What exactly is a supply chain? No, we're not reverting back to basic definitions this late in the book, but most of what we've looked at to this point has focused on physical (or in some cases, digital) supply chains, specifically involving the movement of goods or services from the point of origin to the point of consumption. “From dirt to dust” is a commonly used cliché to describe end-to-end supply chains, implying a product's lifecycle extends from the moment its raw materials are first processed to the moment its usefulness ends.¹ But it's not quite accurate to suggest that a company's most crucial supply chain decisions are always centered on improving the inbound and outbound flow of components and products; in many cases the most important thing a company can do is to improve how it manages its cash flow. Let's take a look at some of the best practices companies use to manage their financial supply chain.

A Convergence of Talent

A company's financial supply chain management framework should start with the creation of an integrated team combining both the finance and the supply chain functions, recommends consultant Carlos Alvarenga, CEO of Katalyst (formerly a consultant with Accenture). Their first task should be to focus on operations research, risk management, and financial optimization tools and techniques. Rather than concentrating on physical product flows and facilities, this team should concern itself with corporate-level risk, financial performance, and shareholder risk and returns, he says.

For example, Alvarenga points out how aerospace manufacturer Boeing has embraced the concept of financial supply chain management when making product development and strategic sourcing decisions, including investment and risk modeling, demand modeling, spreadsheet modeling, and portfolio analysis. Boeing includes financial design considerations into its production and supply chain decisions, such as: Can unit costs be lower if the company spends more on automating production? Are new design features a good investment, or would they be able to sell more planes if they kept the price lower? It's all about making design and production decisions from the perspective of risk and probability, Alvarenga says.

“Supply chain strategists will need to rethink their training and expand their view and knowledge of finance and risk management,” he adds. If manufacturers truly are intent on a convergence of finance and supply chain, “traditional roles will have to change, as will power over supply chain management decisions.” For instance, the role of the chief financial officer could overlap and intersect the role of the chief supply chain officer. In any event, supply chain professionals should get more comfortable speaking the language of the finance department.²

To that end, the finance department at forklift manufacturer Toyota Industrial Equipment Manufacturing works very closely with the supply chain and other departments to ensure all aspects of the production process meet their budgets. As Joseph Kurdziel, Toyota's controller, explains, the company's budget process allocates funds to various departments to pay for every aspect of its production operations, such as product development, raw materials, and labor. “All key personnel are expected to meet these targets to ensure our actual financial performance,” he says. If, for some reason, the company misses its budget numbers, the capital expenditure plan is reviewed and cash disbursements are postponed so that manufacturing can continue at an optimal level.

“Finance provides the reports to assist the departments in their day-to-day decision-making processes, as well as budgeting and capital expenditure planning,” Kurdziel says. All the department heads are involved, along with the president, and they're each responsible for driving the short- and long-term goals of their respective departments. This isn't an every-so-often affair, he stresses. “Communication is very important in Toyota's environment, and the executives meet daily to discuss the events of the day.”

Zero Hour for Budgeting

Why are supply chain professionals always under pressure to reduce costs? The answer is simple, explain Kris Timmermans and Andrew Corr, managing directors with global consulting firm Accenture: Half of a company's costs are in its supply chain or costs of goods sold (COGS). The very nature of a corporate supply chain sometimes seems to be working against a company's ability to keep overall costs under control. Timmermans and Corr cite the example of a personal care company that was able to improve its COGS for existing products by 4% to 5%—sounds pretty good, right? But hold on … while finding success in that area, the company was also seeing costs rising for e-commerce fulfillment and new product development, so the actual improvement to the bottom line was just 1%.³

“This scenario plays out more often than not,” they explain. “Even if supply chain leaders can deliver single-digit category savings in one area, costs end up ballooning in another area. That means no noticeable or sustainable change to the bottom line.” As a result, a condition they describe as “savings fatigue” can settle across the supply chain department.

One way to overcome that fatigue is to adopt a new mindset—specifically, a zero-based mindset, a new spin on the zero-based budgeting concept that dates back more than 50 years. According to Accenture (which coined the phrase “zero-based mindset”), digital technologies can be leveraged to help propel companies into shifting their spending and cross-organizational commitments. Like zero-based budgeting, where companies started brand-new budgets every year (resetting to zero, basically) rather than basing them on the previous year's numbers, a zero-based mindset attempts to build the supply chain from the bottom up.

“Budgets are built by every entity owner, but they also have a horizontal owner—someone that has a view of the performance of every cost package across all the entities,” Timmermans and Corr state. “This structure creates a healthy tension across the organization that ensures tracking and execution—and a culture where everyone is accountable.”

