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Economic Expansion Beginning to Fuel Significant Demand for Working Capital Finance

Man working on finances on his laptop with calculator.

Let’s set the stage for what economic activity we are likely to see during the second half of 2021 and through much of 2022. The Conference Board is forecasting real GDP growth above 6% for the year, fueled by a strong 6.4% annualized growth rate in Q1, federal stimulus, and pent-up consumer demand. This includes a quarterly annualized forecast of 8.6% in the second quarter and 6.4% in the third. One potential indication of this is the consumer savings rate of 27.6% experienced in March. Some economists place the annual growth forecast above 7%. To put this forecast into perspective, the last time the United States saw real GDP growth in excess of 6% was 37 years ago in 1984, as the country exited the recession of the early 80s. The current recovery and expansion, across a wide variety of industry sectors, is now beginning to fuel a rising need for short-term working capital finance, and banks and credit unions that offer these lending services will benefit from this demand in the months ahead.

2020 Saw Declined Demand for Working Capital Finance

For working capital specialists, the forecast mentioned above is a significant shift from last year. Those who follow various forms of working capital finance know that 2020 demand was significantly lower than any other time since the great recession. The Secured Financing Network recently reported that the domestic factoring industry declined more than 25% to a total volume of less than $80 billion. They also reported that asset-based lending commitments in their network fell by more than 21% to $83 billion. In addition to declining demand for many products and services in 2020, many businesses were bolstered by the more than $770 billion funded through the Paycheck Protection Program (PPP), which lessened the need for working capital financing. But those trends are now reversing as we see economic expansion taking hold. As small- and medium-sized businesses use up their PPP monies and other stimulus programs run their course, small business owners will once again be faced with the need to seek financing for new growth opportunities.

Considering the average cash cycle of most small businesses, owners must utilize 40 to 60 cents of short-term working capital to generate each new $1 in gross revenue. This is why many small business owners struggle through high growth periods. They often seek lenders that are familiar with the art of working capital finance and factoring, to bridge the gap in their operating cash cycles. The current growth cycle will offer both a unique challenge and a unique opportunity for lenders. On the one hand, credit officers will be faced with underwriting and renewing lines of credit for many existing business clients that suffered through the pandemic and are left with weaker balance sheets and income statements. On the other, weaker performance in commercial real estate portfolios through 2021 will likely drive the desire for banks and credit unions to diversify their portfolios, with commercial lending being one obvious direction.

Industries Carrying Accounts Receivable & Inventory Will Drive Demand

So, which industries will drive the demand? In short, those that carry accounts receivable and inventory. Consider the asset structure of various small businesses. A temporary staffing firm, for example, carries a lot of receivables and has few other assets to serve as collateral. As an industry average, staffing company accounts receivable make up more than 45% of total assets. That ratio is meaningful. If a company with that structure is facing a growth opportunity, it is highly likely to need a source of short-term working capital financing. In terms of their operating cash cycles, they also have the challenge of meeting weekly or bi-weekly payroll expenditures, even though their customers often pay them on Net 30 terms. Another prime example is small trucking companies, whose accounts receivable average 32% of total assets. They have a high reliance on accounts receivable, significant weekly cash demand for payroll, fuel costs and short-term expenses, and high growth potential in 2021. Before too long, businesses in this position can outstrip their cash cycles. Hundreds of industries deal with the daily struggles of managing accounts receivable and inventory concentrations against their operating cash cycles. Consider these words from Michael Dell (Dell, Inc.) several years ago.


“We were always focused on our P&L statement. Cash flow was not a regularly discussed topic. It was as if we were driving along, watching only the speedometer, when in fact we were running out of gas.”


Keep an Eye on the Market for Short-Term Working Capital

Given the economic forecast for this year and next – and the nature of the pandemic recovery – it is likely that the market for short-term working capital financing will be robust. Community-minded banks and credit unions with the expertise and technology to deliver these services will have an advantage over other organizations (which are primarily real estate lenders), allowing a more diverse portfolio and revenue stream.

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