Supply Chain Vector [Electronic resources] : Methods for Linking the Execution of Global Business Models With Financial Performance نسخه متنی

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Supply Chain Vector [Electronic resources] : Methods for Linking the Execution of Global Business Models With Financial Performance - نسخه متنی

Daniel L. Gardner

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Days Payable Outstanding: A Closer Look

In this instance, an interpretation based solely on a horizontal comparison of DPO will not reveal much. A one-day increase year to year is not a startling event and may not require further analysis. The real question is why the number is so big to begin with. Whether in Y1 or Y2, DPO is unusually high and when properly interpreted should be a cause for concern. A vertical analysis of the accounts payable breakdown validated the concentration of payables over 90 days, and when a key supplier refused to do business with NikoTech in Y2 due to constant payment problems, another analysis was launched to determine the real impact of DPO on operations.

The reason why NikoTech's DPO is so high can be attributed in part to corporate culture. Since the early days of operations, it had been the practice of management to encourage late payment of bills in order to enhance the cash position of the company. The fact that NikoTech has recently had trouble collecting from its own customers only served to make matters worse, compelling the company to delay payment to suppliers in a corresponding fashion. Although the accounts payable department may have found it good business to stretch payment to suppliers as much as possible, the damage done to supply chains and financial outcomes is actually much greater than any one-dimensional benefit.

Another reason for the high DPO number can be assigned to practices upstream in the operating environment that resurfaced downstream in accounts payable. Reference was made to the plants' practice of receiving goods and rushing them to the production floor without accounting for them in the system. Because there was no record of specific purchase orders or part numbers received, the accounts payable department could not reconcile bills with warehouse receipts. This hole in the process precipitated the rejection or return of invoices, with the effect of extending the payables period until each individual order could be reconciled. Uncovered by the same process mapping exercise conducted during the DOI analysis, the enterprise-wide effect of seemingly isolated practices was becoming more and more clear at NikoTech.

The organizational effect of NikoTech's accounts payable practices begins with a return to the key characteristic of its operations, the low-mix/high-volume model. First mentioned in the discussion on the growth in COGS, a similar comparison can be made between the natural characteristics of a low-mix/high-volume structure and an unusually high DPO.

First, the smaller mix of products translates to fewer parts, which allows for concentration of purchases among select suppliers. Second, the use of common parts further increases the probability of concentrating purchases with key strategic suppliers. The fact that NikoTech has used lean supplier management techniques to rationalize its parts list is admirable. Even with these efforts, however, accounts payable was still out of line with credit terms extended by the suppliers. In addition to these obvious points, a primary characteristic of a "collaborative" relationship between seller and buyer is an open-book approach to costs, as well as conscientious treatment of the payment of bills. Cognizant of all of these points, the first two questions that NikoTech must ask is why it works with 350 suppliers around the world and why it takes an average of 106 days to pay them.

Analysis of these questions uncovers a vicious circle in NikoTech's supply chain, the effect of which infiltrates the balance sheet, income statement and cash flow statement. Since the historic practice of the company had been to sweat its suppliers, commodity managers and buyers over the years found themselves seeking more and more suppliers with which to work. In some cases, vendors got tired of the NikoTech runaround, so the buyers rotated purchases based on how much they owed a given supplier. Although the accounts payable department was delighted with the extended payment plan, the company was oblivious to the shock waves this was causing in product quality, inventory levels, lead times and landed costs.

Because NikoTech was rotating suppliers, the landed cost structure of its products was constantly changing, with different component prices, transportation costs and customs duties acting as the primary drivers of this phenomenon. Again, this point leads the analyst to the study of COGS increases and what the true makeup of that line item was. It may be hard to believe that accounts payable could have an effect on COGS, but that was exactly the case at NikoTech. Also, because suppliers were in different countries and at varying distances, any change would alter delivery dates into the factories and exacerbate the existing lead time problem.

At this point in the discussion, the impact of variations in lead times into a production facility should be well ingrained. Finally, since different suppliers were providing the same parts, quality issues arose in all of the factories, based mainly on the inconsistency among vendors.

A major step toward stabilizing NikoTech's COGS is tied to management changing its accounts payable practices. Basically, management has to change its attitude toward accounts payable by paying down the bills to a reasonable level and rationalizing the list of suppliers with which the company works. The first step in cutting down the number of suppliers revolves around asking the right questions. In this case, the question to ask is why NikoTech deals with so many suppliers, instead of how to staff up in purchasing to handle all of the relationships. Management already knows why there are so many suppliers, so the second question becomes how to rationalize the list.

The versatility of Pareto analysis for business applications has been made clear. Supplier rationalization is no exception to this rule, and a quick Pareto analysis of which suppliers represent the bulk of purchases will narrow management's focus considerably. Once identified, those suppliers need to be paid on an immediate basis. The best gesture that NikoTech could make toward establishing strategic relationships with vendors is to get out of arrears with them. If it is determined that the company wants to continue with those suppliers (and they with NikoTech), a new, open-book approach can be undertaken. If Chapter 3 on lean manufacturing, seeking ways to eliminate the use of purchase orders may be another project worthy of Six Sigma examination. The management team already knows that the number of purchase orders issued during the last year has increased (for all the wrong reasons). If management is capable of getting its forecast in line with demand or, better yet, working closer with customers to determine actual demand, raw materials purchases can be stabilized. In a stable materials management environment, it is much more feasible to move to a delivery program for components as opposed to issuing purchase orders. This would be a huge undertaking for NikoTech's management but is certainly food for thought. This type of project is enterprise-wide in nature and would require a total redesign of major processes, beginning with forecasting. Considering the direction in which NikoTech is heading, perhaps it is time for a bet-the-business project of this magnitude.

There is one last point to be made about DPO management and the cash-to-cash cycle. It should be clear that if NikoTech reduces its DPO without a corresponding reduction in DOI and DRO, the calculation will worsen. Paying suppliers sooner without completing the operating cycle quicker does not help from a velocity perspective. However, if NikoTech can wring improvements out of the operating cycle via the methods discussed thus far, the effect should be that improvement in inventory and accounts receivable management will eclipse a tighter payables policy.

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