Cash-to-cash is what counts

Many companies - though still a minority - use key performance indicators to measure supply-chain performance. Typically these indicators try to measure the operating output for each dollar of input or some other indicator. Measurements such as warehouse labor cost per throughput case, transportation cost per pound shipped and line-item fill rate all measure various components of supply-chain performance. Yet none offers an overall, easily understood view to the "C-level" executives (chief executive, chief operating officer and chief financial officer). Without this C-level visibility, too many companies miss opportunities to improve supply-chain performance.

The critical indicator that can provide this visibility is cash-to-cash cycle time. This key performance indicator appears to be correlated with a performance measure that many C-level executives (and financial markets) understand: earnings per share. Using financial data from several publicly traded companies in three industries - Tier 1 automotive suppliers, consumer-goods manufacturers and supermarket chains - we saw good evidence that reductions in cash-to-cash cycle time improved earnings per share.

Calculation of cash-to-cash cycle time is relatively straightforward. It is inventory days on hand, plus days of sales outstanding (receivables), minus days payable outstanding (payables). The factors that make up the measurement of days payables outstanding are accounts payable (from the balance sheet) and cost of sales (from the income statement).

The comparable factors for inventory days on hand are inventory value and cost of sales. Comparable factors for days of sales outstanding are accounts receivable and sales. Each of these factors has associated possibilities for supply-chain improvements.

To reduce the number of outstanding days payable, companies can improve strategic sourcing and weed out redundant or underperforming suppliers, improve procurement practices, and combine duty and tax planning, cargo security and inbound logistics planning.

To improve performance on days of sales outstanding, companies can match raw-materials supply to demand through improved forecasting and collaboration, and lower inbound-transportation costs through consolidation and control of inbound freight.

The Tier 1 automotive companies in our sample showed that reduced cash-to-cash cycle times increased earnings per share. These companies tended to have cash-to-cash cycle times that are relatively low, at less than 40 days. By comparison, similar heavy industrial companies in other industries have cash-to-cash cycle times of 200 days or more.

The correlation between cash-to-cash cycle time and earnings per share was less strong in the consumer-goods sector, but still compelling. Though cash-to-cash cycle times were higher than the Tier 1 automotive group, typically 50 to 150 days, companies with the best cash-to-cash cycles had better earnings per share.

Supermarket chains in our sample tended to have lower cash-to-cash cycle times (typically 10 to 35 days), partly because their sales are in cash or cash equivalents. As in the other sectors, the companies with lower cash-to-cash cycle times tended to have higher earnings per share. For one company in our sample, inventory days on hand was markedly lower - on the order of 50 percent - than others in the group. Its earnings per share were much higher.

-- Since the measurement data for this key performance indicator can readily be drawn from the balance sheet and income statement, collecting data to calculate cash-to-cash cycle time should be relatively straightforward, meeting the test for a robust, yet easily understood, key performance indicator. Recommended practices for companies to take advantage of measuring this indicator include:

-- Tracking trends for cash-to-cash cycle time and earnings per share each quarter and making an analysis of the trend part of the internal evaluation of performance.

-- Requiring subordinates to track the components of cash-to-cash cycle time.

-- If the trends are adverse, drilling down to the various supply-chain activities (as shown above) to see if functional improvements can be applied for corrective action.

The conclusion to be drawn is that C-level executives, many incented by growth in earnings per share, would be well-served to measure cash-to-cash cycle times closely, because improvement in this key performance indicator likely will lead to higher earnings per share.

Peter Ward is a manager in Hitachi Consulting's supply-chain practice. He can be reached at (609) 841-7628, or via e-mail at pward@hitachiconsulting.com.

For the full story: Log In, Register for Free or Subscribe