To make the best decisions, the Supply Chain Manager must control the financial flows of the Supply Chain. Less known than physical flows, financial flows accompany the Supply Chain. They constitute a virtual Supply Chain that feeds the physical Supply Chain. Moreover they are fueled by bankers and shareholders. They also pay permanent staff as well as casual staff.  Finally, they finance suppliers of fixed capital (machines and buildings), as they are used to pay suppliers of services and materials.

These financial flows circulate, but they can also slow down, hide, rest, fall asleep within stocks. This is where the Supply Chain Manager watches for them, seeks to flush them out, to understand their usefulness.

Financial flows from banks and shareholders

These financial flows come from the banks on the one hand. Banks finance small risks at small rates. They finance the stocks in which their money remains easily liquefied. Currently, banks facilitate stockpiling at rates close to 2%, which are constantly increasing.

These financial flows also come from capital. And there the Supply Chain Manager will have to justify the investments he presents to the shareholders. These investments must be profitable for them. Shareholders finance high risks at high rates. The return requested by a shareholder is often close to 10%, even 20% or 30%.

Know how to skillfully manage flows and stocks

The Supply Chain Manager must therefore skilfully manage flows and stocks to optimize the financial component of his job. He must manage by taking care of other components of the company, whose objectives and practices are different: the accounting of the company, for example, the information system, the KPIs of other functions.

The full cost mixes Capex, Opex and BFR

The accountant talks about costs, according to standards that allow financial analysts to understand the “business”. Unfortunately, the costs of the accountant do not allow to manage the cash. And cash is the treasure of the Supply Chain Manager. Where are the differences?

The accountant and accounting, sometimes the management controller, speak of full cost. The latter mixes the cash to be spent and the cash already spent. It combines Capex, Opex and BFR. For example, the production cost on a madeleine manufacturing line will accumulate:

• part of the investment in the ovens used to bake the madeleines,
• a share of the salaries of people very far from production, such as the factory manager or the caretaker,
• a share of the building,
• and finally the personnel directly involved in manufacturing.

Compare the cash in/out differential of various scenarios

But this is not what the Supply Chain Manager needs to know if he should plan the factory in 3×8 or 2×8. Or if he has to bring the staff back on weekends. He actually really needs the cash out and cash in (cash flow) differential between the various scenarios he is considering. The factory manager will be paid, regardless of the work pattern of his employees. We will not pay a penny more for the machines, already paid to the supplier. The material will not be worth more in one mode of work or another. What will change is the “variable” cost (because it changes), that is to say the money, the cash paid to employees. 3×8 work is more expensive for the employer than 2×8, but less expensive than weekend work. For the Supply Chain Manager, the only relevant indicator is the change in cash, which changes according to the scenarios. And a Supply Chain Manager must constantly manage and compare scenarios.

The Case of the “Free” Warehouse

For example: how to evaluate the cost of storage? If I store in the warehouse I own that has space or if I store in a service provider’s warehouse, should I consider that my storage cost is the same? Of course not. In the first case, my warehouse is free. The shareholder has already settled the supplier for years. Now my warehouse is free. Full or empty, it’s too late, the cash is gone! On the other hand, with a service provider, I follow a variable system: I pay by the pallet stored for the duration of the storage. If I compare my 2 scenarios, in the second I have to take out cash to pay the service provider’s bills. In the first, I don’t take out any extra cash.

Calculating the return on investment

But then, is a warehouse really free? Are my machines, my factory free? Certainly not ! They become free once the investment is made. But before that, the Supply Chain Manager must know if it is worth it – the cost – to pay cash to acquire them. This is called the calculation of the profitability of investments (capital budgeting). Financiers and mathematicians worked to perfect calculation techniques. They are all based on cash and the comparison of scenarios. You cannot choose an investment without comparing scenarios, just as you cannot choose a work regime for your factory without comparing the differences in disbursement and cash recording between scenarios.

Reasoning in Net Present Value of the cash flows generated

Choosing an investment or selecting the right investment must be done by the technique of calculating the NPV (Net Present Value). No it’s not a joke! This technique consists of comparing the differences in the timing of cash inflows and outflows between scenarios, and bringing them back to today’s value. We talk about the Net Present Value of one scenario compared to the other. It must be positive to justify an investment. It takes into account the cash coming in and the cash going out. Cash, only cash. It also takes into account the profitability requested by the shareholder. A euro disbursed today does not have the same value as a euro next year. One euro next year is only worth 90 cents today if my shareholder asks me for 10% profitability. So if I spend 950K€ today and recover 1M€ tomorrow, it is not profitable. I lost 50K€. This is why it is called Present Value or Present Value. And since taxes (negative cash flow) and tax savings provided by accounting depreciation (positive cash flow) must also be taken into account to obtain a net result, we speak of the Net Present Value of the cash flows generated. And the “pay-back” is the time it takes for my cash out to balance my cash in in the updated view. It is not the simple division of my investment by what it brings me every year in savings. This division does not take into account the shareholder’s desire for profitability, nor inflation, which must also be taken into account.

Example of an industrial company closing the wrong factory

A few years ago we worked for an industrial company. It had several factories around the world. One of these factories was a joint venture with a Japanese industrial group. The French plant, benefiting from recent investments, could have performed very well by reorganizing the management of its flows to synchronize them (via Onde Verte, Diagma’s specialty). We preferred to close it in favor of an old-fashioned Chinese factory, with mediocre working conditions, because it was very responsive and less expensive in full costs. We have also kept the South American factory, super technological, joint venture, close to the raw materials exploited in ecologically dangerous conditions. Indeed, although very expensive in terms of transport costs (the cash to be paid actually being higher than the variable cost to be paid by staying in France), whether it was charged or not, the partner had to be paid each year. A bit like when you go to the cinema, and you stay in front of a bad movie because you have paid. Double trouble! In fact, we paid, too bad, it’s too late, the past is over. Disregard this since the cost of this factory is the same in all scenarios. The company made the wrong choice, which cost it dearly. A jewel of French industry, alas!

Another company does not maximize its manufactured product mix

Another example concerns a company that manufactures 4 families of products, A, B, C, D from a single raw material. This company considers that B, C and D are co-products of A. Only B is systematically produced with A. We can also manufacture C or D, but not at the same time. The company has therefore decided to allocate all factory costs to families A and B. These 2 families will absorb the production costs. Thus, it is necessary to produce as much as possible of B at the same time as of A to absorb the costs. When the other families are produced, they bring a bonus since they cost nothing to manufacture. Unfortunately, product B significantly limits the quantities that can be produced of C or D. Aggravating circumstance, product B has a selling price 3 times lower than the others. We can sell a lot of it, but for the same quantity of raw material, it brings in little. It is therefore in our interest, if we reason in cash, to throw it away (which will not change the cash spent) to produce more and sell more families C and D. We seek to maximize turnover, the cash in, rather than minimizing costs, which are essentially fixed.

Compare the cash flow of various scenarios to make the right decisions

We see in all these examples that the Supply Chain Manager must focus on cash flow and the comparison of scenarios when making decisions. And this is how the company must, little by little, be led to manage flows: by comparing cash inflows and outflows between scenarios.

Jean-Patrice Netter
President of DIAGMA

Jean-Patrice Netter, President of DIAGMA