Stamping out the misreporting of supply chain finance

Fitch Ratings examines the accounting practices of companies relying on reverse factoring, whereby companies get off-balance sheet treatment of debt

There is a notable upturn in the number of companies expanding their payables days outstanding via bank supply chain financing and not classifying it as debt. That’s according to Fitch Ratings, which views this as a potential “accounting loophole”, allowing companies to forgo the need to report this as debt on their balance sheets.

Citing the sudden liquidation of UK construction company Carillion earlier this year, the rating agency has urged market participants to carefully evaluate debt within a particular company. Carillion reported net debt of £219 million compared to the unreported debt of an estimated £400-500 million to financial institutions alone.

“The debt classified as 'other payables' was unnoticed by most market participants due to the near complete lack of disclosure about these practices and the effect on financial statements. Whether these programmes require disclosure under accounting standards depends greatly on their construction, which in practice allows many companies not to disclose them,” states Fitch Ratings.

“As a result, evaluating trends in payables days is the best way to uncover the use of supply chain financing,” insists Fitch Ratings.

Under a supplier financing programme otherwise known as reverse factoring, companies not only get off-balance sheet treatment of debt but can develop a close relationship with their suppliers, allowing them to gain financing based on their credit. For the supplier in particular it allows them to get paid earlier through the sale of invoices to a financial institution before their due date.

Over the past several years supply chain finance has grown in popularity. According to the World Supply Chain Finance Report 2018, the market for supply chain finance grew by 36% in volume in 2016 compared to 2015, reaching US$447.8 billion.

Looking to risk mitigate the popular financing solution, the International Trade & Forfaiting Association (ITFA) recently announced that it was intending to release updated guidelines on the formation of reverse factoring programmes. The IFTA, along with other organizations a few years ago, created standard definitions/techniques for supply chain finance.

The aim of these proposed new guidelines is to point out programmes that need to be reclassified as debt on a company’s balance sheet. The idea is to prevent the supply chain programmes from being misused by companies, in particular those enterprises that don’t have strong enough credit to support their suppliers.
 

Date

14 Sep 2018

Channel

Treasury

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