A zero-based supply chain does not rely solely on past costs or performance, the Accenture consultants point out. Rather, “it continues to set and stretch performance targets, identifying ‘should costs’ for costs of goods sold based on how the organization will look and operate in the future. And the savings uncovered are redirected into growth initiatives that drive efficiencies and new products and services. Essentially, the organization shifts from having a focus on savings to one that's centered on impact to the profit and loss statement. And in doing so, it remains constantly focused on uncovering inefficiencies in costs that can be captured and redirected for new growth and bottom-line impact.”

Roll with the Changes

When it comes to budgeting, there's a basic rule-of-thumb, says Steve Player, founder and managing partner of consulting firm The Player Group: “You should change it whenever the key assumptions it is based on are no longer valid.” There are any number of reasons why those assumptions might have or will change, he explains, such as a change in the economy's growth (either stronger or weaker than expected); supply chain disruptions (hurricanes, earthquakes, etc.); a shift in the competitive landscape (mergers and acquisitions involving key competitors); altered expectations of how your customers or suppliers would serve the market; or the introduction of new technologies and solutions. But sometimes, he adds, companies need to spend less time on the budgeting process and more time on the planning process.⁴

If you're basing your budget on a set of assumptions that turn out to be wrong, maybe you should consider a rolling forecast, which is a forecasting system that allows you to make adjustments along the way, Player suggests. “A traditional forecasting system is set up to reward employees for reaching low-ball targets that you negotiated for yourself, but a rolling forecast provides opportunities to set more ambitious growth goals that align with industrywide growth.”⁵

According to research conducted by benchmarking firm American Productivity and Quality Center (APQC), companies that use rolling forecasts are better aligned with unfolding business strategy, are more effective at business analysis, derive greater value from their budgeting processes, and have more reliable forecasts than those who do not use them, notes financial management research specialist Elizabeth Kaigh. “In order to achieve truly effective rolling forecasts, finance functions should examine budget deviations and develop an understanding of the underlying assumptions that have changed since annual targets were originally set. Once deviations are identified, the forecast should then be revised to reflect their effects on organizational success.” Not only does this increase a company's agility, but it provides a level of resilience from the inevitable but impossible to predict supply chain disruptions.⁶

Miles Buntin, director of enterprise performance management at consulting firm The Hackett Group, estimates that roughly 60% of world-class companies use rolling forecasts to some extent.⁷ Consumer packaged goods giant Unilever, for instance, abandoned its annual budget in favor of an eight-quarter rolling forecast. Several business units contribute to the forecasting process, including supply chain, sales, marketing, and finance, who all report feedback and input received from customers. Every month, the quarter's forecast is updated based on current information, and appropriate changes are made as needed. Other companies known to be using rolling forecasts include glass manufacturer Corning, beverage cup maker Solo Cup, and oil and gas producer Statoil. The advantage of using rolling forecasts over traditional annual budgets is easy to explain, Steve Player says: “It makes no sense to use a nineteenth century tool to manage a twenty-first century company in a volatile global economy.”⁸

Supply Chain Finance: Part Strategy, Part Technology

“Natural, political, and operational disruptions are the new normal in today's global supply chains,” says consultant Shanton Wilcox, head of North America Supply Chain with Infosys Consulting. “To mitigate these risks, companies are increasingly leveraging supply chain finance.” According to a recent study of third-party logistics trends conducted by Infosys and Penn State University, supply chain finance “allows those within the supply chain to access capital that would otherwise be tied up while goods are in transit.”⁹

Supply chain finance is a fairly recent term that refers to a specific set of tasks within the financial supply chain. It's partly a best practice, partly a facilitating technology, as it involves solutions such as procure-to-pay automation, order-to-cash automation, and the use of a common platform (such as a supply chain network) for buyers, sellers, and financial institutions. It's basically built on the premise: What if you (or your suppliers) could get paid earlier than usual, at reasonable terms, using the resources of a third party who could offer greater liquidity (cash flow) in return for a negotiated fee?

As Daniel Stanton, author of Supply Chain Management for Dummies, explains, “When a big company places an order with a smaller company, the smaller company often has to make a relatively major investment in equipment, labor, and raw materials, which can create cash-flow challenges. After the small company fills the order, months may pass before their big customer pays for the work. In the meantime, the small company may have trouble paying its own bills if it doesn't have adequate cash reserves.”

