1 March 2006 Guy Dunkerley
Supply chain financial optimisation could save you millions, explains Guy Dunkerley, Research Director, AMR research.
Supply chain and finance are linked at every level - from tax planning and supply network planning through to financial transactions that affect supply chain transactions. There is a growing best practice that links and optimises both functions together, allowing for tax-optimised supply chains, profit-based supply chain decision-making and efficient execution.
The benefits from end to end are enormous; conversely, failure to identify the linkages exposes companies to large compliance risks. For many, the annual tax return is a sufficient interaction with the intricacies of tax law, and our personal financial control barely extends to balancing our chequebooks.
However, this thinking extended to the supply chain is dangerous; as the supply chain function increasingly defines the operational competence of an organisation, not knowing how tax impacts on your operations, or how to account for the supply chain in real time will cost you money.
GLOBALISATION: A CHANGING TAX LANDSCAPE
Globalisation means that governments in Western Europe must find new sources of revenue and provide new incentives to ensure balanced budgets and competitiveness for the future. Companies and the managers within them must rise to meet the threats and opportunities that this change represents, and the impact of taxes, especially in supply chains, is pervasive.
A CEO making decisions on where to locate manufacturing or a clerk deciding on which stocking location to satisfy an order from are both making de facto tax decisions alongside their supply chain decisions.
If the tax landscape is changing, so is the accounting one. Traditional accounting approaches (which are still being taught for accounting qualifications) stress the importance of manufacturing cost accounting based on the local manufacturing model.
However, in the distributor economy, it is transport, warehousing activity and the cost of inventory that drive cost and profitability. Many of these drivers do not respect the typical presentation of financial results: for example, transport, an increasingly important element of spend, can be found in raw materials, as a general ledger entry and as a charge to customers, and vary wildly according to mix and volume.
Equally, inventory is growing in importance but is rarely understood in relation to the customers or suppliers who cause it. Thus, there is a developing blind spot in trying to establish how much it costs to serve specific customers.
THE SUPPLY CHAIN ACCOUNTING GAP
At a third level, the distinction between financial transactions and supply chain transactions is becoming both increasingly important and blurred. A failed letter of credit (which occurs in more than 50% of instances) is not only a financial event, but also a supply chain event, since goods will stop moving until the letter of credit is resolved.
Leading companies are beginning to define the perfect order performance in terms of 'on time, in full', with no invoice error. In a world characterised by multiple trading partners (logistics providers, sub-contractors, outsourced partners), the transactional burden is growing both in volume and complexity.
Figure 2 illustrates the relationship at the three levels. The most important thing to underline is the shared interest at each level. Finance directors and supply chain directors have needs that make them co-dependent. For the former, profit maximisation, reliability of forecasting, speed of reporting, efficient transactions, tax minimisation and process execution are paramount. Supply chain directors can make a direct contribution to these issues, while at the same time needing the analysis and output of the accounting process. Moreover, both have an interest in compliance.
The key issues for the finance department are:
- Supply chain planning: is the decision-making on where to locate activity, risk taking, and intellectual property within the supply chain being done in a tax-advantageous manner, or are you exposing the company to tax risks as you make your choices?
- Do you know who your most profitable and unprofitable customers are, and can you accurately predict the consequences of your shorter-term supply chain actions in terms of the company's monthly accounts?
- Is your sales and operations planning process linked to accounts?
- How much accounting time is taken up on invoice queries and disputes resolution, and how many times do your production lines stop for goods held up in customs, or suppliers who have you on credit hold?
- Can your organisation handle the increase in transactions as trade grows?
HYPERBOLE OR REALITY?
Supply chain financial optimisation is a proven source of large and quick returns. Paybacks on financial integration through focus on tax, customs, and decision support are significant, and for this reason they are not readily publicised by individual companies. The following are a collection of benefits estimated from our research:
- Potential to reduce corporate tax rates by 40%
- Inventory savings of over 30%
- Pre-tax profit improvements of 5%, driven by better decision-making
- Improved service
There is, overall, a strong agreement on the magnitude of the benefits. It is also fair to say that the benefits can be difficult to quantify where the businesses are growing or changing for other reasons. Only 10% to 15% of companies have begun to derive returns from financial supply chain management. Our research shows that the vast majority of companies slot into one of these three stages.
Stage 1. Supply chains are run without consideration to tax and other financial linkages. Taxation and customs are seen as compliance issues where medium- and short-term execution is mainly manual and is made without reference to taxation and other accounting / regulatory issues. Management tools are based around node optimisation, and reporting is based on traditional accounts formats with little visibility of true cost / profit. Financial flows are predominantly manual.
Stage 2. Supply chains are planned separately, but the output is checked against basic tax planning to ensure that tax is minimised within the context of the physical network plan. Advanced planning tools come into play, and the reporting picture is enriched with partial views of total cost of ownership / total cost of acquisition, but no real-time decision support. Financial flows include elements of automation.
Stage 3. Tax and logistic costs are modelled together with other business planning processes that have tax implications, for example in the investment in ERP, and the deployment of shared services. Management tools are integrated into full profit to serve capabilities at a decision support level, profit to serve reporting is in place, and automated execution is linked to analytics to identify areas for improvement.
Most companies are still in the first two stages - according to Ernst & Young, less than 25% of companies even consider tax in their supply chain planning - and the use of profit-maximising decision support tools is very limited. However, there are a number of sectors, such as clothing and agricultural products, which have a more developed approach. China's rapid take-over of the clothing market following the lapse of the Multi-Fibre Agreement shows how some companies are adept at switching in response to tariff changes.
A CALL TO ACTION
Supply chain engineers need to become supply chain businessmen and women, and accountants need to understand modern supply chain practice. Cross-train! Don't leave it to chance; build the links.
In a number of areas, such as tax, most companies have not built formal sign-offs into the workflow. Institutionalising these links can save money and limit risk exposure. Never forget the customer, and do not allow the finance tail to wag the supply chain dog: unhappy customers, serviced in a financially tax-efficient way, is not a good result.
Start with the customer in mind and work backwards, weaving the finance logic into the supply chain. The devil is in the detail. Companies that have successfully co-optimised the finance and supply chain functions understand that planning is not enough; you need to invest in advice and technology to ensure alignment between thought and deed.