The Intersections of Working Capital and Procurement Strategy (Part 1)

At the SIG Global Sourcing Summit, I had the chance to listen to duck into the very end of a presentation on tying procurement/supplier strategy to working capital management. Titled "Total Cost of Ownership With a Working Capital Twist," the content in this breakout session did a great job on both foundational and advanced levels as means of informing how companies can tactically unite procurement and finance objectives. Presented by Linda Behan of Nuance and Geoff Peters of Archstone Consulting, the material should be standard reading for procurement and supply chain professionals looking to integrate their supplier management strategies with broader corporate objectives. As a simple definition, working capital is so critical to procurement and the rest of the business because it "measures the time between outlay of cash and cash recovery."

Behan and Peters began by providing a simple schematic to help attendees understand what the heck working capital is about (a simple definition: it is the "life-blood flowing through the operation"). To wit, working capital enables companies to "buy raw materials, equipment and services" then convert said inputs into "work in process" and ultimately "finished goods," which can then be sold either as products or services to customers. Staying on the life-blood analogy, the goal through this entire cycle should be to "keep the cash required to a minimum without causing a heart attack." As a quick primer for those who may just be familiar with part of the working capital equation, the three major drivers are: DSOs (days sales outstanding), DIOs (days inventory outstanding) and days payables outstanding (DPOs). Specifically, "A/R and inventory consume capital; A/P releases capital through terms given by suppliers that finance company capital." The equation, for those who want to distill working capital down to its essence, is: "DSO + DIO – DPO = total working capital."

How can procurement organizations impact working capital in the field? Behan and Peters shared some of the following examples: "A buyer (at an industrial manufacturer) bought a consignment of washers at a price that was 60% below market rates...yet unfortunately that meant the company found itself with 74 years worth of stock." Or take another example: "A low-volume user of steel cylinders were ordering in a quantity suggested by the supplier based on a six-month delivery schedule. The result not only was the tying up of unnecessary cash but the fact many cylinders were out of warranty before they were actually used in an end-product, resulting in additional recertification costs."

Stay tuned as we investigate suggestions that Behan and Peters make for procurement and supply chain organizations to better factor working capital decisions into sourcing and supplier management activities.

Jason Busch

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