What is financialization?
“Financialization is profit margin growth without labor productivity growth. Financialization is squeezing more earnings from a dollar of sales without squeezing at all, but through tax arbitrage or balance sheet arbitrage.” — Ben Hunt, Epsilon Theory
Is payable finance (aka reverse factoring or its generic form, supply chain finance) as practiced by large corporates, really just balance sheet manipulation?
That’s a good question, since so many conferences are centered on supply chain finance and its various derivatives as solving the trade finance funding gap. There certainly have been a number of recent articles or white papers that have provided negative commentary on supply chain finance (SCF), including pieces from Corporate Treasurer, Moody’s, Financial Times and others, that seem to imply as much. Ping me if you would like to see a link to these posts.
To answer the question, it first is important to define supply chain finance and then see how it impacts the balance sheet.
A common definition (please note, a very narrow one) is: “Supply chain finance is a buyer-led initiative that facilitates favorable financing for the supplier in order to achieve mutual benefits for both trading partners, through the use of a technology platform and a third-party financial institution or otherwise.” This form of finance typically refers to post-shipment finance that enable suppliers to sell their invoices “approved & scheduled” for payment by their buyer before the payment due date.
Balance Sheet Effects
How does this form of SCF impact the balance sheet?
The three components of the cash conversion cycle are:
- Days sales outstanding (DSO), which measures how long it takes for a company, on average, to get paid; associated accounting issues include recognizing accounts receivable, valuing accounts receivable and disposing of receivables.
- Days in inventory (DII), which measures how long it takes, on average, for inventory to move through a firm’s various production stages and be sold.
- Days payable outstanding (DPO), which measures how long it takes for a company, on average, to pay its suppliers. Companies buy both direct goods (defined as expenses that are part of Cost of Goods Sold) and indirect goods (defined as those expenses that are part of Selling, General and Administrative Expenses). Companies buy from thousands or hundreds of thousands of suppliers (referred to as long tail), and typically, bank-led SCF is targeted at the top tier.
The relationship between the cash conversion cycle and these three components is:
Cash conversion cycle = DSO + DII – DPO. By extending terms out and collecting cash from customers fast, companies can reduce their cash needs. But that is much easier said than done. The key point as it relates to SCF is that by extending DPO a company can indeed reduce the cash to cash cycle time, but this merely passes the problem onto the suppliers unless they can sell their receivables and reduce DSO.
What Recent Payment Term Data Says
Extending terms is precisely the benefit that continues to be marketed to large companies as a reason for implementing a supply chain finance program. Studies by The Hackett Group on public companies as well at the Fitch rating agency have found DPO extended over the last 10 years.
Hackett’s recent data shows U.S. public companies are holding back payments for an average of 56.7 days, longer than any point in the past decade. For many large companies, extending terms is the easiest way to hold onto cash and make working capital your suppliers’ problem. There are countless examples of large public companies with terms that seem to go beyond common sense.
It’s happening across industries …
Source: The Hackett Group 2018 Working Capital Survey
A recent Fitch study based on a sample of 337 Fitch-rated issuers in Europe & North American sectors likely to use supply chain finance (aka reverse factoring or payables finance), between 2014 & 2017, payables days went up by 14 days, or US $327 billion in aggregate. While Fitch doesn’t claim it’s all due to supply chain finance, they do say this financial balance sheet engineering technique will be monitored closely.
Fitch study of 337 rated issuers & their payable extension
So yes, the evidence clearly shows SCF enables large companies to extend terms to improve their cash position.
Supply Chain Finance Ain’t All Bad
There is no doubt the supplier receives a number of potential benefits, including:
- Faster inbound cash flow due to early settlement of invoices
- Off balance sheet, non-recourse finance
- Where the supplier is a small to mid-size enterprise (SME) and the buyer is a large, credit-worthy corporate, the cost of finance will often be lower than the SME might normally achieve on a standalone basis.
- If a supplier is using credit insurance on a buyer against insolvency, that may no longer be necessary, potentially lowering the cost of sales
Of course, vendor platforms, fintechs, consultants, bankers, pundits, media and others that thrive on promoting SCF programs will point to the opportunities for suppliers to accelerate the payment on their invoice at some advantageous arbitraged rate as a win-win. And certainly, there are many examples of that happening. But this idea that “in an increasingly accountable business environment, corporates are looking for new ways to support their suppliers to adhere to sustainable and ethical standards. Alongside creative supply chain finance solutions, treasurers are analyzing how emerging technologies can assist them in making their supply chains more sustainable,” is just what the missionaries and their shills would like you to believe.
Let’s not be so naive. SCF is balance sheet manipulation with a smiley face.
As Procter & Gamble’s President and CEO David Taylor stated about their payable finance program “it’s yielded us nearly $5 billion in cash in the five years we’ve been driving it.”
Or as, Samsonite’s chief supply officer Paul Melkebeke said, “We wanted to improve our working capital to support the company’s expansions plans in Asia Pacific, especially in China, that’s why we extended our payment terms to 105 days.”
Corporate management is just following the zeitgeist of our times. It’s smart, but let’s remember it for what it is.
David Gustin runs Global Business Intelligence, a research and advisory practice focused on the intersection of payments, trade finance, trade credit and working capital.