SCM Strategy: Don’t press wrong buttons to reduce Cash to Cash Cycle

Cash to Cash cycle is the one of the most important metrics to measure business performance and also it tells a CEO about how lean its business is. There is immense pressure on the supply chain professionals to reduce the cash to cash cycle and free up working capital to increase the ROI from business. This sometimes, forces them to take wrong panicky measures to reduce this cycle and in the long run, the business gets to the see the negative side effects of the strategy. I wanted to focus in this article about what actions we should take to reduce the cash to cash cycle and what actions should be avoided.

Most of us know that cash to cash cycle is the period in which the portion of working capital (cash) is out of reach of your business. It means that shorter the cycle, leaner your business is. In other words, cash to cash cycle depends on three major factors:

• Outstanding invoices from your customers
• Capital deployed in inventory
• Outstanding payable invoices of suppliers

Putting this in a formula, it will become as:

Cash to Cash Cycle = Period sales outstanding + Period cash is locked as inventory – Period cash is free as business did not pay its invoices

Period in above formula will remain constant for all three variables and normally it is taken as one day.

The most obvious targets from above formula, for reducing the cash to cash cycle are reducing the number of days of customer outstanding, reducing inventory and increasing the number of days, we take to pay up suppliers and rightly so but the way of doing it, is often wrong. Some organizations will start pressurizing suppliers to accept more than 60 days or even 90 days as payment terms to shorten their C2C cycle and this can be dangerous as your suppliers viability is at stake and either you will see a growing rift between yours and supplier organization, reduction in quality, increase of prices whenever they get chance or suppliers moving away from you altogether.

Another mistake we normally do is to start reducing inventory indiscreetly instead of looking at the ways how the inventory can be moved faster by offering discounts on slow moving items, by improving the lead times of inventory receipt at your warehouse or by working with suppliers for moving towards just in time inventory etc. The reduction in inventory though will give you shorter C2C cycle but can also trigger multiple stock outs bringing down business and customer satisfaction.

The third mistake is little difficult to achieve as it includes the customer but we see this also often. The organizations not only stop offering credit to customers but also start asking about advance payments in certain cases. No need to say, what impact, this will have on your customers and will they not move away from you given the first available opportunity. Instead, we should focus on improving speed invoice issue and processing, improve response to disputed bills, reduce invoicing errors and reduce the incidents of bad debts. These internal measures will make sure that you are not playing a one sided pressure game and not making your partners pay for your operations. Instead you truly will achieve lean operations and reduction in cash to cash cycle will automatically come as a byproduct.

Now, please don’t ask me, what do I do if my cash to cash cycle is zero (yes, it can achieved) and I have excess cash. Go acquire a target company or pay bonus to your employees or start a new product or service range etc. – the list is endless and fruitful.

Free up your working capital by increasing global inventory visibility

I do not have to sell the idea of reducting your working capital as there is not even a single organization that does not want to freeup its working capital so that it can be invested in expanding, modernizing or improving its operations in many ways. I want to share one of the effective ways of not only reducing the working capital but also to improve some other critical business metrics. 

In case, an organization has multiple warehouses (and in multiple continents) due to reasons like faster delivery to customer, savings in shipping costs or low cost local sourcing of components/products then it makes good sense to improve on its capabilities in having visibility of inventory while booking a sales order from a customer. It means, that if an organization has the ability to see in real time, which all of its warehouses has the item available required by the customer then it makes easier to make decision on which warehouse should be used to ship the material so that following metrics can be improved:

• Reduction in  slow moving inventory - If a warehouse holds large stock of slow moving items and a "closer to customer" warehouse also have that item but in bare minimum quanttities, even then, one might want to select the warehouse which is far but provides the opportunity to reduce that slow moving item in bigger numbers
• Reduction in item obsolescence - Some items have shelf life and having visibility on their stock in different warehouses provides us the opportunity to ship the soon expiring items first
• Higher ontime delivery - Again, if a nearer (and default) warehouse for a customer, does not have the item and will have to procure it to ship to the customer, then visibility of stock in other warehouses provides the opportunity to check out if the item is available elsewhere and can be shipped to the customer cost effectively without compromising on on time delivery
• Higher Customer Satisfaction - This business metric will get a boost from the above metric (high ontime delivery) and we are sure to see much improved confidence in our organization when their orders are reaching on time more frequently
• Higher Inventory Turns - The most obvious and effective benefit of global inventory visibility is its capability to improve the overall inventory turns by provding us the opportunity to optimize stock at all warehouses and hence improving annual inventory turns which results in freeing up of working capital

