Domino Effect

Choke Points: The Domino Effect in the Supply Chain

 

 

In a recent blog post we considered the balance sheet accounts that changed when a business experienced sales growth and uncovered the ‘Growth Paradox’. Growth consumes more cash than it generates and needs to be funded with a supply of cash. Or put another way; no cash, no growth!

What do businesses do and what are their options for supplying the cash needed to fuel growth.

In a growth scenario, it is probably safe to assume that a business will not want to restrict its operating expenses; or those directly related to sales. What it can do more easily is to extend its payables, its creditor days. This supplies cash to the business and proves the economists were wrong; there is such a thing as a free lunch!

On this occasion however, I am with the economists! There are repercussions when you extend your payables and a real cost to the supply chain, even if it is an indirect one. Firstly, let’s consider what happens to the supplier, your creditors. Think of it this way; one company’s accounts payable is another company’s accounts receivable. This is not a zero sum game. So what happens to your supplier when cash collections slow? What are their options, to cover their cash shortfall? Unless your supplier happens to be a blue-chip company with low cost finance lines, I think the practical alternatives are quite limited:

  • Raise the overdraft and take on additional short term debt, providing the bank will agree!
  • Use their accounts receivable as collateral to supply cash, by factoring or invoice discounting. Doable, but invasive, loses sovereignty, has high compliance costs and can be expensive
  • Slowing down; on face value a good option, however in a competitive world, it can open the door to the sharks, or
  • Do exactly as you have done and extend their payables,

Scientists call this a positive feedback loop, it creates a multiplier effect like a chain reaction as each party in the chain slows down their payments. This domino effect chokes growth by holding cash in accounts receivable. It constrains everyone’s growth, no one wins! When you look at it this way, there is a cause and effect, which in turn modifies everyone’s behaviour. The players look at themselves in isolation, they don’t collaborate, they don’t see themselves as connected and interdependent. There is a better way, and that is to collaborate with each other to keep the cash circulating.

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Murray Stevenson
Sales Director
Woodsford TradeBridge