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A Little Supply Chain Finance 101
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  Newsletter Archives                  Can't View In E-mail? June 2, 2011 - Supply Chain Newsletter

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WESCO Drives Continuous Distribution Center (DC) Improvement with Hands-Free Wearable Terminals

From Traditional Handheld and Truck-Mount Radio Frequency (RF) Terminals to a New Generation of "Wearable" Mobile Wireless Devices

Featuring Larry Mosier, VP of Distribution Centers & Transportation at WESCO, Mike Rusnak, Distribution Center Manager at WESCO, Mark Wheeler, Director of Supply Chain Solutions at Motorola Solutions

Wednesday, June 15, 2011


Goya Transforms its Supply Chain to Enhance Profitable Growth and Service

Learn How Goya Grew from a Small Store-Front Business into The Largest Hispanic-Owned Food and Number-One Latin Brand Company in the United States

Featuring Peter Unanue, Executive Vice President, Goya Foods, Inc, Danny Halim, Vice President, Industry Strategy, JDA Software

Tuesday, June 28, 2011


Building a Better S&OP Plan

New Optimization Techniques Deliver
an Adaptive Supply Chain for
Global Automotive Manufacturers

Featuring Dr. Claude Fornarino, Director, Industry Solutions, IBM ILOG Optimization & Analytical Decision Support Solutions

Wednesday, June 29, 2011

This Week's Supply Chain News Bites
Supply Chain Graphic of the Week: Impact of Inventory Reduction on Share Price

This Week's Supply Chain by the Numbers for June 2, 2011:

Slow Steaming becoming Mainstream; Heinz Looking for 57 Ways to Boost Productivity; China Advantages Shrinking; In Search of Six Million Manufacturing Jobs


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Weekly On-Target Newsletter
June 2, 2010 Edition

Crossdocking, PepsiCo TMS Innovation and more

Holste's Blog: Can Shrinking Warehouse Space Caused by Rapidly Increasing Inventory Levels Put the Squeeze on Productivity?
Top Story: Annual WERC DC Metrics Study Finders Leaders Extending their Lead
Top Story: WERC 2011 Video Review and Comment
Top Story: Medical Device Maker DJO Global Finds Success with Mobile Robotic Picking System

Q: What is supply chain noteworthy about a US-based company called America Chung Nam?
A: Found at the Bottom of the Page

A Little Supply Chain Finance 101

Things really do come in threes, don't they?

Over the past month or so, I have been involved in three separate conversations relative to the inter-related topics of inventory, cash flow, working capital, etc. . One was with with a 3PL provider, one with a manufacturer, and most recently with a software provider.


"Gerry Marsh has convinced me with his proprietary models that reducing inventory and improving cash flows has an positive impact on a company's valuation or stock price beyond just the impact lower inventory carrying costs will have on profits/earnings per share."


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These led me to two observations. First, even though most of us are today about generally aware of these supply chain finance matters than we were say 10 years ago, I would say most supply chain professionals are only modestly knowledgeable at best in terms of the details. Second, even for someone like me that follows this stuff for a living, and who considers himself pretty good (for an amateur) on the financial side of the business, if you don't keep at it you have to sort of re-teach yourself the stuff time and time again to keep it straight.

So I am going to make an attempt here, I hope for the benefit of many. I have tackled this topic before, but not quite in this way.

We're going to start with working capital. Part of the confusion is that the term sounds like it is a good thing - I'd like to have a little more "working capital." But it isn't. Working capital is basically the amount of cash a company has tied up just running the business. The more that is tied up, the less cash is available to do something else with, or the more a company has to borrow to fund its operations.

There are various definitions, but current assets (inventory, accounts receivable) minus current liabilities (accounts payable) is the standard one. So, if you shrink the former by reducing inventory and/or reducing the time it takes to collect money from customers, or increase the latter (accounts payable) by stretching out the time it takes to pay vendors, you will reduce the amount of the company's working capital, and that is a good thing. Dell for awhile famously had negative working capital, having little inventory that it owned (it used a lot of JIT and consignment inventory, and used a make-to-order model) and was paid by credit card customers faster than it paid its vendors.

While inventory levels are the most prominent way the supply chain can affect working capital, it impacts the other two main categories as well; that is, timing of payments to vendors (stretching them out is good for working capital if not exactly fair to suppliers) and having perfect orders to customers so that payment isn't delayed while working out the discrepancies.

But inventory is the main focus here, a key indicator of supply chain excellence, the area where supply meets demand. Where it gets confusing to most of us is that changes in inventory levels impact key financial statements differently.

Let's say a company holds on average $1 billion in inventory. Let's further state that through various initiatives, it is planning to reduce those inventories 10%, or $100 million.

