Linking Supply Chain Performance to a Firm’s Financial Performance

Most businesses measure success through a high-level set of financial metrics that are reported on a quarterly or annual basis, such as operating or net income, return on investment, and earnings per share. Financial performance metrics are valuable because they capture the economic consequences of business decisions. They are the “language of business,” used by internal and external stakeholders to evaluate the results of business operations.

Supply chain managers make decisions and use organizational resources that eventually impact the financial outcomes of the firm. To do so effectively, they need to link the results of supply chain decisions to the financial goals and related metrics of the company.

By creating a set of linkages between the work that is being performed and the financial outcomes of the firm, the organization’s supply chain function can gain organizational visibility and demonstrate the impact of supply chain decisions and resource utilization on the firm’s financial performance.

Financial Statements
The financial statements of an organization consist of the following primary statements:

• Income Statement – a report of the firm’s earnings over a specific period of time, calculated as sales activities (revenues) minus product costs (cost of goods sold) and selling, general, and administrative costs
• Balance Sheet – a report of what the firm owns (assets) and owes to either debtors (liabilities) or owners (shareholders’ equity)
• Statement of Cash Flows – a report detailing the sources and uses of cash from three perspectives: operational, investment, and financial
• Statement of Stockholders’ Equity – a report that traces the generation and distribution of stockholders’ equity through capital stock transactions, retained earnings, and other related transactions

Each of these statements report financial information that is important to management, analysts, and investors. How do decisions made by supply chain managers impact the results shown on each of these statements?

Income Statement
Most managers readily understand the basic income statement components of revenues, product costs, and administrative overhead costs. The net income figure is arguably the most focused-upon performance metric in the business community. Firms may also focus on components of net income, such as gross margin (revenues minus product costs), earnings before interest and taxes (gross margin minus administrative overhead costs), or EBITDA (earnings before interest and taxes minus depreciations and amortization expense). Supply chain decisions and performance have direct impacts on income through each of the three primary components of the income statement, as shown below:

Income Statement Component	Supply Chain Issues that Affect Financial Performance
Revenues	Lead time Time to market for new products Response time to customer requests On-time delivery Product quality Product returns Stock outs Fill rates
Product Costs	Transportation costs Network distance Procurement costs Inventory costs – raw materials, work in progress, finished goods Storage costs Packaging costs Waste Stock outs Forecast accuracy Number of suppliers Product remediation costs
Sales, General, and Administrative Costs	Warranty costs Selling costs Transaction accuracy (invoices, shipping documents, export documentation) Exchange rate control

Balance Sheet
Within the balance sheet, a key component of organizational success (or failure) is the control of working capital. Working capital is defined as current assets less current liabilities; think of working capital as the "lifeblood" of an organization, as it is essential to keeping the organization healthy and viable.

The primary components of current assets are cash (and cash-like investments), accounts receivables, and inventories; the primary component of current liabilities for most firms is accounts payables.

Not only do supply chain decisions have a direct impact on working capital, but working capital flows and balances have a direct impact on the financial viability and performance of a firm. A firm that lacks adequate working capital will have not have the funds available to pay its employees, suppliers, or government taxes – any of which have the potential to quickly shut the firm down. The firm will then have to borrow funds to meet working capital needs. A firm with excess working capital will have the ability to fund expansion without increasing borrowings.

One useful supply chain performance measure to evaluate working capital performance is the cash conversion cycle, calculated as Inventory Days plus Accounts Receivable Days minus Accounts Payable Days.

• Inventory Days = 365 / (cost of goods sold / average inventory balance)
• Accounts Receivable Days = 365 / (sales / average accounts receivables balance)
• Accounts Payable Days = 365 / (cost of goods sold / average accounts payables balance)

One goal of cash conversion is to balance the investments a company makes in inventory and extending credit to customers with payments that a company makes for purchases.

The supply chain function influences working capital, as shown below:

Working Capital Component	Supply Chain Issues that Affect Financial Performance
Inventory Days	Holding costs – financing, warehousing, tracking, moving, insurance Obsolescence Theft Forecasting accuracy Sourcing time Delivery time
Accounts Receivable Days	Bad debt Follow-up calls to receive payments Unable to ship due to non-payment Exchange rate changes Correct invoicing terms Proof of receipt
Accounts Payable Days	Discounts not taken Late payments; subsequent orders delayed Correct invoicing terms Payment penalties

In addition to working capital, the balance sheet helps firms measure utilization of the firm’s physical assets. Plant, Property and Equipment (PP&E) productivity is measured by dividing sales revenues by the amount recorded for net PP&E. This measure gives an indicator of how productive the physical assets of the organization are.

Statement of Cash Flows and Statement of Shareholders’ Equity
The Statement of Cash Flows contains information generated through the Income Statement and Balance Sheet, but formatted so that managers and investors can see the sources and uses of cash in three primary areas of the firm: operations, investing, and financing. The information on this statement is key to analyzing the health of an organization, because a company requires positive operational cash flows to endure over time. The supply chain organization impacts this statement through actions that influence the income statement or balance sheet of the firm.

The Statement of Shareholders’ Equity summarizes the ownership portion of the firm – capital stock sales and purchases, income generation and payment of dividends, and other related items. The supply chain management function most directly impacts the net income generated for the firm.

Conclusion
To build an effective model between supply chain decisions and organizational performance, the supply chain organization in a firm must understand how its actions and decisions link to the financial components of the firm. Then, it should analyze the influence that its various actions and components have on outcomes that influence financial performance. This linkage model will help to ensure that the supply chain organization is making and implementing decisions that are valued by the top management of the firm.

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