While the physical supply chain was subject to continued improvements and efficiencies over the past decade, the global recession has led to the spotlight being moved on to optimising the financial supply chain. With the emergence of several key economies from technical recession, financial managers are looking for means to overcome the current conditions, eager to find the necessary working capital to invest in new opportunities and structures that will maximise growth potential.
Payment Terms to Worsen
Firms looking to free up the cash flow needed to see them through the downturn, or those seeking to support economic recovery through business expansion, are still resorting to the extension of payment periods. The chance of getting paid on time by businesses has deteriorated and credit management organisations expect this to worsen still more.1 On the one hand, buyers look to extend terms; on the other hand, suppliers try to resist any extension. Demica’s previous report into the situation, conducted in April 2009, found that 63% of UK firms and 48% of German firms were trying to extend payment terms with key suppliers, while 88% of UK firms and 55% of German firms reported that their key suppliers would be unable to sustain any further lengthening of these terms. The picture remains broadly unchanged, with 50% of European firms now seeking to extend payment terms in 2010 and 63% reporting that suppliers are unable to sustain this. Evidently, no substantial easing of credit conditions is in sight across Europe.
This is leading to unprecedented supply chain tension and a tug-of-war situation between buyers and suppliers, with both parties keen to secure the best terms, often at the expense of the other. If payment terms are extended, the buyer benefits and is able to improve its cash flow – but the supplier’s cash flow suffers.
With unsustainable pressure on suppliers – many of whom who are already operating on paper-thin margins – to reduce prices still further, carries escalating risk – that of supplier failure. The effects are plain to see, particularly when the failure in question relates to a specialist supplier that is difficult to replace. Our research revealed that 51% of European firms had seen supplier failure increase in their industry’s supply chain over the last year. Furthermore, no improvement was expected until January 2011.
Scarcity of Credit
Other economic statistics highlight the root of the problem. According to the European Central Bank (ECB),2 there has been “an unchanged net tightening of credit standards (3%), broadly in line with expectations in the previous survey round… Looking forward, euro area banks expect the net tightening of credit standards on loans to enterprises to remain broadly unchanged.” The Bank of England (BofE) corroborates these findings,3 stating that “net lending to businesses has remained weak, with new facilities granted reported largely to reflect the refinancing of existing lending…consistent with efforts by some businesses to diversify their funding sources. Businesses continue to report higher spreads and fees on the renewal of facilities.”
The challenges currently being experienced in the eurozone, with a drop in bond and stock markets, have led to further doubts as to when economic recovery could take place. Our survey into the three main European economies – Germany, the UK and France – shows to what extent the tightening of credit continues to affect firms, with four in five companies in each country consistently reporting having encountered difficulties in obtaining traditional bank credit. Furthermore, no immediate recovery is in sight, with respondents stating they did not believe the situation would improve until the end of this year (December 2010). As regulations are tightened and a closer examination of lending practices is implemented following the crisis, banks will likely find themselves more risk-sensitive than previously, further contributing to the shortfall in business credit availability.
The market for credit insurance remains extremely fragile yet appears to have improved in some respects over recent months. Credit insurers across the board are continuing to re-evaluate risk. This may be an effective way for credit insurers to reduce their exposure to numerous sectors and companies, but it also withdraws the support that is so vital to many supply chains in a period of high uncertainty.
The impact of the withdrawal of credit insurance was made largely evident by over two-thirds of respondents in our survey, who blamed the increased price and lack of availability of credit insurance over 2009 and 2010 for introducing significant instability into many supply chains. Germany, the UK and France all reported having been affected at similar levels – an indication that credit insurers have followed the same withdrawal trends throughout Europe. Many have also simply priced themselves out of parts of the market – with trade credit organisations reporting an average price increase of 20% for credit insurance and some companies are said to be experiencing rises of as much as 40% to 50% or, in the worst cases, even 100%.4
Banking on Supply Chain Finance
Our findings reveal that supplier failure, the scarcity of credit and the rise in credit insurance will continue to plague European supply chains. This could have potentially damaging long-term financial implications, as 62% of European companies believe that when the upturn reaches full swing, they will have insufficient working capital to make the most of it. Banks are aware of this and are keen to help improve the situation, as economic recovery will be intrinsic to their future performance and ability to lend. Banks also find themselves under considerable pressure from governments and the public to demonstrate that they are proactively supporting business through the recession and encouraging growth. The risk of lending to companies experiencing financial difficulties, however, continues to act as a barrier for many. Supply chain finance (SCF) is therefore increasingly favoured as way of supporting banks’ existing customers and suppliers’ liquidity, while also strengthening business relationships.
