Financial Supply Chain

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Using SCF to Address a Significant Working Capital Shortfall Solar roofing company PetersenDean describe how they successfully utilised supply chain finance to address a significant working capital shortfall.

Using SCF to Address a Significant Working Capital Shortfall

Using SCF to Address a Significant Working Capital Shortfall 

By Steve Doll, Chief Financial Officer, PetersenDean

 

Twelve months ago, a disruption in revenue streams meant that solar roofing company PetersenDean – when faced with an unexpected working capital shortfall – had a choice: delay payments to suppliers while it rebuilt its cash reserve or look for a different solution. Reluctant to do the former, the company chose to implement a supply chain finance (SCF) programme to help solve this challenge – and hasn’t looked back since.

 

When I went to bed on 14 December 2016, the company was looking into the eye of a storm. PetersenDean had just posted a record year – for both revenues and profits and the next year was looking even better. Sure, cash flow always felt a little tight, but that was a function of our growth. For PetersenDean – and for the rest of the sector – we generally paid our bills faster than we generated revenues. For us, that difference amounted to around 20 days. As a result, we’d drawn most of our credit to support our growth.

Still, so long as we continued at this pace, we’d generate plenty of cash to fund our growth.


When it rains, it pours

But then the weather then took an aggressive turn for the worse. Between December 2016 and March 2017, California received more than 30 inches of rain. Even more significant was the number of days it rained. We experienced the highest number of rainy days and the second-highest recorded rainfall in 122 years, according to the United States National Centers for Environmental Information. 

Rain wreaks havoc on our business. Not only can we not install roofs in the rain, we often can’t even begin a job if there’s even the threat of rain. Many of our projects involve tearing off a roof and then installing new roofing and a solar system – a process that requires consecutive days of dry weather. When planning these multi-day projects, it would be irresponsible to start the project if there were even a threat of rain in the near future. The only option was to wait for clear skies.

But since we couldn’t do any roofing work, we couldn’t invoice our customers, either. Without those invoices, we didn’t have any money coming in. Although we knew the challenge was short-term (it wasn’t that the work was disappearing as every house needs a roof), the issue was that any new work coming in was going to the back of the queue – meaning no immediate revenue and a backlog of jobs. 

Meanwhile, our indirect costs, such as admin, facilities costs, equipment leasing fees, and so on, kept on racking up. Suddenly, our accounts payable (AP) days started to increase. At first, it was just a couple of days, but as the weeks with little cash flow wore on, the days payable grew by almost 25%. And the reality was much worse because all of our non-trade AP was non-discretionary. So, the increase in the Days Payables Outstanding (DPO) was disproportionately borne on the balance sheets of our suppliers. 

This led to a number of increasingly costly reactions. The first was the loss of early payment discounts. As a roofing installation company, our business has to run lean – our net income margin is often single-digits. So, the loss of those 2% - 3% early pay discounts was significant - not only did it hamper our bottom line, but without them our recovery would take longer. We also found that managing the relationships with our suppliers was becoming extremely time-consuming, taking valuable resources away from their focus on customers or operations.

In addition, the delays in our payments impacted our relationships with our vendors. Discussions that once focused on optimising delivery schedules and driving volumes for rebates were replaced by a focus on collections. Further, our ability to negotiate better pricing was impaired by our lack of liquidity. We also experienced a loss of priority with our suppliers. In a cash-starved sector, suppliers focus their best service on buyers that provide cash.


Time to press reset

The silver lining to all of this was that, as a sector, we were – and still are – pretty used to surviving challenging times. Since its founding 35 years ago, PetersenDean has operated through four recessions and a number of other operating crises – and we would have survived this one. Roofing work doesn’t disappear, it gets deferred. The ‘catch-up’ work that had been deferred by the rain – which totalled about $32m in revenues – would have gradually got us back to our starting point. 

But we also knew that it would take us a long time to get back on our feet if we just put our heads in the sand. Moreover, the company would have ended up being less profitable as the costs of our materials would have been higher and we would have spent a lot of time and resources managing our suppliers rather than focusing on rebuilding. In fact we estimated at the time that it would be a year before we could start to take advantage of early payment discounts again. 

In addition, we would have faced greater operational disruption – from re-engineering the supply chain, to using pre-liens, weekly payment terms, and personal guarantees. All of these are time-consuming activities, which would have the knock-on effect of making our service less reliable. 

It was clear that we needed to take a different approach to getting through this working capital shortfall. Since this is such a low margin business, factoring was out of the question. Instead, we turned to supply chain finance (SCF).

 

Residential construction: a flawed business model

Many of the residential construction companies that go bankrupt are actually profitable – but only on paper. The problem is that the entire industry is based on a model where a property company can take four to six months (or longer) to build a home – a process which requires the tradecraft of 25 – 35 different subcontractors – exactly sequenced during that period. 

All of this work from multiple parties is done in good faith, with no progress payments from the customer. In fact, most homes are built purely in the hope that the homebuilder can find a customer to buy the property as soon as it’s complete at a price that’s at or above the builder’s estimate. This also hinges on subcontractors delivering their services on time and on budget.

Although homebuilders mitigate the delayed revenues by paying subcontractors with staged bank financing, this often adds another layer of strain on the system. After the financial crisis of 2008, the banks reigned in credit. For homebuilders, this credit contraction meant the pace of their draws slowed and the size of those draws decreased. On top of that, when the banks do advance money, they typically send that money to the homebuilder - not the construction company – often, adding to the delay.

Bank financing for subcontractors is also limited. As such, contractors often finance their growth by slowing the funding of trade payables.

 

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