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When should supply trade finance be considered debt?

Banks and third-party providers have extolled the benefits of supply chain financing (SCF). In its various forms, including reverse factoring, the buyer can extend its payment terms while the suppliers get paid on time, with a third party or bank bridging the financing gap in the middle. But does everyone really win and live happily ever after? The problem is that companies can avoid classifying reverse factor payments as debt, due to an accounting loophole that enables them to classify the obligation as 'other payables', which they don't have to disclose in financial statements. This leads to a lack of transparency and an inaccurate picture of a company's actual debt obligations.

Ratings agency warning

Fitch Ratings has warned that the non-disclosure of SCF structures can lead to increased credit risks. The agency blames this mis-classification and lack of transparency for playing a central role in the collapse of the UK's public sector services provider Carillion in January 2018, leaving 30,000 small and medium-sized suppliers with unpaid invoices. What's more, the use of supply chain financing and its mis-classification and non-disclosure may be on the rise. Fitch added: “We believe the magnitude of this unreported debt-like financing could be considerable in individual cases and may have negative credit implications.”

The agency goes on to say that reverse factoring was “a key contributor to Carillion's liquidation as it allowed the outsourcer to show an estimated GBP400 million to GBP500 million of debt to financial institutions as 'other payables' compared to reported net debt of GBP219 million.”

And it calls for greater awareness of the credit risks involved with this structure: “As seen in the case of Carillion, reverse factoring could have a potentially large impact on vulnerability to default for specific issuers, making awareness critical.”

ITFA to tackle problem

That's why it's good news that an industry body, the International Trade & Forfaiting Association (ITFA), has announced it will take action to clarify this issue. Global Trade Review (GTR) reported this week that ITFA is due to launch a set of guidelines to help assess whether SCF programmes should be reclassified as debt or not. The announcement was made at ITFA's annual conference in Cape Town and the guidelines will include “a list of common features to help the payables finance industry identify such 'extreme cases'”. The guidelines will be designed to drive greater transparency in financial statements and to flag up warning signs over SCF programmes that have suspect characteristics, such as: payment terms far beyond the industry norm, or programmes that are far bigger than would be expected, as well as programmes requiring additional bank collateral. Other warning signs include buyers that pay programme costs or buyers that repay beyond maturity.

UniCredit's Jana Kalousova, a member of ITFA’s young professionals network, is quoted in GTR as saying: “If a company’s payables finance programme fulfils these criteria, then the programme should be reclassified as debt.”


This item appears in the following sections:
Financing
Dynamic Discounting
Factoring
Invoice Discounting & Securitization
Working Capital Management
Procure-to-Pay Cycle in WCM
Total Working Capital

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