It is important for both supply chain and financial professionals to consider the impact of mitigation and risk management efforts on company financial performance. Projected demand for upcoming periods must be planned for, and we look to balance supply and demand using demand forecasts and collaborative planning forums like S&OP or IBP.
In S&OP/IBP, business considerations and issues will be brought to the table that represent risks to the organization from operational and financial perspective. Strategies and mitigating actions are essential and should be chosen considering the expected financial consequences for the company.
The finance function is a key stakeholder in such forums as they supply information and financial analytics that can be used to ensure that all operations can be financed effectively and that decisions made contribute to a competitive ROI for the business. They are an essential part of the team in estimating and evaluating the alternative risk management alternatives available for risk mitigation strategy actions. Finance and supply chain functions have a shared responsibility for supporting the S&P/IBF processes.
Variation in demand as well as supply chain considerations can contribute to the need for safety stock, for example. It may require higher inventory and more points of distribution for the achievement of the desired level of customer service. It may require supply chain adjustments and mitigation that effect the business economics and business risks. Mitigations most often have financial effects – positive and negative – on the company. This kind of risk mitigation can be expensive.
Demand and sales forecasts are the platforms from which supply planning is launched. We are basing the supply chain structure, plans, and operations on these demand forecasts that then affect revenue and operating profit. Supply chains have a myriad individual supply links that interact with other links in the chain and with other supply chains. There are a host of supply chain risks to be hedged, mitigated, managed, and financially evaluated.
There are risks related to:
Disruptions: Supplier bankruptcies, natural disasters, and labor disputes.
Delays: Inflexible supply sources, capacity utilization, border crossings, customs.
Information Systems: System integration issues, networking problems.
Procurement: Exchange rates, single source materials, components, finished products for resale.
Inventory: Demand and supply volatility and uncertainty, excess and obsolete inventory, inventory holding costs.
Capacity: Cost of capacity, cost of flexibility, capacity utilization rates, production flows and set-up, operational and financial condition of supply chain partners.
Lead Times and Related Volatility: Transportation, production, assembly, shipping components, supplies, raw materials, work in progress, finished products.
Demand Forecast Error: Excessive promotional activity, innately high volatility of demand, poor handling of data and information, poorly organized and poorly managed forecasting process, excessive forecast overrides and bias, lack of collaboration, key function participation
There are supply chain management mitigation approaches widely used for demand and supply related risks:
- Increased capacity engagement through redundant suppliers
- Increased oversight and responsiveness
- Increased inventory and working capital
- Increased company and supply flexibility
- Aggregated demand to reduce uncertainty & forecast error
The mitigation approaches may result in increased product costs, operational costs, transportation costs, distribution costs, warehousing costs, and other supply chain management expense areas. Without the beneficial effects of higher revenue through volume and pricing, the mitigation approaches in isolation will probably have an adverse P&L effect.
They may reduce Net Operating Income, Net Income, and Cash Flow from Operations. So, it is important with support from the financial function to estimate financial effects and plan for actions that aid in improving other areas of the P&L – topline and/or expense – to achieve financial balance.
Impact On The Balance Sheet
Where the mitigations require investment in working capital and long-term capital assets, the balance sheet effects come to the fore. The investments will generally reduce cash, increase inventory, increase fixed assets, increase debt and the associated interest expense.
The Return on Assets and the Return on Equity are both impaired due to the reduced Net Income experienced by the company. The Return on Assets is further impaired by the combination of lower Net Income and higher Total Assets. So, again it is important to find other areas of the P&L and of the Balance Sheet with the support of the financial function where improvements can be made to balance the effects of the mitigation approaches on these key return metrics for the company.
Risk Mitigation Requires Collaboration
Throughout our demand planning and supply chain management efforts, we are dealing with volatility and other sources of risk to the business. The challenge is to be able to mitigate and hedge risks while producing a return on investment for the company.
This requires sharing of information and ideas, collaboration, and cooperation, as well as systematic analysis of costs and benefits expected from the mitigation actions that may be taken. It also requires both a short-term and a long-term perspective in our decision-making processes. The S&OP and the IBP processes are forums within which to do this.
We must consider the financial effects of our demand management and supply chain management activities on the operational and financial success of the company. We cannot do this in isolation. It is important to develop a relationship of collaboration with the finance function of the company to take part in our forecasting and planning processes, providing financial information, analytics, and financial counsel. This can help to realize an effective working relationship that balances the considerations of supply chain efficiency and operations, as well as financial ramifications and competitive financial performance for the company.
For further information on how Finance can benefit from collaboration with demand planning, click here.