A new definition of supply chain management emerged. This involved not only the flow of products but also the flow of information and finances through the supply chain in both the directions.
The information flows:
From suppliers: manufacturing capacity, delivery schedules, promotions they are going to launch for specific timeframe;
Reverse flows: sales, orders, inventory, quality, promotions.
The financial flows are as follows:
From suppliers: credits, consignment, payment terms, invoice;
Reverse flows: payments, consignment.
This led to a supply chain where there was movement of goods, information and finance in a cyclic order as shown in Figure 2.
Figure : Integrated Flows of Material, Finance and Information (adapted from iwarelogic, 2010)
The financial supply chain is parallel to the physical supply chain and is represented by the activities related to flow of cash, from the buyer's initial order to the reconciliation and payment to the supplier. Until recently, the financial supply chain was not considered very important. The time required to process transactions was unthinkably long because of the manufacturing supply chain that was creeping with inefficiencies (Bank of America, 2009). Still the companies were prospering due to the lack of global competition and all domestic ones were filled with the same poor quality of demand forecasting limitations, inefficient distribution and were missing supply chain visibility. They used the same strategy to compensate for these problems and mitigate risk against uncertain demand, excess inventory, excess capacity and surplus labour. As the cost of capital was low, reserve positions were routinely used. In other words, companies relied on the strategy of excesses (Bank of America, 2009).
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Today the typical financial supply chain is more fragmented and complex than the integrated physical supply chain (Bank of America, 2009). The movement of goods is faster than the movement of information and finances.
Financial supply chains are important because by optimizing them companies can:
reduce their working capitals by efficient inventory control and cash flow management,
lower financing rates on required working capital,
improve supplier relationships with and for buyers,
reduce days sales outstanding and increase cash flow predictability for sellers (Bank of America, 2009).
Johnson and Templar (2007) say that the structure of today's supply chains is inherently more and more complex and subject to larger number of conflicting requirements. They quote Porter (1980) and state that there are two major winning strategies for business: differentiation and cost advantage. Johnson and Templar (2007) argue that differentiation can be achieved by providing customers with a product or a service that they perceive as having a greater value, whereas cost advantage can be obtained by doing activities and processes that are more economical than the competition. Johnson and Templar (2007) estimate that around 70% of a product's cost is made of costs arising out of supply chain. This shows that supply chain provides a major opportunity to reduce the product costs.
Many companies are increasingly becoming aware of the importance of supply chain and are making use of key performance indicators to measure the performance of the supply chain (Ward 2004). According to Ward (2004), these indicators try to measure the output derived for each dollar invested in the chain. Although indicators such as warehouse labour cost per throughput case, transportation cost per pound shipped and line-item fill rate measure various components of the supply chain performance, none of them gives a complete overview of the supply chain performance (Ward 2004).
Ward (2004) states that the complete metric that can give visibility on the supply chain performance is C2C cycle time. Farris and Hutchison (2002) support the argument saying that C2C is important as it bridges the inbound material activities with suppliers, through manufacturing operations and the outbound sales activities with the customers. C2C cycle is important to measure both from the financial accounting and the supply chain management perspectives. According to Banomyong (2005), cash conversion cycle is a powerful performance metric to assess the working capital management activities undergone by a company or a firm. A company with shorter C2C is more efficient because it turns its working capital over more times per year, and that allows it to generate more sales per money invested. With the help of proper supply chain management, a firm can improve upon the three key drivers of financial performance - growth, profitability and capital utilisation (Rice and Hoppe 2001).
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Despite the potential of SCM, very few companies utilise it as a tool to drive financial performance. According to Lambert and Pohlen (2001), cash conversion cycle is an important financial metric as it highlights the operational performance which can be derived from information readily available in published annual and financial statements. The concept of C2C guides us to the premise that a decrease in the cash conversion cycle time will lead to financial and operational improvement. However, the C2C concept assumes that shortening of cycle time cannot be achieved without increasing costs or decreasing sales (Soenen 1993 cited in Banomyong 2005). This has limitations as reducing the terms of credit for receivers would lead to a reduction in sales volume and revenue as a result of reduction of product's attractiveness from a customer's perspective. Similarly, delaying payment to suppliers will not be well received and is likely to lead to a higher cost of goods supplied. The key here is to have a balance and an optimum cash flow cycle that is not counterproductive to the intended objective.
