Finance and Supply Chain need to develop a common language

For any business that relies on buying, storing and selling inventory, the timing of each activity is critical to performance. This is often expressed through the cash-to-cash cycle. Yet the two departments that oversee this cycle often know little about each other’s processes, goals and KPIs. It is not just a lack of communication: at times, it is as if they speak entirely different languages.

Finance and Supply Chain are directly responsible for cash flow and inventory respectively. Both have well-established process blueprints to manage, control and align plans through Financial Planning & Analysis (FP&A) and Sales & Operations Planning (S&OP). The odd thing is that, while these processes have a great deal of overlap in their design and objectives, their inputs and outputs are not often connected. Instead, they tend to be run in isolation. This leads to missed targets, departments moving in different directions and a wider lack of understanding of why certain decisions are made. By developing a common language, organisations can bring the two processes together and create an Integrated Business Planning (IBP) process.

Let’s start by lining up FP&A and S&OP, looking at their commonalities and differences. From there, we can identify how each process can feed information into the other and support a stronger framework for Integrated Business Planning.

Financial Planning & Analysis

Financial Planning & Analysis comprises the forward-looking planning and analytical processes that guide an organisation’s strategy and decision-making. Primary processes include:

• Revenue forecasting.
• Cost planning.
• (Annual) budgeting.
• Working capital planning.
• Long-term scenario planning.

Looking at these processes, it’s easy to conclude that FP&A revolves around money. Finance ensures that the inflow of money is matched with the outflow of money. It develops models to put guardrails around costs, review cost discrepancies and trends, and test scenarios so that the flow of money does not cause surprises. Finance is not trying to build highly detailed plans at SKU level. It focuses on the aggregate, expressed in currency and margins, and often reports quarterly, annually and by reporting entity.

S&OP

Sales & Operations Planning is the cross-functional process that balances demand and supply, aligning sales, operations and leadership around one plan. Primary processes include:

• Product review / assortment planning.
• Demand planning.
• Supply planning.
• Plan reconciliation.
• Executive review.

These processes bring product teams together to discuss assortment performance and align on product phase-in and phase-out plans. Once those have been established, demand planning creates the demand plan and reviews gaps between the statistical forecast and sales goals or budget. Supply planning then assesses the feasibility of the plan together with operations. The reconciled plans are presented to executive teams, who decide on alternatives.

S&OP collaboration mainly focuses on collecting inputs, creating alignment and reviewing potential constraints in the medium to long term. Typically, short- and medium-term forecasts are SKU-based and contain a lot of detail. Often, forecasts are unit-based rather than currency-based, and for operations other units of measure can be used, such as hours or order lines. The focus is on operational entities, such as warehouses, branches and stores, and the process often follows a weekly or monthly cadence.

Where FP&A and S&OP overlap

Looking at the above, there are many differences between FP&A and S&OP. S&OP contains a level of detail that is not always useful for finance, while finance looks at costing detail that is not always relevant for S&OP. However, if you put a few of the processes side by side, there is also a lot of overlap. More importantly, supply chain can work effectively within financial constraints when the right alignment is in place.

Forecasting

The overlap between the processes mostly centres on forecasting. Finance teams typically forecast monthly or quarterly revenue, while demand planning teams build weekly or monthly SKU forecasts in units. Those are not the only differences. Finance typically works with assumptions around inflation, organic growth and planned expansion. This is not something demand planning typically accounts for, and, in some cases such as inflation, should not account for.

When it comes to collaborating on forecasts, I would argue that neither team should use the other’s forecast as the single source of truth. The goals of finance and supply chain are too different. A revenue forecast that incorporates economic growth, inflation and M&A does not translate well into a very detailed SKU forecast.

On the other hand, a bottom-up forecast converted into currency is likely to have too many gaps — it would need to include all discontinuations and product introductions two years out, all price changes, and more — and is too granular to become a robust and reliable financial forecast. It is, however, wise to compare and reconcile the two.

Large, inexplicable gaps are worth discussing and can highlight incorrect assumptions by either team. In the shorter term, finance can rely more on demand planning forecasts for working capital projections and depreciation estimates. More on that below.

Working capital

One of the most important roles of finance is to keep tabs on cash flow. In essence, you need to ensure that enough money comes in at the right time to pay suppliers at the right time. If not, payments may be delayed, or expensive short-term credit may be needed to finance new purchases. Cash flow is where supply chain and finance need to collaborate closely.

A lot of cash flow is a direct responsibility of supply chain. Supply chain controls the inventory that is bought and that sits in factories, branches and stores. The cash invested in these assets is a direct result of forecasts, inventory policies, network design and purchase conditions agreed with vendors. The only thing supply chain does not control is the sales and payment terms associated with those sales. Although responsibility for working capital is generally clear, the levers to control it are often poorly understood when teams are not aligned on plans.

Take a company that wants to reduce the working capital invested in inventory. What often happens is underbuying: a peanut-butter spread of reductions that will logically affect faster-moving items first. This can lead to underperformance in sales and reduced cash coming in. It is better for supply chain teams to consider other measures, such as changing inventory policies — for example, ordering more often — or renegotiating minimum quantities or payment terms with vendors. This can free up cash flow, although it may increase operational expenses such as labour. Ordering more frequently can lead to higher prices and/or higher inbound warehouse costs. Without collaboration between finance and supply chain, the impacts and scenarios will not be clearly defined, and surprises will happen.

Supply chain has the data when it comes to SKU forecasts, current inventory and the supply plan that should be derived from them. Finance teams can use these detailed plans in their cash-flow planning. Together, both teams should review scenarios when cash becomes a constraint, or when cash is cheap and holding additional inventory becomes a benefit.

Write-offs

Finance teams often create buckets for writing off inventory. Inventory may expire because of shelf life, or become unsellable if a product is outdated or market demand has fallen to zero. Good S&OP processes with product management should prevent this. However, there will always remain a non-zero chance that write-offs are required. Inventory depreciates. Finance teams often work with assumptions on total inventory value, but with help from supply chain they can start building better, forecast-based estimates.

Scenario planning

Both finance and supply chain are responsible for scenario planning. This is where collaboration should be tight, as supply chain decisions around warehouse or production capacity, labour, transportation and the inflow of products have significant impacts on cost and working capital investment. Every scenario has a financial impact, and every scenario has an operational supply chain impact. Without alignment, companies will run into unforeseen constraints.

A new language of planning

Despite the many differences, Financial Planning & Analysis and Sales & Operations Planning have many overlapping processes that are supposed to feed each other. Although the language, goals and cadence are different, companies should focus on building a culture of cross-collaboration between the two. This requires a shared language, clear processes and a regular cadence.

Step one is building an internal library of processes and their goals. Only once we understand that a revenue forecast has a different purpose and different building blocks can we avoid confusing it with a forecast created to plan inventory. We can then define where and how the two should be used, compared and used in conjunction with each other. Compare it to a toolbox: when attaching a roof or building a frame, a nail gun is likely your best tool. But if you are hanging a painting, you are better off using a hammer. There is a tool for every moment and situation, but we can only know which tool to use once we describe each one and its best purpose clearly, especially as not everyone who hangs paintings has ever built a roof, or vice versa.