“Margin Call”: Can Functional Managers Increase Profit Margin by Monitoring Cash Use?

In the movie “Margin Call,” Stanley Tucci’s character, Eric Dale, talks about a bridge he built when he was an engineer that saved people a combined 1531 years in driving time. I started thinking about the fact that Eric only quantified the process efficiency savings the completed bridge offered the community, but avoided any discussion on the cash used, the dollar savings, or the cost of capital. Dale could have quantified the gallons of gas saved and converted that to a dollar value. And he could have contrasted those savings to the cost of building the bridge. But instead, he focused on process savings.

Margin Call: The Bridge Scene

While cost analysis and the cost of capital are familiar concepts within the finance function, they are not often used by business managers in areas such as procurement, shared services, payables, receivables, and apparently engineering. Functional managers often overlook the opportunity cost of maintaining high inventory levels, stretching payables beyond vendor credulity, or the working capital impact of failing to collect receivables in a timely manner.

Increasingly since the great recession, functional managers are beginning to manage cash better and looking beyond productivity to show how they are making their money work for them and their supply chain. Functional managers that do not capture cash use in their departmental reporting miss an opportunity to better understand their true cost of doing business. Consequently, they have little or no awareness of the opportunities to show how they are helping manage cash better.

What are functional measures of cash use? Working capital measures include days payable outstanding (DPO), days sale outstanding (DSO), and days inventory outstanding (DIO). Other cash use measures include the cost of capital, quick ratio, and annualized percentage rate (APR) of return.

How can functional areas of your business measure cash used to show how their functional area not only drives process efficiency, but also increase profit margin and improve the balance sheet? The following are just a few examples of how functional managers can measure, and thereby manage, cash use:

  • Payables: use some of the cash on hand to fund an early payment discount program with annualized rates of return of 12%, 18%, even 36% or higher. Compare this to the return on float from today’s short term cash instruments, which are presently at historic lows to show how your procure-to-pay initiatives are impacting net income and cash flow.
  • Receivables: drive efficiency improvements in your order-to-cash process to not only improve customer satisfaction through automation and invoice error reduction, but also reduction of days sale outstanding (DSO) to show how your order-to-cash initiatives are impacting cash flow.
  • Inventory: leverage advanced ship notices from your suppliers to manage goods to tight re-order levels and ensure your business is neither over-stocked nor under-stocked, and show how this impacts the profitability of your organization.

In this video Belinda Cordina, Procurement Manager at Nalco, shares how Nalco has improved customer service, vendor relations and working capital across various business functions with a business network to improve customer and supplier collaboration.

Belinda Cordina, NALCO: Improving Working Capital with Business Network

Operating cash flow is the lifeblood of a company and perhaps the most important barometer investors have. Although many investors gravitate toward net income, operating cash flow is arguably a better measure of a company’s financial health because cash is still king and a company that does not generate positive cash flow over the long-term will not succeed.

Perceptive executives have clearly come to understand that creating value means embracing networks of people and coordinating their efforts to deliver business results faster. According to a study done by CFO Magazine, global finance executives view using technologies – like business networks – to better discover, connect, and collaborate with their customers, suppliers, and other trading partners as a top priority for agility and growth.

And more will surely embrace such thinking. Managing cash is challenging – particularly under today’s uncertain economic conditions; however, companies that embrace innovative solutions designed to fuel collaboration and drive efficient processes will be able to do it more effectively and drive profitability across the functional areas of their business.

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