Suppliers Tap Receivables for Liquidity Amid COVID-19 Pandemic
Liquidity used as working capital to manufacture goods
June 12, 2020 | by Maureen Sullivan, Managing Director
A growing number of suppliers are using their receivables as a source of liquidity to alleviate financial strains in the wake of the coronavirus pandemic.
Receivables are legally enforceable claims for payment held by a business for the goods it supplies or services it renders that customers have ordered but not paid for. These claims usually take the form of invoices issued by the supplier and delivered to the buyer for payment within an agreed timeframe.
The liquidity challenge facing suppliers
Like many companies, suppliers have been facing liquidity shortages following the COVID-19 outbreak. In some cases, we have seen excess demand for certain goods overburdening suppliers’ production capacity and draining them of working capital. In other cases, lower demand for goods has been causing income shortfalls. And physical disruptions in the manufacturing or delivery of goods have been delaying payments. Cash-strapped suppliers in these situations cannot always afford to wait the full 60- or 90-day payment terms set with the buyers who acquire their goods—a timeframe that would deprive them of the money they need in the interim to sustain their operations.
To shorten their cash conversion cycles, a growing number of suppliers are enlisting in supply-chain finance programs, which enable them to sell their receivables to a bank in exchange for immediate cash. The bank then collects payment from the buyer at the later date in accordance with the payment terms established between the buyer and the supplier. In this manner, suppliers gain quicker access to money they are owed—money that would otherwise be inefficiently suspended until collection is due—while buyers get the time they require to pay off their balances.
Growing demand for supply-chain finance
Since the coronavirus outbreak, we’ve seen that demand for supply-chain finance programs has been rising among suppliers and buyers alike because of their interdependence. A lesson learned from previous financial crises is the need to maintain supply-chain integrity by ensuring that suppliers have access to liquidity in order to produce goods. Following the outbreak, we’ve seen suppliers enlisting in these programs and using cash from receivable conversions as working capital for manufacturing.
The sale of receivables provides suppliers with an alternative and efficient source of liquidity—particularly in this challenging environment—that helps them optimize the capital they use for day-to-day operations. They can then use their credit facilities to borrow additional money for financing purposes other than working capital.
Buyers are equally concerned about the solvency of their suppliers, because their businesses are operationally and strategically reliant on a smoothly functioning supply chain with no interruption. She notes an increase in the number of buyers enlisting their suppliers in supply-chain finance programs as a consequence of the pandemic.
A buyer-led program links a single buyer with multiple suppliers, automating transactions and tracking invoice approval and settlement processes—from initiation to completion—between the buyer and the supplier. In a buyer-led program, the buyer agrees to approve its suppliers' invoices, which are then sent to a banking partner that may provide the supplier with early payment. Conversely, a supplier-led program links a single supplier with multiple buyers in a similar fashion.
The cost of hedging against supply-chain disruptions
There are two main ways that buyers can safeguard themselves against the potential failure of a supplier to deliver the goods they need is to: (1) hold more inventory; and (2) work with a greater number of suppliers.
A buyer could either stockpile a reserve of goods to be used in case of a supply shortage—or expand its network of suppliers to reduce reliance on any given one. However, both options can be expensive. There are storage costs for holding inventory. And the more suppliers a buyer uses, the fewer price efficiencies the buyer can achieve. As an illustrative example, distributing an order of 100 widgets across 10 suppliers would likely cost more per widget than consolidating the order from just one or two suppliers, who might be able to reduce the price per widget using economies of scale if they manufactured more of it.
For these reasons, buyers place a premium on the individual solvency of each supplier. Yet it is occasionally necessary to diversify suppliers by geography in case of regional disruptions having nothing to do with solvency. Certain buyers have faced supply shortages when factories in China were shut down as a result of the pandemic. We believe they will reassess their dependence on any which region and create workarounds with other suppliers to avoid bottlenecks in similar future situations.