Supply Excellence — Credit Crisis Collaboration: The Best Cash Flow Alternative

Credit Crisis Collaboration: The Best Cash Flow Alternative

October 7th, 2008 · by Drew Hofler · No Comments · best practices, financial value chain, mid-market/growing enterprise, sourcing, supply management, supply risk

While it may not have the news-cycle cachet of a $700 Billion bailout, or the immediate voyeuristic drawing power of the battle of the banking titans (i.e. Wells/Citi/Wachovia), 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.

A recent BusinessWeek piece summed up the situation with the story of Drew Greenblatt, owner of a profitable steel wire company. Drew asked his bank for a $175k increase in his line of credit and was told by his bank that he’d have to put up the same in a certificate of deposit (If only they’d asked for 20% of that strict standard for home buyers, right?). As Greenblatt pointed out, “when banks can’t service guys like me, how are they doing it for the other guys?”

The answer: They’re not.

Particularly with small to med-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. The recent credit-crisis survey by AFP (subscription required) reveals that up to 63% of companies with under $1B 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.

But what is a supplier to do? As one article out of the UK puts it, “such a sharp and unanticipated cash drought has made financial directors look to more tangible sources of financing for the business.” So let’s take a look at a couple of the primary categories of alternative financing suppliers have to choose from and what that may mean to buyers:

Traditional Bank Offerings: ‘nuff said! The traditional bank offerings of secured and unsecured lines of credit and other such sources of short-term cash are exactly what suppliers are seeing dry up. And if they aren’t drying up, they are either becoming more restrictive in their covenants, or more expensive in their rates.

Non-Bank Alternatives: Suppliers who can no longer access what used to be relatively cheap sources of capital can often increase their cash flow by accepting Pcards or selling their Accounts Receivables to traditional factoring companies. But such cash flow does not come without a price. Pcards generally charge a 2%-2.5% fee, which can amount to a 24%-36% annualized cost of capital (a primary reason why Pcards have traditionally not been used for higher $ 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.

Buyer-Supplier Collaboration: As one community banker said in BusinessWeek last week: “When there’s disruption in the marketplace, that creates opportunities for banks like ours that have lots of liquidity.” This holds true also for Buyers with strong cash positions as the credit crunch creates an opportunity for them to utilize that 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 .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.

If buyers and suppliers fail to get this situation under control, the crumbling of supply chains - and their repercussions in employment, tax revenues and GDP - could be the next shoe to fall in the ever widening financial meltdown.

I recently contributed to a white paper title Strategies for High-Yield Working Capital in Today’s Economic Environment that dives further into supply chain finance. You can download a copy of the paper here if you’d like to learn more about your options, such as Discounting and Third-Party Finance.

Drew Hofler is the Senior Manager responsible for Ariba’s Financial Solutions suite of products. In addition to extensive experience in banking and financial services, Drew is ACH Accredited and held Series 7 & 63 NASD certifications.

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