Supply Chain Finance Payable Reclassification issue – dead or alive?

balance-sheet-formatprinciples-of-accounting

Every so often, you hear about the threat to reclassify payables on a buyers balance sheet due to supply chain finance programs.

Most readers will be bored by this stuff, yea, like, accounting who cares, but accounting matters. Since 2003, when the SEC first commented on these programs, the debate around threatening re-classification of the payables on the buyers balance sheet is real. Why this matters is that if a corporate is required to reclassify $500 million of trade payable debt to bank debt, it impacts their loan covenants, their leverage, and their access to additional credit.

The crux of the issue is if the Buyer is confirming to the financial institution that it will pay at maturity of the invoice regardless of trade disputes or other rights of offset it may have against the supplier, then it is giving a higher commitment to pay to the financial institution than it owes to the supplier and this may be construed as a bank financing and not a trade payable on its books.

Most corporates have been educated (by other corpoates, accountants, and banks and vendors pitching them programs) of some of the criteria that are important in keeping these programs as trade debt. For example:

  • Keep the initiatives of separating extended payment terms and the discounted early payment as two separate events.  Therefore, if the supplier declines joining a program he is still stuck with the extended payment terms!
  • Do not have tri-party agreements – It is very important to keep these programs with independent agreements – ie, no tri-party agreements between buyer, seller and funder.
  • Always pay on the maturity date stated on the invoice i.e. no early payments with discounts shared with the bank and no prolonged payment terms with interest payments to the bank.
  • No kick backs from the bank - and I know this is becoming increasingly popular on the market with different kind of fees to the Buyers for services provided.
  • Buyers cannot dictate who funds the program - keep hands off.

Some will argue that independent platform providers (ie, not banks) provide a good way to ensure no reclassification, but I do not believe that is the case. There are many programs run by banks. Banks/platform providers make all their profit on financed volumes and not platform fees.

There are many other considerations besides the above, but this is a good start.

Unfortunately, there is no clear guidance from the IFRS in regards to reclassification of trade payables to debt. This is something of paramount importance, as large corporates will continue to be conservative. While not a show stopper, this issue does slow down these programs and make the set up costs more expensive by enriching accounting firms. In fact, I’ve had people tell me auditors in the same office can disagree on the bank debt versus trade payable issue.

No wonder confusion reigns.

P.s. I would like to invite you to receive our Trade Financing Matters Weekly Digest by signing up here https://spendmatters.com/tfm/weekly-tfm-digest/

Voices (2)

  1. Robert Kramer:

    David, also on the subjects of supplier financing and accounting, I think there is a significant issue that is flying under the radar.

    If I told you a company ran a supplier finance program that had the following characteristics:

    1. The buyer negotiates the financing terms with a bank.

    2. The buyer’s payment terms are determined by their agreement
    with the bank, not by their agreements with suppliers.

    3. The buyer signs a contract with the bank.

    4. If the buyer doesn’t pay on the term they pay interest to the bank.

    5. In the event of default by the buyer, all outstanding amounts are
    immediately due to the bank.

    6. The bank pays a rebate to the buyer based on the amount of
    supplier financing provided.

    Based on your post, I think you would say that payables related to the supplier financing program described above should be classified as bank debt. That arrangement is in fact a typical Purchasing Card program which companies classify as trade payables. With all of the discussion around Supply Chain Finance accounting, I’m surprised no one has raised this issue.

    What do you think?

    Bob Kramer
    Vice President, Working Capital Solutions
    PrimeRevenue, Inc.

  2. Robert Kramer:

    David,

    Thanks for this informative post.

    One thing I want to point out. In 2003, the SEC was commenting on SCF programs that operated very differently from today’s SCF programs. Back then, SCF operated as what I would call “early payment” programs vs today’s “sale of receivable” programs. Under early payment programs, when a supplier wanted early payment, the bank simply paid the supplier early on behalf of the buyer. The bank had an agreement with the buyer that guaranteed them payment. Today, in most SCF programs, the banks purchase receivables from the supplier, check for liens against the receivables, file UCC statements (in the US), etc. In order to get paid the bank needs to rely on the validity of their receivable purchase, not on a guarantee from the buyer. That wasn’t the case in 2003.

    Also, regarding your point on independent platform providers. Those providers separate the buyer from the bank and don’t utilize a contract between the buyer and the bank. So, while they certainly don’t ensure maintaining a trade payables classification, they do eliminate some of the risk items you mentioned, such as the possibility of a tri-party agreement between the bank, buyer and supplier.

    Bob Kramer
    Vice President, Working Capital Solutions
    PrimeRevenue, Inc.

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