This is the first part of the three-part series on the relationship between freight and finance. Stay tuned for the rest of the series.
Transportation costs undoubtedly impact a company’s financial performance. And yet, for most CFOs, controlling these costs is far down on the priority list. Despite strong evidence suggesting that better cooperation between transportation and finance leads to more informed and smarter decisions, active collaboration is still rare. Why?
Because CFOs and logistics managers view transportation through a different set of lenses.
While CFOs evaluate strategies based on its impact on profitability, asset utilization, and other company-wide metrics, logistics managers tend to focus more on their departmental budgets and metrics, and don’t always communicate the broad consequences of transportation decisions to the right people.
As a result, CFOs can get a false read on the financial impact of transportation and logistics decisions. It is crucial to understand that transportation strategies need to be evaluated using a wider financial frame, while also recognizing the interplay between these strategies and the key financial levers that shareholders pay attention to. If CFOs are from Mars, then logistics managers are from Venus. The impact of transportation needs to be translated into terms that the CFO can understand.
An area where CFOs and logistics managers can agree is the value of freight savings. If you consider an instance of a $1 billion industrial company with a 5% profit margin, a 10% savings on freight transportation can add a whopping $6.3 million to the bottom line, which is a 12% profit increase.
The trickier part is comprehending the full financial impact of transportation decisions since transport and logistics costs are spread out across many different divisions. To understand it better, several key questions related to transportation and logistics strategy need to be identified and answers to each should evaluate how it can impact financial performance.
How much inventory should you carry?
The pressure is on everyone in the industry to reduce the amount of inventory tied up in supply chains.
Leaner inventory means faster transportation, which can command premium rates and drive up other costs. Trucks are faster than barge and rail, but they’re more expensive, not just per mile, but in terms of loading costs.
And to a CFO, lean inventory would mean a reduction in working capital that’s tied up in inventory. But to a 3PL it would mean a greater need for expedited freight, complicated changes in transport mode, and also pressure for 100% accurate fulfillment.
Lower inventory results in an increase in logistics costs due to the following:-
- Higher freight costs because it precludes the use of cheaper, longer-transit modes, and may even require paying a premium for expedited freight.
- A situation of stock-outs. On the inbound side, this can cause plant or production line shut-downs due to a lack of raw material or parts.
- On the outbound side, it can lead to empty shelves, missed sales or, much worse, the loss of a customer and the associated lifetime revenue.
- Increased labor costs to rapidly process the inventory, monitor stock levels and arrange transport for urgent restocking.
In plain financial terms, inventory is a component of working capital. While it continues to be difficult to borrow money, investors keep a very close eye on levels of capital tied up in the supply chain – the lower the better.
However, if you lower your inventory, and therefore working capital, your profit margin suffers. That looks bad, and additionally, if you have to raise your working capital levels again, investors may react negatively to volatile inventory.
Reductions in working capital related to inventory carrying costs, should be balanced against potential increased freight charges and lower customer satisfaction levels caused by stock-outs.
In other words, when you examine all the logistics implications, it’s possible that lowering inventory levels can cost you more freight and money but will release the working capital. CFOs need to work with their 3PLs and arrive at the right balance.
The 3PLs need to get into the game and provide solutions to reduce working capital, as a service to shippers.