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Spend Matters welcomes this guest post from our regular contributor David Gustin, President, Global Business Intelligence.
The argument “is supply chain finance (SCF) trade debt or bank debt?” has been ongoing for well over a decade. Most “opinions” that you hear expressed as “facts” generally comment without having any clue about the actual accounting rules – whether those of FASB (Financial Accounting Standards Board) or IFRS (Financial Accounting Standards Board) — or about the underlying legal contracts executed by and among the parties, including obligors (or debtors), suppliers, bankers and others, including platforms and asset arrangers.
I started writing on this subject on Spend Matters:
The crux of the payables vs debt issue
The crux of the issue is: what is the supplier finance arrangement – trade payables or debt? And the “what” is important. Financial analysts generally treat the two differently: Trade payables are typically considered part of working capital lumped together with cash and investments and trade receivables whereas debt is treated as leverage.
While all are balance sheet accounts, classifications in accounting rules, payables and debt have a lot in common. They are both money that debtors owe creditors. And that similarity is important and non-trivial as both are governed by contracts which have terms and provisions. One of the reasons that trade payables and debt are considered differently is that the contract terms with regard to trade payables offered so much flexibility (examples include volume discounts, offtake agreements, contractual chargebacks) whereas with debt contract terms offer significantly less variability and little flexibility. Under SCF the variability and flexibility are altered from the original contract terms as the finance agent – the banker or fintech – intermediates into those contracts. And whether or not it is currently classified as trade payables or debt, under current FASB or IFRS accounting rules, there are no requirements to disclose the arrangements PERIOD. Well, that is about to change.
What is changing?
Both IFRS and FASB have public projects to amend financial statement disclosure requirements, governing the types of transactions generally referred to as SCF. In November 2021, the IFRS proposed an amendment to IAS7 and IFRS 7 for supplier finance arrangements with comments to be received by March 28, 2022. In the 24-page exposure draft, they outlined a case for increased disclosure around supply chain finance. And those opinions are about to get a whole lot less relevant, as the most important opinion providers – the auditors of a company’s financial statements, the ratings agencies about the ability for company to repay its liabilities, and the equity and fixed income analysts that track those companies – are about to start weighing in.
For those that have been around trade finance for the last 25 years, this will be the biggest event since Basel 2 capital rules implemented in June 2004 rocked the banks profitability with significant increases in capital for higher-risk credits. Banks were never able to restructure those businesses to regain that profitability.
IFRS has made its proposal public for what disclosure every company will have to make. As it stated in its draft:
“The proposals in this Exposure Draft are intended to complement the requirements in IFRS Standards that apply to reverse factoring and similar arrangements (as explained in the Agenda Decision). The proposed amendments to IAS 7 Statement of Cash Flows and IFRS 7 Financial Instruments: Disclosures would require entities to disclose additional information in the notes about those arrangements. The Exposure Draft uses ‘supplier finance arrangement’ to refer to a reverse factoring or other similar arrangement.”
FASB is expected to release its paper to the public on December 20, 2021.
The IFRS exposure draft proposes to require an entity to disclose:
- The terms and conditions of each arrangement
- For each arrangement, as at the beginning and end of the reporting period:
- the carrying amount of financial liabilities recognized in the entity’s statement of financial position that are part of the arrangement and the line item(s) in which those financial liabilities are presented
- the carrying amount of financial liabilities disclosed under (i) for which suppliers have already received payment from the finance providers
- the range of payment due dates of financial liabilities disclosed under (i)
- As at the beginning and end of the reporting period, the range of payment due dates of trade payables that are not part of a supplier finance arrangement
As per IFRS and the soon-to-be-released FASB recommendations, there are two major issues impacting supply chain finance. First, before today, companies did not have to disclose anything about these types of arrangements. Soon everyone will have to. And, what exactly are these arrangements? Do purchasing card programs need to be disclosed? For example, with Pcards, you get a credit line so your staff can make purchases to defer a payable by up to 55 days. Do various inventory finance programs need to be disclosed? Exactly what gets disclosed? This is important, because this could impact disbursement-based trade products, not just supply chain or payable finance, but commercial cards, inventory finance, etc. It depends on how those programs are structured contractually.
The paper described a supplier finance arrangement that “is characterized by one or more finance providers offering to pay amounts an entity owes its suppliers and the entity agreeing to pay the finance providers at the same date as, or a date later than, suppliers are paid.”
How does a company interpret these regulations? They will certainly rely on their auditors. Will the auditors want to see the commercial contract? Under the IFRS Proposal, there is a requirement to disclose the commercial terms of the arrangement in addition to its size. Accounting is fundamental to understanding a business, and auditors opine, and the analyst community then conducts their analysis on cash flows, leverage, growth rates, etc. It’s extremely important.
At some point in the second half of 2022, corporations will have to disclose how they are using various programs and produce an appropriate footnote for analysts and others to incorporate in their company analysis.
This could impact hundreds of billions of exposures through various products. In BCR Publishing’s World “Supply Chain Finance 2021” report, reported figures for supply chain finance showed a significant increase in volumes in 2020 over 2019 with global volume up by 35% to $1,311 billion and funds in use up by 42% to $505 billion. Many supply chain finance vendors claim that their growth has been substantial over the pandemic. And that’s just payable finance.
Houston, do we have a problem? I don’t know, but certainly it’s time to make corporations aware of their upcoming reporting requirements for disclosures. No more guesswork by rating agencies as to the extent of these programs or the distortions they bring to evaluating a company’s true payable position. As we know, months go by quickly, and soon these accounting proposals will be requirements.
View the IFRS exposure draft here.
Review the current state of FASB on supplier finance here.
