Supply Chain Metrics That Matter: A Closer Look At The .

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Supply Chain Metrics That Matter:A Closer Look at the Cash-To-Cash Cycle(2000–2012)Using Financial Data from Corporate Annual Reports toBetter Understand the Cash-To-Cash Cycle11/11/2013By Abby MayerResearch AssociateSupply Chain Insights LLC

ContentsResearch . 2Disclosure . 2Research Methodology . 2Executive Overview . 4What Is Good? . 5Defining the Cash-To-Cash Cycle . 5Days of Inventory . 6Days of Receivables. 6Days of Payables . 6Managing the Inputs . 7The Big Picture . 7Case Study: Automotive. 9Case Study: Chemical .11Case Study: Consumer Electronics. 14Case Study: Consumer Packaged Goods . 16Case Study: Pharmaceutical . 18Recommendations . 20Conclusion . 21Company Profiles . 22Other Reports in This Series: . 24About Supply Chain Insights LLC . 25About Abby Mayer . 25Copyright 2013Supply Chain Insights LLCPage 1

ResearchSupply Chain Metrics That Matter is a series of reports published throughout the year by Supply ChainInsights LLC. They are traditionally a deep focus on a specific industry. These reports are based ondata collected from financial balance sheets and income statements over the period of 2000–2012.This report takes a different perspective than previous publications in that it focuses upon a singlemetric across several industries. This report is a cross-industry analysis of the Cash-To-Cash Cycle(C2C).In this report, we analyze how companies and industries managed their cash-to-cash cycleperformance as well as the individual components of the metric, i.e. Days of Inventory (DOI), Days ofPayables (DOP), and Days of Receivables (DOR).Within the world of Supply Chain Management (SCM), each industry is unique. We believe that it isdangerous to list all industries in a spreadsheet and declare a supply chain leader. Instead, we believethat we have to evaluate change over time by peer group. Thus, we discuss the cash-to-cash cycle inregard to five specific industry peer groups.DisclosureYour trust is important to us. As such, we are open and transparent about our financial relationshipsand our research process. This independent research is 100% funded by Supply Chain Insights.These reports are intended for you to read, share and use to improve your supply chain decisions.Please share this data freely within your company and across your industry. All we ask for in return isattribution when you use the materials in this report. We publish under the Creative Commons LicenseAttribution-Noncommercial-Share Alike 3.0 United States and you will find our citation policy here.Research MethodologyThe basis of this report is publicly available information from corporate annual reports from the period of2000–2012 for publicly-owned companies involved in five separate industries: automotive, chemical,consumer packaged goods, consumer electronics and pharmaceutical. The analysis takes a closer lookat the cash-to-cash cycle performance over three distinct time periods:2000–2006: Start of the Decade and the Rise of Enterprise AutomationCopyright 2013Supply Chain Insights LLCPage 2

2007–2009: Recession and Economic Downturn2010–2012: Economic RecoveryIn picking companies for the Supply Chain Metrics That Matter reports, we traditionally rely oncompanies recently listed in the Fortune Global 500. In addition, we use the Morningstar industry sectorclassifications to inform our decision. Finally, we intended to provide a fresh analysis of severalcompanies profiled in last year’s report titled: Supply Chain Metrics That Matter: The Cash-to-CashCycle (published November 26, 2012).We use the financial data to help readers learn from past trends, to better understand current operatingenvironments, and we provide recommendations for the future. We augment the financial data analysiswith information from our quantitative and qualitative research studies as well as our work with clientsoperating within the industry.Copyright 2013Supply Chain Insights LLCPage 3

Executive OverviewWhen it comes to metrics that matter, the cash-to-cash cycle is one of the top metrics cited by supplychain professionals. It is among the best financial metrics to provide a comprehensive picture of acompany’s supply chain and the management of working capital.The supply chain is a complex system. Successful management requires both orchestration andbalance. To drive supply chain excellence, companies are required to balance four competing priorities:growth, profitability, cycle management and complexity. Several popular metrics, including the cash-tocash cycle, for a variety of industries are presented in table 1.Table 1. A Review of Industry Progress from 2000–2012Copyright 2013Supply Chain Insights LLCPage 4

