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Module SCM105: Performance Measures for Supply Chain Management
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...in capital-intensive industries such as semiconductors or oil and gas, the production facility is very expensive. The cost of raw materials may be relatively low, and the cost of finished goods typically includes an allocation for use of the expensive capacity. Consider the following example:
| Unit raw material cost: | $1.00 |
| + Allocation for production capacity use:8 | $9.00 |
| Fully-allocated cost per unit: | $10.00 |
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Here the accountants would say the cost of a unit of finished goods is $10.00. Their job is to allocate all costs using generally accepted accounting principles (GAAP), but as important as GAAP is for accounting, it doesn't always contribute to good management decision-making. Suppose you found a way to reduce your finished goods inventory by 100,000 units, for example by using a faster delivery mode to your customers. Using the $10/unit standard cost valuation, you might think that you would be saving $1 Million. But think about it for a moment: if you reduced finished goods inventory by that many units, what would you really save in cash? Select your answer below:
...a third metric involves adding up all the lead times for all the steps in a supply chain; this is called the Supply Chain Lead Time, or Supply Chain Cycle Time. This is much more difficult to do than it sounds, since in many cases the supply chain is actually a network containing different parts or SKUs; you have to cover all possible branches to see which has the longest supply chain lead time. Consider the simplified example of an automobile manufacturer below. What is the sum of the lead times along the longest branch?
...if no one held any inventory in the supply chain, then it would literally take that long to build the components shown, ship them, and assemble the car. Most supply chains do hold inventory, so the actual response time to a customer order for the finished product is much less than the Supply Chain Cycle Time...
...our final "speed" metric is the so-called cash-to-cash cycle, or cash conversion cycle (briefly described in modules SCM101 and SCM104). Here we try to approximate the average time between a company's outlay for materials and labor to build a product and the moment the company gets paid for selling the product. This length of time is approximated by:
| Cash-to-Cash Cycle = |
Inventory
(days' supply) |
+ |
Accounts Receivable
(in days) |
– |
Accounts Payable
(in days) |
Recall days of supply of inventory ("days of inventory") from the prior discussion of inventory metrics; this is the average time inventory waits in a warehouse. Accounts receivable is the number of days it takes to collect payment from your customers, and accounts payable is how long you wait to pay your suppliers. For example, if a company had 45 days of inventory, and its accounts receivable were 30 days and its accounts payable were 35 days, then the calculation would be:
Cash-to-Cash Cycle = 45 + 30 – 35 = 40 days
In this case your cash-to-cash cycle is 40 days from the moment you pay for raw materials to the time you get paid from customers...
8 Obtained by dividing the amortized cost of the plant by the number of units produced in a year, for example. (back)
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