Using The Cash To Cash Cycle To Detect Supply Chain Problems

The C2C gives a lot of information on how the business and the supply chain perform, but we need to able to the information to a more granular level and discern what could be causing the issues with the C2C.

 

There are situations in the business which affect the working capital accounts (A/R, inventory and A/P), which affects the C2C.  These situations affect the working capital accounts:

 

  • Increases/Decreases in Accounts Receivable are caused either by sales growth/decline or increase/decreases in A/R DOH.
  • Increases/decreases in inventory are caused either by growth/decline in the cost of goods sold or increases/decreases in Inv. DOH.
  • Increases/Decreases in Account Payable are caused either by growth/decline in the cost of goods sold or increases/decreases in A/P DOH)

 

The example below shows an example of the effects of management actions on accounts receivable.  The numbers we gleaned from the balance sheet and income statement of a firm in 2001 and 2002.

 

In order to find out what caused the changes year over year (YOY) in A/R, the following formulas help us to discern the story:

 

  • Find the % change in sales growth year over year (Cur Sales – Prev Sales/Prev Sales):  We take the sales of the current year (in the case 2002), subtract the previous year sales (2001) and divide by the previous year.  This will give the change in sales on a percentage basis.
  • To see the effect of sales growth (Sales Change % * A/R from the Prior Year):  We take the calculated sales change and multiply that by the A/R from the prior year (2001).  This will give the increase/decrease in A/R due to sales growth.
  • To see effect of DOH (Compute Avg Daily Sales {Annual Sales in current year/365} * Change in A/R DOH):  Here we compute the daily sales in the current year (2002) by taking the annual sales in the current year (2002) and dividing it by 365 to get daily sales.  We get the change in A/R DOH by calculating the A/R DOH for current year (2002) and subtracting the A/R of the previous year (2001).  This will give the impact on A/R due to increases/decreases in A/R DOH.

 

Example (A/R)

 

–        2001 Sales: 7747  2002 Sales: 6806

–        A/R (2001): 436  A/R (2002): 1440

–         

  • Compute A/R DOH for 2001 and 2002

–        2001: 436/7747*365 = .0562*365 = 20.513

–        2002: 1440/6806*365 = .2115*365= 77.197

 

  • Compute Daily Sales (2002)

–        6806/365 = 18.646

 

  • Compute Sales Growth (2001-2002)

–        6806-7747/7747 = -12.15%

 

  • A/R Growth (Sales Growth) = -.1215 * 436 = -53

 

  • A/R Growth (DOH) = 18.646 * (77.197-20.513) = 1057
  • A/R Growth = 1057-53 = 1004

 

  • Total A/R (436 + 1004 = 1440)

 

From this example one can see that A/R increased substantially from 2001 to 2002.  Sales actually decreased by 12% from 2001 to 2002, which decreased A/R by 53.  But A/R DOH increased by almost 57 days from 2001 to 2002 which actually increase A/R growth by 1057.  The total A/R growth was 1004, which increase A/R from 436 in 2001 to 1440 in 2002.

 

The numbers only tell part of the story.  We know that when A/R increases, there should be a proportional increase in sales.  But there was a drop in sales, so this is not a good thing.  If we looked back at our supply chain effects on A/R, this could give us some clues or reason why A/R increased and sales decreased.  Were the changes due to:

 

  • Changes in negotiated payment terms?
  • Credit Policies?
  • Slow Paying Customers?
  • Seasonality?
  • Cyclicality?
  • Changes in the competitive position of the firm and or the strategy (and/or the supply chain strategy)?
  • The product life cycles of the firm’s products?
  • Other issues regarding financing, operations, or regulatory issues?

 

We could continue, but this shows that by understanding the C2C and its effects on working capital, one can better investigate the causes of what ails the business and its supply chain.  We can conduct this same exercise with inventory and A/P, except that we would use COGS instead of sales to calculate the effects on these items.  You would use the same supply effects to investigate the issues.