The enduring power of working capital in high-rate environments

The Federal Reserve recently indicated it would start lowering interest rates this fall. That is welcome news for a business community that has seen the cost of borrowed money rise dramatically from the low-to-zero interest days of a few years ago.

With the consumer price index (CPI) falling 0.1% in June from May and a continued slowdown in hiring and other measures, the data is telling the Fed it’s time to bring rates back down.

“With abundant signs of a cooling economy, the consumer price index for June certainly constitutes the ‘more good data’ on inflation that Fed Chair Jerome Powell has said we need to see before the Fed can begin cutting interest rates,” Greg McBride, chief financial analyst at Bankrate.com, told CNBC in a recent interview.

Role of finance in supply chain

A drop in interest rates should be welcome news for supply chain finance leaders. However, when rates started jumping in 2022, it did not dampen finance programs. In fact, it did the opposite. According to a July 2022 article in the Wall Street Journal, higher interest rates often lead to an increase in supply chain finance.

Companies can use finance programs for many reasons—inventory management, cash flow management, short-term or long-term capital expenditures to name a few. Depending on what type of program is being utilized, the impact of current interest rates vary. According to Nathan Feather, CFO of PrimeRevenue, regardless of the interest rate, finance programs can be beneficial.

“While it’s inevitable that rate fluctuations will have at least some effect on all types of financing—whether bank loans, credit lines, or supply chain finance—what doesn’t change through rate changes is the profound power of the adept use of working capital. This will remain true for companies regardless of their size and industry, and regardless of the broader economic environment in which they operate,” Feather wrote in a Fast Company article.

In an interview with Supply Chain Management Review, Feather explained that there is a lot of uncertainty in the market, but interest rates are just part of that at the moment.

“In addition to the rates, a lot of the uncertainty is putting a pause on people’s investment; that’s what we are hearing,” he said.

Rate increases were felt by everyone unless they were lucky enough to lock in a fixed rate, Feather noted. He was unsure whether a drop in rates would lead to more supply chain investment, though.

“I’d expect it would depend on the (sentiments) of the Fed on if they think we are heading to a soft landing,” he said, adding that today’s high interest rate environment is relative and while high, is not historically high when compared to other times when rates reached double digits.

Investment is still warranted

One of the misnomers that Feather addressed is that high interest rates have cooled investment. He said for organizations looking at short-term projects, the high rates have impacted decisions. But, for companies taking a long-term view of supply chain investments and cash flow, the rates have had only a minor impact.

“Two years ago, if you could borrow money at 2% and had a project that could yield 7%--it’s not great, but you might still do that,” Feather said. “If you are in a world today where it’s 7% borrowing costs and you think the project can only yield 7%, you might put that further down the list of priorities. The really high-value items, the mission-critical types of items, are still being done and being done regardless of the rate environment.”

“People are getting back to business in this new world we are living in today also with an eye toward what happens and how do I prepare for a decrease, or even a further increase in rate. I don’t think we are going to go back to the world of zero anytime soon. Where we go now maybe is a low 4 or 3, but I think the common thought is that is going to take a lot longer.”

It is Feather’s view that companies should be looking long term in these times, and doing so with their supply chain partners, particularly those further down the chain to “protect the supply chain.”

That means ensuring suppliers are financially sound and offering supply chain finance opportunities if needed “to ensure the health of those suppliers.”

“We are seeing more corporates move in that direction rather than just focusing on their tier one suppliers,” Feather noted.

On the question of whether companies should wait for rates to drop before making investments, Feather said that depends.

“We did see that a little bit in 2023,” he said. “That’s a fine short-term approach if you have the expectation that in six or nine months we are going to see a dramatic change. But you can’t do that if you think we are going to sit in this current time for a [longer period].”

The Fed has indicated a potential rate cut this fall and several next years, but how quickly and how deep those cuts will be is not known.

“People are getting back to business in this new world we are living in today also with an eye toward what happens and how do I prepare for a decrease, or even a further increase in rate,” Feather said. “I don’t think we are going to go back to the world of zero anytime soon. Where we go now maybe is a low 4 or 3, but I think the common thought is that is going to take a lot longer.”

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