Seeking to quantify banking interest in SCF, our survey revealed that over the past two years, banks have been offering prospects a greater range of financing products – including SCF. In fact, just over half of European firms reported having been approached by competitors of their current bank(s) using a greater range of alternative financing methods to try to win their business.
In terms of the solutions offered by their current banks, 34% had been offered factoring; 29% SCF; 35% invoice-based finance; 34% asset based lending; and 31% securitisation in the past two years. Collaborative financing tools such as SCF have recently generated a high level of interest among financial directors and bankers as a way of raising finance to free up working capital, in order to help ease part of the tightening on standard credit lines. Euromoney reported SCF as “one of the hottest topics in transaction banking…over the past few years” and states the demand for SCF services is continuing to grow.5 Demica’s research shows that SCF participation rates have gone from strength to strength – possibly as a result of banks advertising a wider range of commercial finance products. While a quarter of respondents reported having participated in a SCF solution for some years, a further one in five firms was currently considering participating in such a solution.
SCF: Looking Ahead
SCF is therefore taking on a distinct persona in the range of products that companies perceive they need and indeed is an area that banks are keen to develop to meet those needs. Increasingly, banks, companies and their advisors will all be looking into how SCF and other alternative commercial finance products can help fuel growth and improve business prospects once the recession ends.
Furthermore, it appears that these tools are having a lasting effect on European business, as 57% say supplier financing will remain of greater importance even when full economic recovery gains momentum. This was especially evident in France (67%) and the UK (56%), demonstrating that alternative financing tools are starting to become ingrained into the financial manager’s mindset. SCF is therefore expected to play a much greater part in future strategies. When asked where this much-needed working capital would be concentrated, firms revealingly reported that they do not intend to focus on their debt burden, but are instead more concerned that they will miss the coming opportunities once recovery begins. Fifty-three per cent of European respondents labelled sales growth as one of the most important areas to apply free cash and working capital over the rest of this year, followed by 36% indicating workforce restructuring.
Sales growth was particularly favoured by German firms (59%) and workforce restructuring by UK firms (45%), with France lying broadly in the middle for both (49% and 31%). In the UK, a growth spurt is becoming evident if we continue to observe the larger measure of economic health: the manufacturing sector. The manufacturing purchasing managers’ index (PMI) recently increased to 57.2 from 56.5 in February 2010. This was the highest level since October 1994 and, as with any level over 50, indicates expansion. However, at the same time, employment levels within the manufacturing sector fell in March 2010, dipping to 49.2 from 50.1 in February. Manufacturers said job losses, mainly at large companies, were a result of workforce restructuring and related cost-cutting initiatives.6
It seems then that although the opportunity for growth is taking shape on the horizon, European corporations are faced with a number of hurdles – the unsustainable demand to extend payment terms, the looming threat of supplier failure and the withdrawal and rise in the cost of credit insurance. The continued lack of availability and tightening of traditional lines of credit have shown no sign of easing, causing further supply chain woes.
In response to this situation and in order to combat these obstacles, sources of alternative finance such as SCF are increasingly being implemented by corporates and their relationship banks. By increasing liquidity within the supply chain, SCF has the potential to reduce the number of European firms becoming distressed due to lack of access to credit and other financial setbacks – allowing them to free up working capital to focus on managing a path to recovery and funding future growth.
1 Intrum Justitia, European Payments Index & Risk Survey, 2009 and also Forum of Private Business, Economy Watch Report, April 2010.
2 ECB, Euro Area Bank Lending Survey, 28 April 2010.
3 BoE, Trends in Lending, May 2009.
4 Aon Trade Credit, as reported in Commercial Risk Europe. Also see Broker Willis Re, January review of current market conditions.
5 Euromoney, Supply Chain Management: Towards Stronger Chains, by Laurence Neville, April 2008.
6 The Telegraph, ‘UK manufacturing output grows at fastest rate in 15 years‘, 1April 2010.
When Mark Cuban declared that "Data is the new gold" he highlighted why information is possibly the most valuable asset a business has. APIs are the unsung heroes that make it possible to extract that value.
The revised Payment Services Directive regulation, regarded as one of the most disruptive in Europe’s financial services sector, will begin to make an impact on January 13, 2018.
The cost of compliance efforts for banks has increased exponentially in recent years. This is especially true for those banks that are active in the global trade finance domain, where the overwhelming expectation is for compliance requirements to become even more complex, strict and challenging over time.
This year promises to further the regulatory compliance burden imposed on financial institutions. How are firms in the sector responding to the challenge?