So, keep an eye on a solution in your Supply Chain that provides you the capability to improve your real time visibility to global warehouses so that you can reap the benefits that it brings.

Discussion: What key metrics to attack, to optimize your inventory?

Traditionally, it has been understood that to improve customer service you have to have higher level of inventory. This ensures that orders are filled quickly and accurately. But it also means that the value of your inventory is high, to the detriment of your organization as it ties up cash and warehouse space that could be put to other and better uses. So we need to optimize inventory in a way that does not impact your service levels and yet frees up cash. There are multiple ways to achieve this and each one of us uses one or other ways to optimize our inventory and yet keep the service levels at high levels. I used social media to gather inputs from industry experts on this subject so that we can uncover the metrics that they are

Inventory Optimization: Where to Focus and How?

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Traditionally, it has been understood that to improve customer service you have to have high levels of inventory. This ensures that orders are filled quickly. But it also means that the value of your inventory is high, to the detriment of your organization as it ties up cash and warehouse space that could be put to other and better uses. Managing inventory can be a daunting task for an enterprise with tens of thousands of products that are located in hundreds of locations. The fact that different functions in the organizations have different objectives and often conflict of departmental or sub-business interest adds another hurdle in inventory reduction.

Typically, the sales & service head of the organization will want the order fill rate, customer service and the order fulfillment lead time to be the best. This person will never want to lose any sales or for that matter do not want to see customer satisfaction going down just because the organization either could not supply the new product or the service parts at right time. This department will want that the organization should:

• Keep enough inventory of all product models or variants at multiple locations so that there are no stock outs, minimum transit time for product shipping and no unit down (production stopped) cases for their customers
• Make manufacturing operations flexible enough to respond quickly to changing market demand for a particular product model or variant so that they do not lose sales of a single unit for want of timely supply
• Ensure that the procurement & sourcing functions have quick replenishment efficiency with low supplier lead times or procurement starting at high safety stock levels

All of the above will lead in increase of inventory and will contribute towards what I call as reverse optimization of inventory.

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Let us see now, what will a manufacturing leader want to make sure, so that the success KPIs for the shop-floor are met and the production team increase production efficiency in terms of producing more units in same time, less over time is required and rejection rates are at the lowest ebb. Simple logic suggests that if the same model or variant is produced for a longer time, the jigs and fixtures will not need to be changed; the operations sequence will remain same and transition between production shifts will take minimum time – all this contributes to better productivity or efficiency in the production line but at the same time, producing not based on demand but to stock so that the production efficiency targets are achieved, will inflate the inventory.

Both the above examples are not bad practices and in-fact these are seen as best practices in industry if we see them in isolation, as they deliver value for independent business functions. The negative impact of these practices is that they make the job of the inventory owner more difficult.

The inventory owner’s main objective is to reduce the inventory to the lowest possible level so that more working capital is available for operations. This objective, as we saw above, conflicts with the manufacturing and sales/service business function’s objectives and this is the reason why inventory optimization and not reduction is the activity where we should focus on.

If the inventory owner decides to reduce the inventory in isolation based on some fuzzy logic which might be the best, keeping in mind different demand variations and patterns, it is highly likely that it will hit the objectives of other business functions negatively and the whole purpose will be lost. But, if the focus is inventory optimization in such a way that there is a trade-off between service levels and inventory level, production efficiency and order fill rate and so on, only then we can it a real win-win situation where organization as a whole, can gain substantially.