What Is Good?Financial metrics are a valuable tool in examining and comparing supply chain performance. Ratiosespecially, offer a chance to compare across currencies, countries, and company size. The cash-tocash cycle is one of the most popular metrics used to obtain a relatively holistic perspective of acompany’s supply chain performance. This metric is composed of three other separate metrics: days ofinventory, days of payables and days of receivables. The cash-to-cash metric wraps these threeseparate metrics up into a big-picture understanding of the functioning of a supply chain. However,because of the different inputs, it’s possible for the single cash-to-cash value to be misleading and notreflective of the underlying improvement or lack thereof of the company’s performance. So while it’seasy to look at the single numbers, we do ourselves a disservice by ignoring the individual components.Embedded within the cash-to-cash cycle is a much more complex story of inventory, payables andreceivables management. That’s why it’s important to dig into the three “levers” of the cash-to-cashcycle.Determining the right target requires study. The waters are murky. A good cash-to-cash value for asmall medical device company is likely significantly larger than one good for a large and wellestablished consumer electronics company. Each industry and each company, to a certain extent, hasits cash-to-cash potential. This will depend upon the specific structure of the company, the supplychain, its customers and supplier network.Defining the Cash-To-Cash CycleThe cash-to-cash cycle, cash conversion cycle or C2C cycle are all the same. The equation is asfollows:𝐶𝐶𝐶𝐶𝐶𝐶ℎ 𝑇𝑇𝑇𝑇 𝐶𝐶𝐶𝐶𝐶𝐶ℎ 𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶 𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷 𝑜𝑜𝑜𝑜 𝐼𝐼𝐼𝐼𝐼 𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷 𝑜𝑜𝑜𝑜 𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅 𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷 𝑜𝑜𝑜𝑜 𝑃𝑠𝑠The unit is in days and provides an approximation of the flow of cash through the company. A goodcash-to-cash cycle, contrary to most other financial metrics, is as low as possible. It means that thecompany is efficiently using cash and not holding excess inventory, or allowing excessively lenientpayables or receivables terms. The most advanced companies in specific industries have evendemonstrated negative C2C values over the past decade.Finally, notice that days of inventory (DOI) and days of receivables (DOR) are both positive numbers,while the days of payables (DOP) number is subtracted from the final C2C value. This small notationmakes a large difference which we will examine in greater depth in the following section.Copyright 2013Supply Chain Insights LLCPage 5

Days of InventoryDays of inventory is by far the most popular of the three components or levers of the cash-to-cashcycle. The equation is shown below.𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷 𝑜𝑜𝑜𝑜 𝐼𝐼𝐼𝐼𝐼 𝐴 𝐼𝐼𝐼𝐼𝐼 365𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶 𝑜𝑜𝑜𝑜 𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺 𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆Inventory management, as with most things in supply chain, is tricky. Too little inventory leads tostockouts and backorders. Too much represents cash locked up in inventory and a greater potential forwrite-offs or markdowns to move the product. DOI is positive within the C2C value because itrepresents cash the company possesses (although held up in the form of inventory).Days of ReceivablesDays of receivables is compiled from information available on the company’s income statement andbalance sheet, and is a value showing the amount currently outstanding and owed to the company bydownstream customers.𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷 𝑜𝑜𝑜𝑜 𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅 𝐴𝐴𝐴 𝑅𝑅𝑅𝑅𝑅𝑅𝑅 𝑅𝑅The addition of the 365 as a multiplier creates an approximation of a “daily” value. The goal of anycompany is generally to collect monies owed as quickly as possible and so a high performing DORwould be as low as possible while still enabling growth and good relations with downstream customers.This is positive money coming into the company and so it is a positive value in the cash-to-cashcalculation.Days of PayablesDays of payables is the final component of the C2C cycle and in my experience, the least understood.Again the information is available through public documents for any publicly owned company.𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷 𝑜𝑜𝑜𝑜 𝑃𝑃𝑃 𝐴𝐴𝐴 𝑃 365𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶 𝑜𝑜𝑜𝑜 𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺 𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆Days of payables is a daily approximation (hence the 365) of the amount of money owed by thecompany to its suppliers. It is really just the opposite of days of receivables as discussed above. This isthe trickiest metric for which to define a “good” value. If DOP is extremely low, the company is payingsuppliers quickly, maybe too quickly, and not maximizing their cash flow. If DOP is extremely high, theCopyright 2013Supply Chain Insights LLCPage 6

company is holding onto that cash, but as a result, may be jeopardizing or starving their upstreamsupply chain with a lack of cash flow.Reasonable payments terms vary across countries, geographies, industries etc. so it can be especiallyvaluable to compare the DOP value to close competitors to see how it matches up. DOP shouldn’t betoo low or too high and perhaps most importantly it shouldn’t be wildly changing over short periods oftime.Managing the InputsImprovement in the cash-to-cash cycle can happen through one of three ways: Reduction in Days of Inventory. Most companies believe they have reduced inventory, but thefinancial results tell a very different story. The best way to improve the cash-to-cash cycle is toimprove DOI. This requires commitment, discipline and a long-term focus. Reduction in Days of Receivables. A company can decrease the terms of receivables andcollect payments owed more quickly. As waste has been pushed backwards in the supply chain,companies have been under intense pressure to improve receivables management. This can bean effective approach as long as the terms are comparable to other companies within theindustry. A reduction in receivables, just as in inventory, would lead to a lower C2C value. Increase in Days of Payables. By increasing DOP, a company will retain their cash longer andreduce their C2C value, but withholding payment for too long can be costly to downstreamsuppliers. The automotive industry has provided several examples over the past decade ofcompanies that increased DOP only to force downstream suppliers into bankruptcy because ofa lack of healthy cash flow.In the next sections, we examine the cash-to-cash performance of companies from five differentindustries in five separate case studies. We begin with a big-picture pattern analysis of trends seen inmultiple industries.The Big PictureOver the past decade, we see several patterns i