That's where supply chain finance comes in. “Supply chain finance strategies,” Stanton says, “give small companies options for managing their cash flow based on orders that they receive.”¹⁰

To get a better understanding of what supply chain finance is, Tom Roberts, senior vice president with PrimeRevenue, explains what it is not: It's not a loan; it's not dynamic discounting; it's not factoring. “There is no lending on either side of the manufacturer/supplier equation,” he explains, so there is no impact to balance sheets. It's not an early payment discount program, either, since it doesn't involve offering suppliers earlier payments in return for a discount. Dynamic discounting, Roberts says, “is expensive for both suppliers, who are getting paid less, and manufacturers, who tie up their own cash to fund the programs.” And finally, with factoring, suppliers sell all their invoices to a financial institution in return for earlier but only partial payment—“the suppliers can't pick and choose which invoices to sell based on cash flow needs,” he points out. Supply chain finance is sometimes referred to as reverse factoring because while factoring is a supplier-driven approach, reverse factoring is a customer-driven approach.¹¹

“Supply chain finance improves cash flow by allowing buyers to optimize their cash conversion cycle by focusing strategically on payment terms with their suppliers,” Roberts continues. “At the same time, suppliers can get paid early by a third party, typically a financial institution. By extending the invoice due date, buyers free up cash that would otherwise be trapped in the supply chain. Likewise, suppliers can accelerate their own cash flow through access to early payment.”¹²

“Supply chain finance,” adds Rick Erickson, global director of freight payment solutions with US Bank, “facilitates transactions between trading partners by providing financing and payment options that are negotiated to improve each trading partner's financial position.” By extending payments—to 45, 60, 75, or 90 days—companies have more cash on hand they can use for other projects without negatively impacting their relationships, he says. “Preserved cash can then be leveraged to purchase assets, make acquisitions, manage restructuring efforts, reduce debt, repurchase stock, enhance earnings per share, or create increased liquidity.”

“High performing supply chains minimize the number of days between the time they pay their suppliers (cash out) and the time they receive payment from their customers (cash in),” explains supply chain consultant Jane Malin with Bridge Consulting. “When Net 30 becomes Net 60 or greater, imagine how that positively impacts your cash-to-cash cycle.” The bottom line, according to Erickson, is that the shorter the cash-to-cash cycle, the more cash is accessible and the more net working capital is available for investment.¹³

Of course, there are at least two sides to every story, and as consultant Paul Ericksen (former chief procurement officer with truck manufacturer Oshkosh Corp.) points out, cash is never really “trapped in the supply chain.” “That's like saying that when you buy groceries, the money you pay for them is trapped in the store,” Ericksen observes. “I wonder how stores would react if we told them we were going to extend payment terms.” He also emphasizes that in order for a supplier to get paid per the previous payment terms, the supplier must accept a discount on price. So, it's important that all parties embarking on a supply chain finance strategy understand that everything—and especially cash flow—comes with a price.¹⁴

Supply chain finance isn't just for small companies, however. Even large companies, such as $9 billion medical device manufacturer Boston Scientific, can benefit from a strategy designed to improve its working capital while increasing its cash flow. The company has invested in more than 30 acquisitions since 2004, with many of the transactions being cash deals. As a result, Boston Scientific needed a way to increase its cash flow without slowing down its momentum, or threatening its suppliers or investors. The company implemented a supply chain finance program that provided a way for its suppliers to get paid earlier than usual for a nominal fee, which meant the suppliers wouldn't need to borrow from traditional banks at a much more expensive rate. The supply chain finance platform allows the suppliers visibility into when invoices were approved and when payments were processed. To date, more than 100 suppliers have signed on to the program. And for Boston Scientific, the program has led to a cash flow improvement of more than $200 million, which has helped fund significant acquisitions.¹⁵

Financials on the Rocks

As we saw in Chapter 12, managing a supply chain can be a risky business, particularly since even the best managed companies are often subject to the financial performance—or lack thereof—of their customers and suppliers. On the customer side, Christopher Smith, senior finance manager, resource management with Lawrence Berkeley National Laboratory (formerly vice president of finance and administration with defense contractor SAIC), suggests there are seven signs that indicate when a customer is in financial distress and poses a significant supply chain risk. If any of these situations come up, a company should consider it “a red flag that the customer requires additional scrutiny and potentially greater contractual management”:

1. The customer's financials are getting worse.
2. The customer is constantly reporting bad news as its credit rating downgrades.
3. Habitually slow payments or a change in frequency of payments.
4. More liens, debt, and creditor financing statements.
5. Invoice disputes are becoming more frequent.
6. Silence, secrecy, and concealment.
7. Discrepancies between accounts receivable and accounts payable.¹⁶

On the supplier side, supplier management needs to be very robust and sophisticated due to the constant presence of risk in the supply chain, suggests Michael Chagares, director of risk consulting services with consulting firm PwC. You have to examine your critical suppliers' overall financial and operational health, he says. “You have to look at doing a specific contractual engagement and understanding how that can be used to potentially mitigate the risk. You've got to have really strong communication between you, your key suppliers, and your key vendors to understand and be very proactive on whether there are any issues they should be anticipating.”

