The hidden cost of ignoring your supply chain’s cash flow
Optimizing working capital involves more than just pressuring suppliers for better terms and postponing your payables – or bullying your customers to pay you more quickly. It must be systematic and sustainable if you are going to create a truly resilient supply chain and a competitive advantage.
The cash conversion cycle is only half the story
Most finance teams look at the world through the lens of the cash conversion cycle – the period between when you lay out money to produce a product or service and when you actually get the cash from your customer to pay for it. It’s important. It’s also limited. But it’s easy math, and shortening it feels like the obvious (if simplistic) goal.
If you’re a buyer, the logic goes, you reduce days sales outstanding, increase days payable outstanding, move inventory faster and voilà! – DPO appears as if by magic, ready to fund growth, dividends, and share buybacks. Sounds good?
Sure, in a theoretical sense. In practice, maximising DPO – in the hopes that nobody will notice the huge stack of invoices you’re sitting on to do it – is management arbitrage, not a strategy. It’s a zero-sum game, within your business and across your supply chain. If you’re a buyer and you push your suppliers into a suboptimal DPO position, you may have a net benefit in the short term but the cost feeds back to you in prices because your vendors don’t have a more creative financing solution than just taking it on the chin.
Paying early as a margin strategy
Many companies that have extra cash on hand overlook dynamic discounting. Here’s how it works: Instead of taking 60 or 90 days to pay a supplier, you pay in 10 to 15 days in exchange for a slight discount – perhaps 1 to 2% off the invoice. The supplier receives its cash quicker than expected. You improve your cost of goods sold without having to reprice the underlying contracted services or materials.
For those with varying cash positions, Supplier Finance does something similar in a different way: A finance provider pays the supplier early on the buyer’s behalf, and the buyer then settles with the finance provider on the original due date. The supplier enjoys early liquidity. The buyer maintains its cash reserves. Neither party shoulders the impact of the timing difference independently.
Why does the latter approach matter? Because the former approach (unilaterally extending terms with no enabling mechanism) wreaks havoc on the supplier relationship and creates brittleness in the chain. A supplier already operating on a thin margin suddenly waiting an extra 30 days to be paid is a supplier looking for other customers.
The inventory paradox no one talks about enough
Inventory is the working capital that is probably mismanaged most frequently. Insufficient inventory results in missed sales and subsequent, often permanent revenue loss. Excessive inventory has you store cash rather than product and incurs holding costs plus the risk of obsolescence if demand patterns change.
With the increasing trend toward a “just-in-case” approach to inventory (in stark contrast to the just-in-time concept that was very fashionable just a few years ago), companies are holding even more safety stock across an even wider range of products. As with any just-in-case inventory, the decision typically makes sense in terms of business continuity and ensures access to an optimal range of resources. However, the associated cost of capital is sub-optimal and, since the capital is locked up for longer than would typically be the case with a just-in-time inventory strategy, it requires a more efficient source of funding.
Procure-to-pay efficiency is the foundation
If none of the above functions properly it doesn’t really matter. Late invoices, unauthorized invoices, purchase discrepancies all create bloat within the P2P timeline, inflate your DSO and DPO, and your working capital, above natural strategic levels. This is simply unnecessary friction.
Obviously, cleaning up P2P isn’t the fun stuff but it’s where the magic often happens. Faster invoice processing and predictable payment runs mean suppliers can plan their own cash flows better. Some suppliers trade at slightly depressed margins in exchange for buyers who pay them reliably each month.
Liquidity flows in both directions
The best companies at managing working capital currently are not the ones squeezing the life out of their suppliers – they see supply chain finance as a two-sided issue. The obsession with helping your suppliers be as healthy as possible isn’t just some morality play. Since many of the ways you make your suppliers more robust have the same effect on your relationship with them, it’s also just good business sense.
Suppliers who aren’t cash-stressed are more reliable, more willing to take on risk, and more likely to make the investments necessary to improve their process in your shared interests.
