Aug 182009

Turning Supply Chain Management into a Profit Center

There are a number of ways to generate value for your organization through the management of the supply chain. 
One thing that you will want to do is publish your results publicly within the company. 

 This will serve three purposes:
    (a)  Toot your horn – you won’t have to toot your own horn as much because it will be in black and white
    (b)  Good results will set a precedent that will keep you going to constantly improve
    (c)  It will inspire those around you to maybe compete in the process improvement arena
    (d)  If you are an employee, it will set you up for your next review and if you are the owner it will increase your bottom line.

We’re going to pick some low hanging fruit here.  This is by no means an exhaustive list of things to do, but it will get you on the right track and we can do an update in the future to expand the list.  For the carrying cost calculations we will use a rate of 8% which is a reasonable rate for the purposes of these illustrations.

Inventory reduction

This is what almost every company wants to do.  Reducing inventory squeezes cash out of the business on a dollar-for-dollar basis.  There are two numbers that you will want to quantify when it comes to inventory reduction: (1) dollar value of the reduction and (2) annual carrying cost on the dollar value of the reduction.
For instance at one location I was involved with, we reduced the inventory from $17 million to $12 million over the course of a few months.  What this produced was a cash infusion to the business of $5 million and another $400,000 reduction in annual carrying cost.

In episode 2 of CashFlow ABC’s we covered how to find the low hanging fruit, in episode 6 we showed you how to properly determine your reorder points and in episode 8 we address economic order quantities and all of these play a part in the equation.  We’ll spare you a rehash of the three episodes that would surely be as juicy as microwave toast – check out those three episodes for the details.  Suffice it to say, reducing the investment that your company has in its inventories pays off in real dollars to the organization.

Extended terms

As we seen with the discussions about the statement of cash flow, which I know had everyone on the edge of their seats, getting extended terms from your suppliers adds to the cash balance of the company.  In addition, this will have carrying costs implications just like the inventory reduction.  If you have a supplier that you have net 30 terms with a supplier that you normally have a $100,000 balance with.  If you get the supplier to go to net 60 terms, you wind up with the equivalent of an interest free $100,000 loan because you now have an average A/P balance of $200,000.  Like a reduction of inventory, this will inject the additional $100,000 into the company’s bank account and end up with a benefit of $8,000 in reduced carrying costs on this one vendor over the course of a single year.

Prompt pay discounts

Prompt pay discounts are commonplace in every industry.  A supplier might offer 1% 10, net 30 terms or something similar – I’ve seen as little as 1/2% and as much as 5%.  In many organizations, the effect of carrying costs isn’t seen until you get up to parent companies, so it isn’t as appreciated as much at the division or plant level and discounts are more tangible and evident and therefore more appreciated.  Also, some companies can’t offer extended terms because of company policy, but they can offer the discounts.
Objectively, you have to determine your requirements and at what threshold you need for a discount to be preferable.  If cash is an issue in your company, then usually management is valuing extended terms over discounts because the cash need is immediate and, by the same token, the value of reduced carrying costs may be visible to corporate, but terms discount will bring the benefit to your division’s P&L rather than corporate’s.  You have to think logically and actually do some calculations to determine your answer.  As an example, let’s say that you have an average balance of $100,000 with a supplier on net 30 terms offers you 1% 10, net 30 – you now have a decision to make.

Carrying cost benefit of the $100,000 average A/P is $8,000 annually and if you take the discount, you will be giving up 2/3 of the benefit because you will be paying in 10 days instead of 30 – a reduction of 20 days.  To make the decision, take your annual purchases $1,200,000 (12 months X $100,000) multiplied by the discount rate of 1% gives you an annual benefit of $12,000 plus the carrying cost benefit on the 10 days that you have to pay in ($1,200,000 X 8% / 360 X 10 days = $2,667) and you come to $14,667.  That one is a no brainer as long as you have the cash flow to handle it.  This decision would turn around if you had 1% 10, net 60 because the carrying cost benefit would double to $16,000.

Good luck in your efforts and keep us apprised of your successes and opportunities for improvement!

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