“Is this too good to be true?” asked Carillion in its own two-page brochure introducing its early payment facility for suppliers. Perhaps it wasn’t at the time – but as Carillion’s financial position started to unravel in 2017, the supply chain finance programme put in place to support suppliers could in fact have made matters worse for them as the UK’s second-largest construction group headed into financial difficulties. The company was forced into liquidation in January this year when a rescue proved impossible.

In July 2017, the company issued a profits warning and sacked its chief executive, Richard Howson. The company said in a conference call to investment analysts that its borrowings had hit £695m, up from £587m six months earlier, and that the average utilisation of its early payment facility stood at £412m. But the company also told analysts that it would be looking at its EPF “as part of the strategic review” that would be undertaken by the acting CEO, Keith Cochrane.

“I think it’s fair to say that over time we will probably seek to reduce our utilisation of reverse factoring but as to what form and shape that takes we will just need to wait and see,” he said.

One accountant with a major firm who is familiar with the workings of supply chain finance but who is not connected to the events at Carillion said he could not imagine any reason why the company would have sought to reduce its early payment facility, other than “Probably because they couldn’t get banks interested in continuing to fund it.” This accountant asked SCFBriefing not to be quoted by name.

“Supply chain finance is like a drug”

Supply chain finance programmes provide value for banks because it gives them the ability to do volumes of business with SMEs without taking on an SME-type credit risk exposure. “But supply chain finance is like a drug,” the accountant said. “As long as it’s available, it’s fine and everybody is happy. But if the bank loses its risk appetite and there’s no one else interested, then all of a sudden the whole supply chain is in disarray.”

Carillion won no friends amongst its supplier base when it extended its payment terms several years ago to as much as 120 days. But while the early payment facility that was put in place eased the working capital burden imposed on suppliers, banks almost certainly became increasingly nervous through 2017 that what they had seen as a short-term, low-risk exposure to Carillion could in fact become a bad debt.

“Banks always assume that supply chain finance is based on a normal trade flow and that it is just an advance of trade flow. But if the buyer gets into trouble, then all of a sudden they realise that they are taking a risk on the buyer,” the accountant said.

What, exactly, a bank that provides an SCF programme can do as a company gradually heads into difficulties will depend entirely on the terms of the contract. It may have the ability to reduce the level of funding or it may be able to give notice and bring the programme to a premature close. In such circumstances, however, the buyer would not likely have the financial ability to revert to the previous, shorter trading terms with its suppliers.

Like a run on a bank

It’s also possible that industry knowledge across the supplier base could result in greater demand on the part of suppliers to make use of the early payment facility as soon as possible and to the full extent of outstanding invoices. This could cause an effect not dissimilar to a run on a bank – a loss of confidence in the company that quickly uses up any available funding in the facility.

“If the counter is closed because the limit is reduced or reached, then you have this stress cycle like a run on a bank,” said the accountant.

At the same time, other suppliers will then find themselves stuck with long payment terms that they now have to fund themselves. They may seek to raise prices to cover their higher risk and financing costs or to demand payment upfront, potentially losing the contract completely if the increasingly-stressed buyer can’t or won’t meet such demands.

“It’s like a case of musical chairs when the music stops,” says the accountant. “It causes huge stress in the supply chain.”

Suppliers are hit hard, faced not only by the loss of future business but by the loss of up to 120 days of receivables. When being offered an SCF facility, suppliers should also be looking at the cost of credit insurance and the volume of trade that they can protect in that way, the accountant advises. Industry figures suggest that credit insurers were covering just £30m of the £1bn owed to suppliers.

At least those suppliers who took advantage of Carillion’s early payment facility almost certainly will not have to repay money received back to the bank (contrary to what was said in a recent Forbes column, which also erroneously described supply chain finance as a UK government scheme).

The reason is that auditors will always meticulously examine any supply chain finance deal to ensure that it does not fall foul of the accounting rules, forcing the reclassification of trade payables as debt. If an early payment facility allows the bank to go back to the suppliers to recover payments should the buyer fail, then the programme will not be accounted for as a true SCF programme but rather as a debt facility. Where a bank is able to recover money from either of two possible sources – the buyer or the supplier – then it is in a better position than the supplier was originally, so the buyer’s trade payables are, in reality, bank debt.

This, of course, is little comfort to Carillion suppliers who have been left wondering whether or how they will get outstanding sums owed to them – or how they will get future business with the potential loss of a major customer.