Cash is the Oxygen of Business.

January 4, 2012 Purchasing Insight

cashWe are excited to welcome back Pete Loughlin from PurchasingInsight.com as guest blogger who contributed today's blog post!


CASH IS THE OXYGEN OF BUSINESS.

Of course, a business needs lots of things. It needs customers. It needs products and services it can sell. It needs a healthy market, reliable suppliers, a good reputation, low costs and all that jazz but without cash, whether that's cash in the bank or access to someone else's cash, a business can suffocate. And when cash is in short supply, it’s not just your business that you need to worry about.

Since the global financial crisis hit, constrained liquidity, the inability or lack of will of banks to lend to their customers as well as each other, has begun to deprive whole supply chains of their oxygen. Like fish swimming in a sterile sea, suppliers in many industries have become highly vulnerable. Starved of cash, fluctuations in their cash flow can prove catastrophic.

VRM - THE ROLE OF SUPPLY CHAIN FINANCE

Vendor risk management (VRM) is standard procurement practice that covers the management of a whole range of supplier related risks. It ensures that suppliers don’t have all their eggs in one basket, that they operate in an ethical way so that any potential reputational risk is mitigated, that they are able to offer post sales and ongoing support and importantly, it provides a view of suppliers’ financial strength. It is financial failure in particular that represents one of the most significant risks in the current cash constrained climate because while the banks aren’t lending, businesses that would ordinarily be considered perfectly healthy are failing because they’re running out of cash. What is especially frightening is that standard VRM practice would not be able to spot the danger signs in time to do anything about it.

DYNAMIC DISCOUNTING AS A RISK MITIGATION STRATEGY

Whereas small businesses could, historically, rely on an overdraft or other short-term financial package to manage unforeseen cash flow issues, that funding is no longer available in many cases. These businesses are fragile and they could be your suppliers! Relying on a supply chain that is unable to manage fluctuations in cash flow is crazy. It means taking on the vulnerability of your suppliers. Their problem becomes your problem. Their failure becomes your failure and it’s unnecessary.

Dynamic discounting is an arrangement between buyers and supplier whereby the supplier offers a discount in return for early payment. It’s ‘dynamic’ because everything is negotiable – the early payment term, the discount and the invoices to which it applies. It is often seen as a treasury manager’s tool because it can give a much better return on cash than traditional bank products but there’s another important benefit that should not be over-looked. It puts cash in the hands of your suppliers. The benefit to your supplier could be immeasurable. Paying a customer a discount that offsets the cost of their DPO impact is cheaper for the supplier than overdraft rates and may indeed be the only realistic source of cash.

Just as it crazy to rely on a supply chain that struggles to manage it’s cash flow, it’s also crazy not to include dynamic discounting within a portfolio of vendor risk management strategies.

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