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Here's why businesses must focus on cash management, namely components of the “cash conversion cycle,” to help offset the fiscal impact of shipping delays.
By now, we’re all familiar with congestion at major U.S. ports, with container ships waiting weeks to unload goods. We’re also accustomed to the resulting spike in shipping costs, as companies have paid a premium to accelerate the movement of supply.
The prevailing belief is that elevated shipping costs and lengthy delays will be relatively short-lived, with bottlenecks being cleared out sometime in the next year. Yet, for many businesses, especially small and mid-sized suppliers, the effects of this shipping crunch could create longer-term challenges for revenues, growth and the ability to access capital.
Businesses can avoid the worst of this pain, but they must do two things — focus on cash management, namely components of the “cash conversion cycle,” to help offset the fiscal impact of shipping delays and make changes to their supply chains to improve responsiveness and agility.
Companies have mostly absorbed higher shipping costs, which has negatively impacted gross margins and profit margins. Some of these costs have been passed on to consumers. But, for the most part, businesses recognize that lower profit margins are the cost of doing business in this climate.
Indeed, projected higher costs were a common theme in Q3 earnings calls. Even giants weren’t immune.
Small businesses don’t have the cushion that their larger counterparts do. This is where making decisions today to accommodate higher costs without a sufficient backup plan can hurt companies in the long run.
Lower or negative profit margins coupled with reduced revenues create an artificial cap on future profits because the business won’t have the working capital to accommodate growth, even if customer demand is strong.
Slower growth and/or lower margins can reduce a business’s ability to secure working capital from outside sources, too, as companies that show downward-trending growth are less appealing to lenders and investors. Banks are already strict with their business lending standards. If they’re choosing between one company with shipping challenges and lower profit margins and a similar business with a domestic supply chain and fewer issues or costs, chances are they’ll select the latter.
Similarly, a business may try to avoid supply issues by stocking up on product or raw materials. This can create problems later, given that extraordinary demand may be in response to supply restrictions and not reflective of typical sales patterns. When demand normalizes, the result is a glut of supply, forcing companies to drastically cut margins on these goods to clear out inventory.
Rising shipping costs are just some of the headwinds that suppliers will face in the next 6-12 months. Higher oil prices also continue to increase production costs. The same goes for inflation. Finally, labor shortages are not only increasing wages and reducing margins but also stripping companies of the manpower to alleviate supply chain woes. Needless to say, supply chains will feel the pressure well into 2022.
Companies have to be measured in their response to these various challenges. Supply chains aren’t primed for short-term solutions. They respond poorly to volatility and take longer to normalize. Ensuring growth and maintaining stability in this environment requires companies to be more diligent about their working capital and making supply chain choices that ultimately improve their resilience.
The Cash Conversion Cycle (CCC) is simply the time it takes for a supplier to convert a product from inventory into cash, with a reserve for how long they can extend or delay payment to their vendor. It’s a metric that is used to evaluate the efficiency of a company’s operations and management. It’s also highly sensitive to today’s supply chain issues because a 1-day delay in delivery to the customer that isn’t accompanied by a day’s delay in paying their vendor means CCC goes up.
The shorter the CCC is, the better a company’s cash flow is because it takes that company less time to collect bills due to them and/or it has more time to pay its bills.
One way to reduce the CCC is to accelerate payments on invoices due. Suppliers can achieve this by asking buyers to pay their invoices earlier in exchange for a small discount, a method that has proven to be highly successful and efficient.
Another way to accelerate this cycle, albeit larger in scale, is to remove bottlenecks in the supply chain, ensuring that goods are delivered faster and that suppliers are paid sooner. Indeed, many companies are looking to make changes along these lines in response to the recent constraints in shipping capacity.
One such change involves shifting production away from the busier Asia-to-US West Coast shipping lanes. Many companies are realizing that it’s more cost-effective to produce and transport goods from Latin America and Mexico, where they can be trucked in; even amidst a truck driver shortage, this route can be more efficient. Goods produced in Latin America can be shipped to secondary ports that avoid the logjams at other locations.
Additionally, larger companies and nimbler small businesses are considering more domestic production, with an eye toward placing manufacturing and delivery as close to demand centers as possible. Automation, including the use of robots, is making domestic production more economical, too.
These geographical shifts have the added benefit of making supply chains more agile and responsive to market demand. Today’s retail supply chains, for example, can be six to nine months long; changing a product or adding a new feature requires a significant lead time or extensive costs in order to keep up with trends. Shipping delays worsen this. Shifting production and accelerating delivery helps businesses roll out new concepts faster, and again, improve the CCC.
Buyers can also help accelerate supply chains by accepting direct imports from suppliers, which reduces transition times and allows buyers to take possession earlier and therefore pay earlier.
Buyers and suppliers alike have an additional incentive to shift production and delivery — tariffs. Tariffs on Chinese goods are likely to remain, putting both cost and governmental pressures on companies to consider different options.
Runaway shipping costs and delivery delays do require immediate attention. But solving these short-term issues doesn’t need to sacrifice future growth. Business owners and executives have options.
Preventing the knock-on effects of supply chain delays requires businesses to look more broadly and consider their ability to access working capital. The supply chain impacts access to working capital through its ability to extend or shorten the CCC.
Rather than accepting that spending more to avert delays or absorbing costs is unavoidable, suppliers might be better off investing more in revamping where and how goods are produced and delivered. Likewise, they’d benefit from examining where they can accelerate revenue collection to improve their working capital health and enable them to be more responsive to cost crunches and supply chain issues.
The global supply chain is resilient but certainly not super elastic. It will take some time to recover and these supply chain issues will not end in the next month. Companies hoping to recapture some sense of normalcy will see more out of playing the long game with their supply chain and working capital situations.
Chris Atkins is C2FO’s senior vice president of capital finance. This article originally appeared in Supply & Demand Chain Executive.
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