Supply Chain Finance is in the news, with Carillion as a controversial early adopter, Balfour Beatty running a pilot, and Kier looking into the options. Here, Grant Thornton partners Ian Corfield (Recovery and Reorganisation) and Dave Riley (Asset Based Lending) answer CM‘s questions on the topic.
David Riley
Supply Chain finance is new in construction, but is it common elsewhere?
Yes, Lloyds TSB, Santander and RBS are all active in this area. All the major supermarkets are using it, and also the automotive sector. Essentially the risk [of the end client not paying] is borne by the bank, but they’re typically lending to AAA rated organisations so they’re able to offer suppliers a lower interest rate than if the suppliers were borrowing directly.
Last October we had the government initiative backing Supply Chain Finance to get more funding into UK plc and in particular help the SME sector. Basically it’s a government drive to free up liquidity. At the same time the banks are now targetting businesses where there’s clear sales relationship, where they can ask the question “has the product been delivered?” and there’s a clear yes/no answer.
Will it benefit construction SMEs?
For the SME it could be more beneficial than taking an early payment discount. If they take a 2% discount to get paid on Day 45 rather than Day 60, that could add up to 16% over the annual cycle – that’s quite expensive money.
That said, the interest charges for supplier finance are still relatively expensive, so the small supplier needs to balance the pros and cons of applying for this facility, or managing cash flow conventionally. But if Carillion are doing it on a no-fee basis, then their suppliers will gravitate towards it. Yes, it might be better if they paid at Day 30 in the first place, but that’s not how it works in the real world.
Ian Corfield
What are the drawbacks for SMEs?
The money will only be available for drawdown if all the paperwork and governance is fully agreed – you can’t just fire off a payment application. It won’t shorten the payment cycle unless you have good paperwork.
Also there is often talk in the press of Tier 1 contractors cutting their supply chains – will not signing up to these scheme cause an issue about remaining a preferred supplier?
Overall, subcontractors need to fully understand what they’re signing up to – as a principle, supply chain finance works for the banks and the umbrella organisation, but the supplier needs to make sure it understands the financial returns.
What are the advantages for the Tier 1 contractor?
The average construction company is making a net margin of 1-1.5%, so anything they can do to improve their cash flow is worthwhile. With supplier finance, you’re improving your working capital by holding on to money for longer. You’re talking small percentage movements, but that can mean a big absolute number, although to see a real advantage you’d need throughput.
Each organisation runs their cash position differently so it’s hard to predict the effect exactly. But it means that every month Carillion makes one payment to RBS [the bank offering the facility], not 1,000s, so it should simplify their business.
Do you think it will catch on in construction?
I think you will see more of this in construction, but I don’t think it will be an explosion.
What effect are Project Bank Accounts having?
If I was an end-user and if I’m paying large sums to a Tier 1 contractor, I’d want that money to be passed to the suppliers who’re actually doing the construction – at the moment, it’s used in a way that suits the main contractor. With PBAs, Tier 1 contractors lose flexibility, and to compensate they need a higher debt base and the ability to borrow, which adds a large cost. But PBAs are now almost a prerequisite for infrastructure projects – the government wants to avoid another situation like Connaught [where a Tier 1 contractor went bust].
So I think we’ll see a flight to quality – we’ll see clients going time and time again to the big players. And I’d also expect to see that ripple down the supply chain with preferred Tier 2 subcontractors, so it’ll get rough for companies that aren’t inside these groupings.
