Finance costs a balancing act for business
10 Mar 2023
Atradius News
In the second of two articles, we discuss the impact of inflation and interest rate rises on different sectors
In more prosperous times, organisations may have increased the price of their goods or services to cover rising costs, but this is a risky strategy in a global downturn. At the same time, finding new customers is a tough task when business and consumer confidence is low.
Businesses need finance to survive, but how do they meet the rising costs of borrowing in difficult economic circumstances? In this article, we’ll look at the challenges facing businesses in a range of sectors, and also discuss the growing interest in alternative finance arrangements to meet short-term needs.
Business reaction: the bigger picture
Across sectors, businesses are having to shoulder higher costs and, at the same time, retain customers who are themselves financially squeezed. It’s a tough balancing act.
With that in mind, many organisations are looking at cutting internal costs. That can mean slowing production or reducing staff numbers. But while these certainly lowers costs, they also limit a firm’s ability to grasp opportunities when they occur.
Another avenue many will explore is making savings through greater efficiency. That can be done by investing in equipment and technology. The challenge here is the need to invest up front to see savings down the line, something which becomes less attractive when finance is expensive.
Organisations everywhere are hoping that the current situation is a temporary one, and in this there are one or two positive signs.
“Currently there are signs that inflation is easing, along with a gradual easing of supply chain bottlenecks, and somewhat softer energy and commodity prices,” says Dimitri Pelckmans, Head of Risk Services (Belgium and Luxembourg) at Atradius. “Due to this, the pressure on businesses’ cost structure is expected to gradually ease.”
But it will be easing from a great height. The economic landscape looks bumpy throughout 2023 and well into 2024. Many businesses can’t wait for an economic upturn. They need finance to survive.
The sector impact
Sectors are being impacted by inflation and high interest rates in different ways.
ICT
The technology sector is awash with entrepreneurs with good ideas. But start-ups in the sector need to raise capital, which is more difficult in a high-interest environment.
“What we also see in the ICT industry is that businesses are struggling to curb costs by boosting efficiency through digitising and automation processes, because this requires them to finance these projects with borrowing,” says Dimitri.
Agriculture and food
In farming and food production, energy and other production costs have risen steeply. It’s a highly competitive market, and while large players have significant bargaining power, it’s difficult for smaller companies to pass costs to retailers and, ultimately, consumers. “Big food distributors and retailers are reluctant to pay higher prices, and therefore they choose to buy from the cheapest suppliers,” says Dimitri.
Many SMEs in the sector are looking to consolidate or access finance to ride out the downturn.
Construction
Profits margins in construction are under significant pressure - and that includes companies that supply materials as well as the builders themselves. Some construction businesses suffer from inflexible contracts, which see profit margins shrink as production costs increase.
On the upside, supply chain bottlenecks are easing, but this too is a double-edged sword. Many material suppliers bought significant stock at higher prices when supply was limited, and will now struggle to break even on these deals as prices fall.
“Construction materials businesses experiencing this challenge need to borrow liquidity to fulfil their working capital requirement and stay afloat,” says Dimitri.
Others
Higher gas and electricity prices are eating into profitability in the energy-intensive chemicals sector, with sub-sectors like paint and fertiliser particularly badly hit. Clothing manufacturers are struggling as costs rise and consumers decide to avoid or delay purchases rather than pay higher prices. The interlinked paper, publishing and printing sectors are also experiencing significant difficulties.
The demand for finance
As our sector analysis shows, the need for finance is increasing across the board, but higher interest rates have made it more expensive for businesses to raise capital to start, manage or grow business operations.
When we analyse the market, we see that demand from businesses for long-term loans to finance investment has significantly weakened. By contrast, the demand for short-term finance has grown over the last few months. That’s a clear sign that companies are struggling for liquidity.
“That means they are turning to lenders to finance their increased working capital requirements due to inflationary pressures on their heavily affected cost structure,” says Dimitri.
Worryingly, this is true for otherwise successful businesses as well as those in difficulty. Companies are turning a profit but struggling for cash flow.
It is a difficult time for businesses across sectors, and many are turning to alternative finance solutions to meet short-term challenges. At the same time, they hope the gradual easing of inflationary pressures will lead to lower interest rates sooner rather than later.
