Published: November 28, 2022
Recent research from fintech company C2FO highlights the pressure that high inflation and interest rates are applying to the global economy and outlines steps companies can take to shore up their working capital in the face of these pressures.
C2FO’s 2022 Working Capital Survey takes stock of the impact that some of the year’s significant economic developments – specifically high inflation and rising interest rates – are having on business financing for companies worldwide.
The survey, which polled 1,240 respondents across 10 countries, reveals firms’ business sentiment as they cope with these challenges. It also takes the temperature of managing directors, the C-suite, and managers from finance and procurement spanning all industry sectors to gauge their approaches to the future.
Businesses report a pessimistic view of their country’s economy (39%) rather than a positive perspective (28%). Companies in the UK have the most negative outlook (where 54% viewed their national economy as either not very good or not good at all), followed by the US (50%) and Italy (49%).
Chris Atkins, President of Capital Finance and Capital Markets, comments: “Covid was brutal. As we emerged from that crisis, we all understood how mentally rough it was. But then we moved into the challenging supply chain situation, and now, not just higher inflation, but continuously growing higher inflation – for many business leaders, it feels like one hit after another.”
Nevertheless, current economic sentiment in APAC is far more positive than negative. In India, 57% of respondents feel optimistic about the current state of their economy, compared with 19% reporting a negative sentiment. In China, 56% of respondents are positive compared with just 16% negative, and this trend is also seen in Australia (34% positive versus 28% negative).
Despite the challenges that most national economies have faced during the height of the pandemic and the continuing aftermath, the survey also finds more positive sentiment when looking ahead to the next 12 months. Globally, 44% believe that their economy will perform better in the year ahead, while one-third (33%) think that economic conditions will deteriorate. The most optimistic countries are India (82%), China and Mexico (57%). European nations displayed the most pessimistic outlook, led by the UK (where 51% of respondents feel the national economy will be worse in the next 12 months), Germany (44%), France (41%) and Italy (40%).
Respondents are even more positive regarding the outlook for their own businesses over the next year. Just over two-thirds (68%) believe their company revenue will increase over the next 12 months, while only 8% predict a decline in fortunes ahead. Respondents from Mexico demonstrate the most enthusiasm, where 83% believe their business will grow.
“When you think about the tariffs between the US and China, originally there was quite a heated response to them, but that has now faded into acceptance that we’re going to have them,” notes Atkins. “What we see in the market is more of a geopolitical push where companies want to diversify and localise their supply chains, creating an increase in nearshoring. The highly concentrated supply chain in China is making many US firms nervous, with a lot of other APAC hubs and Mexico catching a lot of the movement of that business.”
Globally, inflation is viewed as the biggest threat to businesses over the next 12 months. Annual inflation reached a 40-year high in the US in June 2022 of 9.1%[1] While this dropped back to 8.2%[2] by September, it remains far above the Federal Reserve’s target rate of 2%[3] In the UK, inflation rose to 10.1%[4] in September, while the EU saw inflation climb to 10.9%[5] in the same month. It is perhaps not surprising that, with inflation rates rising to levels not experienced in decades, this issue is perceived as the major threat to businesses both today and continuing into 2023.
“With almost two-thirds believing that inflation will hurt their business over the next 12 months and inflation continuing in the face of rapidly tightening monetary policy, we now know that inflation is a real, and not transient, problem,” warns Atkins.
With inflation continuing to rise, businesses are faced with the tough decision of needing to increase prices. While this notionally puts them on a better footing to manage increased raw material costs, it is also now further worsening the situation.
“Along with the current pessimistic economic view, and the belief that inflation will negatively impact businesses in the year ahead, I think the other main finding from the survey is just how many businesses are planning to increase their prices,” continues Atkins. “Around 7% of firms will increase prices by more than 10%, which will present additional challenges in supply chains. We believe we’re seeing the beginnings of even further increases as inflation has remained at elevated levels, unabated, for almost a year.”