What will happen on the three key corporate financial statements (the balance sheet, income statement, and cash flow statement)?

Inventory levels on the balance sheet would decline by $100 million.

Cash flow on the cash flow statement would also increase by $100 million - a dollar for dollar improvement. This would happen because working capital would be reduced by $100 million. The reduced inventory would move from being tied up in working capital turn into cash.

The trickier thing is what would happen on the income statement. Does having lower inventory improve profitability as well as improving cash flow?

Well, it certainly is assumed to do so for most companies when estimating the payback from various initiatives. For an easy and timely example, when calculating the benefits of low cost country sourcing, the lower unit price obtainable of course has to be balanced with extra costs for transportation, duties, etc., plus the costs of holding additional inventory due to the longer supply chain, more supply uncertainty, etc.

Now, what should that cost of inventory number be? And frankly, I will say that there is the theoretical number and then ultimately the actual number that will eventually show up (or not) on the real future income statement.

Do you know, as an aside, that in the annual state of logistics report from CSCMP (coming in two weeks, by the way), that a key driver of total US logistics costs is the cost of holding inventory - and that can vary significantly from year to year, based primarily on interest rates. In 2009, for example, coming from the 2010 report, inventory carrying costs were down a significant 14.1% from the previous year, partly from lower interest rates, partly from lower overall inventories. That inventory cost decline was an important part of the sharp drop in 2009 in the percent of GDP related to logistics costs.

There are actually several potential ways to calculate the cost of inventory relative to the income statement:

1. What is costs a company to borrow money: right now in the mid-single digits for most firms.

2. The company's "cost of capital": this gets a bit trickier (going into something called weighted average cost of capital, for example), and basically means the return shareholders expect from the company's use of capital. Varies from company to company, but let's say in general it ranges from 8-12%.

3. Inventory carrying costs: interest costs or cost of capital plus all the other costs associated with inventory (storage, handling, obsolescence, insurance, taxes, shrink, etc.). Here, there is huge variation in the numbers companies use. Dr. Stephen Timme of Georgia Tech and FinListics argues persuasively that most companies underestimate true inventory carrying costs (more on this soon). Inventory carrying costs can certainly range well into double digits for many companies. As a note, in the CSCMP state of logistics model, inventory carrying costs for 2009 were calculated at about 19%, but that included all warehouse/distribution costs. But we will use that percent here for this example.

So, back to our example: if the company was pondering moves that would reduce inventories by $100 million, the estimate of what the return from an income/earnings perspective would be is not the $100 million in improved cash flow that would be achieved but instead that $100 million times some number of the CFO's choosing, roughly picking a number from the three categories above. So, we might say $5 million on the low end, and as much as $19 million give or take on the high end (using a 19% inventory carrying cost).

That's the estimate. Would those increased profit dollars really show up on the income statement? That is often the key question, in part because the cost of capital part of inventory carrying costs is not an income statement item.

Still, supply chain financial consultant Gerry Marsh of High-Tech Analyst Group told me this week that "As you correctly point out, this $19 million savings will never be seen in the income statement because only some portion of the carrying costs represent a reduction in operating expense (which goes through the income statement). The capital reduction benefit goes through the cash flow statement. Nevertheless, converting the capital reduction benefit of $100M into an annual benefit by multiplying it by an annual cost of capital figure is not unreasonable."

I will make two other quick points. First, the $100 million in inventory reduction will also improve other ratios of key interest to investors, notably return on assets and return on invested capital. You divide profits by assets and/or capital, and since the denominator in either case is now lower by $100 million, the percentage will improve.

Second, as we have noted before, Gerry Marsh has convinced me with his proprietary models that reducing inventory and improving cash flows has an positive impact on a company's valuation or stock price beyond just the impact lower inventory carrying costs will have on profits/earnings per share. He has demonstrated how the difference in share price for two companies with otherwise similar earnings and growth numbers can be explained by differences in cash flow. See our supply chain graphic of the week nearby for more on this (it's very good).

Another way to look at this same issue is the "economic profit" of a firm, which gets into the whole "economic value add"/EVA model and such, measuring how much capital is required to generate profits, and this comes out somewhat similar to Marsh's view in the end.

I summarize this made up case study in the small table below.


