Global trade, finance and banking media may well be focusing on the latest J.P. Morgan Working Capital Index that was reported this week.
As an example, a published report by Global Trade Review reflects a headline of a growing amount of trapped liquidity in supply chains:
“The amount of working capital held-up between corporates and their suppliers has risen 8% as companies look to hold on to inventory amid uncertain times, according to the latest JP Morgan Working Capital Index.”
The JP Morgan Index report analyzes cash conversion cycle data, namely the number of days to convert inventory purchases into cash flows from sales. This weeks reported Working Capital Index reflects a $37 billion increase in cash held up businesses and their suppliers, which is itself concerning unless a broad context of ongoing supply network risk or mitigation is placed in context to the overall rise.
The Index itself pegs historic data that captures Working Capital, Cash Index and Conversion data of the S&P 1500 from 2011 to 2019.
As an example, the latest Index report cites Pharmaceutical, Semiconductor and Apparel companies as the top three industries demonstrating highest deterioration in working capital including inventory. The top three industries indicated as the highest improvement are listed as Chemicals, Utilities and Consumer Staples. We argue that what the former three industries with highest deterioration have in common are global based supply chains, many of which are subjected, either directly or indirectly to the ongoing escalating trade and tariff tensions among China and the U.S. Apparel is also an extreme case of demand shock with obvious consequent inventory challenges that will need to be addressed.
JP Morgan continues to advocate for “Supply Chain Finance (SCF) whereby banks take more of the responsibility of the financing of working capital rather than the businesses involved in global supply chains. Banks have an obvious vested interest in advocating for such approaches. However, the approach potentially transfers higher borrowing costs to suppliers when they could possibly least afford such costs, because of their own cash liquidity challenges.
Supply Chain Matters Insights and Perspectives
During these unprecedented times of economic, business and supply chain challenges, CFO’s are obviously under enormous pressures to free-up cash and liquidity resources and maintain shareholder value. That stands to reason.
As Supply Chain Matters and others have opined, the current COVID-19 pandemic coupled with heighted trade tensions among the U.S. and China lays bare prior references to historic inventory trending and working capital data. Context is essential and is industry specific consequences and options in terms of likely impacts to business service level and financial outcomes.
At the same time, we would argue that global-wide inventory needs should not be the sole target of freeing-up liquidity. Needs for financial assistance for a key strategic supplier should certainly be an option open for assessment on a case by case basis.
In prior recessions, companies outright elected to transfer financial risk burdens to various multi-tiered suppliers, who in-turn, subsequently succumbed. In some cases, product and process innovation suffered. When recovery occurred, new suppliers were very careful to partner with customers who demonstrated more supportive supplier relationship strategies and tactics.
Further, previous recessions or negative business cycles may not necessarily provide a guidepost as to what working capital preservation strategies will be the most effective in balancing the stakeholder needs of large or institutional shareholders as well as private company owners. Working capital liquidity as well as supply chain risk mitigation are now both top-of-mind topics for major customers and shareholders. Both can draw ire and finger-pointing for business leaders.
Thus, we urge procurement and supply chain leaders to continue to be proactive in educating and collaborating with their respective CFO’s and finance teams on ongoing analysis of inventory risk associated with either insuring fulfillment of key customer product demand, mitigating financial risks for certain key suppliers, or overcoming the high uncertainties presented by the ongoing COVID-19 disruption of global supply networks. Evaluating various strategic sourcing options related to China are difficult decisions take will take time to evaluate. In the meantime, supply risk mitigation is an ongoing concern as our continuing erosion in service levels related to global transportation and logistics. Inventory safety stock decisions are thus a form of risk management under abnormal situations.
Procurement and supply chain teams also need to be in alignment as to various strategies related to working capital reduction opportunities. Unilateral or mis-informed actions can prove costly in terms of the need to build added agility and resiliency across supply and product demand networks.
The good new is that today’s more advanced supply chain planning and analytical technologies can support more integrated planning, scenario development and working capital risk management needs.
Indeed, this is a complex topic and this commentary’s purpose is to spur additional conversations and perspectives. There are no canned approaches.
But for heaven’s sake, context any historic inventory policy data for what it is, a snapshot in time. Today’s needs are about being more informed and proactive to what is likely to occur under different scenarios. Functions and lines-of-business need to come together with consistency in data, scenario and risk assessment.
The stakes are far higher.
Bob Ferrari
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