The C2FO survey found that, globally, 43% of companies plan an increase between 1% and 5%, 18% will increase them by 6% to 10%, and 7% are looking at hikes of more than 10% in the coming year. India (13%) and Germany (11%) are outliers regarding price increases of 10% and above.
The average price change intentions are for a 3.1% rise worldwide. This is at its lowest in China (1.7%) and then Australia (1.9%), while businesses in India (4.1%), Germany (3.9%) and Spain (3.4%) plan the highest price increases in the next year.
“It is quite surprising that the average price increase globally is at 3.1% when you consider how inflation in many countries is far outpacing that,” observes Atkins. “One explanation for this is the dynamic that exists with smaller suppliers selling to bigger companies. A supplier may think their distribution through Walmart or Costco, for example, is far too valuable, so they’ll try to stomach this. The problem is, they can’t do it forever. If a company is losing 5% of its gross margin, and it’s a 25% gross margin business, then it just lost 20% of its margin and potentially 100% of its profit. That’s a real problem.”
Raising interest rates is one of the primary tools central banks have at their disposal to combat elevated inflation. The US Federal Reserve made its first rate hike since 2018 in March 2022[6] with a 25 basis points (bps) rise, and has followed that up with further increases of 50 bps in May,[7] and consecutive 75 bps hikes in June[8], July[9], September[10] and November. It is a similar story at the Bank of England, which has progressively raised its bank rate initially from 0.1% to 0.25% in December 2021[11] to 3% in November 2022.[12] The European Central Bank (ECB) waited until July 2022 to make its first upward move, starting with a 50 bps rise[13] to take the bank’s benchmark deposit rate out of negative territory for the first time since 2014. This was followed with a 75 bps hike in September.[14]
“C2FO carried out another survey before the recent interest rate hikes that showed two-thirds of the around 10,000 global businesses that we interviewed borrow at a rate greater than 8%,” reveals Atkins. “This is particularly shocking for the EU as rates had broadly not been lower–those rates would now be above 10%”.
Of those decision-makers concerned about higher interest rates, nearly half (47%) say they will increase their prices. The next most popular courses of action are to delay investment in new products and services (36%) and minimise pay increases (28%). Concerns about how rate hikes will impact corporates’ costs are genuine.
“A US business with a line of credit, borrowing at prime, will have seen a 70% increase in interest costs this year alone,” exclaims Atkins. “Whether their cash flow is increasing or not, the cost is increasing 70%. Looking at this from a debt service coverage ratio [DSCR] perspective, if a company’s DCSR was 1.4 to begin with and then interest cost goes up 70%, it suddenly doesn’t qualify for its line of credit at 0.8x DSCR. This will cause a number of businesses, mostly SMEs, to be asked to find alternative arrangements by their banks.”
This consideration was revealed in the survey results, where interest rate hikes are the primary obstacle to businesses obtaining capital, and was cited by 45% of respondents. The next most common barriers to funding are decreasing revenue (38%) and poor cash flow (30%).
“As a major obstacle to securing capital, decreasing revenue really means that the business is too much of a credit risk,” comments Atkins. “It’s the same thing for poor cash flow. Companies are finding that their bank won’t approve them for credit, which further constrains the economy and will worsen the upcoming recession.”
With access to credit from banks at a premium due to soaring inflation and the accompanying interest rate hikes, many firms are evaluating their sources of financing and exploring alternative options to provide the support they need for themselves and their supply chains. Two of the more popular sources of financing are dynamic discounting and invoice factoring.
Dynamic discounting, a form of invoice discounting, allows for a more significant discount to be offered on an invoice in return for earlier payment. Some 88% of survey respondents who use dynamic discounting demonstrated a level of satisfaction with its ease of use, with 85% either somewhat or very satisfied with its flexibility.
“Dynamic discounting is such an elegant programme for taking control of cash,” confirms Atkins.
