Knowing Your Options for Mitigating Tariff Risk

Mid-market companies are trying to determine the impact of tariffs, but the task has proved difficult given that the scope and duration of tariffs isn’t always clear. Responding to tariffs requires companies to forecast for an undefined period, and the full effects won’t become apparent until tariffs are annualized in a new budget season.

Companies have pretty straight-forward questions to assess the impact—what does this tariff mean for my business and what are my options? A manufacturing firm, for example, needs to know how tariffs will affect the supply and cost of the materials it uses, and they’ll likely consider whether they can pass the costs through to customers or find alternate suppliers who are more cost efficient.

Assessing Counterparty Risk

Deciding on either of these options involves understanding the risks associated with your suppliers, also known as counterparty risk.

If you decide to stay with your current suppliers and pass the costs on to customers, you’ll need to have a sense of the degree to which your current supplier may raise prices. You’ll also want to know if they’ll still be able to meet your inventory demands once the tariffs are in place. If your suppliers must import their products, then tariffs could put pressure on their cash flow, making it difficult for them to have the funds they need to purchase their materials.

If you decide to go with new suppliers, due diligence will be key. The high-level information you will need relies on assessing counterparty risk:

  • Can a new supplier meet your product specifications?
  • What is the status of payment liquidity? Are payment and receipt of funds in local currency or US dollars? Can this be negotiated?
  • Will there be a premium for managing funds in US dollars?

Particularly for manufacturing firms, the relationship with a supplier is not simply transactional but strategic, meaning the C Suite and purchasing departments have to assess their options holistically. When a firm changes to a new supplier in response to tariffs, it needs to establish new relationships in addition to setting up quality controls, agreeing on payment liquidity terms and learning who their suppliers are, if possible.

Payment liquidity in particular may seem like a small concern, but it does affect the bottom line.

“Companies may often assume they don’t have foreign currency exposure because they are receiving US dollars or paying for supplies in US dollars, but they do have exposure, it is just indirect exposure,” says Robert Tull, Managing Director and Global Head of Financial Risk Solutions at Fifth Third.

When the currency in the home country of a supplier fluctuates, it will change the USD payables. Domestic firms have options including managing the exposure in-house, in cooperation with the supplier, or through hedging. In cases where companies are purchasing from China -- where that currency is not freely convertible -- other options such as the offshore renminbi (CNH) can be utilized to manage Chinese currency exposure. Considering these factors in the context of tariffs can carry weight when choosing a new supplier.

Stabilizing the Financials

Underpinning the tariff issue is the health of the company balance sheet. At the end of the day, you want to know that you are doing everything you can to ensure the volatility of the industry doesn't compromise the business.

Coping with tariffs can, for example, create new challenges in managing the firm’s balance sheet—cash flows, currency exposure and commodity exposure can be impacted. A banking partner can help by discussing alternatives to managing the costs of supplies, smoothing out currency and commodity volatility—thus potentially mitigating significant cash flow volatility.

"The key is identifying internally which risks are most prevalent and what is most concerning," says Tull. "Having a banking partner with that vertical expertise can help companies mitigate the impact and build a network within the industry."

Taking measures like these can help stabilize some factors on the firm’s balance sheet and income statement so companies are better able to forecast their financial situation and account for tariff impact.

Firms which have production facilities abroad may also want to shift some production to locations that are not subject to tariffs, or they might look to develop a new plant or contract out to other countries or domestically. Banking partners can help with the risk management associated with these strategic changes, as well as help raise capital.

Employing Your Resources

Firms can benefit from their membership in industry trade organizations which are often well informed about changes pending in Washington on regulations, tariffs and taxes. They can also provide best practices and tactical responses.

For more tailored information, leverage your banking partnerships. Their experts can provide an analysis that is more specific to your industry and goes beyond the general news from media outlets.

With that extensive knowledge, you’ll be better able to assess and prepare for the impact of tariffs.

The views expressed by the author are not necessarily those of Fifth Third Bank and are solely the opinions of the author. This article is for informational purposes only. It does not constitute the rendering of legal, accounting, or other professional services by Fifth Third Bank, National Association or any of their subsidiaries or affiliates, and are provided without any warranty whatsoever. Deposit and credit products provided by Fifth Third Bank.