How Financially Articulate Are You? (Part 1)

We are delighted to publish this informative insight from Gerard Chick, chief knowledge officer, Optimum Procurement Group, a leading procurement outsourcing and consulting company.

Shareholders and CEOs are interested in profit. In fact shareholders expect the businesses they invest in to make intelligent investments in operational assets, and it just so happens that most of these assets happen to reside on the supply side! It is therefore incumbent on supply management professionals to be able not only to work with other senior executives to make these intelligent investments but to be cognisant of how operational investments affect margins, turnover, and, ultimately, cash flow.

The involvement of CPOs in discussions with other CXOs about supply chain finance is becoming the norm. But do CPOs and other supply management professionals have the lucidity and pecuniary ‘nous’ to be able to articulate their grasp of financial concepts amongst their peers?

Do you and your team ...

... appreciate the financial impact of your activities?

CFOs see corporate world through two key financial reports: the balance sheet and the income statement. Therefore CPOs and their teams have to make the connection between these statements and their world too if they are to communicate effectively with CFOs.

The balance sheet gives a snapshot of a company’s assets, liabilities, and shareholders’ equity, including inventory, accounts receivable, and accounts payable, while the income statement provides a summary of the company’s revenues and costs over a defined period of time.

… know what the DuPont Ratio is and why it matters?

This method of performance measurement was developed by the DuPont Corporation in the 1920s. Using this method, assets are measured at their gross book value rather than net book value in order to produce a higher return on equity (ROE). Employing DuPont analysis reveals that ROE* is affected by three things:

1              Operating efficiency:  (profit margin)
2              Asset use efficiency:   (total asset turnover)
3              Financial leverage:      (the equity multiplier)

CPOs can use this method to their advantage and to broaden supply management’s remit beyond cost reduction. E.g. CPOs might use it to reveal how higher prices (the ‘cost’ of better service delivery) can actually improve margins.

* ROE = Profit Margin (Profit/Sales) * Total Asset Turnover (Sales/Assets) * Equity Multiplier (Assets/Equity)

… recognise that accounts and finance are not ‘rocket science’?

Accountants have to use their discretion over how they classify transactions. Consequently CPOs must be aware of this and on their mettle in situations where flawed classifications can lead to problems.

… know what activity-based costing (ABC) is and what benefits it offers?

Activity-based costing is an accounting method that identifies the activities that a business carries out, and then assigns indirect costs to products (and services). An ABC system recognises the relationship between costs, activities and products, and through this relationship assigns indirect costs to products less arbitrarily than traditional methods such as an “average costing” model.

 

In the second part of his article, Gerard explains all you need to know about holding costs, the relevance of cash flow and supply management’s influence on working capital.

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