Or, more accurately, outdated financial assumptions. Finance lives and dies by metrics that go by three (and four) letter acronyms such as CAPM, CFC, COGS, DSO, EPS, etc. If these don’t “add up”, Procurement can forget about ever getting any additional funding (and might even get rewarded with a budget cut by a CFO who thought that Procurement simply wasted his time with their last request), even though having these metrics “add up” isn’t always the right thing for the business.

Most CFOs are intensely focussed on CAPEX, COGS, DSO, DPO, ROI, and EPS. These have to look good because CAPEX and COGS take up most of the operating cash flow not swallowed up by salaries, DSO and DPO define how much cash flow there is to work with, ROI defines the return on using limited cash flow on an endeavour, and at the end of the day, all of this better add up to an acceptable EPS or the CFO can find himself in the unemployment line with the CEO if the shareholders get angry.

Now, the CFO is right to sweat these metrics because the organizational health depends on it, and it’s pretty much impossible to keep Procurement healthy in a sick organization, but if the metrics are misinterpreted or misused, and Procurement denied the budget it needs for talent, platforms, and services that will enable Procurement to deliver (significantly) more value (and bang for the buck), then in an effort to keep the organization healthy, the CFO will actually be making it sick by starving Procurement of the resources it needs to stay healthy.

Why would it do this? Because of outdated models and invalid assumptions. You see, most Finance organizations believe:

• Unless your business is leasing, CAPEX should be minimal because all assets should be as liquid as possible.
• COGS should be as low as possible, because minimizing COGS maximizes profit.
• DSO should be as short as possible because the more cash on hand, the better.
• DPO should be as long as possible because the more cash on hand, the better.
• Only the projects with the highest, short-term, ROI should be funded.
• At the end of the day, EPS has to increase quarter over quarter, year over year, because that’s what keeps the shareholders happy.

But not all of this is true. Do you know where the fallacies are?
We’ll give you a minute to think about it. And remind you to

Have you figured out where the fallacies lie? We’ll make it easy for you. Every single assumption is wrong. Why?

It’s not liquidity of the asset, it’s liquidity of the business. Sometimes it’s better to buy a valuable asset, and if cash is tight, use it as collateral against a low interest business loan than to lease at a rate that essentially doubles the cost of ownership over a 5 year period.

It’s not COGS, it’s POGS (no, not those annoying circular discs that plagued us during the mid-90’s) Profit On Goods Sold. If a few changes to the distribution and marketing strategy doubles sales, then it doesn’t matter that the COGS is increased 3% from 82% to 85%. 15% profit on twice as many units is much better than 18% profit on a base amount of units any day of the week.

It’s not DSO, it’s TSM – Total Sales Made. If increasing DSO allows a customer to buy more, well, if the organization has the war chest, or the credit rating to survive on a very low interest line of credit (compared to a weaker supplier or customer that might borrow at 12% to the organization’s 4%), then DSO should be increased for the right group of customers.

It’s not DPO, it’s TCO. If extending payment forces a supplier to take unreasonable loans or factor invoices at ridiculous discounts, that’s increasing their overhead operating costs considerably and, guess what, at contract renewal time, your rates are going up, up, up. Your short term gain translates into a long term loss.

It’s not always ROI, and the direct and indirect savings generated, sometimes it’s about the brand (image), such as switching to renewable energy or renewable materials which incurs a short term penalty due to the need to build new energy plants or switch to new processes, or about the knowledge gained, which would result from training, new systems, and the implementation of new processes. Organizations that stand still fall behind. Sometimes an organization has to take calculated risks and try a few high-risk investments to help it identify the best investments.

