This is the third part of a 17-part series on collaboration between finance and procurement, in which we countdown (from least important to most important) the top ways that procurement would like finance’s help to jointly improve spend/supply management. The rankings come from provisional results of a joint Spend Matters and Institute for Supply Management (ISM) research study that is still open to practitioners (participants can win an Apple Watch or one of 10 Spend Matters PRO premium memberships).
Coming in at No. 15 is this message from procurement to finance: “Don't reduce working capital at the expense of supplier health and TCO.” The corporate folks in treasury certainly want to maximize their cash positions and that includes minimizing working capital. That’s understandable. But all metrics have trade-offs, and this is clearly the case with a metric such as days payable outstanding (DPO), where you might want to maximize DPO and hang on to your cash. Obviously, however, this has an impact on suppliers that can’t float you the money for long periods of time, and if they have a higher cost of capital than the buyer, then TCO is not being minimized.
Still, corporate finance can often become a slave to working capital metric benchmarks even though stretching DPO actually seems to negatively correlate with enterprise value as measured by levered free cash flow margin percentage. We wrote about this in “Does Increased DPO Actually Destroy Enterprise Value?” Luckily, early payment discount programs and/or supply chain finance programs can provide value, but they do take time and effort to implement, and more importantly, procurement and finance need to get on the same page regarding how to truly optimize working capital to balance cost, cash and risk. For more on the “financial supply chain,” you can download some research that we conducted with the ISM here. The financing of trade in the supply chain is a big topic that goes far beyond just discounting and factoring programs, and if you are interested in this topic, you should definitely subscribe to the content in our sister publication Trade Financing Matters.
In the next edition of this series, we’ll focus on how finance can help procurement by not trying to use the general ledger as a substitute for a spend data warehouse.