How Financially Articulate Are You?

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Author: Gerard Chick 

Shareholders and CEOs are interested in profit. In fact shareholders expect the businesses they invest in to make intelligent investments in operational assets, and it just so happens that most of these assets happen to reside on the supply side! It is therefore incumbent on supply management professionals to be able not only to work with other senior executives to make these intelligent investments but to be cognisant of how operational investments affect margins, turnover, and, ultimately, cash flow.

The involvement of CPOs in discussions with other CXOs about supply chain finance is becoming the norm. But do CPOs and other supply management professionals have the lucidity and pecuniary ‘nous’ to be able to articulate their grasp of financial concepts amongst their peers?

Do you and your team…

… appreciate the financial impact of your activities?

CFOs see the corporate world through two key financial reports: the balance sheet and the income statement. Therefore CPOs and their teams have to make the connection between these statements and their world too if they are to communicate effectively with CFOs.

The balance sheet gives a snapshot of a company’s assets, liabilities, and shareholders’ equity, including inventory, accounts receivable, and accounts payable, while the income statement provides a summary of the company’s revenues and costs over a defined period of time.

… know what the DuPont Ratio is and why it matters?

This method of performance measurement was developed by the DuPont Corporation in the 1920s. Using this method, assets are measured at their gross book value rather than net book value in order to produce a higher return on equity (ROE). Employing DuPont analysis reveals that ROE* is affected by three things:

1              Operating efficiency:  (profit margin)
2              Asset use efficiency:   (total asset turnover)
3              Financial leverage:      (the equity multiplier)

CPOs can use this method to their advantage and to broaden supply management’s remit beyond cost reduction. E.g. CPOs might use it to reveal how higher prices (the ‘cost’ of better service delivery) can actually improve margins.

* ROE = Profit Margin (Profit/Sales) * Total Asset Turnover (Sales/Assets) * Equity Multiplier (Assets/Equity)

… recognise that accounts and finance are not ‘rocket science’?

Accountants have to use their discretion over how they classify transactions. Consequently CPOs must be aware of this and on their mettle in situations where flawed classifications can lead to problems.

… know what activity-based costing (ABC) is and what benefits it offers?

Activity-based costing is an accounting method that identifies the activities that a business carries out, and then assigns indirect costs to products (and services). An ABC system recognises the relationship between costs, activities and products, and through this relationship assigns indirect costs to products less arbitrarily than traditional methods such as an “average costing” model.

… get hung up hold on holding costs?

Holding costs are a major element of supply management, since businesses must determine how much of a product to keep in stock. This represents an opportunity cost, as the presence of the goods means that they are not being sold while that money could be deployed elsewhere. Holding costs also include the costs of goods being damaged or spoiled over time and general costs, such as space and labour.

Many procurement professionals are introduced to this concept when they are taught how to calculate economic quantity orders. This is essential in setting inventory policies because the holding cost is frequently used to calculate the savings yielded by an inventory reduction. However, you need to be careful as this can lead an underestimation of the value of an inventory reduction.

… understand the relevance of cash flow?

A cash flow is a revenue or expense stream that changes a cash account over a given period. Cash inflows usually arise from one of three activities: financing, operations or investing. Cash outflows result from expenses or investments.

Finance departments will issue an accounting report called the “statement of cash flows,” which reflects the amount of cash generated and used by a company in a given period. It is calculated by adding noncash charges (such as depreciation) to net income after taxes. Cash flow can be attributed to a specific project, or to a business as a whole for example as an indication of the financial strength of the business.

Determining which cash flows are important to you (the CPO) can be difficult. For example if you were looking at the impact of discounted cash flow (DFC), you might want to think about what should be included in your spreadsheet and where given its impact on your activities, e.g the cost of transportation and delivery or make-v-buy decisions.

… supply management’s influence on working capital?

Working capital* is a measure of the business’ efficiency and its short-term financial health. The working capital ratio indicates whether a company has enough assets to cover its short-term debt. CPOs have a key role to play in reducing working capital because they are instrumental in controlling inventory levels, but more particularly they directly impact two key components of working capital: receivables from customers and payables to suppliers.

Today’s CPO is expected to make key decisions about where to invest much of the capital provided to the business by its investors, they must be able to work closely with the CFO. It is imperative they have a well-developed knowledge of the world of accounting and finance.

*Working Capital = Current Assets – Current Liabilities

Gerard Chick is chief knowledge officer at Optimum Procurement  Group. His new book, ‘The Procurement Value Proposition: The Rise Of Supply Management’ is available from Kogan Page: http://www.koganpage.com/product/the-procurement-value-proposition-9780749471194. Enter this discount code and receive 20% off with a special PASA offer: PASA2016

PASA has declared 2016 to be ‘The Year of Entrepreneurial Procurement’. Read more here: http://www.pasaconnect.com/2016/01/2016-the-year-of-entrepreneurial-procurement/ 

About Author

Procurement and Supply Australasia (PASA) is the leading provider of information and education to procurement and supply professionals throughout Australia and New Zealand. PASA supports the largest community of engaged procurement stakeholders in the region, through its renowned series of events, publications, awards, plus various community and network building activities. PASA is a trading name of BTTB Marketing, for many years recognised as the leading producer of conferences and events for the procurement profession in Australia and New Zealand. Whether producing under the BTTB, CIPSA Conferences or now PASA brands over the last ten years, our events have consistently led the market in terms of both educational and networking opportunities.

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