Rethinking working capital for the mid-market

Access to funding is crucial for any mid-sized business, providing the freedom to respond to market challenges and opportunities as they arise. But the ability to source ready finance has been constrained in recent years, with regulations including Basel III and the European Union’s (EU) Markets in Financial Institutions Directive (MiFID II) reducing the ability of traditional lenders to provide liquidity at an affordable cost, holding back growth for this vital section of the economy.

Recent reports in the Financial Times – and elsewhere in the business press – of an ongoing review by The Basel Committee on Banking Supervision (BCBS) suggests that the situation may deteriorate further, with banks required to increase their trading book buffer by an average of 74%. In this climate, an alternative long-term strategy is needed by companies looking to optimise their working capital and maximise business growth.

In response to pressure on cash flow, many buyers are looking to lengthen supplier payment terms, with a view to boosting working capital. Yet this also comes with its problems, trapping valuable funds in the supply chain and pushing the pressure down to smaller businesses. Research carried out by YouGov among suppliers found that 17% of revenue is currently tied up in invoices with non-standard payment terms, suggesting that around £29bn* is being withheld from UK plc.

This issue has the potential to significantly impact not only business growth but also supply chain sustainability, putting a strain on client relationships and increasing the risk of suppliers going out of business.

YouGov’s research highlighted the most serious implications of longer payment terms for suppliers including its negative impact on cash flow (cited by 55% of survey respondents), additional administration (33%) and client relationships (29%). It can also prevent them these businesses from paying their own suppliers (21%), exacerbating the cash flow crisis.

It is in the best interest of those higher up the chain to help their suppliers to operate sustainably for the long term; ensuring customers and reputation aren’t lost through disruption in the future. Treasurers know that keeping working capital flowing through the supply chain makes good business sense, but striking a balance with this concern while maintaining their own liquidity presents a challenge.

Supply chain finance

Once considered a defensive strategy, supply chain finance (SCF) is increasingly being used proactively by large investment grade businesses; the ‘World Supply Chain Finance Report’ published by BCR last April estimated the market’s growth rate at 30% per year. Yet until recently, it has been too complicated, time-consuming or expensive for non-investment grade and middle market companies to use.

SCF provides funds that enable suppliers to take early payment less a small discount, while enabling buyers to standardise and potentially lengthen their payment terms. This is a ‘win-win’ across the supply chain, providing low-cost access to working capital on both sides of the transaction.

While great news for treasurers, reducing their reliance upon traditional sources of funding, it can also bring numerous broader benefits which will be felt by the entire business.

SCF can deliver what is being termed ‘the collaborative supply chain’ to the mid-market. This ‘win, win, win’ system has positive effects for buyers, suppliers and funders. By offering suppliers improved payment terms, the buyer-supplier relationship is strengthened, as is the working capital of the suppliers. Taken in tandem, this strengthens the supply chain, reducing the risk of issues in the future.

There is also evidence of increasing demand amongst supplier businesses. While over three quarters of suppliers in the YouGov survey haven’t been offered supplier finance by their customers, over two thirds (69%) of those who do currently use it would be keen to increase their use of such tools.

SCF and the middle market

With such a strong business case for SCF, why has it not been more widely adopted before now?

The answer is largely one of business size. These solutions have traditionally been targeted at the largest businesses: those with complex supply chains that can rely on funding from the capital markets. From the perspective of unrated companies, the cost, complexity and administrative burden of SCF solutions has discouraged many, who have felt it may not be justified by the working capital released.

However this is now changing, with technology-enabled platforms revolutionising the delivery and management of SCF. Online platforms, which seamlessly link with existing accounting software are entering the market and vastly simplifying installation, operation and reporting. Combined with fast supplier onboarding and holistic invoice management, it can make the transition from an attractive concept to a practical reality for middle-market companies. Which leaves just one challenge – how to provide the working capital at an efficient rate?

The latest innovation in the market is seeing mid-market firms’ risk underwritten by credit insurance. By smoothing out the credit risk in this way, capital market funders are able to provide financing at a highly competitive rate. This is a game changer.

Working capital is the elixir of life for mid-sized businesses and their suppliers, enabling them to invest in growth and expansion for the future. For a long-time these companies have been disadvantaged when compared to their larger customers or competitors, who benefit from much easier and cheaper access to funds. This is now set to change, thanks to the revolution in SCF offering a practical alternative. With this in their back pocket, mid-caps can reduce their reliance on bank funding for the long-term.

*AIG and PrimeRevenue research carried out by YouGov. Total sample size was 250 adults with responsibility for invoicing and payment terms within businesses which provide goods and services to large organisations (with revenues of £100m or more). Businesses were asked how much of their revenue is currently tied up in invoices with payment terms longer than the standard. If these results were replicated across all businesses in the UK which provide goods or services to large organisations, they suggest that around £29bn is tied up in this way.


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