Per Gartner, an analyst firm, a financial key performance indicator (KPI) is a leading high-level measure of revenue, expenses, profits, or other financial outcomes, simplified for gathering and review on a weekly, monthly or quarterly basis. This information truly projects the health of the organization, both in the short and long term. As mentioned in my earlier blog,” why finance should push for improved supply chain planning”, it is becoming important for most organizations to integrate supply chain planning and S&OP (sales & operations planning) in their financial planning and budgeting processes to have a better view of all the impactors. These financial KPIs are valuable and are used by all stakeholders to evaluate business success.
The supply chain function (“Supply Chain”) is often the backbone of an organization, touching many areas of the business ranging from procurement (including supplier relationships) to distribution (including logistics relationships). The actions and decisions by the supply chain team have a direct bearing on the bottom line of the organization, and therefore it is important to align Supply Chain goals with the financial goals of the organization.
To understand the impact Supply Chain has on financial KPIs, we first need to understand how and where Supply Chain fits in each of the financial statements. Each of the three financial statements report financial information, which is important not only for shareholders, but also from other stakeholders (suppliers, analyst, management). Below are the three financial statements, which are impacted by supply chain team action and decisions on a daily basis.
- Income statement: Supply Chain impacts almost all the major numbers in this statement either directly or indirectly. The top line of the income statement shows the total revenue, which is calculated by multiplying units and the price per unit.
- Supply chain team decisions regarding lead time and servicing customer orders on a timely basis has a direct impact on the revenue numbers. More and more companies are reviewing the OTIF (“on-time, in-full”), CFR (“case fill rate”), and other version of fill rate on periodic basis, to ensure that customers’ orders are fulfilled on timely basis to avoid customer loss to competitors’ products. Even though all companies take these sets of metrics very seriously, there are companies who have institutionalized policies around this metric and accordingly their vendors are charged financial penalties if they don’t meet certain OTIF / CFR rates.
- Other Supply Chain decision areas pertain to reverse logistics, product quality, and out-of-stock situations that impact customer trust and loyalty. These metrics help the organization to maintain and build long-term relationships with their customers and can be considered as “hygiene” factors.
- Lastly, Supply Chain decisions regarding product costing (including procurement, manufacturing, distribution, and waste) also impact the income statement. Therefore, performing regular Supply Chain KPIs reviews is critical to having a strong income statement.
- Balance Sheet: Similar to the income statement, supply chain decisions and actions have a direct influence on the health of the balance sheet. Inventory quantity (Days of Coverage), quality (aged and obsolescence status) and accuracy (forecasting and manufacturing yield) are key metrics, and truly impact the components of the Balance Sheet. Specifically:
- The supply chain inventory policy impacts working capital ($ and ratio), current assets and current liabilities of the organization.
- Supply chain decisions around supplier relationships and accounts payable also impact the Balance Sheet.
- Statement of Cash and Equity: Lastly, the statement of cash and equity details the quality of cash flow including the sources and consumption (including operations), which is a direct result of Supply Chain decisions.
Even though Supply Chain is mostly considered a cost, implementation of best practices in supply chain management can help reduce operating costs, improve operational efficiencies, improve customer satisfaction, and drive better financial performance. Alignment between Supply Chain and Finance is also helped by the evolution of Finance-led IBP (“Integrated Business Planning”) discussions, which in turn strengthens coordination between the various stages of an IBP process such as (1) alignment of the demand forecast, (2) supply / demand balancing, (3) financial review, and (4) executive review.
As organizations embark and evolve on this path, the focus is shifting from working sequentially in silos to strong real-time collaboration that supports financial performance. The other important evolution, which is truly helping many organizations in this journey is the use of a single-enterprise integrated planning platform. A single-enterprise integrated planning platform can support inter-enterprise data and drive alignment on reporting and planning structures, including scenario-based financial analyses.
In conclusion, better supply chain management through supply chain KPI reviews, can have positive direct and indirect impacts on the financial statements.