Category Archives: Finance

Economic Sustentation 02: Bank Failure

As indicated in our original damnation post, Wikipedia states that a a bank failure occurs when a bank is unable to meet its obligations to its depositors or other creditors because it has become insolvent or too illiquid to meet its liabilities. Since some banks, including the Federal Reserve, have a license to literally print money, most people think that bank failure is impossible. But since some banks over-invest in hedge funds, high risk mortgages, or commodity markets, it can happen and it has happened.

Banks have been failing since they first incorporated, and the fiscal crises in the late 2000’s caused the failure of a number of really big banks, including Washington Mutual, Lehman Brothers, and Bear Stearns. And regardless of how many new acts are passed to try and insure banks limit their risk exposure or keep enough cash on hand to cover withdrawals or payouts in the case of a loss, banks will still fail. Regulators will never keep up with the new and inventive ways banks and investors will come up with to invest, and lose, money.

This is a damnation because not only do they hold your money, all of which above the FDIC (or equivalent) insured amount could be completely lost in a bankruptcy, but your supply chain probably depends on letters of credit and inventory based loans, and they can disappear with the bank that disappears with a bankruptcy. This could cause your critical supply lines to stop, which would result in your production lines going down, and revenue losses mounting by the day while you search for new banks, new lines of credit, and new inventory loans.

So what can you do?

1. Diversify your Banking Portfolio

Just like you should diversify your physical supply chain, and have alternate sources of critical raw material and product supply, you should diversify your financial supply chain and have alternate sources of savings and financing.

2. Include your Banks in Your Supplier Risk Management and Monitoring Program

Even if you have multiple banks, and no bank has more than the insured limit of your money, a failure will still cause you significant grief as you would have to file insurance claims to get your money, arrange new payroll solutions, arrange new letters of financing, and so on.

3. Balance bank financing and private lender financing

Sometimes private lenders will give you a better deal on invoice factoring and inventory financing than banks. Be aware of all your options and balance them appropriately.

How to Save a Whopping £500 on 1.0M of Spend!

Unless you are a best-in-class purchasing organization (and that is not the case for 92% of you), then you need to save. Budgets are shrinking. Costs are rising. Growth and consumer spend is flatlining. And if you don’t get your costs under control, you will be out of a job one way or the other.

But there’s a right way to save, and a wrong way to save.

The right way to save is to apply advanced analytics and optimization across your strategic and high spend categories which has proven time and time again to save an average of 10% across the board year after year when properly applied.

The right way to save is to influence and control demand. The only time demand should increase year over year is when it is for products or components that are for sale, or go into for sale products, and sales for those products are increasing. Demand should not increase more than x% for office supplies or MRO where x% is the increase in workforce, and, in fact, in many categories, should be decreasing year over year. For example, paper spend should decrease (since so much can be distributed online). MRO should decrease, as better inventory management and higher quality parts should decrease the number of products required. Etc.

The right way to save is to increase the value of the product sourced without increasing the price, so that even if costs stay constant, value increases and allow for an increased revenue stream.

So what’s the wrong way to save? Capital manipulation. In particular, earlier customer payment and later supplier payment.

The majority of analysts, accountants, and consultants, especially the unenlightened ones, will dazzle you with calculations that show how if you decrease accounts receivable from 30 days to 15 days and extend accounts payable from 30 days to 60 days, the extra 45 days of working capital you have will save you a fortune as you’ll either have to borrow less or can invest more and generate a huge savings on every Million that stays in your coffers an extra 30 to 60 days.

For example, if you have an annual cost of capital of 6% and you typically have to borrow 50% of required working capital to pay your suppliers on a timely basis, you will be paying:

  06% ACC   12% ACC  
Borrowed Amount 30 days 60 days 30 days 60 days
1 M  5,000 10,000 10,000 20,000
10 M  50,000 100,000 100,000 200,000
50 M   250,000   500,000   500,000 1,000,000

And as soon as a CFO at a mid-size company believes that if he can squeak out an extra 60 days across 50 Million of expenditure at 6%, he can save £500,000, a blind mandate to delay payment terms and expedite payment collection goes out across the board. And then CFO pats himself on the back and goes on a well deserved corporate retreat to the next conference he can find at a mountain resort.

But what actually happens?

If you do the proper calculation, which is:

You see that very little is actually saved because the savings is on the cost of capital for the payment days of the amount, NOT cost of capital for the payment amount. Which is a much smaller number. If you do this calculation, the real numbers are:

  06% ACC   12% ACC  
Borrowed Amount 30 days 60 days 30 days 60 days
1 M  500 1,000 1,000 2,000
10 M  5000 10,000 10,000 20,000
50 M   25,000   50,000   50,000 100,000

Remember, in the long run, the payments still have to be made and, most importantly, still have to be made on a monthly basis. So while you might see a savings the first month, there will be no further savings because all you have done is shifted all payments ahead by x days. A payment delayed is not a payment negated.

