One of the oldest debates around supply chain finance has been reinvigorated this month by a letter from the ‘big four’ accounting firms to the accounting standards body, FASB (pictured), asking for stronger guidance on the accountancy treatment of supplier finance programmes.
The issue, as SCF Briefing recorded way back in 2016 (Keeping SCF trade payables from being moved into debt), is whether trade payables which are subject to supplier finance should be regarded as debt.
This is something the ratings agencies have been especially keen to highlight in the wake of high-profile company failures like that of Carillion, where very extensive supplier finance programmes effectively buried borrowing where it couldn’t easily be spotted.
At Fitch, managing director Frédéric Gits explained in a recent webinar that the company now uses a formula to adjust company debt ratios to reflect their use of supply chain finance – even if those payables aren’t shown as debt on the balance sheet.
Rival Moody’s has similar concerns about the ‘high, but hidden, risks’ of supplier finance. It issued yet another warning earlier this month, with associate managing director William Coley pointing out that, “Users of financial statements may not be aware of a customer’s usage of reverse factoring, despite the potentially material consequences. The customer itself may not fully understand the added risk that accompanies the use of this financing technique.”
Now comes that letter to FASB from Deloitte & Touche, Ernst & Young, KPMG and PricewaterhouseCoopers (read the full text here).
In it, the firms point out both the rising popularity of supplier finance and the fact that there is no specific guidance in U.S. GAAP. Lacking specifics, accountants have been working on the basis of SEC staff speeches at the 2003 and 2004 AICPA national conferences.
When does SCF become debt?
For potential users of supplier finance, the letter itself neatly encapsulates current ‘best practice’ on the subject:
‘If the intermediary’s involvement does not change the nature, amount, and timing of the entity’s payables and does not provide the entity with any direct economic benefit, continued trade payable classification may be appropriate.
If the nature, amount, or timing of its payables changes or the entity benefits from transactions between suppliers and the intermediary (e.g., by receiving fees or rebate payments from the intermediary), however, reclassification may be required.’
Elsewhere in the letter, the firms set out one key identifier that may push a supplier finance programme over the line into debt; have payment terms been extended beyond industry or sector norms – if they have, it’s more likely that these payables will be identified as debt.
In practice, many of today’s supplier finance programmes are being set up without complete clarity on how they may ultimately be treated by accountants, auditors, and rating agencies. A change is long overdue.
Reacting to change
One person who is well aware of the probability of closer oversight is Lex Greensill, founder of supplier finance specialist Greensill.
“I foresee considerable changes coming, in no small part driven by the fact that I expect the rating agencies to change the way that they think about supplier credit from the perspective of actual indebtedness of companies,” he told SCF Briefing in an interview earlier this year.
“What that’s going to mean is that the SCF that you know and understand today is going to look very different in two to five years’ time; and in future, we’re moving away from something that looks like buyer-confirmed SCF toward something that is data-confirmed SCF. That’s the move that people are underestimating at the moment, and that’s where we are investing.”
Greensill won’t be the only firm paying close attention to what eventually emerges from FASB on the accountancy treatment of supply chain finance. It could change the playing field for SCF in ways many of those who currently use it have yet to consider.
William Coley of Moody’s will be speaking on this topic at SCF Forum Europe on 28th November in Amsterdam. SCF Briefing readers can claim a 20% discount on ticket prices by using this link or entering the code SCFB20 on the registration page.