Michael Poveda is a partner at UHY LLP and a managing director at UHY Advisors. UHY is a professional services firm that provides audit, tax, consulting and advisory services in the middle market. Views are the author's own.
Even though the calendar has flipped to 2023, things have not gotten any easier for CFOs. Following three years of upheaval, financial tightrope walking and the ongoing learning curve of the “new normal,” CFOs grappling with supply chains find themselves right back in the midst of another fire-fighting mission. This time it’s in the form of burgeoning inflation.
From price hikes in raw materials and transportation costs, to surging energy costs and labor challenges, the headaches that the inflation crisis has rained down on supply chains are complex and diverse. And naturally, with many questions still being answered in the wake of the COVID-19 pandemic, CFOs and their teams are struggling to effectively build strategies that can help them navigate this uncertain period without compromising any of the gains they have made as the pandemic has ebbed.
With that in mind, here are a few key best practices that CFOs throughout the supply chain can put in place to mitigate the impacts of the current inflation crisis and achieve short-, medium-,and long-term growth.
Under normal circumstances, just-in-time inventory logic may be very appealing for boards that are keen on immediate returns – especially after three years of flat-lining revenue. But these of course are not normal times. To successfully manage the inflationary environment that the world finds itself in, CFOs need to push back against stakeholder pressure to cut costs and catalyze revenue by any means necessary and find a way to build an inventory strategy that balances business agility with risk aversion and resilience.
To do so, CFOs should consider a strategy of stockpiling inventories that are the most sensitive to price rises that are also the most profitable and which will likely be in high demand. This is of course easier said than done, however, it is eminently possible.
For example, by investing in automation and more sophisticated technology and data science, CFOs can get real-time information on demand, material availability and other factors. This will in turn enable them to make better decisions about where surplus inventory is needed, and where it isn’t.
Admittedly, businesses will need to absorb upfront costs that many boards may have grown weary of. However, if it insulates businesses against sudden price surges and the lost revenue from running out of stock, it is likely one of the most effective tactics supply chain businesses can take to keep up any post-pandemic momentum.
An effective inventory management program can also uncover opportunities to diversify the supply chain, including domestic alternatives, which could serve as a natural hedge to rising inventory costs.
Hedge Energy Costs
For organizations looking to secure cash flows in an inflationary environment, a hedging strategy using derivatives is also a good option to consider.
Energy prices are volatile and geopolitical tensions are creating even more uncertainty in prices as time goes on. To combat this, organizations can look to hedge against rising fuel costs by purchasing financial future contracts or enter fixed versus float financial swaps to lock in a fixed forward price for fuel.
In this environment, organizations should also consider longer-term risk management strategies around their supply chain, energy resiliency and climate risk. With the growing worldwide push towards energy resiliency and renewable energy sources, organizations are already considering new, diverse energy sources, and evolving technologies.
So, while pressing fast-forward on green energy transformations come with upfront costs in the short-term, breaking away from traditional sources of energy today should result in significant cost savings. (Not to mention, there should be tax credits and incentives available to make the ROI more attractive.)
Stay Calm and Avoid Getting Stuck in the Present
The current environment makes it easy for CFOs to fall into a pattern of jumping from knee-jerk decision to knee-jerk decision. However, while it is important to remain nimble and responsive to evolving market conditions, CFOs simply cannot afford to adopt an approach that prioritizes short-termism regardless of how tenuous the current situation is. Instead, CFOs need to revamp their business intelligence strategies and adopt an agile scenario planning and forecasting process.
During this uncertain period where forecasting beyond one or two quarters is nearly impossible, scenario planning can be a key risk management tool for executive teams. To start, organizations should focus their efforts on developing reasonable scenarios for their businesses under various time horizons and consider a variety of key inputs including raw material prices, salary levels, and supply/demand imbalances.
With these insights in tow, management teams can then develop the appropriate business strategies for each scenario. From there, executives should then take these longer-term scenarios and integrate them with shorter-term (13-week) cash flow forecasting and modeling to create a comprehensive dataset by which outcomes can be mapped out over the short, medium- and long-term and the best decision can be made.
There are undoubtedly going to be more twists and turns as the world fights to bring inflation under control. However, that doesn’t mean that CFOs need to be blindly at the mercy of the market. By taking a balanced approach to supply chain management, CFOs can insulate their organizations against highs and lows of inflation environments and carve out a clear path for future profitability as well.