Moreover, all you’ve really accomplished is p!ss!ng off the supplier. And any chance of being a customer of choice has been thrown under the bus, where you effectively threw the supplier, who now has to borrow more capital to stay in operation, often at a rate double yours. In other words, the whopping £5K you saved likely cost the supplier £10K and, at the end of the contract, the first thing they are going to do is increase their costs substantially to cover their loss. So, at the end of the day, your short term savings of £5K is likely going to cost you £15K or more (especially when you consider the value associated with being a customer of choice). But hey, the CFO is always right, right? Wrong!

Don’t believe the doctor? Check out this great piece over on the public defender‘s blog that goes through this calculation in even more detail.

Geopolitical Sustentation 33: Taxation

As we stated in our original damnation post, taxation may be the only certainty left (especially if the futurists who think that cybernetics will eventually allow us to preserve our mind and live forever are right). Even if your current government(al system) fails, a new order will rise up and, like every order that has come before, in some way, shape, or form, it will tax you.

And, as clearly pointed out in our original post, taxation makes it nearly impossible to answer the ultimate sourcing question: what is the lowest cost of ownership and the best overall total value. When we source according to total value management, we want to maximize the value to cost ratio — but this can only be done when we understand the cost.

And when so much of the cost is taxes — sales taxes, export taxes, import taxes, special surtaxes, state or municipal taxes on top of federal sales taxes, and so on — and when all of these taxes can change almost overnight, how do you answer the ultimate sourcing question? For example, some countries in South America change their import tariff codes twice a week. Taxes generally change when consortiums or labour groups cry foul when a market is flooded with cheaper goods from a foreign market or “buy at home” lobbyists get upset that the best products are being exported and stir up a fuss.

When a 10% duty today can be a 30% duty tomorrow, how do you build accurate cost models that allow you to create three year plans and cut three year contracts? The answer is, you don’t. So what do you do?

Gather a lot of market intelligence and analyze it. Taxes for most of the products or services you are buying are usually going to fall into one of three categories:

  • stable
  • trending, with significance confidence as to approximate future prices, up or down
  • changing unpredictably

If the tax rate is stable, then the organization can take confidence that it will most likely be stable for the life of the contract and put a tax increase in the low risk category and, more or less, ignore it unless an event occurs or information is obtained that something might change.

If the tax rate is trending up or down, then you can do what-if analysis at different tax rates defined as now, 6 months, 1 year, 2 years, contract length to see at what point the lowest cost or highest value buy tips to another market and if that will happen in the first half of a contract period, work with a potential supplier in a market with a stable or lower tax rate to see if there are other cost reductions that would make the other supplier a lower cost over the expected contract length.

If the tax rate is unpredictable, and could increase significantly to a point where the buy would cost considerably more than the next lowest cost buy or cause considerable financial harm to the organization, the organization should consider if there are sources of supply that would avoid the tax rate entirely. If not, then the organization has to figure out some sort of hedging strategy that would allow it to profit financially from the tax increase to cover the increased costs of supply. And that should be left to the financial pros — but it’s good to know when they should be trying to work their voodoo and when they shouldn’t.

Organizational Damnation 57: Finance

We’ve covered quite a few organizational damnations to date. (Nine to be exact.) But, as with the other damnation categories, we’ve saved the best for last. Marketing was bad. Sales was often worse. Legal is a nightmare. But Finance. Finance controls the four horseman of the apocalypse. War, Famine, Pestilence, and Death — and they all fear the CFO. Because if he dies, then Death will forever have to listen to plans to increase productivity, decrease cost and profit from the dead. (Trust me, give former CFOs the opportunity and they’ll try.)

Finance brings War to the party.

Finance is not only the gatekeeper between the CEO and the various department heads but also the mediator between them, especially when there are budgetary disputes or strategic disputes in terms of corporate direction. That’s because money talks and Finance signs the checks. And if they decide that they don’t want to play mediator and problem solver and they want the department heads and/or CXOs to work it out, they can incite all out war, sit back, and see where the mortars fall. In the interim, Procurement is getting caught in the crossfire as every department makes contradictory requests and expects to get them fulfilled by Procurement.

Finance brings Pestilence to the party.

Finance has the ear of the CEO. As a result, they are always getting whispers from the COO, CMO, Chief Council, the VP of Sales, the VP of HR, and anyone else who runs a department. If any of them are making the CFO promises in terms of increased success, increased status, increased bonus, or, and yes this happens, lining in the pockets (direct or indirect kickbacks), your requests might fall on deaf ears. Marketing promises free trips to all of the global launch events. You promise an extra 10%, which may or may not materialize in the eyes of Finance, unlike those tickets to San Francisco, London, and Shanghai which can be in the CFOs hands as “guest speaker” tomorrow.

Finance brings Famine to the party.

Finance controls the budget. They determine how much money you get for talent, software, and services. Without enough money, you can’t get the talent; the talent in place can’t get the tools they need; and they definitely can’t get augmentation services or training, which they desperately need to do the job they are tasked to do. If Finance wants to bring Famine, they cut the budget, and your department starves. Famine is just one budget cut away.

