Even before COVID-19, growth in the global economy had slowed. The impact of the pandemic however has dramatically accelerated that trend as consumer spending has dropped and global trade reduced, with an expected surge in insolvencies and defaults globally. Through their global insolvency index, Insurer Euler Hermes estimates (COVID-19: Quarantined economics, March 23 2020) record high insolvencies of +35% cumulated over a two-year period. Unlike in 2007-2009, all regions and countries are expected to post double-digit increases.
Volatility and uncertainty are the watchwords for the remainder of 2020 and beyond for most businesses. Later payments and rising inventories have been highlighted among large corporates, working capital requirements (WCR) will increase by +5 days to 74 days in 2020 or USD8tn of additional financing needs worldwide. Suppliers will continue to play the role of a financier to many of their clients, although the innovative world of supply chain finance continues to grow and bridge the gap. Many industry experts are predicting changes to the payables landscape in the short to mid-term.
Since the outbreak of COVID-19 we have seen unprecedented measures from regulators to take swift actions to encourage banks to provide much needed emergency relief or a liquidity lifeline to the private sector. Banks have been steadily increasing default reserves for non-performing loans. The question remains for financial institutions, where should they allocate resource, capital and investment for the future? Will the private sector witness a natural tightening of lending criteria in 2021 and how will businesses adjust to this? This may put some companies at risk and drive accelerated innovation through the banking industry. Our industry continues to evolve at an increased pace to support client needs with the systematic use of credit solutions in the finance industry.
These are key reasons why a close focus on working capital practices and the ability to preserve liquidity and cash flow have become so critical. For many, the credit insurance and surety markets could play a key role in supporting businesses in identifying potential future credit losses, mitigating the balance sheet impact and maximising the working capital opportunities.
The economic signs are ominous
The initial stages of the lockdown led to a steep rise in the volume of payment moratoriums where organisations reschedule debt, either under existing finance facilities or under trade contracts. As these payment moratoriums come to an end, the question arises as to whether companies are able to make those rescheduled payments.
It’s still early days but losses are beginning to crystallise in the credit insurance market, with the quantum only set to increase throughout the remainder of 2020 and into 2021. While lockdown measures are increasingly being lifted or even re-imposed in some regions, the economic impact has yet to fully materialise, but the dark clouds are ominous.
A big change is that even in resilient markets, like pharma for example, businesses are now looking for solutions to free up additional working capital. According to figures from JP Morgan (J.P. Morgan’s 2021 Working Capital Index report), nearly US$500 billion remains tied up in the working capital of the S&P 1500 companies. And while there will be businesses that have robust credit management procedures in place and the ability to quickly convert receivables into cash – often it might be because without a large, healthy balance sheet behind them they have no other option – it’s not always the case. Ultimately, it’s vital that business looks to leverage every tool available to convert sales into cash as swiftly as possible or face a growing potential for default.
The longer that cash is uncollected, it’s effectively funding another business rather than the creditor’s. Illustrating the scale of the problem, JP Morgan’s figures again show that the cash conversion cycle lengthened to over 71 days in 2019 – an increase of nearly six days over 2018 and further revealing the challenge businesses face. This is further backed up by many economists’ predictions that global days sales outstanding (DSO) will reach its highest level in the 10 years. Businesses will need to manage their key performance indicators acutely to emerge stronger through the recovery period.
Ways to improve working capital practices
How can organisations improve their working capital practices? There are a wide number of possibilities, many of which are explored in Aon’s recent C-suite report on credit solutions – Driving growth through uncertain times – but it could be a focus on improving cash conversion cycles; funding a trade receivable; or, purely looking at credit management. Making investigations around e.g. collection activities and results, payment terms, contractual terms and conditions.
To help businesses respond, Aon has developed a Working Capital 360 Advisory offering to help businesses navigate in this volatile trading environment. By pairing our experience as a credit intermediary with data analytics, we can help clients identify credit risk in terms of the probability of a default across their portfolio, and also quantify the potential loss value while looking at ways of mitigating the impact on the balance sheet using insurance.
We also look at ways of maximising working capital opportunities. As detailed in Aon’s C-Suite report, for example, banks are using credit insurance to enable larger, longer-term loan facilities because they have been able to benefit from replacing the counterparty risk with well-rated insurance security. Or through the use of surety bonds and guarantee solutions to replace traditional Letters of Credit and/or cash collateral security to support liquidity and cost improvements.
Succeeding in an opaque trading environment
We aim to help clients manage volatility and provide visibility in an otherwise opaque trading environment, as well as looking at ways in which we can use our existing portfolio solutions to create working capital improvements which deliver tangible financial benefits. It’s clear that organisations are beginning to talk more holistically around credit solutions, rather than just on trade credit insurance.
We are having valuable conversations across organisations from credit managers, through to treasury and C-suite decision makers who are getting more involved. This wider engagement is to be welcomed and the questions is, ‘will it continue after the crisis, or will it go back to the pre-crisis position?’ Our challenge as an industry is to make sure that we can continue to converse with the whole eco-system of decision makers to help businesses maximise the benefits of utilising credit solutions.
Aon Credit Solutions evolution
Aon’s Credit Solutions team look at the working capital challenges for businesses post-pandemic and ways in which to ease liquidity and cash flow issues.
We live in a world of constant change and business leaders are coping with the challenges that impact every part of their organisation. Aon’s Credit Solutions practice has evolved from broker to trusted advisor, with flexibility in our model that enables a tailored approach to the industry and more importantly – to our clients’ needs. We continue to drive our teams to look holistically at our client’s objectives and build a strategy together that not only resonates with their goals but delivers tangible outcomes. We are looking deeply within our organisation and evolving, our Working Capital 360 Advisory is one of many initiatives that focus on the new normal to help business from crisis to recovery.
To find out more as to how credit insurance solutions can help your business, download a copy of Aon’s latest C-Suite Series report ‘Driving growth through uncertain times’.
Written by Aaron Bailey (Executive Director – Structured & Capital Solutions at Aon)
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