Justin Schmidt, head of new-sector development at Absa Retail & Business Bank, points out that South African manufacturers are experiencing supply chain constraints and are having to wait longer to receive raw material or to deliver final goods
We continue to see a significant improvement in manufacturing confidence, as well as strong increases in selling prices and output and improvements in gross domestic product. Further, the industry has seen better-than- expected demand and there are indications that this may continue – with an especially positive export outlook over the next 12 months.
While green shoots are showing, the sector is not out of the woods yet. Raw material stock availability remains under pressure across much of the industry, which is leading to a knock-on effect on input prices. To ensure that there is sufficient raw material to produce inventory to meet forward-looking demand, many manufacturers are now importing directly from international suppliers and increasing their inventory levels.
Another important consideration as we are now in the second half of 2021 is that we are entering the peak season for manufacturers. Traditionally, about 53% of sales are achieved in the second half of the year and about 27% in the fourth quarter. If we compare sales in the first quarter with those in the fourth quarter, sales are, on average, 17% higher in the last quarter of the year.
Working Capital Constraints
With the rebound, the improved sales outlook, potential margin constraints (if sales prices do not increase at the rate of input price increases), potential stocking up of raw materials and inventory build-up to avoid unfulfilled orders as well as higher seasonal sales, the managing of these cash flow constraints is an essential consideration in the coming months.
Let us look at the cash conversion cycle (CCC) multiplied by sales (or cost of sales) as a proxy for how much working capital is tied up at each point in this cycle. More specifically, the CCC is a measure of how long it takes a company to turn its cash investment in inventory back into cash (from sales of that inventory). The longer the CCC, the greater the amount of capital invested in the sales process.
As noted above, manufacturers are experiencing supply chain constraints and therefore waiting to receive raw material or to deliver final goods by an extra few days. This increases the inventory days and therefore means that more capital is tied up in the process. Likewise, investing in greater inventory levels, owing to the concerns around raw material shortages, will also mean longer inventory-holding periods, as well as more capital tied up in this step of the sales process.
If one also takes the seasonality of manufacturers into account, the higher sales period will also drive up working capital needs.
Therefore, considering the combination of the above scenarios for a manufacturer, manufacturers are coming into a period where a significantly higher value of working capital will be tied up in this cycle. Funding thereof through cash or some form of short-term funding is key to short-term planning. Importantly, when cash is locked up in the sales process, it cannot be used anywhere else in the business.
Schmidt heads New Sector Development in Retail and Business Banking at Absa – Justin.Schmidt@absa.africa