Farris and Hutchison (2002) highlight the importance of C2C cycle for understanding the effectiveness of the supply chain network. Their work tries to find the leverage points that can be achieved from the usage of the C2C cycle. C2C cycle is a composite metric that encompasses all the participants of a supply chain. Farris and Hutchison (2002) identified 3 major leverage points to manage the C2C within a firm:
extend average accounts payable,
shorten production cycle to reduce inventory days of supply,
reduce average accounts receivable.
Farris and Hutchison (2002) add that opportunities to reduce the cycle of cash in supply chain management exist at the seams outside of the four walls of the firm where they interface with their customers, tier 1, and tier 2 suppliers. In a subsequent work Farris et al (2005) suggest that C2C strategies in a supply chain environment promise to improve efficiency between trading partners, profitability, and cash flow management.Â One important aspect of SCM involves increasing the efficiency of capital movement throughout the entire supply chain. It all depends on how fast the goods move through the supply chain. The faster the goods move through the supply chain, the quicker the members will be paid, which increases cash flow. The C2C calculation involves three key financial pointers from the balance sheet: inventory, accounts receivable and accounts payable. The next step is the calculation of net sales and cost of goods sold from the income statement to convert the financial pointers in terms of days.
The result will be a positive or negative number of days. A number greater than zero tells us how many days a firm has to borrow or tie up capital while it waits for the payment from a customer, whereas a number smaller than zero shows how many days the firm received cash from sale of goods before payment to suppliers is made.
In order to identify opportunities that could benefit all parties, it is important that there is constant information-sharing that permits comparison among C2C trading partners. Specifically, the supply chain can optimise inventory as well as receivable and payable terms to reduce costs to increase operating profit and cash flow.
It is a fact of life that almost all businesses have working capital tied up in receivables and inventory. Interestingly, according to a report by CIMA (2009), many of the UK's big supermarkets chains, for example, have negative working capital. This means that while the customers pay in cash, the stock is provided by suppliers on credit often on very generous terms. This means that at any given time, the supermarket has excess cash that can be used for expansion or process improvement or simply for reinvestment to earn interest. According to a report by Consultancy firm REL as cited in CIMA (2009), in response to the global recession: 'the supermarkets were paying suppliers more slowly to artificially bolster their balance sheets. But in doing so they're often damaging supplier relationships and creating gains that cannot be sustained over time. A typical European company takes over 45 days to pay its suppliers - nearly a day and a half longer than last year'.
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Hingley (2005a) in his paper tries to explain the issue of power in the context of the UK agri-food industry vertical business-to-business relationships and further states that the majority of power and control lays in the hands of large multiple retailers. Hingley (2005a) further states that the supply chain members closer to the markets always benefit more than those away from the markets. He gives the proof of this by stating that those members of the UK food supply chain closer to market have benefited from at least inflationary growth, which has seen the value of retail sales reach approximately £118 billion; with market leader, Tesco taking £28 billion (Tesco 2004 cited in Hingely 2005a). At the heart of the discussion by Hingley (2005a) is the nature of the relationship between farmers, food suppliers and retailers.
As mentioned by Farris and Hutchison (2002), working capital ratios such as the cash conversion cycle are composite performance metrics for assessing how well a company is managing its capital. These key numbers express operational performance in financial terms and can be derived from information readily available in published financial statements (Lambert and Pohlen 2001). For example, a company with a lower cash conversion cycle is more efficient because it turns its working capital over more times per year, and that allows it to generate more sales per money invested. The result of this working capital issue is reduced inventories, faster receivables collection and extended payment terms with suppliers.
