Jack Large has brought to our attention a Wall Street Journal article titled Delaying Payments to Suppliers Helps Companies Unlock Cash. Jack argues the case for the suppliers caught funding their customers working capital.
We all know the games played in the UK where budget holders sit on invoices until they want to pay them, then put them into the AP system and claim all paid on time. Well, on time from when they put them into the AP system. The attractions of the game are clear. The budget holder can massage budget compliance while claiming he is managing the supplier to the benefit of the organisation.
The game works best when the supplier is weak and dare not complain due to fear of losing a material customer. The absurdity in the UK is that the cost of funding rises strongly as the credit weakens and market size and share is one of the factors which influences credit worthiness. To follow the WSJ’s logic, large companies fund their investment at small companies’ cost of debt.
This cannot be a uniquely UK issue. The EU rules under CRD4 require the weaker credit bears a thicker credit margin than the typically larger businesses. The theory of the worldwide response to the GFC is that this process is replicated throughout the G20 and Basel 3.
The result is simply bad corporate finance and lack of focus on EpS. Large companies are through their suppliers paying double digit financing costs when they could be paying low single digit interest. Add to this that many large corporates are also cash hoarders. Today we also have the FT and the Daily Telegraph reporting on analysis by Link Asset Services that UK corporates are also borrowing heavily to fund dividends on the assumption that future profit growth will fund the debt service. More worrying is the observation that our view of the increased debt is clouded by increased equity prices which flatter market-price based gearing ratios.
The coming uncertainty over Brexit may be a reason for large UK corporates to borrow while rates are low and then hoard cash. It is always better for the lenders to need to worry about repayment rather than the borrower worrying if it will be able to borrow when funds are needed. When rates rise, refinancing can be the trap.
Gameplaying small suppliers and budgets has its attractions, but only if the small suppliers survive to supply.
Perhaps as rates rise, Brexit approaches along with the deadlines for Basle 3 implementation, and share valuations look vulnerable as tariff wars emerge, the time has come for treasurers to start thinking about cost of capital and the bottom line when discussing financing options with FDs and their Boards.