As Chagares sees it, companies have actually gotten pretty good at managing their financial risk, but they haven't quite figured out the nuances of operational and strategic risk management—that's where risk analytics comes in. Companies need to assess all three types of risk across the entire supply chain, he says, and then apply analytical tools to better understand what could happen should those risks occur. “Instead of reacting to something that happens, you can look across your supply chain to help sharpen your view and provide stronger capabilities in how you prioritize the risks across the supply chain, how you measure those risks, and how you understand different scenarios and test for those scenarios.”

According to Chagares, failing to manage supply chain risk invites disaster, so you need to identify, prioritize, measure, and map risk across your entire supply chain ecosystem. Develop a rating system based on key metrics your company uses to measure risk, and then communicate the results across your supply chain.

“You also have to ask ‘what-if’ questions,” he adds. “Use probability modeling to identify unknown risks, different levels of volatility, and develop appropriate plans to deal with potential scenarios. When is the right time to only have one plant in one country? When is the right time to put a duplicate operation in a second country?” It's important to constantly consider and evaluate how your business environment can change, he stresses, so always test out potential scenarios to ensure your company is insulated as much as possible from the risks that could impact your customers or suppliers and reverberate throughout your entire supply chain.¹⁷

Show Me the Money

As the authors of Financing the End-to-End Supply Chain observe, the amount of cash a company has on hand can be compared to the level of oil in a car engine. Without sufficient engine oil, the car's moving parts will seize up and eventually cause serious, perhaps irreparable, damage. So too, a company without sufficient cash won't be able to pay its employees, its suppliers, or its creditors, and won't be able to invest in maintenance or product development. In short, like a car without oil, a company without cash will soon break down.

A car with too much oil, though, can also lead to problems, as the engine will literally be leaking excess fluid on the ground. Likewise, a company holding onto too much cash will similarly be plagued by inefficiencies. Without pushing the analogy too far, the authors conclude that “cash management within a business is as essential as the engine management system in an automobile.” While supply chain professionals are quite adept at managing the physical flow of goods, and have become by necessity very skilled in overseeing the flow of information as well, it's just as important to be aware of the financial flow that moves from the buyer to the supplier and up the supply chain.¹⁸

The authors cite as an example the efforts Unilever took several years ago to support hundreds of small and medium-sized suppliers in Indonesia, when that country's economy was in turmoil. The CPG giant acted as an intermediary between the suppliers and the local banks, not only providing the suppliers with much-needed cash but also helping improve their credit ratings. This of course helped the suppliers, but it also helped Unilever, which ensured the stability of its supplier base while also lowering its overall costs by gaining better terms with the suppliers—certainly a case of win-win.¹⁹

Economic downturns, such as occurred in Indonesia at the turn of the century, are an all-too-frequent type of supply chain disruption. Rarer by far, but all too familiar thanks to the COVID-19 pandemic, are global disruptions that impact virtually every country in the world. As consulting firm The Hackett Group points out, even before the coronavirus hit the United States, the 1,000 largest US companies (not counting financial firms) had taken longer to pay their suppliers in 2019 than they had in the previous year. It had also taken these companies longer to get paid by their own customers, and as a result, they had to hold on to inventory longer. That kind of ripple effect led to overall working capital performance in the United States taking a dip, as both cash on hand and debt grew to record levels—and again, that was the trendline before the pandemic had even arrived.²⁰

COVID's arrival led to a renewed focus on working capital and overall liquidity as companies struggled to reinvent themselves to deal first with the crisis and then the aftermath. While companies had been relying heavily on supply chain financing and other external solutions, the pandemic led to “a sense of urgency driving improvement,” notes Craig Bailey, associate principal with The Hackett Group. Instead of turning to banks and greatly increasing their debt, “companies began making liquidity and cash flow a top priority.”

With supply chain disruptions—whether economic, geopolitical, weather-related, or viral—becoming more of the norm than the exception, it's increasingly important that companies do all they can to improve their cash situation. The Hackett Group offers these best practices:

• Don't let the disruption go to waste—it can be the propellant driving your company to overhaul your current processes, particularly if they've proven to be inefficient.
• Adopt technology solutions that offer real-time visibility into all facets of your supply chain, as well as smarter planning and analytics tools, such as scenario modeling, integrated business planning, cash flow forecasting, and risk management solutions.
• Get your own house in order before making changes to terms with your suppliers and customers. Incentivize your employees—sales, procurement, commercial teams—to optimize for cash. And definitely prepare for more disruptions by improving your risk management and contingency plans.
• Do keep a close eye on your suppliers and customers, though. If one of your suppliers fails, will that severely impact your supply chain? Provide incentives to your customers to encourage their prompt payment, and offer support as needed to ensure the continued viability of your key suppliers. Plan out alternative scenarios in anticipation of potential failures within your supplier or customer base, always with an eye toward protecting cash and building for what The Hackett Group's experts call “the next normal.”