There is a looming question from the perspective of supply chain management: Who control the supply chain and how much influence they have? Large and powerful companies can enforce their terms with smaller companies, which in turn impose their terms with those smaller than them (Rafuse 1996 as cited by Padachi 2006). Small and powerless supply chain actors have little influence in the situation, in which they are providing a lot of net funding to their larger customers believing strenuous collection effort could jeopardize their sales volume. Similarly in the case of debtors, aggressive collection action by influential supply chain actors only succeeds in transferring resources from their smaller customers. As a result, often smaller and powerless companies of the value chain must pass on their increased borrowing and administrative costs, though they sometimes go bankrupt in the efforts.
Why is it not possible to manage financial flows in the same way as flows of goods in a collaborative manner? Despite the potential of SCM, relatively few companies utilise the approach as a tool to drive financial performance in a collaborative way (Simatupang and Sridharan 2005).
The aim of this study is to understand the relationships between the bigger and smaller partners of a supply chain when each firm is trying to achieve negative cash conversion cycle. C2C, though being a composite metric (Farris & Hutchison 2009) to measure the effectiveness of the supply chain, still deals with the working capital management of a single firm in a supply chain. The aim of this study is to explore the C2C that exists for different participants in the supply chain of dairy and milk sector in the UK and explore the nature of the relationships when the primary/bigger member of the supply chain is trying to improve its cash conversion cycle.
In order to explore further, the following research questions were formed:
What are the implications for the smaller members of the UK milk supply chain where the biggest member has a very short cash conversion cycle?
What type of relationships exists between the supply chain members?
According to the DairyCo (2010) report on the UK dairy supply chain, the majority of the output of the UK dairy industry is packaged for direct consumption by the consumer and over 73% is produced in consumer packs. Major retailers are the industry's most important link before reaching to the final customers. Other major customer segments include wholesale distributors, catering outlets, institutional customers, traders and export customers. The industry still sells direct to the consumer around 3 million pints of milk a day in returnable glass bottles through the doorstep delivery service. Around 5% of raw milk ultimately ends up with the consumer by this route. The sale of food and drink for consumption out of home is a growth market, along with the ingredients sector, which covers the use of milk products as an ingredient in the food processing industry.
According to a report by Spedding (2009), an Arthur Rank Centre project, the UK dairy farmers produce just over 13 billion litres of milk each year, which is processed into a variety of dairy products. The report further adds that the manufacturers of dairy foods in the UK are working hard to increase the proportion of products. Liquid milk, which takes up almost half the market, has evolved from whole fat milks to skimmed and semi-skimmed products (Spedding 2009).
The Spedding (2009) report states that since 2004 the annual total milk production in the UK has been decreasing and this is expected to continue in the short term due to a variety of factors. The most important of them is the lack of confidence of the farmers. If the efficiency is compared of the UK and EU farms, the UK farms stand apart. Also they can be competed against other non-EU farms like that in the USA (Spedding 2009). However, the UK dairy farms still cannot match the efficiency achieved by the New Zealand dairy farmers (Spedding 2009). The RuSource report identifies that majority of dairy farms are still essentially family businesses, between 70% and 75% are owner occupied and between 20% and 25% are tenanted.
Dairy farm incomes were recovering in the recent years as quoted by Spedding (2009) report. However, recent profitability has not been enough to meet the long term re-investment requirements of running the farms (Spedding 2009). There is a considerable divergence in the cost efficiency between the most and the least efficient dairy farms, which shows that many of the farmers are into milk farming as a lifestyle choice and not with a business intention. On one side, the proportion of the UK milk supply accounted for by lifestyle farmer is falling rapidly as they reach retirement. On the other side, there are business minded individuals who require a competitive rate of return on the capital; otherwise they will take their capital and expertise elsewhere. The efficiency of the business can be improved at a short notice by improving and implementing good farm management techniques. But in order to be a sustainable business in the longer term, cost efficiency requires fixed costs to be spread over a larger scale of operation. This means that there is a direct correlation between farm size and efficiency. This shows that the future of the UK dairy farming is in becoming competitive and having large scale of operations and economies of scale.
