The International Accounting Standards Board (IASB) in late November published for comment an Exposure Draft of proposals to require additional financial statement disclosures for supplier finance arrangements. In this Exposure Draft, the IASB has defined the scope of supplier finance arrangements and has proposed that the following are disclosed:
Moody’s views these proposed disclosures as an important and very positive step in helping to clarify both the existence and impact of supplier finance arrangements on all companies for all users of financial statements.
Supplier finance arrangements, also known as reverse factoring or payables financing, can be a mutually beneficial arrangement that large customers offer for the benefit of their smaller suppliers. Earlier payment to suppliers, later payment by the customer and a liability to make payments to a bank that is typically not disclosed as bank lending makes supply chain financing a potentially attractive product. The amounts due to the supplier typically continue to be disclosed as trade payables (or other non-debt payables) even when the supplier has received payment and the amount is now owed by the customer to the bank.
With limited or no additional disclosure, the arrangements and the related risks are often not apparent in the financial statements. Without adequate disclosure, the supplier finance arrangements can lie hidden in the capital structure until enough stress crystallises. At that point, they fall away leaving a big liquidity hole that magnifies and intensifies the underlying credit problem. Moody’s wrote to the International Financial Reporting Interpretations Committee in January 2020 to set out our concerns about this lack of disclosure.
We are also aware of cases flagged to us by suppliers where the customer appears to be pressuring suppliers to channel invoices through the supplier finance arrangement as a condition of contract when bidding for new work. Among the companies we rate, we sometimes see the same transaction from both sides, so are better placed to judge the liquidity and financial policy of both the supplier and the customer.
The proposed new disclosures are a necessary step in response to a number of cases in recent years, the most high profile being support services and construction group Carillion and supplier finance provider Greensill Capital. These have contributed to a growing reputation of supplier finance arrangements as a risky financing tool that can make bad situations worse, with the potential to push a customer company to the brink of, or indeed into, default.
Carillion, for example, entered into compulsory liquidation less than a year after its directors approved the accounts for 2016 on a going concern basis. A supplier finance arrangement that commenced in 2013 had enabled Carillion to delay the outflow of cash to many of its suppliers.
According to the company's consolidated balance sheet for 2016, the liability to banks in relation to overdrafts and loans amounted to £148m. However, an additional amount, possibly as much as £498m, was owed to banks under the supplier finance arrangement. The latter liability appears to have been reported within ‘other creditors’ and was excluded from borrowings.
The size of the supplier finance arrangement was revealed in a presentation by management that accompanied the results announcement for 2016. However, neither the size of the supplier finance arrangement – nor the actual amount drawn down at any year end – was ever disclosed in Carillion's audited financial statements. The IASB proposals would require such amounts to be disclosed, and Moody’s therefore welcomes them.
Philip Robinson is VP and senior credit officer at Moody’s
