Of all the changes that happened in 2020, one thing has remained consistent: cash is king. Unsurprisingly, the global pandemic threw many businesses into a “dash for cash” as they rushed towards lending to strengthen their liquidity buffers against extended economic uncertainty. In the U.S., investment-grade companies increased cash ratios to an average of 34.4% in the second quarter, up from 18.6% at the end of 2019. Non-investment-grade companies followed suit with cash ratios at 51.8% in the second quarter compared to 28.1% before the pandemic. Drawing on revolving credit and back-up credit lines were also key strategies for European businesses.
While many large, investment-grade companies may have access to multiple liquidity options, their smaller supplier base may not have the same “menu” available to them. For a lot of these suppliers, drawing down lines of credit may seem like the only option to quickly insulate the business from economic volatility. But this is often not the best solution for suppliers as it can be expensive and come with a high opportunity cost – especially for those with limited access to low-cost liquidity.
As we prepare for this unprecedented year to come to an end, many suppliers are running pulse checks on their financial health and finding themselves eager to strengthen their balance sheets. Now is the perfect time to evaluate whether supply chain finance can help you strengthen the balance sheet as we head into the new year.
Supply chain finance offers suppliers a low-cost option to strengthen cash reserves while improving the balance sheet and reducing debt ratios
Accelerating payment on invoices via supply chain finance benefits suppliers in a multitude of ways. For one, getting paid early is a cost-effective liquidity option to wrap up the year on a strong note. Suppliers can take advantage of untraded invoices to free up a significant sum of cash before year’s end – all without taking on additional debt. Even better, smaller suppliers can leverage their customers’ strong credit ratings to secure more favorable rates than they would be able to get on their own. This cash can be used to sustain the business, invest, or pay down debt and strengthen the balance sheet heading into 2021.
There are two benefits of using early payment to pay down debt, the first being that reducing debt ratios frees up a company’s credit utilization. Not only does this help the balance sheet, it also gives more flexibility to utilize credit lines in the future.
The second benefit is that deleveraging can actually save a company money in the long run. Unless a company has a very high, investment-grade credit rating, bank debt is likely more expensive than the cost of accelerating payment on approved invoices. So, by paying down the debt, a company will save money on interest payments, especially if they have been sitting on the debt for a while.
An added benefit of advancing payment is that suppliers have the option to unlock cash almost immediately. Unlike cost-cutting or selling assets, which can still sit on the books for months, getting paid early has an immediate positive impact on a supplier’s balance sheet. Heading into the 2021 budgeting season, having cash on hand is helpful as suppliers plan for their strategic initiatives for next year.
If you’re a supplier participating in a buyer-led supply chain finance program, give yourself a pat on the back – you already have a powerful tool at your immediate disposal. Now is a good time to advance payment on any remaining available approved invoices so you can strengthen your balance sheet in advance of year’s end and start 2021 strong.