The level of milk production in the UK is affected by many factors. According to Blackburn and Lott (2008) of Kite Consulting, the key factors that drive whether a farmer stays in milk business or not, and if they do stay in milk business, whether they expand or not, are:
â€¢ milk price;
â€¢ cost of production;
â€¢ confidence in future milk prices;
â€¢ milk price: feed price ratio - which affects sentiment;
â€¢ non-dairying alternatives - e.g. arable cropping;
â€¢ higher stock prices creating an opportunity to cash in 'on a high' (Blackburn and Lott 2008).
Retailer decisions on milk sourcing are based on price, but also on the security of supply, provenance, traceability, service levels and sustainability. This offers significant opportunities for producers and processors to work together to take out costs and capitalise on other specific supply chain opportunities to create value for all links of the chain.
The aim of the dissertation is to look at a supply chain and analyse the cash conversion cycle of the individual players and understand the implications of the cash conversion cycle on the small suppliers. For these it was imperative to select a supply chain which has not been previously studied from this perspective. According to Yin (2003), when there is little known about the research topic and when it is an exploration to research, case studies are the best methods to move forward. The UK Dairy Supply chain was selected to analyse the research topic through. In order to achieve overall understanding of the business, all the players of the supply chain were studied. Data gathering was done using the published company and industry reports. Data was also collected from the various public surveys undertaken to study the UK dairy farmer morale and future intentions.
During the data analysis phase, efforts were made to explore the contractual structures existing between the different players and the implications of the cash conversion cycles of the respective player.
Overview of Dissertation Chapters
A comprehensive literature review has been carried out and key findings from the literature will be presented in Chapter 2. The first section involves the discussion of the cash conversion cycle, the advantages of C2C as a supply chain metric and finally the criticism of the C2C. The second section will include the discussion on the current state of dairy industry in the UK and the organisation of the dairy supply chain in the UK. The next section will include the discussion of the focus supermarket supply chain and the different actors involved in the supply chain.
Chapter 3 will contain the detailed description of the methodology of this research, the various approaches for data collection and sources of data collection.
Chapter 4 will show the calculation of the cash conversion cycle for the members of the UK milk supply chain. This chapter will also deal with the analysis of the contracts existing within the case supply chain.
Chapter 5 will include the discussion of the findings and analysis from the previous chapter. This chapter will also present the discussion on relationships that exist between the different supply chain actors resulting from the contract structures. Data from various public surveys will be used to understand the relationships between the different supply chain actors.
Chapter 6 is the conclusion that this research study tries to reach. This chapter also contains sections related to limitations of this study, the scope for future research and also the contributions this study makes to the academic research literature.
In the next few sections a thorough literature review is conducted to explain and understand the concept of cash conversion cycle, also the advantages and the criticism of it. A study of the factors affecting the UK Dairy Industry and the UK dairy supply chain is also undertaken to understand the relationships between the different supply chain actors.
Cash Conversion Cycle
According to Farris et al (2005), cash conversion cycle metric is an important measurement tool which can be used to bridge the management of firms and functions in a supply chain that can be used by management to improve firm liquidity position and overall firm value. From the work of Farris et al (2005), measuring C2C helps in identification of the strengths and weakness in a supply chain. This is because the C2C gives use the measure across time that is truly consistent. This helps in identifying the leverage points and the opportunities to improve. Finally, C2C is a measure that can be used to optimise the entire supply chain.
As the field of supply chain management continues to evolve, the C2C metric is one of the currently available measurement tools to transform the relationships between firms and functions of the supply chain into a value chain by helping to synergistically optimise the entire process through a systems approach. C2C can be easily calculated and provides the difference based on days from when suppliers are paid and payment is received from customers (Farris et al 2005). Subsequently, C2C analysis can be done and generalised to compare companies and industries by common traits.
There has been much research on the working of C2C and its utilization to increase the value created by the supply chains. Beed (1981) as cited in Farris et al (2005) recommends using C2C to deal with problems related to account receivables. Byers et al (1997) cited in Farris et al (2005) support using C2C to manage the current assets that deal with daily operations of a firm. Farris and Hutchison (2002) in their paper, propose opportunities for extending C2C as a benchmark for supply chain management.