Submitted by: Susanne Svizeny, Eastern Division Commercial Banking leader, Wells Fargo
Most companies have mastered managing working capital and managing risks since the Great Recession. They had to do it to survive, and now they have to do it to remain competitive. Entertaining expansion or new business opportunities without a thorough examination of the working capital implications and assessment of other key risks can be a recipe for failure.
Taking risks doesn’t mean taking a flier into expansion without careful consideration. Successful risk takers understand the hazards first.
A recent study of corporate agility by Accenture, one of the world’s leading management and technology consultants, found that, when faced with an opportunity, high–performing companies assess risk quickly and thoroughly, perform a “What if?” analysis, and move forward decisively. A company’s risk analysis first should assess uncontrollable factors. Next, factors that could impact the expected financial outcome of expansion must be considered.
Commodity Prices
What happens when commodity prices change? First, depending on the segment it serves and its inherent receptivity to price increases, a company’s margin will stay constant or will fluctuate. Business leaders need to know which will happen. Second, working capital investment will expand or contract. Companies need to factor that into their “What if?” scenarios.
Interest Rates
Since 2008, the federal funds target interest rate has remained at 0.25 percent. Market participants are preparing for a rate hike in 2015’s second half. Since 1983, the Federal Reserve has enacted six rate‑tightening cycles, each lasting approximately 14 months. On average, the Federal Reserve has increased rates 2.8 percent per cycle. If businesses haven’t tested their expansion plan for a 3 percent hike in interest rates, they haven’t performed an adequate risk analysis. And if a company doesn’t run that model, it can be assured that its financial institution will. Banks are fundamentally in the business of buying and selling money; and we know that interest rates will rise, even if we can’t always predict when.
Exporting and Importing
When selling overseas, consideration must be directed to a number of factors, to include: payment risk, working capital, global competition and currency volatility. While still awaiting reauthorization, Exim bank provides solutions not only for enhancing working capital availability, but also offers attractive buyer financing options to allow U.S. companies to be competitive in selling product abroad. Additionally, an exporter can mitigate payment risk under letters of credit through bank confirmations and then discount the letter of credit to speed payment. Conversely, strong importers may offer supply chain solutions to their suppliers in higher interest rate environments, permitting the importer to extend days payable while providing a shorter time in which the supplier is paid at an attractive discount rate.
Foreign Exchange Rates
Whether a business’s sales or purchases are dollar denominated or not, currency volatility affects its costs and prices. Since 1975, there have been at least 20 major reversals in exchange rate direction, with trends lasting from one to five years. Currency markets are expected to remain volatile due to uncertain domestic and international monetary policy. We advise attention to currency volatility in “What if?” scenarios, particularly as companies consider expansion in new markets.
Labor
In response to a worsening labor shortage, employers are increasing wages and using innovative recruiting techniques. Average hourly wages have increased by $2.45 since early 2007. It used to be that the primary consideration given to labor was the length of outstanding union contracts, the company’s history of labor relations, and its pension obligation funding status. That was before private sector unionization fell to its current level of 6.6 percent. Right now, we’re more often having dialogue about labor shortages and succession planning. Companies contemplating expansion must factor in wage escalation, as well as increased costs associated with higher turnover and retention expenses.
Technology
Staying on top of the sea changes that are coming across industries is a full-time job for Wells Fargo. Every experienced banker has a story about the deal where neither they nor their client anticipated the category‑killer ahead. What are the category killers that could require your company to redirect spending away from existing technology? What are the capital budget implications?
The risks presented here are only a few to consider when undertaking expansion. Others on the list are customer and supplier concentrations, changes in regulation, environmental concerns, and — one of the most important risk factors ―management. Has the company ever done anything like this before? What is its track record of execution on new opportunities? What has its reaction time been to unexpected bumps in the road?
Building flexibility into expansion plans will help companies navigate risks and grow without breaking the bank.
Susanne Svizeny is the division manager for Wells Fargo Commercial Banking in the Eastern Division. She can be reached at Susanne.Svizeny@wellsfargo.com.
