Is Supply Chain Financing Making Manufacturers More or Less Resilient?

This isn’t a generalization. It’s a fact supported by data from our Murky Waters of Overseas Manufacturing study. Our study found that 69% of manufacturers have used supply chain financing in the last 12 months and 66% expect to use it in the next 6 - 12 months. This suggests manufacturers are using various lines of credit to keep the lights on throughout the year. 

Supply chain financing is certainly a lifeline that can help you weather uncertainty and it’s tempting to think that it can make your supply chain more resilient. But we’d argue against that claim. The more financing you secure, the higher your debt becomes. All it takes is a drop in customer orders and revenue and you may not have enough cash to pay back what you owe. When that happens, you could sink into default on your loans and damage your creditworthiness. 

Of course, this doesn’t mean we don’t see value in supply chain financing. It can be a boon to grow your business and can sustain operations during times of economic uncertainty. But it’s about understanding when it’s helping and when it’s hurting your business growth. For example, taking out too much supply chain financing could make it tough for you to sell your business or merge with another business.

Before any deal can go through, potential buyers will check your business credit report to see how well you’re managing your finances, cash flow and payments. So, if your business credit report shows your cash flow is dwindling, your credit limit has dropped drastically in recent months and you have a high percentage of past due payments, it’s more than likely the deal will fall through. And from the buyer’s perspective, that’s understandable because they need to vet you and determine if their investment will deliver ROI.  

Based on our study’s findings, we noticed a paradox. On one hand, a significant portion of manufacturers have already and will continue to use supply chain financing to bolster their operations. This indicates there’s a need for a cash injection and their finances may not be too stable. 

However, 86% of the respondents in our study are confident they’ll have enough cash flow to pay suppliers in the next 6 to 12 months. Maybe this faith in their cash flow comes from having great customer relationships and order values so they aren’t worried. Or maybe they’ve already secured financing and aren’t worried about securing more.

For us, this paints a nuanced picture of supply chain financing. On one hand, it’s extremely helpful for injecting cash into the business and sustaining the business operationally. On the other hand, it can be an enabler for manufacturers who are spending unwisely and not managing their cash flow effectively.

With that said, we’d encourage you to do a couple of things before trying to secure supply chain financing:

• Understand the credit risk data that lenders look at when deciding to approve or reject financing applications.

• Be aware of best practices and industry trends so you can make smarter financial decisions.

Let’s dive into these two points in more detail.

If you apply for financing, the lender will likely check your business credit report and look at key markers to determine your creditworthiness. This kind of data includes:

• Average DBT: This figure shows how many days past the agreed payment terms you pay your invoices. If you have a high DBT score (15+ days), this will likely give a lender cause for concern because it indicates that you have a cash flow problem, which means you’ll have trouble repaying loans down the road.

• Monthly DBT variation: This analysis shows how your DBT fluctuates each month. So, if you’ve had a relatively stable DBT (at 5 days) for some time and then it jumps up drastically to 15 and stays there for some time, that will definitely get the attention of potential lenders.

• Past due payments: This indicates to lenders how much debt you have. For example, if 85% of your payments are past due, this is an instant red flag for financing companies. 

• Total amount owed: This metric will be taken into consideration alongside the percentage of past due payments. Just because a company has a high percentage of past due payments on their credit report doesn’t necessarily mean that will translate to a heft amount of money owed. But lenders will certainly be concerned if they see a high percentage of past due payments that equates to a massive amount of money owed (i.e. $2 million).

• Legal filings: This covers lawsuits, court judgements, tax liens and UCC filings. In our State of Credit Risk: 2022 report, we found that legal filings cost American businesses over $54 billion in 2022. So, if the lender sees dozens of legal filings on your report, this indicates cash flow issues may be on the horizon and your finances will have to go towards paying for legal fees, settlements and fines.

The amount of money you choose to borrow through financing is directly tied to how you manage and pay suppliers. Being aware of the trends that are driving these decisions. The more you know, the more informed decisions you can make and the less reliant on financing you can become. That’s a good thing. 

We’ve seen an increase in the number of manufacturers (a whopping 95%) asking their suppliers for discounts in the next 6 - 12 months to protect their cash flow. This isn’t surprising given all the chaotic factors impacting global supply chains. Zero-tolerance COVID policies, labor shortages and a recession have all taken their toll on North American manufacturers.

You could be motivated to ask for a supplier discount for a couple of reasons. The first is because you want to cut back on certain costs and are proactively preparing against economic uncertainty. This is a smart move and makes a lot of sense.

Whole Foods is a good example of what this first choice looks like in action. Earlier this year, the grocery chain asked its suppliers to reduce their prices and it’s not because the organization is in bad financial shape. We can see this in Whole Foods’ credit data. The company has a high credit score of 80 and a credit limit of $10 million, indicating savvy financial decision-making and a forward-thinking attitude.

The second reason to ask for a supplier discount is out of necessity. You don’t have enough revenue coming in to offset the payments you have to make. In this scenario, there are a few things you can do to increase revenue:

• Get rid of manual invoicing systems and automate your accounts receivable process. This means you can collect invoice payments faster and set up cash flow alerts to adjust where your spending is going.

• Conduct regular audits on the financial health and payment patterns of your suppliers. This will indicate whether they can afford to give you discounts and reveal whether it’s worth the risk of working with them long-term. 

Instead of being too dependent on supply chain financing, you could lean into the strong relationships you have with certain suppliers. This could mean negotiating with suppliers on payment terms e.g. Net 90 as a way to pay less overall but offer a larger percentage of total order value as a partial deposit. 

This approach is worth considering because our research shows an important trend between manufacturers and suppliers: relationships are more important than money. And both sides are flexible with payment terms - 31% of international suppliers prefer to be paid with a partial deposit of 30 - 60% upfront. Meanwhile, 33% of manufacturers are willing to pay a partial deposit of 30 - 60% and then the remaining balance on completion of an order. Even more revealing is that only 9% of manufacturers we surveyed would be put off by their suppliers asking for full payment upfront. 

So, the more your suppliers trust you, the more open they are to negotiate. Here are some ways to keep that trust strong:

• Regularly keep in contact with suppliers and look beyond the surface of revenue. Meet them where they want to be met and develop good personal connections with the founders of those companies (if appropriate).

• Provide adequate lead times and inform suppliers of new business goals. This will give them the chance to prepare bigger inventory orders and ensure you have the right items in stock to continue bringing in revenue.

• If a supplier has consistently done a great job, refer them to people in your network. This gives them more business and establishes you as a reliable partner. 

Another reason why you might seek supply chain financing is that you’re paying a lot of money fixing product quality issues. And from our perspective, product quality isn’t just a priority for your quality control team. It should be top of mind for your finance team too. 

Let’s say half of your orders come back damaged. You now have to spend more money on getting those orders produced and shipped again, which eats into your cash flow. To address this issue, your finance team should set up a payment protection policy and write it into supplier contracts so you’re able to recoup the losses. 

It’s encouraging to see lots of manufacturers taking these kinds of steps to protect their cash flow. For example, 39% of the respondents in our recent study said the set a clear product quality definition before purchasing any products from suppliers. Plus, a further 17% of the respondents request a sample order as a test before committing to a full order and paying full price. 

Our parting advice is to really think hard about the data and trends we’ve mentioned regarding supply chain financing. Don’t be fooled into having a false sense of security about your financial stability. Remember, there are always ways you can improve your cash flow and creditworthiness – that way, supply chain financing won’t be a crutch in the long term. It will be there to help you if and when you truly need it.