Given the recent recession and current uncertainty, there is still a sense of gloom and doom in many of the published economic statistics, whether it’s the national debt levels, government spending, unemployment, GDP or housing starts.
So how can you create positive results in this environment? I have scripted a few ideas below to help supply chain managers look at their supply chains and ask the question, “How can I improve my company’s financial health position by squeezing more cash out of my supply chain?” Here are the steps you can take to start making a positive impact:
Understand the connection between the profit and loss (P&L) statement and the cash flow statement. Some supply chain managers do not realize what makes their stock price tick up on Wall Street and how they can contribute to it. For the share price to go up, usually the company needs to have a healthy income level (from the P&L statement) and generate enough cash flow (from the cash flow statement) to fund growth initiatives or dividends. It’s generally not enough to have one of them.
So how do we ensure we impact both of them in our daily professional lives? It’s not just enough to reduce the cost of a given product; you have to ensure that the cost reduction can be carried over to the cash flow statement to generate cash. More importantly, be cognizant of the fact that cost reductions can sometimes come at the cost of decreased cash flow.
For example, you can negotiate the price of a raw material from $1.50 per pound to $1.40 for a cost reduction, but at the same time you increase inventory and reduce the payment cycle for the supplier. This might have an adverse impact on the cash flow statement. See the simplified schematic in Illustration 1 (page 38) for explanation. You can flow each decision you make through this model.
Bottom line: unless we are able to convert net income to free cash flow, Wall Street won’t recognize our efforts. The faster you can convert the product you sell to cash (also called the cash conversion cycle, or CCC), the better financial health your company will be in.
Measure CCC. Once you understand the above, measure and improve your cash conversion cycle so you can convert your net income into free cash. You will want to measure your cash conversion cycle by each strategic business unit (SBU) as you do for net income. This will present a clearer picture of which business units actually deliver the cash and which are being subsidized. Remember:
Cash Conversion Cycle (CCC) = Sales Outstanding - Payables Outstanding + Inventory
Improve your CCC. Once you understand the CCC per strategic business unit, shorten the cash conversion cycle by working on each component and aligning collection and payment cycles. You can use the following levers to improve your CCC.
Use inventory postponement and package on demand in plants and warehouses. Hold inventory at a work-in-process (WIP) level in the bill of materials (BOM) and differentiate when you get an order. This limits the SKU’s you have to hold in inventory on and hence you can hold less inventory. For example, if you are selling identical items to different retailers in different packages, hold the inventory prior to packaging it (a lower level in the bill of material) and pack it on demand.
Supplier-owned managed inventory initiative in the plants. Urge your suppliers to manage and own the inventory in your plants. Your competitors probably do this. This is quickly becoming not a differentiator but an order qualifier for many suppliers. The idea is not to shift the inventory upstream but to make your suppliers work with you to reduce it. Once they have it, they will work with you on reducing it.
Cross docking in warehouses. Use a third-party logistics (3PL) provider to synchronize the inbound and outbound movements out of your warehouses. The idea is to never take possession of inventory, but just receive it, turn around and ship it on another waiting truck. Most 3PLs have built this expertise, which was once the forte of a few pioneering companies.