How Financially Articulate Are You? (Part 2)

Gerard Chick, chief knowledge officer at Optimum Procurement Group concludes his look at what CPOs need to understand about how operational investments affect margins, turnover and cash flow. See Part 1 here.

Do you and your team ...

… get hung up hold on holding costs?

Holding costs are a major element of supply management, since businesses must determine how much of a product to keep in stock. This represents an opportunity cost, as the presence of the goods means that they are not being sold while that money could be deployed elsewhere. Holding costs also include the costs of goods being damaged or spoiled over time and general costs, such as space and labour.

Many procurement professionals are introduced to this concept when they are taught how to calculate economic quantity orders. This is essential in setting inventory policies because the holding cost is frequently used to calculate the savings yielded by an inventory reduction. However, you need to be careful as this can lead an underestimation of the value of an inventory reduction.

… understand the relevance of cash flow?

A cash flow is a revenue or expense stream that changes a cash account over a given period.  Cash inflows usually arise from one of three activities: financing, operations or investing. Cash outflows result from expenses or investments.

Finance departments will issue an accounting report called the "statement of cash flows," which reflects the amount of cash generated and used by a company in a given period. It is calculated by adding noncash charges (such as depreciation) to net income after taxes. Cash flow can be attributed to a specific project, or to a business as a whole for example as an indication of the financial strength of the business.

Determining which cash flows are important to you (the CPO) can be difficult. For example if you were looking at the impact of discounted cash flow (DFC), you might want to think about what should be included in your spreadsheet and where given its impact on your activities, e.g the cost of transportation and delivery or make-v-buy decisions.

… supply management’s influence on working capital?

Working capital* is a measure of the business’ efficiency and its short-term financial health. The working capital ratio indicates whether a company has enough assets to cover its short-term debt. CPOs have a key role to play in reducing working capital because they are instrumental in controlling inventory levels, but more particularly they directly impact two key components of working capital: receivables from customers and payables to suppliers.

Today’s CPO is expected to make key decisions about where to invest much of the capital provided to the business by its investors, they must be able to work closely with the CFO. It is imperative they have a well-developed knowledge of the world of accounting and finance.

*Working Capital = Current Assets – Current Liabilities



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