Executive Briefings

A Better Risk Management Metric for Supply Chain Finance

Analyst Insight: It's surprising yet true that not many professionals in supply chain or S&OP are aware of Cash Conversion Cycle (CCC), a critical success factor metric. Many in finance are well aware of the metric. The elements are simple - Inventory Days of Supply + Accounts Receivable Days of Supply - Payables Days of Supply. Why is the metric so foreign and why doesn't everyone in SCM and S&OP use it to measure success? - Gregory Schlegel, executive-in-residence, Center for Supply Chain Research, Lehigh University

A Better Risk Management Metric for Supply Chain Finance

Many S&OP frameworks are domiciled inside an integrated supply-chain group. With that said, many S&OP process owners and teams tend to utilize the classic demand and supply balancing metrics, such as Driving Revenue, Reducing Costs and Improving Asset Turnover. There's nothing wrong with these metrics. They are good-for-the-enterprise metrics. However, the metrics don't get finance's attention until one goes astray and impacts the income statement or balance sheet. And with that, comes the rub — not many S&OP process owners get finance to participate in their monthly meetings. Utilizing CCC as a metric of SCM/S&OP success will get finance’s attention. That's because finance knows all about Free Working Capital. They know improving CCC will improve profitability, produce higher capital utilization and potentially lower the cost of capital. So, by using CCC as a metric of success an S&OP team can make friends and influence people in finance.

What needs to be done by 2020
Initially, more education for SCM and S&OP professionals on the compelling reasons to act in terms of using CCC as a metric of success for the enterprise. Second, inject the calculation into undergraduate and graduate SCM university programs, curriculums and credentialing organizations. Third, capture more and more case studies of S&OP teams utilizing CCC as a metric of success and improving cash flow and the bottom line. And finally, reach out to the finance community to validate the metric for the good of the enterprise.

Where things are likely to be by 2020
A daunting task, considering major research organizations continue to witness low usage of the metric over the last five years. However, the encouraging news is the finance community, through research organizations such as The Hackett Group, are capturing compelling data to embrace the metric with statistics such as: “An additional turn in working capital can enable companies to boast net profits by up to 11 percent” and “A one-day reduction in days sales outstanding can be worth $80,000.” Killen Associates have found “A typical billion-dollar company spends approximately $27m annually on unnecessary working capital.

Can you “game” the metric? Yes, mainly in Payables. But many of us in academia and consulting have run financial scenarios for clients that stat: -“Yes, you can extend payables to improve your CCC, but only for about 9 to12 months. After that, your supply base either retreats or increases pricing.”

The Outlook: Beyond 2020

Dr. Robert J. Trent, SCM Director at Lehigh, in his new book Supply Chain Financial Management, says: “SCM is a relatively young profession and by leveraging established financial tools, such as CCC, can experience better analyses, decision-making and risk management for the good of the enterprise.”

Many S&OP frameworks are domiciled inside an integrated supply-chain group. With that said, many S&OP process owners and teams tend to utilize the classic demand and supply balancing metrics, such as Driving Revenue, Reducing Costs and Improving Asset Turnover. There's nothing wrong with these metrics. They are good-for-the-enterprise metrics. However, the metrics don't get finance's attention until one goes astray and impacts the income statement or balance sheet. And with that, comes the rub — not many S&OP process owners get finance to participate in their monthly meetings. Utilizing CCC as a metric of SCM/S&OP success will get finance’s attention. That's because finance knows all about Free Working Capital. They know improving CCC will improve profitability, produce higher capital utilization and potentially lower the cost of capital. So, by using CCC as a metric of success an S&OP team can make friends and influence people in finance.

What needs to be done by 2020
Initially, more education for SCM and S&OP professionals on the compelling reasons to act in terms of using CCC as a metric of success for the enterprise. Second, inject the calculation into undergraduate and graduate SCM university programs, curriculums and credentialing organizations. Third, capture more and more case studies of S&OP teams utilizing CCC as a metric of success and improving cash flow and the bottom line. And finally, reach out to the finance community to validate the metric for the good of the enterprise.

Where things are likely to be by 2020
A daunting task, considering major research organizations continue to witness low usage of the metric over the last five years. However, the encouraging news is the finance community, through research organizations such as The Hackett Group, are capturing compelling data to embrace the metric with statistics such as: “An additional turn in working capital can enable companies to boast net profits by up to 11 percent” and “A one-day reduction in days sales outstanding can be worth $80,000.” Killen Associates have found “A typical billion-dollar company spends approximately $27m annually on unnecessary working capital.

Can you “game” the metric? Yes, mainly in Payables. But many of us in academia and consulting have run financial scenarios for clients that stat: -“Yes, you can extend payables to improve your CCC, but only for about 9 to12 months. After that, your supply base either retreats or increases pricing.”

The Outlook: Beyond 2020

Dr. Robert J. Trent, SCM Director at Lehigh, in his new book Supply Chain Financial Management, says: “SCM is a relatively young profession and by leveraging established financial tools, such as CCC, can experience better analyses, decision-making and risk management for the good of the enterprise.”

A Better Risk Management Metric for Supply Chain Finance