Supply chain financing programs have become popular in recent years. But concerns have emerged during the COVID-19 pandemic and the ensuing economic uncertainty that struggling companies may use these arrangements to hide working capital, liquidity and cash flow issues.
The Financial Accounting Standards Board (FASB) recently issued a proposal on supply chain financing. Here’s a summary of what would change and why credit analysts think the proposal falls short.
How it works
Supplier finance programs offer buyers and suppliers the benefits of lower cost and greater financial flexibility — a win-win amid today’s economic uncertainty. These arrangements, also called reverse factoring, payables finance or structured payables arrangements, vary. For example, a buyer might set up the program with a finance provider. This allows the supplier to be paid by the finance provider for invoices that the buyer has approved before the invoice due date in an amount less than the stated invoice amount.
First, the buyer purchases goods or services from the supplier on credit, and the supplier issues an invoice to the buyer. In turn, the buyer reviews the invoice and, if acceptable, informs the finance provider that the invoice is approved. The finance provider then offers early payment to the supplier at a discount.
The supplier is incentivized to use this arrangement because the discount is based on the buyer’s credit rating, as opposed to a normal factoring arrangement where the discount would consider the supplier’s credit rating. If the supplier elects to be paid early, the finance provider will collect payment from the buyer on the invoice due date. If the supplier doesn’t elect to be paid early, the finance provider will just act as a paying agent and pass the buyer’s payment of the invoice amount to the supplier.
Need for change
Currently, there are no explicit disclosure requirements under U.S. Generally Accepted Accounting Principles about a buyer’s use of supplier finance programs, even though they’re widely used in certain industries. As a result, companies’ footnote disclosures often leave investors with limited clarity about the effects of those programs on working capital, liquidity and cash flows.
Under proposed Accounting Standards Update (ASU) No. 2021-007, Liabilities — Supplier Finance Programs (Subtopic 405-50) Disclosure of Supplier Finance Program Obligations, buyers that use supplier finance programs to pay for goods or services would need to provide new details about how that payment structure impacts their working capital. The proposal specifically wants buyers to disclose:
- The key terms of the program,
- The obligation amount that the buyer has confirmed as valid to the third party that’s outstanding at the end of the reporting period,
- A roll-forward of that amount,
- A description of where that amount is presented in the balance sheet, and
- Changes in that amount during the period, including the amount of obligations confirmed and the amount subsequently paid.
In general, the objective is to help investors understand the nature of the supplier finance program, activity during the period, changes from period to period and the potential magnitude.
Credit analyst feedback
Companies have until March 21, 2022, to submit comments on the proposed changes to the accounting rules for supplier financing programs. However, Moody’s Investor Service recently issued a report, indicating that the proposed changes would leave investors with more questions than answers on key issues, such as:
- How do these programs affect operating cash flow?
- What amount is outstanding past the original invoice date and could be considered debt-like?
- Is the bank effectively financing the company’s working capital obligations?
Moody’s credit analysts believe that the proposal would provide some limited benefits to investors. For instance, the proposed changes would help them identify which companies are using supplier finance programs. But credit analysts feel the proposal falls short in three key respects.
- It wouldn’t help investors identify arrangements where the company’s paying the finance provider at a much later date than would otherwise be required under normal operating terms.
- It wouldn’t require companies to disclose information about the original invoices put into supplier finance programs
- It wouldn’t show how a company uses the supplier finance program. This information would show the risks of the supplier finance program relative to the short-term liability that it replaces.
The report concludes that “without information about the invoices put into the programs, investors’ understanding of the programs’ economic impact will be entirely speculative.”
ACLI comment letter
The insurance sector, which is a major institutional investor in public companies, also has asked the FASB to add more grit to its proposal on disclosures about supplier finance programs. The American Council of Life Insurers (ACLI) sent the FASB a comment letter on January 27, 2022, asking for more disclosures to be added to the proposal, including:
- Descriptions about the differences in contract terms among multiple finance agents,
- The discounted amounts outstanding at the end of the reporting period, and
- Enhancement to codification describing the activities for disclosure.
The ACLI would like companies to provide quarterly disclosures about these arrangements, and more information about the identification of finance agents, as they often have “significant, complex, and multifaceted roles with debtors.”
Transparency is key
If your company has jumped on the supplier finance bandwagon, it might be prudent to review your footnote disclosures and provide additional information, if needed. Your CPA can help you report these arrangements with transparency and in compliance with any changes to the accounting rules that may be approved in the future.
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