Sales and Operations Planning (S&OP) may remain “a Supply Chain thing” if there is no integration with Finance.
A less mature S&OP resides within functional silos, preventing companies from fully grasping the significant benefits that a mature S&OP process — also named Integrated Business Planning — can bring, including increasing EBITDA by 6 percent and inventory reduction by 25 percent.
In Vineet Khanna’s words—Former Global Head of Supply Chain at Nestle— “Integrated Business Planning (IBP) done well works. It delivers results. Is it magical? Not really…but definitely the best next substitute.”
A mature S&OP/ IBP is a highly cross-functional business process with focus on the company’s financial performance.
To take S&OP to this level of maturity, demand and supply planners need to learn the fundamental concepts of Accounting and Finance, as this is the language of the business.
So where can planners start to learn this language that will help them to translate operational aspects into financial impact when running what-if scenarios or evaluate trade-offs to make better decisions considering the business in its entirety and not each department individually?
Understanding how to read the financial statements—they portrait a company’s performance —can be helpful for demand and supply planners to translate from physical units and supply chain metrics to monetary units and financial metrics.
However, going some layers deeper, understanding the foundations on how the financial statements are built could even be more helpful and simpler at the same time.
This article will equip demand and supply planners with the fundamental concepts on which the financial statements are built. These are accrual and cash Accounting.
When running different scenarios and conduct product portfolio review in S&OP/ IBP, planners will understand better how operations translates into financial performance.
Accrual vs Cash Accounting
Accrual and cash accounting are the steppingstones for the P&L, balance sheet, and cash flow statements. Naturally, the cash flow statement follows cash accounting. It tracks the in-flows and out-flows of funds from revenue and expenses.
Cash accounting doggedly chases money. It is straightforward; it is like “show me the money” from Tom Cruise’s movie, Jerry Macguire.
For example, by following the cash accounting, the business records a transaction when receiving payment from a sale to a customer. It also records a transaction when paying suppliers.
Accrual accounting is more complex. This is a concept that I struggled with when I was studying for my bachelor’s degree in accounting.
I used to think that it was a fake concept, something that Accountants had made up. I didn’t see any value in it. My thoughts at that time were that accounting was all about money. Wouldn’t the cash accounting be enough and the only criteria to consider?
I was wrong. The best way to observe the flaws of my original reasoning is with an example. Consider that the business makes a large sale to Walmart and payment terms are Net 120 days.
Following the cash accounting, the business doesn’t record this transaction until receiving the funds four months later. Can you think of a significant transaction not reflected because the business has not yet received payment?
Precisely, the accrual accounting addresses this challenge. Instead of the in-flows and out-flows of funds, it tracks the actions that generate revenue or expenses.
In our example with Walmart, accrual-basis accounting records the sale, regardless of payment terms. The revenue and cost of goods sold (COGS) will be included in the P&L and the reduction of inventory in the balance sheet.
There are no effects in the cash flow statement until payment is received.
Even more mature S&OP or IBP process may not include the cash flow forecasts, not portraying the true financial situation of the company.
The P&L could show a profitable business, but such a business may need to file bankruptcy due to lack of cash. Cash flow forecasts may not be present in Financial Planning and Analysis (FP&A), a process that resides in Finance, either.
Certainly, the cash flow forecast area represents an opportunity for improvement. To take advantage of it, understanding the differences between accrual and cash accounting are critical.
Conclusion
-More mature S&OP/ IBP processes require finance and supply chain integration. For this integration to be successful, demand and supply planners need to learn the language of the business that is Finance and Accounting.
-In running what-if scenarios, it is critical to see the financial impact of operations for better decision-making and results, considering the business as a whole and not the individual functions working in siloes.
-For this, it is important to understand the financial statements and even better, to understand their foundations. Foundations in forecasting financial statements are accrual and cash accounting. The key difference between these concepts in timing.
-Cash accounting tracks the in-flows and out-flows of revenues and expenses while accrual-basis accounting tracks the actions that generate such revenues and expenses.
-The P&L and balance sheet follow accrual-basis accounting and the cash flow statement follows cash accounting. It is critical to forecast all the financial statement to convey a comprehensive view of its financial performance.
