Credit Crisis Collaboration: The Best Cash Flow Alternative
It is often said that the perception of a recession is more powerful than the recession itself. And more often than not, it”s the former that creates the latter. During tight times, the tendency for most organisations is to shore up costs and adopt a myopic approach to conducting business. Buyers become complacent bystanders as suppliers begin to run into trouble. Suppliers in turn become less flexible in their negotiations with buyers, eyeing badly needed present revenue over long-term growth. Isolated and wary, organisations on both sides often find themselves navigating through tough economic times on their own. They give less, they spend less, and in doing so, they gain less.
Now, with recession looming large over the economy, it”s more important than ever for buyers and suppliers to work more closely together and embrace innovative ways to ensure their mutual health. If a supplier can”t access capital, it will fail. And when suppliers fail, the companies that rely on them face a higher likelihood of failing as well.
How can buyers and suppliers bind together to better weather the storm? As the gap between low-quality and high-quality borrowers grows, more suppliers will experience cash flow problems. For forward-looking buyers willing to come to the rescue of their most important suppliers, third-party supply chain financing options exist today that enable buyers to hold onto their cash and suppliers to be paid early at far more competitive rates than traditional factoring or card providers allow. Buyers can use their good credit rating to help suppliers borrow at lower rates than they could achieve on their own. The result is a healthier and more productive relationship and supply chain.
In addition, buyers who have the capital to pay suppliers early can also offer suppliers accelerated cash flow through dynamic discounting, which gives suppliers quick access to capital by offering buyers discounts in exchange for early payment.
By joining together to optimise working capital and lower overall costs, buyers and suppliers can dramatically reduce risk and create the strong relationships that will not only protect themselves in the short-term, but also give both sides greater flexibility in pursuing opportunities in the long term.
While it may not have the news-cycle cachet of a US$700bn bailout, or the immediate voyeuristic drawing power of the battle of the banking titans, the struggles that suppliers are facing finding cash flow and short-term credit can have immediate and long-term impact on supply chains if those suppliers fail or are forced to raise prices to cover increasing costs of alternative sources of capital.
Particularly with small to medium-sized suppliers (SME) and those with longer cash conversion cycles – the life-blood of many supply chains – cash flow is the most immediate risk to an otherwise healthy business model in the current environment. A recent credit crisis survey by the Association for Financial Professionals (AFP) reveals that up to 63% of companies with under US$1bn in revenues depend on secured and unsecured lines of credit for their short term cash needs. Unfortunately, as we have seen over the past year, and especially the past few weeks, this is exactly the type of credit that is becoming less and less available.
So what is a supplier to do? Know your options. Traditional bank offerings of secured and unsecured lines of credit and other such sources of short-term cash are drying up. And if they aren”t drying up, they are either becoming more restrictive in their covenants, or more expensive in their rates.
Suppliers who can no longer access what used to be relatively cheap sources of capital can often increase their cash flow by accepting P-cards or selling their accounts receivables to traditional factoring companies. But such cash flow does not come without a price. P-cards generally charge a 2%-2.5% fee, which can amount to a 24%-36% annualised cost of capital (a primary reason why P-cards have traditionally not been used for higher dollar spend in better times). Factoring also enables suppliers to access the value of their receivables, but depending on the particular “factors”, this too can come at a high price and usually only advances a portion of the receivable”s value. Certainly not ideal, but to suppliers without other alternatives, it does keep the cash flowing.
Buyers with strong cash positions have an opportunity to utilise their cash lucratively and become “the bank” for their supply chain. Giants like GE and Dell have been doing this for years, using their own cash to finance supplier early payment at rates that are far less expensive to suppliers than alternative forms of financing, but at the same time are far more profitable to themselves than alternative short-term cash investments.
If a buyer has the cash sitting somewhere earning 0.5% (treasuries) or 2-3% (money markets), why wouldn”t they offer early payment to a supplier in exchange for a discount equaling 10-16% APR? For a supplier paying 20% or more, and in vital need of cash flow, that”s a bargain. And it”s a win-win for both parties…particularly when such collaboration is facilitated by network technology, which allows the thousands of individual supplier early payment “conversations” to scale for the buyer and gives the supplier the ability to access early payment at the click of a button.
Buyers and suppliers need to remember that they are each other”s key business partners, and they should be valued as such. By creating a more collaborative environment, buyers and suppliers are both positioned to achieve their own working capital goals. Improving terms of trade and managing spend is, of course, always important. But in the face of an economic downturn, it”s an absolute must.