Goldilocks, Capital Structure and Supply Chain Finance

Ahhh. This porridge is just right.”

— from “Goldilocks and the Three Bears”

The Goldilocks principle is named by analogy to the children's story “The Three Bears,” in which finding the right temperature for porridge took some sampling.

So how do you make sure the porridge is just right if you are today’s middle market treasurer and need to balance liquidity, access to capital (and if rated, a quality rating), and ensuring the right amount of cash?

Most middle market companies are not flush with cash. In fact, when thinking of capital structure, there are many things that keep the CFO/treasurer up at night.

  • First, if you are a rated company, you want to ensure you can balance your rating versus becoming over-leveraged and risk a credit review and reduction.
  • Second, you want to maintain enough liquidity to meet unexpected demands for cash.
  • Third, you don’t want to hold too much cash, or else shareholders will push for a return of capital. It’s the old, “If you don’t have anything better, give it to us.”
  • Finally, you don’t want to be under-leveraged, or else corporate raiders will push you to take on more debt.

Short of being able to improve your credit rating, which most middle market companies don’t have, companies need to focus on liquidity like never before, especially with the prospects of a looming recession. Having liquidity or access to bank credit lines certainly can help absorb shocks (i.e., a quicker downturn than expected, etc.) but too much liquidity sitting unused can be expensive and provide real concerns for being over-leveraged.

While a third-party supply chain finance solution can help provide a dependable source of working capital to your supplier ecosystem without necessarily adding to your credit lines, it does tend to be focused on the largest of suppliers.

Another solution for companies that have surplus investment cash is using that to pay suppliers early. But having too much undeployed cash and using it to pay suppliers early may not be in the best interests of shareholders. This may sound like a paradox (hey we are earning 18% APR on early pay discounts), but paying early may have shareholders question your procurement team’s capabilities and wonder if there aren’t better uses of that cash.

And while card-based solutions can be attractive, both as a way to convert suppliers from check to electronic early payment, and as a source of rebate fees, the uptake tends to be a small percentage of the supplier base.

In addition, bank supply chain finance solutions tend to be offered only to the large corporates, as banks’ cost of capital and KYC costs involved make the middle market less attractive.

A critical component in any middle market company toolbox should be an early payment solution that provides the following through a single, consolidated platform:

  • Dynamic Discounting to enable them to use surplus cash if they so choose.
  • Digital Supply Chain Finance to provide ALL suppliers an ability to access early payment, and providing the company an option to extend terms.

Balance sheet optimization is always a tough balancing act, especially in today’s world of ZIRP, Central Bank intervention, etc. But supply chain finance can provide that scalable tool that becomes an important part of the solution. But this really speaks to a larger question of how companies should approach payment harmonization, term extension, supply chain finance programs, and other early pay techniques such as dynamic discounting.

  • Are you looking to put all 10,000 suppliers on some early pay technique or just a small subset of larger spend suppliers?
  • Is working capital and payment something that you want to exclude as part of the buyer-supplier negotiation process by paying suppliers promptly or not?
  • Are you looking for a non-bank (less compliance issues) or do you need to feed your relationship banks?

There are no simple answers. But in the philosophy of keeping it simple, we can see that supply chain finance does offer a working capital benefit on both sides.

David Gustin runs a research and advisory practice centered on helping financial institutions, vendors and corporations understand the intersection of trade credit, payments and the financial supply chain. This post was written while David worked on a special project with The Interface Financial Group. He can be reached at dgustin (at)

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First Voice

  1. Jason Busch:

    The semantics of the SCF and associated markets are very inconsistent … definitional labels amongst the “insiders/experts” delineating SCF, DSCF, DD, AR Financing, virtual cards etc. are great to debate among the trade financing intelligentsia — even if some vendors have co-opted certain terms for their own purposes 🙂 — but the broader market confuses terms, uses them imprecisely and generally is confused. We need standardization here more broadly …

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