SaaS solution will require some setup, and the e-Procurement system will need to be integrated with accounting systems, sourcing systems, payment systems, and other enterprise (resource planning) systems in order for the organization to extract maximum value for the system.

Then there’s training costs. Even though a good system will be extremely easy to use and self-explanatory where basic functions are concerned, some training will still be required. This is especially true for the administrators, who have to maintain the system, and analysts, who have to analyze processes, performance, and spending. In addition to training costs, there will be support costs. Administrators will have to be employed to continually maintain the system (data) and train new users. If the system is installed, they will also have to do patches and upgrades in addition to maintaining system data and (business) processes.

If the organization is looking for an installed or hosted ASP solution, there will also be hardware costs, database costs, application server costs, and middleware costs. These costs can easily dwarf the system costs if the organization doesn’t already have any of these solutions. And even if the organization has some of these solutions in place, there will likely be additional license fees. Finally, there will likely be additional IT (support) costs to maintain the hardware, which will have to be upgraded on a regular basis, and the supporting software.

When all is said in done, the cost of a solution can end up being 10 times the sticker price, so it’s important to understand the total cost of ownership before choosing a solution. This is not to say that a solution with a seven figure total cost of ownership is expensive. It might be, it might not. It all depends upon how much it costs relative to other solutions being evaluated, how many users will use the system, how much it will increase organizational efficiency, and what ROI the organization expects to see.

Fortunately, the calculation of expected value is quite straightforward once the TCO is known. It’s simply a matter of computing the ROI according to the following formula:

(savings expected from increased efficiency +savings expected from maverick spend reductions +savings expected from newly identified opportunities) /total expected cost

While some of these numbers may appear hard to calculate, they are easy to estimate and what is really important is order of magnitude. For example:

  • if the organization expects to increase efficiency 200%, that’s a 65% workforce reduction against current workload; if the organization currently requires 20 people to handle tactical procurement tasks, at an average salary of 62K, that’s a reduction of 13 people or about 800K per year
  • if the organization currently has a maverick spend rate of 30% and expects, using third party benchmarks, to reduce that by 66%, that’s an 20% reduction in maverick spend; if maverick spend, on average, costs the organization 5% of spend on average, if the organization spends 100M annually, that’s a projected savings of 1% (20% of 5%), or 1 M in one-time savings
  • if the organization expects that an e-Procurement system will identify additional savings opportunities on 20% of spend annually and that the average savings that will be obtained will be 10%, then the organization would expect to save 2% of spend, or 2M annually

All told, if the organization expects to use the system for five years, it would expect to save 15M over five years (5*800K + 1M + 5*2M). If the total cost of ownership of the system was determined to be 3M for five years, then the organization would expect to see an ROI of 5X, which should be a buy decision. Of course, if the calculations worked out that the organization only expected to save 5 M, and the ROI was only 1.6, the decision should be to find a more cost effective solution.

For more details on cost calculations, and a starting spreadsheet, see Sourcing Innovation’s post on Uncovering the True Cost of On-Premise Sourcing & Procurement Software in the archives.

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