Cash injection from the warehouse

Interview with the eCommerce magazine

In conversation: Dr.-Ing. Götz-Andreas Kemmner, Managing Director of Abels & Kemmner GmbH, and Andreas Herbertz, financing consultant. The interview was conducted by Dunja Koelwel, editor-in-chief of eCommerce magazine.

Alternative financing – according to business consultant Dr. Götz-Andreas Kemmner, anyone thinking of venture capital and mezzanine capital lacks imagination. Liquid funds can also be created from within the company. Financing expert Andreas Herberz scrutinizes the concept.
Dunja Koelwel, Editor-in-Chief of eCommerce Magazine, in an interview with Dr.-Ing. Götz-Andreas Kemmner and Andreas Herbertz.

Dunja Koelwel
Dunja Koelwel

Koelwel: You often hear that banks no longer give loans to SMEs. Why are banks finding it so difficult to finance SMEs at the moment?
Kemmner: Whoever has collateral to offer always gets money. However, many are not always able to provide this security. Some entrepreneurs still think that their banker has to sit on their side of the table and jointly bear the entrepreneurial risk. However, the bank’s task and objective is to minimize the risk that a loan will not be paid without jeopardizing the lending business because no company wants more loans from it. If you look at the migration matrices – these tables show the percentage of companies that belonged to a certain credit rating category in the previous year that migrated to other credit rating categories in the following year – you can understand why banks are cautious about granting loans. Companies with medium and poor credit ratings in particular often slip quickly.

In addition, Basel 2 and Basel 3 are increasing the requirements for banks’ capital ratios. The higher a credit risk is assessed, the higher the collateral the bank has to provide on its side and the higher the interest rates. This is why the situation for SMEs will not become more relaxed in the near future. Many banks are now specifically approaching companies that have loans with them to reduce their credit requirements. Companies are usually expected to take action themselves. In such cases, it is often difficult to fall back on other lenders, as every potential new lender critically scrutinizes the company’s financial situation and wants to know why the house banks are pulling out. This is where our special approach of an alternative form of financing comes into play.

Koelwel: How much is known about alternative forms of financing?

Kemmner: Most companies are familiar with the traditional options. These include mezzanine financing and venture capital as an alternative to traditional loans. However, these forms require a company to relinquish decision-making power. It involves others in the company, in its success and in the risk. In the case of venture capital, the VC investor wants to have a say, and in the case of mezzanine capital, most of the parties involved are keeping quiet, but want a higher return.

Herberz: In your experience, how high are these returns?

Kemmner: “I don’t understand why entrepreneurs consider external financing when they can generate the liquid funds from their own business.”

Kemmner: I don’t have any statistics, but I know of expectations of eight to 12 percent and more. Eight percent can still be considered an acceptable value. As a weak-chested medium-sized company, you also have to put this on the table with banks.

Herberz: Not only as a “weak-chested” medium-sized company! From daily experience, I can report that even SMEs with a good credit standing and rating – partly due to the equity weakness of German banks in an international comparison – have an interest burden of seven to nine percent in current account transactions. This is despite the fact that the three-month Euribor, which is used as the basis for refinancing in the current account area, is currently around one percent per annum. In other words, we are talking about bank margins of between six and eight percent within the agreed current account framework. As soon as customers enter the tolerated overdraft area in the short or medium term, current account interest of up to 15 percent p.a. is charged.

Kemmner: I agree with you that some German banks are using the margins to make up for the losses of the last two years. The experience I have gained time and again in the restructuring sector is that SMEs do better with small regional banks such as the Volksbanken, Raiffeisenbanken or savings banks than with large banks. At large banks, the medium-sized company is a number where everything is calculated according to a scheme. Regional banks tend to take into account the fact that if a loan is not granted or extended, a whole avalanche of personal and real estate loans that employees of the company have taken out with the same bank may fall down with it.

Koelwel: What are the first questions that a company asks you?

Kemmner: The typical first question that is often asked is: Is it even possible to reduce inventories without jeopardizing delivery capability and thus competitiveness? Many SMEs have not yet realized that they can create liquidity, reduce costs and still remain able to deliver, or even become more able to deliver, by reducing inventories and working capital.

Koelwel: Why is alternative financing beyond VC and mezzanine capital interesting for SMEs?

Kemmner: The reduction of working capital leads to an improvement in liquidity without any entrepreneurial restrictions. For the company, external financing through mezzanine capital or venture capital always means in some way giving up either decision-making authority or returns or both. The advantage of internal financing by reducing working capital is that you remain in control of your own decisions and your own returns. You don’t take on outside capital that you have to pay dearly for, but reduce costs, and do so drastically. When considering the cost of inventory, many people think primarily of the financing costs of the loan of, for example, six to eight percent. However, the total costs, i.e. the actual financing costs of the inventories, are often between 19 and 30 percent. Companies often have to write off a portion of their inventories, for example because expiration dates have passed or the products can no longer be sold at cost. You have to store what you buy or produce, possibly externally, and you need infrastructure for this. You also have to pay staff to manage the stock. These and other costs must be added to the financing costs. Inventory assets therefore cost between 19 and 30 percent per year rather than just eight percent debt financing. If a bank were to charge you 30 percent interest on a loan, this would be an immoral legal transaction. Companies uncritically enter into such immoral legal transactions with themselves by obtaining money from the bank for eight percent and tacitly adding up to 22 percent in operating costs every year.

