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SCM Financial Analysis

blogrollLet's put ourselves in the position of a financial analyst for your company's Supply Chain Management division. You will have a diversity of functions in your area of responsibility: CRM, EDI, Logistics, Procurement and others. Your challenge is to communicate effectively with a variety of individuals on the staff. Don't go over their heads with number-packed reports. Know the staff. They are "action" people. Bet you find they like words and graphs better. Use their language. Remember, your not in the hallowed halls of finance; you are out where the money is made (or lost).

Next is your value to the SCM manager or director. An important function for you is Management Controls – assigning responsibility for executing strategy. Management Controls need to include:

(1) How responsibility is assigned and measured

(2) How tasks are measured

(3) Controls such as when to order inventory

(4) Why actual and budget vary (cause)

(5) Plus, "soft" measures such as intangible assets, impact of changes on the staff.

So from a financial person's viewpoint, what is a Responsibility Center (some places call it a "Cost Center") all about? It is like a small-to-medium business, and its manager (YOUR MANAGER) has been tasked to run that business and preserve the interests of the larger organization. Goals for the Responsibility Center should be specific and measurable; they should promote the long terms interests of the organization and should be compatible with other Responsibility Center activities.

Let's use Inbound Logistics as just one of many Responsibility Centers. Logistics dispatches trucks to pick up or deliver shipments from local terminals or suppliers. Shipments could be brought to one or more factory sites. Success of this service would depend on service commitment to manufacturing (on time, without damage) and controlling costs. How should you measure the performance of this Responsibility Center, its mangers, and its employees?

To focus on efficiency: we could measure number of shipments picked up, sorted or delivered, per route, per employee, per vehicle, per hour or per shift. To focus on customer service, we could measure each time the Responsibility Center met its deadlines, when Inbound Logistics was required to sort shipments, what the sorting error rate was. We could also measure customer service by:

  • number of complaints received
  • average time taken to respond to complaints
  • and effective resolution of complaints.

Most organizations use financial controls – cost, revenue, and profits, etc. However, such measures are not applicable to all units within an organization. For example, Inbound Logistics. It can only be done on a cost measurement basis.

Measurements are different across diverse organizations, but they generally measure efficiency and effectiveness. Efficiency is the ratio of output to inputs, but you can only use in a comparative sense. If Inbound Logistics is more "efficient" than Warehousing, do not rush to conclusions; examine why Warehousing is less efficient and what can be done about it. Also, comparisons are possible only if Warehousing and Inbound Logistics use comparable outputs and comparable inputs. You cannot compare apples to oranges.

Efficiency is generally measured by comparing actual costs to standard costs, but standard costs do not remain stationery and recorded costs are often different from actual resources used. Remember, establishing a Responsibility Center is easy; but measuring its efficiency in a reasonable manner is not easy. We need to understand the relationship between a Responsibility Center's output and its objectives (what it was intended to do or perform or deliver). If the output contributes to satisfying the objectives, then it is doing what it is supposed to.

A Responsibility Center must both be efficient and effective. It must use the least amount of inputs to get the maximum amount of output and yet deliver on the goals. Now after all that about efficiency, effectiveness can be simply defined as how well you reach your goals.

Responsibility Centers can include Revenue Centers, Cost Centers or Expense Centers, Profit Centers and Investment Centers. Inbound Logistics is a cost/expense type of center. Here, employees control costs, but do not control their revenues or investment level.

Our costs are:

(1) direct: those costs that can be reasonably associated with the cost center – direct labor, direct materials, telephone/electricity consumed, office supplies

(2) indirect (discretionary): where a direct relationship between a cost unit and expenses cannot be reasonably made.


Management allocates them on a discretionary basis (e.g. depreciation expenses for trucks and other equipment utilized). The difference between budgeted expenses and actual expenses does not indicate efficiency. Suppose if the actual cost is less than budget, does it mean good or bad? Suppose if the actual cost is higher than budget, does it mean good or bad?

Budgeted costs are target estimates. It points to a goal to be achieved, but it can and will change. Actual costs are those incurred during a given period. The difference between the two could be either positive or negative variances. However, making conclusions on the basis of positive or negative variances must be done carefully Instead, find the cause behind the variances. Use your common sense and rationale as a good financial analyst.

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