Your Balance Sheet is More Important than Your Income Statement
When trying to lose weight, it’s not about what the scale says — it’s about how the clothes fit. The number is irrelevant if the pants don’t close or the once too-tight shirt is now too big. The scale is reductive and insufficient as the sole indicator of one’s overall health. It allows for loopholes like dangerously depriving oneself of calories while completely ignoring important details such as increased muscle mass, improved hydration levels, or resting heart rate.
The same thing goes for the operations of your business. While everyone is scrambling to make sure their income statements show for a profitable year by squeezing procurement costs, it’s actually the balance sheet that tells the full story of long-term financial health. The balance sheet shows companies what they owe versus what they own and tells the story of operational efficiency; in other words, how much cash is tied up in inventory, versus how aptly companies turn inventory into revenue. For the typical Fortune 100 company, a day of supply chain locks up $50M to $100M in cash. So when it comes to running the numbers, the ability to respond to customer demand without holding excess inventory is a much more sustainable path toward financial health than crunching costs at the expense of operational efficiency.
How Did You Get Here?
The root of the problem rests in fundamental disconnectedness. Today’s operations aren’t optimized to respond in real-time to fluctuating demand because they run on functional, informational, and structural silos. This pervasive compartmentalization makes it impossible to gain clarity regarding the interdependencies and activities across any given supply chain. From procurement, to manufacturing, to warehouse inventory levels, to global shipments, no one — not even top executives of the world’s biggest brands — can see the whole picture with enough resolution to cut out the fat. Instead, terrified of stock outs or missing out on sales opportunities, companies inundate their operations with buffer, while desperately squeezing supplier margins in a scramble to end the year black on the ol’ income sheet.
But this strategy of crunching suppliers is inherently limiting. For one, hammering partner costs is financially shortsighted. After all, there is only so much you can squeeze before there’s nothing left. Your partners will reach their limit, and your cost savings will stagnate. Secondly, you are unloading your burden on the backs of your third party partners, who are linchpins in your operation. Remember, suppliers, contract manufacturers and logistics providers are all businesses too. They too need to put dinner on the table, and the tighter you run them, the less of a priority you’ll be. By jeopardizing your partner relationships, you’re risking being “bottom of mind” in times of material shortage or demand spikes. Such an event would make you more susceptible to stockouts and send your customers to competitors who were able to get their hands on the materials you couldn’t.
Rebalancing Your Perspective
To run a fundamentally sound business, you have to cut out the excess from your operation in terms of time, inventory, and materials. Ultimately, this boils down to bridging sources of information so that you can have a better idea of what is going on across your operation. Operational clarity will allow you to allocate materials in real time, rather than trying to forecast based on guesses and obscurity.
The first thing you can do to help unlock the flow of information in your operation is reorganizing it. You must incentivize open, transparent, and real-time information sharing across teams rather than just within them. The concept of “need to know” is archaic and misguided. If businesses truly want to run an agile and lean operation, they have to start making information available pervasively.
Secondly, executives must encourage open and transparent partner communications. They have access to information that you need, such as material shortages or seasonal spikes — and they will only share it within their trusted network. So it’s time you start considering yourself a part of their network. This requires a fundamental psychological shift: an acknowledgement that your partners aren’t secondary to your operation, but rather, they are shared owners in it.
Lastly, executives must provide the technological tools that contextualize communication and data, helping teams turn information to swift action. Most of the tools companies use today over-index on specific operational functions, essentially exacerbating silos rather than breaking them down. Executives must make the difficult decision to refocus from functional optimization to cross-functional optimization by normalizing data to generate cross-cutting insights.
Don’t get me wrong: such change won’t be easy. Shedding hundreds of millions in excess weight in time, inventory, and materials by means of an organizational transformation will be a daily battle. But it will pay off in the end. Because an inevitable consequence of a healthy balance sheet is a profitable income statement.
Executives who want to support company growth while still meeting margin targets need to start finding ways of freeing up cash flow from operations rather than myopically focusing on cutting costs from procurement. Knowing what materials your operations carry versus how much gets wasted and how much inventory you turn over versus the volumes that age or expire will transform your operation from a cost center to a strategic weapon that fuels your brand’s success.