The Financial Accounting Standards Board’s (FASB) newly issued requirements for supplier finance programs sparked both curiosity and apprehension for buyers. The call for public companies to disclose information previously disregarded has brought on many questions about what it means for the industry.
We gathered the top questions that we’ve heard from our clients and provided some clarity on what the new FASB changes are and the likely impact they will have on their business.
1. Why is this being done?
Headline making bankruptcies have brought supply chain finance programs to the forefront of accounting concerns.
Large insolvencies such as Carillion, Abengoa, and Greensill, raised concerns that companies are taking advantage of supplier finance programs by extending terms well beyond market norms and creating debt-like structures without the appropriate disclosures to analysts and investors.
This raised the concern that companies were developing significant dependence on uncommitted bank financing without reclassifying the obligations from payables to debt. As mentioned in the now infamous report by Moody’s in December 2015 on Abengoa, “these activities can become a permanent feature of a company’s financing activities… if these sources of funding were to become unavailable to a company, this could affect a company’s short-term liquidity.”
2. How does FASB define SCF?
FASB defines supplier finance programs, sometimes referred to as reverse factoring, payables finance, or structure payables arrangements. To be considered a supplier finance program, FASB looks for 3 structural elements:
- There exists an agreement between the Funder and the Buyer to establish a supplier finance program.
- Buyer confirms Supplier invoices as valid under the agreement.
- Supplier has the option to request early payment from a party other than the Buyer.
- An indication of a supplier finance program is any commitment from a Buyer to pay a party other than the supplier.
- Point two seems to be relatively open-ended in its interpretation, and FASB dictates that all evidence will be considered, including arrangements where the Buyer has confirmed invoices as valid to a finance provider.
3. What are the FASB Changes?
Previously, there were no requirements for U.S.-based public companies to disclose their supplier finance program details. The new FASB changes require the following information to be disclosed in each annual reporting period:
Key Terms of the Program
- Total outstanding obligations under the program (approved invoices) at month-end
- Where these items are presented in the balance sheet.
- A roll forward of the obligations showing:
- Amount open at the beginning of the period
- Amount of new obligations added during the period
- Amount of obligations settled during the period
- Amount of obligations open at the end of the reporting period.
4. How will regulators or rating agencies use this information?
The use case of these new disclosures remains unknown for the time being. Based on the previously mentioned concerns by rating agencies, what they will primarily be looking for is whether the facilities are within market norms and the impact of them being withdrawn.
Carillion and Abengoa raised issues around non-standard programs where the corporate had developed an unbalanced dependency that would be more akin to bank financing. They will want to avoid mass reclassifications to avoid spooking the industry and causing a knock on effect on suppliers that rely on these programs.
Suppliers rely on said programs for a wide range of reasons. Considered a cheaper form of funding with low risk, SCF programs provide suppliers with newer forms of liquidity and a faster turnaround of cash flow.
These programs have become entrenched as a form of financing for suppliers and corporates, and mass changes will result in substantial unforeseen effects on suppliers. If programs get wound down, customers that arrange these programs might force the market to accept the new, longer, payment terms without the financing option.
For programs where the extended credit terms are beyond the market norms for the industry, there is a possibility that rating agencies will argue these need to be reclassified as bank debt, even though it’s not required from an accounting perspective. In addition to this, there will be significant scrutiny when the credit terms on invoices in the program differ substantially from invoices not in the program. This further adds to the narrative that the terms received are not within normal market standards, and would not be sustainable outside a supplier finance program. These changes have led to speculation on how supplier finance programs will impact credit ratings.
Ultimately, most industry experts agree that the new level of transparency is important and will serve to strengthen the industry by bringing new layers of trust and furthering investments to corporates. Until this is proven though, many corporates are justified in remaining cautious about misunderstanding or misusing the required disclosures.
5. I offer a Supplier Finance program. How can I prepare for these changes?
It is recommended that buyers take the following steps to make sure they are in compliance and prepared for the change:
- Assess your program
- Compare your DPO terms with the market
- Educate and work with your auditors.
- Avoid running a significant volume through the payables program.
- Automate reporting & working with a tech partner
6. I participate in a Supplier Finance program. How can I prepare for these changes?
Talk to your suppliers on the steps they are taking to make sure they are in compliance with FASB. We recommend inquiring after the following information:
- Are they continuing their program or winding down?
- If they are winding down, what is their timeline?
- Will payment term lengths change?
7. Are there any alternatives to Supply Chain Financing?
Some suppliers may wind down programs as a result of these changes, but maintain their long payment terms. To continue meeting those needs, an attractive alternative leveraged recently is receivables finance. Accelerating receivables makes collecting payments faster and helps bring immediate liquidity into the business. Incorporating receivables finance often improves cash flow, reserves, and company resilience.
8. How can LiquidX help?
LiquidX provides industry-leading technology in the trade finance space that helps our customers pivot with ease and simplicity. With middle and back-office digitization, your business can leverage automated reporting that can make compliance easy. We also offer supply chain financing alternatives, such as receivables financing. Our experts can help transition you from an SCF program to a receivables one, or assist in augmenting your SCF program to make space for receivables.
As a global company, LiquidX remains committed to both maintaining a pulse on new developments within the trade finance industry as well as consistently contributing to the international dialog regarding acceptance of digital assets in trade programs. We will continue to keep our customers and partners informed with the latest announcements that impact the trade finance community.