The macro economic impact of prompt payment
If it was possible to inject, at no cost to the tax-payer – not million or billions – but trillions of dollars into the economy, should it be done? It’s not a rhetorical question although the answer does seem obvious – of course it should be done but a more pertinent question is how can it be done? Well, it can be done. Trillions of dollars could be injected into the economy simply by changing the way businesses pay their suppliers.
I spent some time recently discussing this issue with Bertram Meyer, CEO of Taulia who explained how dramatic the effect on the economy could be if the culture of paying suppliers in months was changed to paying them in days.
The biggest businesses in America spend about $17 trillion on buying goods and services from their suppliers and typically, they take between one and three months to pay for those goods. We hear lots about what impact that has on suppliers but what impact does this have at a macro level – the effect on the economy as a whole? $2.8 trillion – that’s what! That’s how much money is locked out of the economy if just the 2,000 largest businesses in America wait 60 days to pay supplier invoices.
But those 2,000 big businesses, some of the biggest employers in America, would say different. Far from being locked out of the economy, holding onto cash helps their cash position and makes them more profitable. And this is true at a micro level. To a large corporation, retaining cash for 60 days supports cash flow, reduces cost of capital and it has a direct and positive impact on stock valuation.
If we were to do a simple estimate of the positive cash flow impact of the top 2,000 companies holding on to their payables for 60 days and earning say 1% on that cash, it’s a whopping $28 billion per year.
The effect on suppliers is less positive. There are 2 paydays in 60 days and payroll can’t wait for customers to settle their bills. The suppliers’ business needs to be funded through that 60 days and that comes at a price. Even in times of low interest rates the cost of funding for a small business can be in the region of 20% APR especially if they are forced to use facilities like invoice factoring and overdrafts. The macro economic impact of this is dramatic. If suppliers are faced with 60 days to cover the outstanding receivables due from the top 2,000 corporations at an average 20% APR, their aggregate cost of financing is $558 billion.
So let’s ask ourselves this, what if all invoices were paid in 10 days? What would that look like for the small business economy? And what effect would it have on suppliers and their customers?
If big business charged their suppliers just half of the market rate, 10% instead of 20% and paid in 10 days instead of 60 they could make over $200 billion – almost 10 times what they make on cash now. The impact on supplier is even greater. They’d save a staggering $233 billion.
The enormous discrepancy between the cost of capital to large business and the cost of funding outstanding payment to their suppliers and exploiting this discrepancy is what makes SCF work. SCF is not a zero sum game. It actually adds economic value and the question we should ask is not if it should be encouraged but rather, how the value within the financial supply chain should be best distributed.
The discrepancy in the cost of working capital is really a symptom of our economic inefficiency. We can see it manifested in actual examples of inefficiency. Most bank led SCF schemes go no further than working with a customer’s largest suppliers because the cost and inefficiency of managing the KYC makes the cost of working with smaller supplier prohibitive. The value that can be extracted using SCF is the value that can be added by creating efficient financial supply chains.
But the macro economic impact of SCF goes much further than the distribution of value that it can bring. Small business is important employers and they need to borrow to support growth. They need to pay and train a growing work force, invest in new machinery and stock. Without capital they cannot grow unless the profit they make during that growth is greater than the cost of borrowing, and thus, it is not cost effective to borrow. This is why high borrowing cost stunts economic growth and why cheaper funding sources are necessary to support the growth of small business. It is why we hear of fundamentally sound business going belly up – they have a full order book, they have a sound business model but if they run out of cash they’re dead. This is what we saw in post reunification Germany when there was massive growth in the construction sector and it’s what we saw in Southern Europe after the global financial crisis. If the banks stop funding at affordable levels, businesses run out of cash and fail.
Supply chain finance can be difficult to define exactly but in its loosest sense it refers to methods by which business can exploit their financial supply chain – the flow of money associated with their actual supply chain. There is real value locked up within these inefficient financial supply chains that can be unlocked and it could have a dramatic effect – not just on the suppliers and buyers but on the wider economy, supporting economic growth creating and protecting jobs and further accelerating economic recovery.
Pete Loughlin can be found on twitter @peteloughlin