Evolution Of Working Capital In the Supply Chain Enterprise
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Responding to a black swan event like COVID-19, its financial impact, related shutdown and disruption requires a calm, unemotional and composed response at a time when that’s the most difficult to achieve. Because all businesses have experienced some level of disruption and uncertainty, the approaches to working capital management taken in the past will require additional planning and foresight on the part of the CFO’s office as the economy is returning to business.
Even before COVID-19, growth in the global economy had slowed. The crushing impact of the pandemic just accelerated that trend. The aftereffect of this global shock wave and its impact on working capital availability can turn out to be truly cataclysmic for certain industries. Through their global insolvency index, Insurer Euler Hermes estimates record high insolvencies of more than 35 per cent cumulated over a two-year period. Unlike in 2007-2009, all regions and countries are expected to post double-digit increases.
A VUCA is what one needs to be thinking of for 2021 and onwards, unless we see some sort of normalcy across trade and supply chain lines. Additionally, payments and rising inventories have been highlighted among large corporates, working capital requirements (WCR) will increase by five days-plus to 74 days in or $8 trillion of additional financing needs worldwide. Suppliers will inadvertently continue to play the role of a financier to many of their clients, in such volatile times although the innovative world of supply chain finance continues to grow and bridge the gap. Supply chain experts are predicting changes to the payables landscape in the short to mid term.
Since the outbreak of COVID-19, we have witnessed unprecedented steps from regulators to take swift actions to encourage (and sometimes push) banks to provide much-needed fiscal relief or a liquidity lifeline to the private sector. Banks have been steadily beefing up the provisions in the light of the pandemic and the subsequent rise in defaults. Debt servicing becomes the next big question for corporations of all sizes. The question remains for banks and financial institutions, as to where should the resources be allocated, capital and investment for the future? What is not available is data for one to take an informed call. Will the private sector witness a natural tightening of lending criteria in 2021 and how will businesses adjust to this? This may put some corporations at risk and accelerate product structure innovation throughout banks in particular as the need of the hour would be to deliver an ROI. Traditional underwriting methods will not enable the scale that is expected in 2021 coupled with keeping the industry well oiled, any strain or lack lubrication could throw the system off gear. The supply chain industry continues to evolve at an increased pace to support client needs with the systematic use of credit solutions in the finance industry.
These are some of the key reasons why a laser focus on working capital practices, the ability to preserve liquidity and cash flow have become paramount. For many, the credit insurance and surety markets could play a vital role in supporting businesses in identifying potential future credit losses, mitigating a balance sheet impact and maximizing the working capital opportunities.
Innovative models of extending working capital needs are going to be the need of the hour, both to keep it well-oiled and also to ensure that financial institutions don’t suffer an income compression by the very reason of them not lending enough and that too judiciously.
The economic signs are very apparent
A big change is that even in resilient markets, such as pharma for example, businesses are now looking for solutions to free up additional working capital. According to figures from JP Morgan, nearly $500 billion remains tied up in the working capital of the S&P 1500 companies. And while there will be businesses that have robust credit management procedures in place and the ability to quickly convert receivables into cash—often it might be because without a large, healthy balance sheet behind them they have no other option—it’s not always the case. Ultimately, it’s vital that business looks to leverage every tool available to convert sales into cash as swiftly as possible or face a growing potential for default.
The longer that cash is uncollected, it is effectively funding another business rather than the creditors. Illustrating the scale of the problem, JP Morgan’s figures again show that the cash conversion cycle lengthened to over 71 days in 2019, an increase of nearly six days over 2018 and further revealing the challenge businesses face. This is further backed up by many economists’ predictions that global days’ sales outstanding (DSO) will reach its highest level in the 10 years. Businesses will need to manage their key performance indicators acutely to emerge stronger through the recovery period.
With that being said, innovative working capital augmentation structures are the way forward, there won’t be a David and Goliath in the financial marketplace. Partnerships and newer co-lending structures will however evolve, a David and Goliath who will partner to push through these opaque times which lie ahead of us in 2021.