One of the things I greatly appreciate about working with a wide range of clients is that we can learn from each other. Some days I’m the teacher and other days, I’m the student. As every client’s business and credit risk management system has a vast array of distinguishing characteristics, it’s imperative to listen and learn what makes each of them unique.

One of my clients is a small manufacturer who provides his product to some mid-size manufacturers (both are considered SME’s — small medium enterprises), who in turn sell to major global manufacturers on a Just-in-Time (JIT) inventory management system. JIT (also known as lean manufacturing) is the process of ordering and receiving inventory for production as it is required. This means that a global manufacturer does not need to hold any safety stock and operates their manufacturing process keeping minimum inventory levels. This strategy helps companies to lower their inventory carrying costs, increase efficiency and decrease waste.

JIT efficiency relies heavily on a concise manufacturing forecast and a strict coordination of all the suppliers in the supply chain to keep the final assembly line moving smoothly. In fact, some JIT forecasts are based on complex mathematical probabilities and statistics that help hone in on the accuracy of the inventory parts required to be on hand, even at a specific time during the day.

Even when all the moving parts of what can be a very complex supply chain are in sync, there are two very important downsides for the suppliers in the supply chain.

1) The Suppliers are the ones who actually need to hold a sufficient amount of safety stock in their warehouses in order to provide product on a needs only basis. For example, if Supplier C sells to Supplier B and Supplier B sells to the End Manufacturer A, then Suppliers C and B must have enough safety stock available at all times to meet the on-demand requirements. If for some reason Supplier C cannot provide product to Supplier B, this hitch in the supply chain can bring the entire manufacturing process to a complete halt.

2) The Suppliers, by virtue of being on standby, are the ones who also have to deal with large cash flow swings. While the global End Manufacturer normally pays its suppliers when inventory is used, often with long payment terms, the suppliers holding significant levels of safety stock may have difficulties paying their suppliers. In other words, until End Manufacturer A pays Supplier B, Supplier B often cannot pay to Supplier C, and so on down the supply chain.

Many SME’s are willing to accept these difficult conditions for the business opportunity of being a part of the supply chain to a well known global manufacturing company.

Some of the major problems that confront SME’s which can disrupt the JIT inventory system include:

  • needing to change their manufacturing or sourcing process on a dime’s notice
  • shipping the wrong parts, producing poor quality or not maintaining specifications
  • incurring logistic delays or enduring calamities outside the supplier’s control

When these problems occur, SME’s are almost always required to respond by:

  • taking inventory back
  • discounting for delays
  • discounting for shortages
  • extending agreed upon payment terms
  • not charging interest on past dues

The result is that in addition to the long payment terms under normal conditions, accommodating any of these problems can impede payment and initiate a cash flow roller coaster.

For the credit manager who is working at an SME within a JIT inventory manufacturing process, understanding these sudden cash flow peaks and valleys and how they can affect a cash forecast is an imperative part of supporting their company’s financial viability. For starters, the credit manager, along with the CFO, controller, and other members of the ARM cycle should consider:

  • mirroring their collection forecast with one that reflects past JIT inventory usage and current projections
  • setting up Bank Financing, A/R Financing, or Purchase Order Financing to smooth over the unexpected cash flow shortfalls

As in every business opportunity and transaction, there are potential risks in a Just-in-Time Inventory that can reach every part of a business. This is yet another area where we credit professionals need to be knowledgeable of all risks potentially affecting our companies.

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This article was edited by Steven Gan.

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