It is not that compromise between different business functions is the only way to optimize inventory. There are more factors that drive this initiative and can substantially impact the result. These are:

• Forecast accuracy – More is the accuracy of forecast, better will be inventory planning vis-à-vis market demand. So with less inventory, you will be able to maintain or increase your order fill rate and service levels
• Supply Chain Visibility – If, it is known to all stakeholders that the required material is in the way and will reach in a day or two, it will help in correct promises to the customer and while customer satisfaction will improve with better delivery performance, the inventory will also get optimized as no unnecessary panic buying will happen for emergency orders. Also, supply chain visibility means visibility of goods in the distribution centers or warehouses and other channels so that fastest and most economical way of shipping can be achieved which will again make sure that double inventory is not being purchased for a product that is available in some other warehouse or distribution center
• Supplier Lead Times – Less time to get supplies from supplier means faster replenishment and less time an inventory will stay in the warehouse. This also means that you will need to keep lower safety stock levels and thus overall inventory will be reduced
• Inventory turns – More is the number of times you sell and replenish your inventory in a given period, more will be available working capital and less will be obsolescence. The inventory carrying cost will reduce as a result, which is a key KPI of Inventory optimization
• Inter warehouse transfer – An analysis of inventory movement across warehouses might tell you that there is some inventory lying in couple of the warehouses for long with no demand for them in last 6 months and very low forecast in next 6 months. If this process can be automated to do the analysis and transfer the slow moving or dead inventory from one warehouse to another where it can be consumed faster, the inventory can be optimized considerably
• Field returns process – Lot of field engineers get the inventory (mostly service parts) issued from warehouse to service customer(s) and at least 40% of the time all issued parts are not consumed at the location. These parts are either kept at customer location or in the service van of the field engineer and either becomes obsolete/expire or are not visible at all for supplying against other demands. This results in duplicate buying and hence more inventory than required. A proper process around this, can not only ensure lesser inventory but will also reduce scrap (obsolete) inventory
• Accuracy in Bills of Material – Incorrect bills of material often increase inventory. For example, after a design change a casing will need only 5 bolts instead of 7 earlier but since the BOM was not changed after design change was approved and implemented, it still shows 7 bolts and every-time 2 extra bolts are getting issued as part of the back-flush which results in excess unused inventory in WIP. The production in-charge will return the excess parts to inventory as and when the priorities allow and till that time, more procurement of same part will be done based on the available visibility which results in inflated inventory. Correcting the bills of material will help in controlling this inflation of inventory
• Lot Sizes Review – Since the safety stock, demand and lead times that impact the inventory level requirements, keep on changing, a regular review of the lot sizes of items for procurement will always help in making sure that the procurement is as per the finalized strategy of stocking and will in inventory optimization
• Inventory accuracy – Lastly, if we are optimizing something but do not know the exact picture, then it is obvious that where will we reach. We need to make sure that the physical inventory matches the inventory in system as all the calculations on service levels, order fill rate etc. will be based on it only.
  

So, we saw that while it is important to iron out the conflicting interests between different business functions by discussing and finalizing the service levels, production efficiency and other KPIs along-with the inventory levels so that all business functions work as a team on one strategy and with same objectives in mind, there are other ways too that can help you in achieving optimized inventory without impacting other functions operations.

Key Constituents of Supply Chain Performance Measurement

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I got multiple questions/comments in my mailbox and post related to my Supply Chain Metrics post where I talked about some metrics that we generally talk about, to improve the Supply Chain efficiency and to measure its maturity levels. One of the comments from a reader were, "...these metrics are fine but how will you relate these metrics like perfect order and cash to cash cycle time with real measurement of Supply Chain maturity level? Are they tied with  higher level attributes in the supply demand train and if yes, then what are those attributes. Lastly, how exactly we should proceed scientifically to do a status check on our Supply Chain?".

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I did not answer this question in mail and want to take a shot at it in this post. Though, I would not like to dwell into how can we scientifically do a status check of Supply Chain as there are mutliple ways to do it and in my view, no way is a panacea for all organizational SCM issues. This has to be a custom approach looking at the KPIs first and then tying them to multiple dynamic org specific factors. To learn about this, I will suggest reading book called Strategic Supply Chain Management which is the authoritative, all-in-one reference and guidebook for creating value and competitive advantage for each core supply chain process: plan, source, make, deliver, and return.