Alternatively, invoice factoring is where a business sells its invoices to a third party in exchange for immediate payment, while the third party collects from the original customer. Factoring can increase the fees that a company pays. Still, it also steps up the pace of the cash conversion cycle (CCC), so deciding whether or not to deploy invoice factoring will depend on a company’s priorities.
“Firms are looking at ways to speed up the cash conversion cycle – increase the amount of AP they have, reduce the amount of inventory and reduce the time it takes to get invoices paid – factoring and dynamic discounting can be helpful in that,” explains Atkins. “The costs for doing so may sometimes make businesses slightly wary of using this option. But, when you’re looking at 10% per year inflation in the US, paying 12% isn’t an issue. You’re accelerating receipt of cash to secure lower inputs prices and then selling into a situation where prices are higher with inflation. There are ways to get control of your cash and cash conversion cycle.”
Surprisingly, only 16% of the respondents who expressed concern over the current inflation levels said they are seeking to optimise their CCC. There is an opportunity for treasurers to investigate this strategy to mitigate a poor liquidity situation for the business.
“Treasurers can take a holistic approach to partner with their purchasing executives to create a more strategic, robust and sustainable supply chain,” comments Atkins. “We see authentic thought leadership from certain corporates that understand the benefits of having a healthy supply chain. For one, there will be less involuntary supplier turnover, as they don’t have to drop out for cash flow and inflation issues. Treasurers can improve their company’s margins with dynamic discounting. They can also enhance the supplier’s affinity for the company so that when a price increase can’t be approved, the supplier doesn’t leave over it. Treasurers are in the driver’s seat to take control of this situation.”
Another compelling finding from C2FO’s Working Capital Survey 2022 is how sustainability and diversity criteria from larger corporates are trickling down to all areas of the economy, specifically in this case, through financing. Globally, 43% of the survey respondents have been offered preferred terms thanks to their sustainability practices.
“From a financial return standpoint, we know that companies doing more in the ESG space have a better financial return,” affirms Atkins. “Companies spending extra money on ESG are seeing higher revenues and profit growth. It’s also coming through in employment trends. More of the new generation of the workforce want to work for an organisation that they perceive is ‘doing the right thing.’ That is reflected in financial returns because companies make smarter decisions when they have better people working on these issues.”
One area for improvement with both ESG and D&I is ensuring that the offers of preferential rates are available to suppliers of all sizes. While 58% of companies with more than 1,000 employees had been offered better rates due to their sustainability practices, only 19% of those with fewer than 50 employees had been offered preferred terms. For D&I practices, this split was 41% to 19% in favour of the larger businesses.
“A point that businesses often ponder is just how to ‘do the right thing,’” reflects Atkins. “We know that the more diverse a thing is, the better its outcomes. Many treasurers are looking at that. We’re also providing some data on this. Our minority- and women-owned businesses are participating at more than double their majority counterparts. This points to the fact that banks are not able to service them as well as a highly scalable solution such as C2FO. That’s the kind of scenario we’re seeing and tracking, so we can advise treasurers to create and hit all of their impact and ESG metrics by offering programmes like this.”
While the survey has found businesses to be generally pessimistic about the current state of the global economy, confidence for the future also endures. As central banks look to tackle inflation, enterprises of all sizes are focused on ensuring they have enough liquidity to ride out today’s high inflation and any size of incoming recession. Alternative financing methods such as dynamic discounting or invoice factoring can be another weapon in the financial arsenal for businesses.
“Fears that a recession is imminent are reasonable, but there are reasons to hope that the economy can escape the worst possible outcomes,” concludes Atkins. “If the actions by the Fed, ECB and other central banks can thread the needle – which remains possible as they battle inflation and try to tame it while not inflicting disastrous economic damage – then we won’t have a deep and prolonged recession. And remember, about 70% of businesses surveyed have a positive outlook on the future, even in the face of all of these challenges.”
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