Working Capital Effects on Supplier Financial Risk

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Working capital whipsaw effect on supplier financial health

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Working Capital Effects on Supplier Financial Risk

  1. 1. Supplier Financial Risk – Not Out of the Woods Yet A fter the shakeout from lower Q1 volumes, many think the worst is over and most of the have on working capital. As revenues increase, working capital is almost always consumed due suppliers have survived, but the real surprises are go- to increases in accounts receivable and inventory, ing to occur during Q3. This is when, as volumes where 30 to 90 days is often required to stay stagnant or slightly increase, that the one-time see the impact of the growth hit cash flows. working capital boost most suppliers experienced will not be enough to keep them afloat. As shown in the graph below, the steel and corrugated industries show the volume impact on working capital changes. Most suppliers would have performed much worse from a cash burn perspective without the one-time benefit working capital changes had on cash flow. Awareness of the working capital whipsaw effect is the first step to ensure continuity from the sup- ply base. The US has not experienced a recession of this magnitude since 1982. Due to this volume downturn, many of the forecasting models used to predict supplier insolvency do not adequately eval- uate growth and working capital impacts against As volumes stabilize or grow, working capital the liquidity requirements for the supply base. requirements have the potential to push a supplier into bankruptcy. Credit revolvers and covenants need A disciplined approach to supplier engage- to be monitored to ensure that as the one-time ben- ment can uncover the factors that can bring efit of working capital ends, the supplier has liquid- down suppliers, including the changes in work- ity available to continue to supply. The following ing capital due to the dramatic volume de- graph shows the impact that major revenue changes clines experienced during the previous quarter. 208.610.0032 n tbokowy@costandcapital.com n P.O. Box 2126, Sandpoint, Idaho 83864
  2. 2. In this environment, suppliers face several pres- Supply chain organizations are just starting to de- sures and therefore need to be engaged to se- velop the competence and depth of talent to man- cure visibility into their quarterly volume projec- age financial risk in the supply chain. The com- tions, capital requirements, and access to credit. bination of financial acumen, supplier engagement techniques and commodity knowledge need to be Effective supplier risk management requires a cat- deployed to assess financial exposure to suppliers. egory-appropriate approach. Each spend category faces different pressures from this market. Several financial risk metrics are useful, but applying the wrong metrics can draw inconsistent conclusions and leave the supply chain organization exposed when the warning signs look apparent in hind-sight. Restricted liquidity has reduced the ability for many suppliers to tap the existing credit mar- kets for additional capital. Reduced volumes require suppliers to right-size operations while commodity volatility creates a lag effect which can drag on sales as commodity prices head higher. The current environment has placed supply chain professionals in a position where they need to be applying tools that in the past have been the re- sponsibility of the finance group. Risk manage- ment continues to grow in importance to imple- ment world-class supply chain management. Now is an opportunity to deploy world-class risk assessment techniques which, when combined with a developed sourcing toolbox will reduce expo- sure while driving performance in the supply base. This commodity lag effect was responsible for 5-10% of Q1 revenues for transportation suppliers. These effects are temporary and can have just as strong of a Tom Bokowy is the founding partner of Cost and negative impact in times of price escalation. Capital Partners LLC. Tom has published sev- This lag effect is a benefit to suppliers as eral position papers on supplier engagement best commodity prices retreat, but can squeeze practices including negotiations, spend manage- supplers as commodity prices increase. ment, target setting and financial risk assessment. 208.610.0032 n tbokowy@costandcapital.com n P.O. Box 2126, Sandpoint, Idaho 83864

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