Coming to the broad attributes which define the performance of a supply chain, as defined in the SCOR (Supply Chain Operations Reference) model, these are:

• Supply Chain Reliability - This is the performance of the supply chain in delivering: the correct product, to the correct place and customer, at the correct time, in the correct condition and packaging, and with the correct quantity and documentation. The key metrics that measure reliability are:

1. Delivery Performance
2. Fill Rates
3. Perfect Order Fulfillment

I will not talk about these metrics in details as these were explained in earlier post.

• The next one is Supply Chain Responsiveness - It is the speed at which a supply chain provides products to the customer.  This attribute is totally govered by Order Fulfillment Lead Times only.

• Supply Chain Flexibility - Flexibility is the agility of a supply chain in responding to marketplace changes to gain or maintain competitive advantage. The key mtrics that we need to measure here, are: Supply Chain Reponse Time and Production Flexibility.

• Supply Chain Costs - These are the costs associated with operating the complete supply chain. These costs include metrics like cost of goods sold (COGS), inventory carrying costs, value added productivity and warranty and returns costs (including their processing costs). This SCM attribute is one of the biggest ones and need to be further broken into multiple level2 metrics to make sure we do not miss on any of the costs.

• Supply Chain Asset Management Efficiency - Finally, the effectiveness of an organization in managing assets to support demand satisfaction. This includes the management of all assets: fixed and working capital. Metrics like Cash to Cash Cycle Time, Inventory days of supply and assets (inventory) turns per annum are key to measure this attribute of supply chain management.

I hope, I am able to answer atleast the first part of his question and we saw that all those SCM Metrics that we discussed earlier is tied to one step higher attributes of SCM, which are the direct inputs to calculation of Supply Chain Performance. All these attributes are part of balanced scorecards that have the capability to convert the analytical problem to a numberical problem so that the numerical problem can be resolved fast (We are always good in fixing numbers). After the numerical problem is fixed with a numerical solution, it can be again converted to analytical solution and this process is used in multiple organizations to fix even the most complex of supply chains.

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Supply Chain Metrics

We often ask this to the experts and sometimes remain silent in a meeting just because we do not know the exact definition of the acronyms used in the business and does not want to be seen as idiots among the elite. These acronyms are in almost business areas and since this blog is focused on few areas like SCM, ERP and Logistics - I thought of sharing with the readers some of the definitions that will help us understanding the discussions better and the meetings will have more ideas generated which were buried just because the idea man was not exactly sure. Some of them are:

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Perfect Order: An order that is complete, on time, accurate and in perfect condition. The conditions that prevent a Perfect Order are:

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1) Orders not delivered on time due to

• Stock Out or Manufacturing/Procurement Delay
• Late Shipment
• In transit or delivery delays

2) Order not meeting meeting requirements due to:

• Inaccurate shipment
• Poor quality of finished goods
• Damage to finished goods in transit

Forecast Accuracy: It is the difference between forecast and actual demand. This is also the inverse of the mean absolute percent error (MAPE) between forecast and actual demand

Cash to Cash cycle time: The length of time between when an organization spends money to buy raw material to the time money flows back into the company from its customers. This generally includes the metrics like:

• Ship to Customer Delivery - Time taken from shipment of finished goods from company warehouse to delivery at customer's address
• Raw material receipt to payment - Time from receipt of raw material to payment to supplier. This is called Days payable outstanding or DPO
• Inventory Days - Average days of inventory on hand
• Days Sales Outstanding - Measurement of the average collection period from invoicing to cash receipt

Supply Chain Management Cost - This is a general cost that have multiple factors like:

• Direct purchasing operating cost
• Manufacturing operating cost
• Transportation Cost
• Warehouse/Distribution center operating cost
• Inventory holding cost
• Customer service operating cost etc.

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