Working capital whipsaw effect on supplier financial health

1. Supplier Financial Risk – Not Out of the Woods Yet
A fter the shakeout from lower Q1 volumes,
many think the worst is over and most of the
have on working capital. As revenues increase,
working capital is almost always consumed due
suppliers have survived, but the real surprises are go- to increases in accounts receivable and inventory,
ing to occur during Q3. This is when, as volumes where 30 to 90 days is often required to
stay stagnant or slightly increase, that the one-time see the impact of the growth hit cash flows.
working capital boost most suppliers experienced
will not be enough to keep them afloat. As shown in
the graph below, the steel and corrugated industries
show the volume impact on working capital changes.
Most suppliers would have performed much worse
from a cash burn perspective without the one-time
benefit working capital changes had on cash flow.
Awareness of the working capital whipsaw effect
is the first step to ensure continuity from the sup-
ply base. The US has not experienced a recession
of this magnitude since 1982. Due to this volume
downturn, many of the forecasting models used to
predict supplier insolvency do not adequately eval-
uate growth and working capital impacts against
As volumes stabilize or grow, working capital the liquidity requirements for the supply base.
requirements have the potential to push a supplier
into bankruptcy. Credit revolvers and covenants need A disciplined approach to supplier engage-
to be monitored to ensure that as the one-time ben- ment can uncover the factors that can bring
efit of working capital ends, the supplier has liquid- down suppliers, including the changes in work-
ity available to continue to supply. The following ing capital due to the dramatic volume de-
graph shows the impact that major revenue changes clines experienced during the previous quarter.
208.610.0032 n tbokowy@costandcapital.com n P.O. Box 2126, Sandpoint, Idaho 83864

2. In this environment, suppliers face several pres- Supply chain organizations are just starting to de-
sures and therefore need to be engaged to se- velop the competence and depth of talent to man-
cure visibility into their quarterly volume projec- age financial risk in the supply chain. The com-
tions, capital requirements, and access to credit. bination of financial acumen, supplier engagement
techniques and commodity knowledge need to be
Effective supplier risk management requires a cat- deployed to assess financial exposure to suppliers.
egory-appropriate approach. Each spend category
faces different pressures from this market. Several
financial risk metrics are useful, but applying the
wrong metrics can draw inconsistent conclusions
and leave the supply chain organization exposed
when the warning signs look apparent in hind-sight.
Restricted liquidity has reduced the ability for
many suppliers to tap the existing credit mar-
kets for additional capital. Reduced volumes
require suppliers to right-size operations while
commodity volatility creates a lag effect which can
drag on sales as commodity prices head higher.
The current environment has placed supply chain
professionals in a position where they need to be
applying tools that in the past have been the re-
sponsibility of the finance group. Risk manage-
ment continues to grow in importance to imple-
ment world-class supply chain management.
Now is an opportunity to deploy world-class risk
assessment techniques which, when combined with
a developed sourcing toolbox will reduce expo-
sure while driving performance in the supply base.
This commodity lag effect was responsible for 5-10%
of Q1 revenues for transportation suppliers. These
effects are temporary and can have just as strong of a Tom Bokowy is the founding partner of Cost and
negative impact in times of price escalation. Capital Partners LLC. Tom has published sev-
This lag effect is a benefit to suppliers as eral position papers on supplier engagement best
commodity prices retreat, but can squeeze practices including negotiations, spend manage-
supplers as commodity prices increase. ment, target setting and financial risk assessment.
208.610.0032 n tbokowy@costandcapital.com n P.O. Box 2126, Sandpoint, Idaho 83864