Finance brings Death the party.

Not only can they starve you, cut you out, and subject you to contradictory requirements that you will be expected to unreasonably fulfill, but they can bring Death upon you. Unreasonable cost saving expectations. Unreachable metrics in terms of automated invoice processing or Spend Under Management in a mere 12 months. Impossible results from the supplier innovation program you are expected to launch. Followed by a pink slip when you don’t deliver (under the new mandatory right-sizing policy that cuts everyone who does not make their annual goals).

If the CFO doesn’t like the CPO or care for the Procurement department, the damnation that he can reign can exceed the damnation caused by all of the other departments combined.

Regulatory Damnation 33: Taxation

Yet another damnation you’ve been waiting for. In our modern world, at least if you believe the futurists who think that cybernetics will eventually allow us to preserve our mind and live forever, it’s the only certainty left. Even if the government falls, a new order will rise up, and like every order that has come before — in some way, shape, or form — it will tax you. And taxation is not just a damnation for Finance, it’s a damnation for Procurement too.

Taxation Makes it Nearly Impossible to Answer the Ultimate Sourcing Question.

The pinnacle of strategic sourcing is to alway select the option with the best total value. When sourcing according to total value management you are sourcing to maximize the value to cost ratio. This requires a good grip on the value (total expected revenue for goods for resale, efficiency gain for products and services to support work efforts, knowledge or capability improvement for services, etc.) and the total (lifecycle) cost. Guess what a big component of that cost is. Export duty. Import tariff. Federal sales or value added tax if the good is purchased in the same country or union. State or municipal tax on specific products or services. Taxes on the fuel used by the trucks to transport the goods. Tax, tax, tax.

And it’s not just as easy as asking the seller what the applicable taxes are. On import, and sometimes even export (depending on when your organization officially takes possession of the goods), it’s up to your organization to know what the right tax rate is, file the tax forms, and pay it. But we all know how easy it is to interpret global H(T)S codes – where there are eight entries for the same item and it’s sometimes a matter of interpretation whether the 50% leather glove falls under leather gloves with synthetic materials, synthetic gloves with cow-hide leather, or leather and synthetic products and each has a different tax rate. If the customs inspector doesn’t agree with you, not only can you be subjected to a higher tax rate, but a large fine as well, increasing the expected total cost of the purchase even more!

Documentary Requirements make it onerous, if not unrealistic, to reclaim taxes the organization is owed.

Many of the taxes that your organization will have to pay will be taxes that your organization is not legally subject to and that can be reclaimed, if your organization can demonstrate it was not legally subject to those taxes. For example, in the EU, if the sale is a distance sale, then if the amount exceeds €100,000, the exporter should be charging VAT at the rate of the importing state. So, if you are buying from a locale where VAT is 25% but importing to a locale where VAT is 15% for sale, and the organization was charged 25% VAT, it is eligible to claim a refund of %10 VAT. In Canada, any business with revenue (or the expectation thereof) that exceeds $30,000 must collect HST on all sales, but businesses are exempt from HST on goods and services required for their operation. Typically, since it is expected HST from sales will exceed HST paid, the organization will be making an annual, quarterly, or monthly HST payment (depending on revenue size), but if the sole purpose of the Canadian operation is to manufacture goods for export to US consumers with no effective Canadian presence, its HST paid will (far) exceed its HST collected and it will be eligible for a refund. There are a number of other situations around the globe. But, of course, these refunds are not automatic. They must be filed for, the documentation required, in some cases, is extensive and must be complete, reviews can take 3 months to a year (or more), and if a detailed audit is requested, sometimes the cost of the internal effort exceeds the amount to be reclaimed. This makes it difficult to compute the total cost of ownership when there are a myriad of taxes that may be refundable, but each of which has a refund cost. (Do you discount the refund you expect to receive by X% or a fixed cost for manpower, do you discount it using a net present value calculation designed to estimate the loss in the value of the money owed to you as it is held in the taxation authority’s hands for an expected amount of time, etc.)

Trying to optimize the tax for value-added products and services is a nightmare and essentially impossible without strategic sourcing decision optimization.

Not only can there be multiple H(T)S codes that a single product can ultimately qualify for with different rates, but if the product is actually a bundle of individual products, which may or may not contain a “value-add” service component, there can be different tax rates as well. For example, there’s a reason that many printers come shipped with the cartridge separate — if the cartridge is pre-installed, in some locales, the importer has to pay a higher tax rate. Plus, in some locales, state or municipal service taxes are not always reclaimable while federal taxes are. It’s a complex sourcing model just to capture the taxes, the reclaimable portions, the (expected) costs associated with the reclamation, and the value loss based upon net present value when the organization knows it will be 6 months to a year before that money is back in the coffers.

Not only is taxation one of the few damnation that every organization in the world is sure to experience on a daily basis, it’s also one of the most complex and horrific.