How CFOs Can Address Inflation's Squeeze on Supply Chains: Key Strategies and Practices
Persistent inflation continues to impact supply chains, with CFOs facing rising costs for raw materials, transportation, energy, and labor challenges. This article proposes three key practices: optimizing inventory management to balance agility and resilience, using financial derivatives to hedge against energy price volatility, and integrating scenario planning with short-term cash flow forecasting to develop medium- and long-term strategies, thereby maintaining profitability in an uncertain environment.
Editor's Note:Michael Poveda is a partner at UHY LLP and a managing director at UHY Advisors. UHY is a professional services firm providing audit, tax, consulting, and advisory services to the middle market. The views expressed in this article are solely those of the author.
Although the calendar has turned to 2023, CFOs are not in an easier position. After three years of turmoil, financial tightrope walking, and continuous adaptation to the "new normal," CFOs find themselves once again in "firefighting" mode in supply chain management, this time triggered by rising inflation.
From rising raw material and transportation costs to soaring energy prices and labor challenges, the impact of the inflation crisis on supply chains is complex and multifaceted. Meanwhile, many issues left over from the COVID-19 pandemic remain unresolved, and CFOs and their teams, when formulating effective strategies, must navigate uncertainty while avoiding damage to the gains achieved during the pandemic.
With this in mind, the following are key best practices that CFOs in the supply chain space can implement to mitigate the impact of the current inflation crisis and achieve short-, medium-, and long-term growth.
Inventory Management: Balancing Agility and Risk Resilience
Under normal circumstances, just-in-time (JIT) inventory logic may be attractive to boards seeking short-term returns—especially after three consecutive years of flat revenue. But these are not normal times. To successfully navigate the global inflationary environment, CFOs need to resist pressure from stakeholders to cut costs and boost revenue at all costs, and instead build an inventory strategy that balances business agility with risk avoidance and resilience.
To this end, CFOs should consider strategically stockpiling inventory that is price-sensitive, has high profit margins, and is in strong demand. This is easier said than done, but it is not impossible.
For example, by investing in automation, more advanced technology, and data science, CFOs can gain real-time information on demand, material availability, and other factors, enabling them to more accurately determine where excess inventory is needed and where it is not.
Admittedly, companies will incur upfront costs, and many boards may already be weary of this. However, if this move helps companies withstand sudden price spikes and revenue losses due to stockouts, it may be one of the most effective strategies for supply chain companies to maintain post-pandemic growth momentum.
Effective inventory management can also uncover opportunities for supply chain diversification, including domestic alternatives, which can serve as a natural hedge against rising inventory costs.
Hedging Energy Costs: Locking in Cash Flow
For companies looking to protect cash flow in an inflationary environment, hedging strategies using derivatives are also worth considering.
Energy prices are highly volatile, and geopolitical tensions have further exacerbated price uncertainty. To address this, companies can hedge against rising fuel costs by purchasing financial futures contracts or entering into fixed-for-floating interest rate swaps to lock in fixed forward prices for fuel.
In the current environment, companies should also consider longer-term risk management strategies around supply chains, energy resilience, and climate risk. With the global push for energy resilience and renewable energy, companies are already considering new diversified energy sources and evolving technologies.
Therefore, although accelerating the green energy transition entails short-term upfront costs, moving away from traditional energy dependence now should yield significant cost savings in the future. (Not to mention the tax credits and incentives that can make the return on investment even more attractive.)
Stay Calm and Avoid Being Trapped in the Present
The current environment can easily trap CFOs in a cycle of "reactive" decision-making. However, while staying flexible and responsive to market changes is crucial, CFOs must not adopt a short-sighted strategy, no matter how fragile the current situation. Instead, CFOs need to revamp their business intelligence strategies and adopt agile scenario planning and forecasting processes.
In uncertain times when forecasting beyond one or two quarters is nearly impossible, scenario planning can become a key risk management tool for the executive team. First, companies should focus on developing reasonable business scenarios across different time horizons, considering multiple key inputs, including raw material prices, wage levels, and supply-demand imbalances.
Based on these insights, management teams can develop corresponding business strategies for each scenario. Subsequently, executives should combine long-term scenarios with short-term (13-week) cash flow forecasts and modeling to create a comprehensive data set, enabling them to map possible outcomes in the short, medium, and long term and make optimal decisions.
There will undoubtedly be more turbulence ahead as the world works to control inflation. But this does not mean CFOs are helplessly at the mercy of the market. By adopting a balanced approach to supply chain management, CFOs can shield their organizations from the ups and downs of the inflationary environment and chart a clear path to future profitability.