Impact of Reducing Inventory on Company Financials

Financial Area

Financial Statements Affected


Original Average Inventory Level

Balance Sheet

$1 billion

Expected Reduction

Balance Sheet

$100 million (10%)

Impact on Working Capital

Balance Sheet, Cash Flow Statement

Reduction of $100 million

Impact  on Cash Flow

Cash Flow Statement

Increase of $100 million

Impact on Profits/Earnings:

Income Statement

Using Interest Cost Method (e.g., 5%)


$ 5 million (reduction in interest expense)

Using Cost of Capital Method (e.g. 9%)


$5 million (reduction in interest expense), plus possible imputed value of an extra $4 million

Using Inventory Carrying Cost Method (e.g., 19%)


$15 million (interest expense plus operational cost savings) plus possible imputed value of an extra $4 million

Hope this helped - and didn't put too many of you to sleep. Video on this next week.

Do you well understand these types of supply chain issues? Do most supply chain professionals understand them well? Is this kind of information useful? What would you change in what we have presented? Let us know your thoughts at the Feedback button below.


Dan Gilmore


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A mishmash of feedback link, a few on Gilmore's Blog wondering if global supply chains would need to start ordering Geiger counters to protect again irradiated product coming from Japan, some on the Lessons from Dell's Supply Chain Transformation, and one on McKinsey's view of the future supply chain.

Most short and suite - you will find them all below.

Feedback on Geiger Counters for the Supply Chain:


Given our sensitivity to radiation, I would not be surprised that any thing from Japan will be view as suspect for the time being and until the facility over there is "capped". Americans have a great underlying fear of radiation and are quick to avoid it where ever possible. Even to the point of having their granite counter tops tested and removed if there is any sign of radiation. While this fear is present, it is poorly understood and "even made fun of" with a great risk to anyone who tries to sell any thing that could be contaminated.

No on really knows what a safe amount of radiation is and this is the basis of much of this fear. While there is radiation all around us all of the time that we are totally unaware of, once we have a heightened awareness, it does not subside for quite a long time. It would behoove those importing items from Japan to demonstrate a before and after reading of radiation if they can to prove to their customers that it is not an issue.

Ralph Salier-Hellendag
ONEOXY Services Team

Like it or not, this threat is real.

Special customs processes should be initiated for all cartons, boxes, inner packs, and items coming from Japan.

Are there any plans? I don't think I would be musing over this during dinner, ( and as you know, I regard myself as a fun guy).


Mark Shuda

On Dell's Supply Chain Transformationi:


Supply chain segmentation. It's clear that one size doesn't fit all, and at the same time decissions have to be taken in order to not fully segment the whole supply chain. Therefore a unite view on non-core supply chain attributes has to be implemented at the same time of a segmentation exercise, in order to design a effective (segmented) and efficient supply chain.

Although Simchi-Levi methodology can be easier to understand as it is related to real cases (Inditex, Wal-Mart, Dell....) I believe Dr. John Gattorna approach on Supply Chain Segmentation is a more complete approach, with very deep roots on human behaviour (the most important element in any organisation) thefore in my point of view, a conceptually stronger and more feasible to implement in any business environment methodology.

Xavier Farrés
International Supply Chain Consultant


Great summary of Dell's supply chain management breakthroughs. I am sending you a copy of my book "Supply Chain Management: The Real WOW Factor", just published after 32 years with P&G. The book details P&G's consumer-driven supply network, shelf-back supply chain design by customer segment, price-back costing, and customer-centric supply chains. Great to see that Dell is walking the talk.

There is also a part in the book on SCM in developing markets which is getting great reviews.

William D. Peace Jr.

Actually, it was impressive for me to hear about Dell’s transformation in relatively short period of time. I’m a student at Illinois Tech and one of my assignments was on Dell’s supply chain and after watching the video and reading the articles I came to the following question: since Dell segments its supply chain based on customer’s demands, what is it going to do when these demands change, like they did before. How are they planning on moving in sync with the customer? It is a very good but risky strategy, from my point of view, but I am with Dell on this issue.

Vadim Vorobyov


On McKinsey's SKU Segmentatiion Graphic:


A company's competitive strategy differs depending on where it is situated. Multi-nationals (MNCs) with operations in Asia typically compete on cost and hence strive towards operational excellence. With the luxury of simply relocating to a cheaper location (as in the case of Motorola in Singapore and Malaysia), it only shows that cost is still a major contributory factor to strategic decisions. Having said that, we are beginning to see SMEs accept a higher cost model in preparation for their changing consumer landscape. SMEs realise that their competitive edge differs from that of larger companies and are capitalising on this fact through the movement on the mechanisation/systemisation matrix.

KOH Niak Wu, Ph.D.

Singapore Institute of Manufacturing Technology


Q: What is supply chain noteworthy about a company called US-based company called America Chung Nam?
A: America Chung Nam, the sister company and supplier of wastepaper to China’s largest containerboard manufacturer, was the largest American exporter of containers by volume in 2010 for the 10th year in a row, according to the latest Journal of Commerce estimates.
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