Cash flow challenges faced by OEMs
Credit09 Jan 2025
Original Equipment Manufacturers (OEMs) face several challenges when managing their cash. These problems can make it harder to keep their business running smoothly.
A clear understanding of cash flow involves monitoring:
Cash inflows: revenue from sales, client payments, and financial inflows from other sources like loans or investments.
Cash outflows: payments for raw materials, labour, machinery, and operational expenses.
Let's break down some of the common challenges faced by OEMs:
Late payments from customers: OEMs often sell their products to customers who take a long time to pay, sometimes weeks or months after receiving the goods. This delay extends their sell cycles, creating a gap where the company has spent money but hasn’t received any return. Without clear agreements on buying transactions and payment terms. As a result, OEMs must look into trade credit with partners, using unsecured working capital from financial institutions to manage this period effectively.
High upfront costs: OEMs must spend a lot of money at the start of production, buying materials, paying workers, and keeping machines running. They need to pay for these things before their customers pay them, which puts pressure on their available cash. For some, the solution is leveraging off-balance-sheet financing, 30-day credit options, to manage seasonal demand and maintain a steady cash flow.
- Managing stock: OEMs need to keep many materials and finished products in stock to meet customer demands, which requires a lot of cash. If demand is slow or delayed, this money is tied up in unsold goods, making it hard to use for other needs. In these cases, exploring trade Accounts Receivable (AR) can free up cash tied to inventory.
- Pressure from suppliers: suppliers often require quick payments, but if the OEM hasn’t been paid by its customers yet, it creates a cash flow problem. This pressure can be relieved by negotiating better payment terms or using supply chain financing to bridge the gap, allowing OEMs to manage payments more effectively.
- Changes in demand: OEMs must deal with sudden changes in their product needed. When demand goes up, they need to spend more money quickly. When demand drops, they might be left with extra stock that isn't selling, reducing their cash flow.
- Currency changes: OEMs that buy or sell internationally face the risk of currency values changing. If the value of a currency goes up or down, it can make supplies more expensive or lower the amount of money they earn from sales in other countries.
- Investment in new technology: OEMs often need to spend money on new machines and technology to stay competitive. While this is important for the future, it can be expensive and may not bring profits immediately.
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Case Study: cash flow challenges at TechGear Ltd
Background:
TechGear Ltd is a company that makes parts for the automotive industry. Recently, they signed a ₹12 crore contract with a global car manufacturer. The contract lasted six months, but the client agreed to pay TechGear Ltd after 90 days. This was a great opportunity, but it caused some cash flow problems.
Problem 1: rising material costs
During production, the price of steel—one of TechGear Ltd's key materials—increased by 15%. This meant an additional ₹60 lakh in unexpected costs. Since the contract price was fixed, TechGear Ltd had to absorb these extra costs, further tightening its cash flow.
Problem 2: investment in innovation
TechGear Ltd invested ₹1.5 crore in new technology and equipment to improve production efficiency to stay competitive. Although this was important for the future, it strained their cash reserves, as the investment did not bring immediate returns.
Solution: to tackle these cash flow issues, TechGear Ltd took several steps:
Taking a short-term loan: TechGear Ltd took out a ₹2 crore short-term loan to cover the gap between expenses and incoming payments. This allowed the company to continue production without running out of money.
Planning for the future: the company began exploring supply chain financing options to help them receive payments earlier by working with financial institutions. This would make it easier to manage cash flow in future contracts.
Key takeaway: TechGear Ltd's experience shows how important it is for companies to manage their cash flow carefully. Even with a growing business, OEMs must balance spending and income, negotiate better terms with suppliers, and plan for unexpected costs.