In this week’s ‘Supply Chain Talk’, Arkieva CEO Harpal Singh discusses how to identify inventory buffer factors to help control working capital fluctuations.
According to REL, a division of The Hackett Group and CFO Magazine, over 1000 U.S. companies surveyed in 2016 saw working capital performance deteriorate. In fact, the cash conversion cycle performance declined by 2.4 days or 7%, from the prior year according to their report.
The more alarming result of the study was that these companies have over $4.86 trillion in debt. It is evident that some of the tied-up cash can be freed up by improving operations in collections, payables, and inventory management.[Read Previous: Supply Chain Talk: Do You Have a Supply Chain Knowledge Repository?]
Going back in time to 2009, businesses focused on cash and reduced inventories to minimize the need for credit. Unfortunately, many of these improvements were short term, and the need for working capital increased as companies began to focus on sales and profits. This, however, didn’t change the fact that inventory buffers due to the inability or flexibility to immediately respond to demand changes existed.
Fluctuations in inventory are caused by the buildup and drawdown of buffers. If you had the flexibility to respond to demand immediately, clearly no buffers would be needed, and no inventory would be required.
This is the “pot of gold at the end of the rainbow” for practitioners of lean manufacturing.
Addressing Working Capital Tie-ups by Identifying Inventory Buffer Factors
For companies with inventory buffers that tie up working capital, there is the need to understand the underlying reasons or factors and eliminate unnecessary buffers when possible. The inventory buffer factors include material aggregation, inherent uncertainty, and inefficiency.[Read Also: Supply Chain Talk: Using Excel for Planning – 4 Telltale Signs That You’ve Pushed Excel to The Limits ]
If you are shipping in truckloads or ordering in railcar loads for financial reasons, then you are aggregating material within the supply chain and creating buffers. The reality is that no supply chain can operate efficiently without some of these buffers. Simply transferring the responsibility of the material buffer to a supplier does not increase efficiency; it merely transfers the financial responsibility.
If the business is required to respond to customers faster than the internal supply chain allows, then buffers need to be created to provide the required service level because there is no practical way to account for all uncertainty in the market.
The buffers required to support material aggregation and uncertainty are magnified if the supply chain process is operating inefficiently. Many companies attempt to account for uncertainty in the market by imposing a rigid planning process. While it may feel good to declare that all schedules are “frozen” for a month to try to avoid unscheduled changes, it will likely increase the size of the buffers needed. It is for this reason that the S&OP plan needs constant monitoring. The S&OP process is a mechanism to help tactical execution, rather than a process to inhibit flexibility. Tactical changes made within the plan to react to daily fluctuations should be the norm rather than the exception.[Related: Supply Chain Talk: Integrating Finance and Operations – What You Should Know ]
The lack of information flow is another big reason why buffers are created. If the transport group does not know that the plant is going to run slower next month, it will probably schedule the normal number of railcars which in turn would result in a surplus of empty cars at the plant. Visibility and collaborative planning can go a long way towards reducing these unnecessary buffers.
Fewer buffers mean fewer fluctuations of working capital. While some of these buffers are necessary for the supply chain to function, they are dwarfed by the unnecessary buffers caused by the lack of information and broken processes found in many supply chains.
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