Herberz: Is this where your SCM consulting comes in to counteract this development and the expansion of working capital, ideally to reduce it?

Kemmner: Exactly. Liquidity is created by keeping the bank’s credit line constant, reducing storage costs and using the resulting buffer for expansion or to reduce the bank’s credit burden. That’s the fascinating thing about it: when I take out a loan, I increase my liquidity, but also my costs. Inventory reduction reduces costs and increases liquidity at the same time. The trick is to reduce inventories in such a way that I can still maintain or perhaps even increase my ability to deliver with the reduced stock. This can be achieved with suitable approaches in every sector, from the luxury industry to pallet production – logistically speaking, it is always about the same issues. As a rule of thumb, it can be said that eight out of ten companies can achieve at least a 20 percent reduction in inventory. For a statistical average company in the manufacturing industry, this makes it possible to increase cash and cash equivalents by 60 percent or reduce liabilities by 30 percent. The problem for many companies, not just SMEs, is that although they are constantly working to reduce their inventories, the effects are not sustainable. Sustainability can only be achieved by ensuring that scheduling decisions are made as objectively as possible.

Virtually all companies today use ERP systems to manage their warehouse, among other things. Very few have a clean, structured system with the right focus. A lot is controlled by hand. When we start an inventory reduction project, the first thing we do is pull data from the ERP system, which we can use to calculate what stock levels would have to be in the company if we were to follow the MRP suggestions of the ERP system. We also take a look at what stocks are actually available in the company. There are almost always serious deviations between the two values. This does not mean that employees are scheduling incorrectly or that the system is working incorrectly. However, it shows that the ERP system says “hü”, while at the end of the scheduling process it says “hott”. Both stock values should actually be close to each other. The differences are due to the fact that the systems usually do not map the processes in the company correctly and employees have to make manual adjustments. The only way to get more stringent figures is to automate the ERP system. For this reason, employees should never have to retare more than 20 percent of the ERP system’s scheduling proposals. Time and again, we find that planners often think they have to correct the ERP system’s planning suggestions when this is actually necessary. For me, the situation is similar to that in fund management: every year you read which investment funds have beaten the DAX thanks to the fund managers’ clever planning decisions. If you follow the performance of many funds over the years, you can see that the DAX always wins. Similar mechanisms are also at work in scheduling decisions in companies. On average, dispatchers do not beat a properly configured and regularly adjusted ERP system. All of them have examples where they were better than the systems and were able to avoid blatantly wrong decisions through their intervention, but they ignore where they themselves made wrong decisions. Since an ERP system does not have all the information that humans have, there are always reasons for dispatchers to override system suggestions. Building awareness among employees of when to intervene and when to follow system recommendations is an important aspect of sustainable liquidity improvement.

Andreas Herberz
Herberz: “Liquid funds from our own operations and the optimization of production processes are only available to a limited extent and, above all, to a limited extent.”

Koelwel: Is the approach suitable for the manufacturing industry and for online retailers?

Kemmner: The approach is suitable for anyone who needs to finance inventories. The only requirement is that the company must hold inventories.

Koelwel: How long does a typical project take for you?

Kemmner: On average, a project takes three to four months. The duration depends 80 percent on the company and how it is able to cooperate. The decisive factor here is the company’s situation. If a company is in a critical situation, some time tends to be taken away from day-to-day business and progress is made more quickly, partly because the consultant has to complete the project more quickly. Of course, it is better if the company reacts in good time and can implement a project so quickly or so slowly that the project team is continuously trained by working on the project. In our projects, we use a simulation model developed in-house that is based on research carried out at RWTH Aachen University. We usually set the optimization target so that we aim for the minimum cost and not the maximum possible inventory minimum. Procurement costs and purchasing conditions also play a role in this consideration. However, we often start one step earlier by talking to suppliers about how the customer and supplier can simplify the processes together. Many retailers try to reduce costs by agreeing consignment stocks with their suppliers, for example. I’m not a fan of these warehouses where the customer orders and the supplier has to deliver after a defined time. Although they improve liquidity, they increase procurement costs, as the supplier passes on its financing costs to the prices and the internal warehousing costs, which we discussed earlier, continue to exist. In many cases, VMI (Vendor Managed Inventory) is the way forward – at least if you are buying in Europe – as this allows you to decouple the supplier from your own demand rhythm. This gives the supplier scope to optimize its own production capacity utilization and scheduling and thus save costs itself instead of burdening the customer with additional costs. However, such VMI concepts require the supplier to know the customer’s current stock levels and to receive forecasts from the customer about future demand trends.
Debt financing is therefore expensive, especially if the loans are used to build up inventories and thus add operating costs to the financing costs. Conversely, if liquidity can be created by reducing inventories, running costs can be drastically reduced. Our model can help you find the right operating point and maintain it in the long term. Only when a company can no longer generate liquidity from its own value chain should it turn to banks.

Further information on this topic can be found here:

Prof. Dr. Andreas Kemmner

Prof. Dr. Andreas Kemmner

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