The global economic crisis has created a world that we would not have imagined a year ago. Who would have believed offshore suppliers would be refusing to ship components to customers in Europe without cash “up front”?
The credit squeeze has had a massive and sustained impact on the way manufacturers operate throughout the world. The trouble is, too many businesses in the UK are continuing to trade as normal, without changing their operations to take account of the new cash-hungry regime.
A significant number of otherwise solid businesses are weathering the current economic storm while living on borrowed time in a financial sense.
Smaller, tier-two suppliers might be facing problems finding cash to pay offshore suppliers up front, but even more alarming is the number of larger original equipment manufacturers (OEMs) that are being severely hampered by the squeeze on finances. We are hearing of major electronics manufacturers that appear to have sound businesses, but a deeper look at their accounts reveals they are built on shifting sands.
Dangerous debt levels
Let us take the example of a profitable, innovative manufacturer developing products in a mature market. Growing at an impressive 30% per annum in recent years, the company is making good annual profits of over £20m.
All looks rosy in the garden – until we learn that the business has recently been acquired with highly leveraged funding on a debt to equity ratio of 10:1.
While this level of gearing was available when banks were keen to lend and confidence in the global market was high, the economic climate has changed dramatically and such gearing is unsustainable as banks seek to de-gear their balance sheets by at least 15%.
So, while the shopfront and headline figures of the business look healthy, the high level of debt that the business is operating with, typical in businesses that need to invest in R&D, creates a totally different picture and may lead to a trading liquidity crisis.
While huge interest payments of tens of thousands of pounds per month were serviceable when credit was available, now that banks are looking to pull in capital, the available working capital is being reduced to businesses, and apparently healthy, profitable and growing businesses are facing immense financial pressures and potential insolvency due to the credit squeeze.
While businesses that predicted the credit crunch acted decisively several years ago to manage down the level of debt, there is a hidden strata of enterprises in the electronics sector that has been caught out by the sudden loss in world banking.
Growing technology businesses are inherently cash-hungry, and typically highly leveraged. Not only is credit being limited by banks, but also as credit insurers take a much more aggressive stance on limits, suppliers are also curtailing credit options.
Alternative supply chain
Many electronics businesses are facing a double whammy. Offshore suppliers have also become a lot more reluctant to engage with new customers and are spending more time on due diligence.
As a viable gateway to low-cost manufacturing, UK manufacturers can now turn to outsourcing companies with years of experience and a well proven supply chain that can spread risk in this inherently complex area.
The rules of financial engagement have changed dramatically in recent months. Many company directors have not had the experience of managing in a recession before, and need to fundamentally review their strategies now. While we can wait for liquidity to seep back into the banking markets, there are actions that businesses can take now to improve performance and improve the likelihood of securing finances.
Understanding that turnover on its own is no indication of success, that liquidity and profitability are truer measures of financial strength and that the cost of finance is vital, are facts that all too often get overlooked.
2009 is going to be tough. We need banks to support businesses in the medium term, but we also need businesses to look after their own interests and make sure their own houses are in order from a financial perspective, with cash and costs managed particularly acutely.
Craig Wright is CEO of electronics outsourcing business Exception