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The Effects of Chinese Tariffs & Proposed Mexican Tariffs

The Effects of Chinese Tariffs & Proposed Mexican Tariffs

How trade wars can impact working capital.
 

By Roberto Cortez, CPA, CIRA, CFE

If there is one thing that all business leaders count on to remain constant, it is uncertainty. Uncertainty in economic and political factors can alter a company’s short-term and long-term goals, and often informs and influences important strategic decisions. A changing political landscape may negatively impact the ability of a company to have access to working capital, which can have far-reaching effects as it may constrain liquidity that could otherwise be used to fund growth, reduce debt levels, lower costs, maximize shareholder returns, and even compete effectively with peers.

Today, businesses are currently wrestling with the effects of Chinese tariffs and proposed Mexican tariffs, with the industrial sector being one of the market segments most at risk. This includes building products, construction & engineering, electrical equipment, road & rail, and transportation infrastructure, just to name just a few.

For many companies impacted by the tariffs, the unavoidable effects are easily acknowledged: we are (or will be) paying more for raw materials or products needed to run our business. The business question becomes “do we pass them onto the end-user?” Beyond these obvious and unavoidable hurdles, business leaders should be asking if there are tangential costs that can be reduced or eliminated by taking a more proactive stance towards managing the working capital pipeline.

Adjustment Period

As companies initially adjust to the imposed tariffs, they may take some quick steps to limit or avoid rising costs and, where necessary, to assist their clients’ absorption of the resulting higher prices:

  1. Companies may try to anticipate or get ahead of rising tariffs by accelerating inventory purchases.
  2. Companies that are passing on tariff costs to end users may extend existing credit terms to provide more time to customers to pay higher invoices.

The real and immediate impact of these decisions is that it locks up working capital in inventory and/or accounts receivable. The company becomes the lender and warehouseman for the benefit of its customers and vendors. Potential longer-term impacts are increased carrying costs, reduced liquidity (possibly limiting strategic options), increased accounts payable, increased obsolete inventory costs, and increased bad debt expense, among others. So, what are the strategic solutions to be considering?

Short Term

The short-term steps that manage cost of goods and maintain the customer base are logical. But what can be done to minimize the unwanted financial consequences that come along with these decisions?

  • Visibility of Cash Flow Reporting - Develop periodic reporting processes to improve availability and reliability of information that will allow you to see if, when, and by how much your cash position is affected.
  • Cash Conversion Cycle Metrics - Build metrics into the optimization process to provide constant feedback to FP&A and Treasury.
  • Supply Chain Strategy – Understand the full breadth of available options to maximize value and flexibility. Maybe higher-cost domestic purchases are now better than low-cost imports, or perhaps the risk and cost of obsolete inventory outweighs the savings from a plan to front-load inventory.

Long Term

Long-term planning and implementation of targeted procedures and processes can be added to help identify, monitor, and address other issues that would otherwise negatively impact working capital.

  • Vendor & Customer Management - Develop preferred buyer/supplier lists and approval processes which will allow for managed assessment of financial and operational reliability of customers and vendors, the negotiation of favorable (and possibly flexible) payment and delivery terms and use of supplier analytics to manage key supply chain metrics.
  • Prepare Demand Forecasts – Tomorrow rarely looks like yesterday. The ability to manage working capital effectively is predicated on having a good estimation of the impact of market forces on sales, along with the ability to work that into the different working capital components. Input should be obtained regularly from all relevant business units when formulating forecasts.
  • Contractual Review Processes - Minimize improper billing practices to address overpayments and/or duplicate payments. In addition, routine contract reviews can ensure adherence to industry terms in addition to compliance with new applicable regulations.
  • Contingency Planning - Use liquidity management to develop financial flexibility and the ability to react thoughtfully to market interruptions. This type of planning helps address risks by maintaining liquidity that may be needed to address business disruptions from natural disasters, supplier inconsistency, and regional political distress, amongst a host of other challenges.

Working capital is impacted every day - not only by the decisions that a company makes but also by market forces. Thoughtful planning and vigilant monitoring of working capital processes and metrics designed to maximize utility will strengthen your balance sheet and improve operational performance. When you lead from a position of financial strength, you will have more options not “if”, but when, your company is forced to adjust to the ever-changing landscape in which it operates.

More Information

If you have any questions regarding trade wars or working capital, please contact Roberto Cortez, CPA, CIRA, CFE at rcortez@jsheld.com.

 
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