And while EPS is still the gold standard in the Wall-street led financial world, EPS cannot increase perpetually without investment, otherwise, at some point, the entire company will come crashing down. Remember, to continually increase EPS, one has to continually increase profit. To continually increase profit, that requires either continuously increasing revenue or continually decreasing costs, or both. Costs have a baseline that cannot be passed. And increasing sales almost always requires additional investment in marketing, which, at some point, will hit a point of diminishing return due to market size and consumable disposable income. And the faster one tries to grow, the faster the ceiling is hit, and the faster the rug is torn from beneath one’s feat when the dream comes crashing down. Just like leading Procurement organizations realized it’s not TCO but TVM, it’s not EPS, but VPS.

However, as long as Finance works on antiquated metrics based on antiquated assumptions, Procurement will be denied of the technologies, processes, services, training, and talent it needs to get the job done better. It’s damnation at it’s finest.

Bank Failure, which can be a result of fiscal crisis, is pretty bad, but the fiscal crisis that precedes it is often much worse. This is due to the fact that while a bank failure only affects the handful of companies that are using, and relying, on the bank, the fiscal crisis affects every company equally. No company is safe from a fiscal crisis — every company that does business in a country affected by the crisis is a company that is going to experience considerable supply chain impacts. Why?

Letters of credit become worthless

A letter of credit, which is a document from a bank guaranteeing that a seller will receive payment in full as long as certain delivery conditions have been met, is worthless in a fiscal crisis as sellers understand that the guarantee is only good as long as the bank is stable. But in a fiscal crisis, even apparently stable banks can become unstable so quick that a guarantee today might be worthless in a week when the bank, that over-insured buyers who are in danger of bankruptcy and in financial default, becomes unable to honour the letters of credit. As a result, no seller will be willing to take on additional letters.

Lending halts

As more and more companies begin to experience financial duress and become late, or default, on payments, banks will become very reluctant to lend additional funds as they will be short on cash and fearful of additional loss. As a result, companies that depend on that cash for payroll and day to day operations as they wait for customer payments will enter severe financial hardship, and their situation will worsen. These companies will then be unable to support their suppliers who will then be unable to deliver the products on time that the customers require before payment can be made, creating financial turmoil up and down the supply chain.

Corporations go into cash hoarding mode

As a result of the financial crisis that will result from the lending halts and the bank’s unwillingness to issue letters of credit, those corporations with cash will go into hoarding mode. Supplier payment cycles will be extended to 90, 120, and even 180 days and those companies that rely on the cash to survive, especially with few options, will be under even more undue hardship. So even if your company is okay, and doesn’t hoard cash and pays its suppliers on time, your suppliers could still be suffering as a result of most of their payments being delayed, and the actions of others puts your supply chain in jeopardy.

Consumers panic and stop spending

Eventually, when the fiscal crisis starts to enter panic mode, a large number of consumers, fearful for their jobs (as fiscal crisis almost always result in layoffs from cash-strapped or cash-hoarding corporations, take your pick), stop all unnecessary spending. As a result, any product line that your corporation makes that is considered unnecessary by a segment of consumers sees a drop in sales and all those nice rebates and discounts you negotiated based upon an expected volume commitment go out the window.

And since fiscal crises cannot be predicted, it’s another damnation that will drive you mad.

As per Wikipedia, 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 (and shady replacements for hedge funds and high risk mortgages will soon be on the way), and banks will continue to fail. Possibly even yours.

And if you depend on that bank for letters of credit and inventory based loans, this could be more of a problem than losing any cash above the FDIC (or equivalent) insured amount. Having your critical supply lines stop, your production lines go down, and revenue losses mount by the day as you search for a new bank, new lines of credit, and new inventory loans will be far worse than a short term cash loss which can happen anytime a market shift causes demand for a high-selling product to suddenly drop, forcing a fire sale of a large amount of remaining inventory.

And, as per the Wikipedia article, the failure of a bank is relevant not only to the country in which it is headquartered, but for all other nations that it conducts business with, especially if the bank owns investment subsidiaries in those markets. People are put out of work. The local economy drops. And everyone suffers. Yet another damnation waiting around the corner.