He costs of satisfying customer demand can be significant and yet, surprisingly, they are not always fully understood by organizations. One reason for this is that traditional accounting systems tend to be focused around understanding product costs rather than customer costs. Whilst logistics costs will vary by company and by industry, across the economy as a whole that total cost of logistics as a percentage of gross domestic product is estimated to be close to 10 per cent in the US1 and in other countries costs of similar magnitudes will be encountered.
However, logistics activity does not just generate cost, it also generates revenue through the provision of availability – thus it is important to understand the profit impact of logistics and supply chain decisions. At the same time logistics activity requires resources in the form of fixed capital and working capital and so there are financial issues to be considered when supply chain strategies are devised. Logistics and the bottom line Today’s turbulent business environment has produced an ever greater awareness amongst managers of the financial dimension of decision making.
The bottom line’ has become the driving force which, perhaps erroneously, determines the direction of the company. In some cases this has led to a limiting, and potentially dangerous, focus on the short term. Hence we find that investment in brands, in R&D and in capacity may well be curtailed if there is no prospect of an immediate payback. Just as powerful an influence on decision making and management horizons is cash flow. Strong positive cash flow has become as much a desired goal of management as profit.
For example, many successful retailers have long since recognized that very small net margins can lead to excellent ROI if the productivity of capital is high, e. g. limited inventory, high sales per square foot, premises that are leased rather than owned and so on. Figure 3. 1 illustrates the opportunities that exist for boosting ROI through either achieving better margins or higher assets turns or both. Each ‘iso-curve’ reflects the different ways the same ROI can be achieved through specific margin/asset turn combination. The challenge to logistics management is to find ways of moving the iso-curve to the right.
Logistics impact on ROI Logistics and the balance sheet As well as its impact on operating income (revenue less costs) logistics can affect the balance sheet of the business in a number of ways. In today’s financially-oriented business environment improving the shape of the balance sheet through better use of resources has become a priority. Once again better logistics management has the power to transform performance in this crucial area. Figure 3. 3 summarizes the major elements of the balance sheet and links to each of the relevant logistics management components.
Balance sheet Assets Cash Logistics variable Order cycle time Order completion rate Receivables Inventories Property, plant and equipment Liabilities Current liabilities Debt Equity Invoice accuracy Inventory Distribution facilities and equipment Plant and equipment Purchase order quantities Financing options for inventory, plant and equipment Fig. 3. 3 Logistics management and the balance sheet
Cash and receivables This component of current assets is crucial to the liquidity of the business. In recent years its importance has been recognized as more companies become squeezed for cash. It is not always recognized however that logistics variables have a direct impact on this part of the balance sheet. For example, the shorter the order cycle time, from when the customer places the order to when the goods are delivered, the sooner the invoice can be issued. Likewise the order completion rate can affect the cash flow if the invoice is not issued until after the goods are despatched.
One of the less obvious logistics variables affecting cash and receivables is invoice accuracy. If the customer finds that his invoice is inaccurate he is unlikely to pay and the payment lead time will be extended until the problem is rectified. Inventories Fifty per cent or more of a company’s current assets will often be tied up in inventory. Logistics is concerned with all inventory within the business from raw materials, subassembly or bought-in components, through work-in-progress to finished goods. The company’s policies on inventory levels and stock locations will clearly influence the size of total inventory.
Materials handling equipment, vehicles and other equipment involved in storage and transport can also add considerably to the total sum of fixed assets. Many companies have outsourced the physical distribution of their products partly to move assets off their balance sheet. Warehouses, for example, with their associated storage and handling equipment represent a sizeable investment and the question should be asked: ‘Is this the most effective way to deploy our assets? ’ Current liabilities The current liabilities of the business are debts that must be paid in cash within a specified period of time.
From the logistics point of view the key elements are accounts payable for bought-in materials, components, etc. This is an area where a greater integration of purchasing with operations management can yield dividends. The traditional concepts of economic order quantities can often lead to excessive levels of raw materials inventory as those quantities may not reflect actual manufacturing or distribution requirements. The phasing of supplies to match the total logistics requirements of the system can be achieved through the twin techniques of materials requirement planning (MRP) and distribution requirements planning (DRP).
If premature commitment of materials can be minimized this should lead to an improved position on current liabilities. Debt/equity Whilst the balance between debt and equity has many ramifications for the financial management of the total business it is worth reflecting on the impact of alternative logistics strategies. More companies are leasing plant facilities and equipment and thus converting a fixed asset into a continuing expense. The growing use of ‘third-party’ suppliers for warehousing and transport instead of owning and managing these facilities in-house is a parallel development.