Since 2016, the drive to create true free trade across the world has hit choppy waters. Whether it is Brexit Britain, Trump’s America or tensions between Japan and South Korea, we now have several major examples where it is getting more difficult to trade internationally.
The public debate around these trade wars centres mainly on the fact that tariffs will drive prices higher for consumers and will, therefore, be against the public good. But what about cash? What is the impact of these trade wars on corporate liquidity?
The simple answer is that trade barriers of any kind are bad for corporate cash flows, but there are several factors that contribute to this suboptimal result. Firstly, if tariffs increase consumer prices, then companies must choose between lower consumer demand or lower profits. Both results are bad for cash flows. But let’s look at some issues apart from tariffs.
When the UK leaves the EU Customs Union, there will be a need for additional paperwork and inspection for companies on all sides. This will slow down the flow of trade and lengthen supplier lead times. This will mean that more stock needs to be held by the supplier to cater for this additional buffer. Or it could mean that the customer company holds additional stock to mitigate against the risk of stock-outs. That will increase working capital for all parties and thus create a squeeze on cash.
In the past eighteen months, many US companies have been reconfiguring their supply chains so that they are less exposed to the trade war between the US and China. But that does not mean manufacturing has migrated back to the US. Instead, multinationals having been moving to suppliers based in Southeast Asia, particularly Thailand and Vietnam.
While this is great for the suppliers who are the recipients of these new American customers, the effect is that the supply chain is now longer than when everything was made in China. Shipping direct from Shanghai can take nearly three weeks on the ocean. Shipping from Thailand to San Diego usually takes an additional seven to eight days. That will mean that more stock will be in transit at any one point in time. That stock needs to be financed and that will place yet another squeeze on corporate cash flows.
But what about those companies that stand to increase their revenues as a result of these trade wars? One example is the European pork industry. China has been suffering from an epidemic among its pig herd of African swine fever. The result is that the pig herd in China has dropped by more than half – and the average Chinese person derives around 60% of their protein from pork.
The disease has created a need for China to import huge quantities of pork. Traditionally, that would have been sourced from the US, but because of the trade tariffs, this has not been possible. Instead, the Chinese have sought out European suppliers to fill the supply vacuum. Those European meat companies exporting to China have seen their revenues and profits increase substantially.
But the changes have also created major liquidity problems for the same companies. For some, it is the lead time contrast of two days to a local supermarket versus 35-40 days to Shenzhen by sea. That inventory needs to be funded. Others are bumping uncomfortably close to their debt covenant conditions on working capital because of increased inventories and accounts receivables. And some are finding that the debt facilities that they agreed in the past year or two are now inadequate to fund this increased level of trade.
It is easy to see that trade wars are bad for cash, but it is also true that these changed circumstances have exposed the weaknesses many of these companies already had in their balance sheets. For too many companies, working capital is a problem they deal with when cash suddenly becomes a problem. Dealing with the issue in that way may mean the end for some companies – but it doesn’t have to be that way. Companies that manage working capital well manage most things in their business well. But the contrary is not necessarily so. In practice, that will mean you need to consider working capital management as a core business strategy
You need to:
These are all parts of having a business with a true cash culture. With all these elements in place, you give your company a much better opportunity to weather the storms that will inevitably occur and gain a competitive advantage over those that did not take these prudent steps.
Trade wars are probably not going to go away in the near future, so companies have a choice: be a victim of change you cannot control – or take advantage of adverse circumstances to make your company stronger.
Brian Shanahan is founder of working capital consultancy Informita and a commentator on working capital, procurement and supply chain issues