The dramatic global events of the past 2 years like the COVID-19 Pandemic and The War in Ukraine have had a dramatic impact on manufacturing companies in particular. This has resulted in rising cost and scarcity of raw materials and labour, lengthening supplier delivery timelines and time to market, not to mention general overhead increases and now to cap it all off, a relentless escalation in the cost of energy.
While the focus has been on managing these costs and channel management, one area that doesn’t get quite the same media coverage is the impact all of this turbulence has had on manufacturers ‘peak funding requirement’ and what impact this has on profit and performance.
What is ‘Peak Funding Requirement’?
Across the life of any manufacturing project (or process), the requirement to fund things like supplier costs, labour, raw materials and expenses ebbs and flows, before the finished product is eventually sold and paid for.
The point at which the highest amount of cash is required and the length of time it is required for during the life of a given project is known as the Peak Funding Requirement.
Totally unrelated to the impact world events have had on actual pricing and profitability, Peak Funding Requirement is something all manufacturers should estimate before embarking on any project and ensure that they have a reliable source of funding in place in order to meet this critical cost summit.
Without it, at best manufacturers ability to manage multiple projects will be severely limited. At worst, it may lead to defaulting on contractual obligations in terms of labour and raw materials payments and ultimately their ability to fulfil order completion for their customers.
All good accountants in well-run manufacturing companies will of course be aware of managing cashflow and ensuring the business has sufficient cash reserves to meet demands, but with so much turbulence in such a short period of time, previous financial modelling may well be underestimating quite how much this peak funding requirement has increased over the last 24 months or so and what the true cost of it is on their finances.
What factors determine Peak Funding Requirement?
In a previous blog post, we discussed one of the contributing factors on Peak Funding Requirement – your Cash Conversion Cycle (CCC). This is it is an accounting formula that determines the time it takes for your initial cash outlay and manufacturing processes to turn back into cash in your bank account. The CCC formula determines how efficient a company is at managing its working capital. (You can read more about the Cash Conversion Cycle and actually benchmark your company vs. global norms here).
However, Peak Funding Requirement is slightly more complex and there are a number of other factors that determine the Peak Funding Requirement including among others:
- Order size
- Rising Raw Materials costs
- Rising Labour and Overheads
- Supplier staged deposits & payment agreements
- Increase in raw materials cost and delivery days
- Additional days credit taken by customers to pay
- Additional days production time
So, what does this mean for manufacturers?
Putting all of these factors into a predictive model, the amount of funding required at the peak of a manufacturing project has increased alarmingly. As has the length of time this peak is sustained for.
Here is an example to help illustrate this.
Example: ABC Manufacturing
ABC Manufacturing manufacture a range of educational technology devices, which they supply to a range of online and offline retail customers for sale. Pre 2020, their average order size was €500,000 and their gross margin was approx. 43%, which was extremely healthy.
They have arrangements with very reliable suppliers in the Far East, who ship the units ready for assembly within a guaranteed delivery turnaround time of 8 weeks from order. Payment terms are 20% upfront with the 80% balance to be paid on shipment. It takes ABC on average 5 days to complete assembly, packaging and delivery to their customer, who pays them in full 30 days after delivery.
Post 2020 and ABC are facing a very challenging and much changed environment. Their once reliable supplier is now only able to guarantee a 10-week turnaround. Due to the cost of raw materials increasing, they have put up their prices by 20%, which ABC has no alternative to pay, as securing a line of supply is crucial to maintain their customer orders and there are many competing manufacturers looking to work with their supplier. Shipping delays are also adding more time to the manufacturing process. On average this is now taking 10 days longer than it did in 2020 to arrive.
The issues don’t stop there. Once the goods are landed, the labour and overhead costs have now risen by a combined 10%. While they were able to negotiate an increase of 10% in the order value with their customer, they had to agree to extend credit terms by an additional 15 days. So, overall, their cash conversion cycle has gone from 91 days to a massive 130 days.
In summary, ABC Manufacturing now have a Peak Funding Requirement amount of €353,100 versus €285,000 pre-2020. A difference of €79,100.
Also, this increase in cash required to sustain the order has to be funded over an extra 39 days (the increase in their cash conversion cycle from 91 to 130 days).
The increase in days means ABC will have to fund an additional month of Payroll and overhead before the order payment is received.
All this in the context of a reducing gross margin, putting further pressure on funding future orders.
As stated at the outset, most financial analysis would likely focus on sales price, cost price, gross margin and other typical business health indicators, it can be very easy to overlook other indicators like Peak Funding Requirement. Especially in an environment in such a state of flux that requires strong – and quick financial leadership.
While one would hope that the markets correct themselves and costings, timings and profitability come back into line, in the near term, companies like ABC need to find a reliable and flexible source of funding that they can rely on to help them to steer through these choppy waters.
The turbulence we are seeing now on a disturbingly regular basis means that even the best performing companies can fail due to not having access to a reliable source of ongoing funding support – one that they can activate quickly to allow them to react to sudden change.
Want to get a more accurate idea of your Peak Funding Requirement?
InvoiceFair provide a range of innovative funding solutions for businesses that can release cash at every stage in the credit cycle. So you can get access to funding when you need it most – during the project and not after it is completed! We do not require personal guarantees from Directors, we don’t implement debtor or geographic concentration limits and funds are released within 24 hours once approved.
Book a free 1 hour consultancy with one of our Qualified Funding Managers, from which we will recommend the most efficient strategy to help you manage funding any increase in your Peak Funding Requirement and manage your cashflow more effectively.
Call our Business Development team on 003531 6632662 or email firstname.lastname@example.org