Supply-chain finance—also known as supplier finance, structured trade payables, and vendor financing—is a financing tool that can boost cash flow by allowing companies to negotiate extended payment terms with their suppliers while providing those suppliers an opportunity to get paid early. Though the tool can be quite useful for companies with healthy balance sheets, some companies use it to disguise their financial performance, making it a target for increased regulatory scrutiny.
Supply-chain finance is nothing new; it’s been around for decades. We saw an uptick in its use after the 2008 financial crisis. Not surprisingly, the uncertainty and volatility of the COVID-19 pandemic, together with the high-profile bankruptcies of UK-based supply-chain finance provider Greensill Capital and construction management firm Carillion PLC, have sparked concern over whether companies are being transparent as they struggle to stay afloat and free up working capital trapped in their global supply chains.
Greensill Capital collapsed in early 2021 when it lost financing after its shady practices came to light. And Carillion suffered a similar fate in 2018 when it filed for insolvency after crumbling under the weight of $2 billion of debt, a significant portion of which it disguised to appear more financially sound.
No mandatory disclosure standards currently exist in the US to prevent these sorts of abuses of supply-chain finance, but regulatory progress is being made as investors, auditors and other concerned parties demand transparency in the absence of a disclosure framework.
Understanding the supply-chain finance process
In general, the financing arrangement is one where:
- A bank or other lender pays your supplier earlier than it would normally be paid, at a slight discount;
- You pay the lender the full amount that you would have paid your supplier, usually later than you would have paid the supplier; and
- The lender keeps the difference as a fee in exchange for its services.
All interested parties can benefit from this arrangement. You’re better able to control your cash flows and avoid supply disruptions, which can help optimize working capital. Suppliers, though typically paid less, are more likely to receive steady payments, which can go a long way towards minimizing risk across the supply chain. And lenders get their financing fees. This sort of win-win scenario can be seen if you run your supply-chain finance programs effectively, but if you misuse the financing tool, there’s cause for worry.
Regulatory concerns around supply-chain finance
Though some of you disclose the terms of your supply-chain finance arrangements in your regulatory filings, US companies aren’t currently required to do so. This leads many to classify the arrangements as part of accounts payable, making liquidity positions appear stronger than they actually are. The SEC warned in CF Disclosure Guidance: Topic No. 9A, Coronavirus (COVID-19) — Disclosure Considerations Regarding Operations, Liquidity, and Capital Resources (available on Thomson Reuters Checkpoint), that the absence of detailed disclosure of these arrangements in financial statements can leave investors and analysts without the material information needed to make informed decisions. Members of the FASB have also cautioned against a lack of transparency, saying that these programs can distort cash flow cycles.
To put these regulatory concerns into context, let’s say that a company reports a large improvement in cash flows that may not be sustainable on account of its use or overuse of supply-chain finance. If the company doesn’t disclose the reasons for the large improvement, then investors may not be aware of the degree of liquidity risk that the company may face if the lender were to end the arrangement suddenly. If bankruptcy, for example, were to occur, the company would have to make payments sooner, and possibly in larger amounts, which could be disastrous if it doesn’t have the cash, as was the case with Greensill Capital.
The bottom line is that poor, misleading disclosures could be tantamount to hiding financial problems. So, if the terms of a supply-chain finance arrangement materially impact your liquidity in the present or in the future, they ought to be disclosed.
The SEC is watching
Supply-chain finance arrangements and related disclosures are on the SEC’s radar. Though to date there’s no rulemaking on the subject, SEC Staff, through interpretive guidance and comment letters, are encouraging tailored disclosures regarding risks posed to business and operations that help guide investors’ decision-making process.
In the Topic 9A Guidance, for example, SEC Staff noted that many companies are undertaking new financing activities in response to the pandemic, including supplier finance programs, and advised companies to “provide robust and transparent disclosures about how they are dealing with short- and long-term liquidity and funding risks in the current economic environment, particularly to the extent efforts present new risks or uncertainties to their businesses.”
To help evaluate disclosure obligations as they pertain to supply-chain finance, SEC Staff suggests that you include a discussion of the following in Securities Act and Securities Exchange Act registration statements and in periodic reports, particularly in the Management’s Discussion and Analysis (MD&A) section:
- Whether you’re relying on supplier finance programs to manage cash flows.
- Whether these arrangements had a material impact on your balance sheet, statement of cash flows, or short- and long-term liquidity, and if so, the nature of the material impact.
- The material terms of the arrangements.
- Whether you or any of your subsidiaries provide guarantees related to the programs.
- Whether you face a material risk if a party to the arrangement terminates it.
- The amounts payable at the end of the period related to these arrangements.
SEC Staff are also looking for enhanced disclosures in the MD&A section of regulatory filings, as communicated through their review and comment letter process. As examples, Graphic Packaging Holding Company, The Boeing Company and The Coca-Cola Company recently responded to SEC comment letters inquiring into the use of supply-chain finance, with inquiries similar to those addressed in the Topic 9A Guidance along with others aimed at providing investors with a metric of how the arrangements impact working capital (see SECPlus Filings Highlight, Coca-Cola and Others Respond to SEC Comments on Use of Supply-Chain Financing, dated September 9, 2020 and available on Thomson Reuters Checkpoint).
The FASB has moved forward with a disclosure proposal
In October 2020, the FASB added to its technical agenda a project on disclosure of supplier finance program obligations, in light of the absence of explicit disclosure requirements in the FASB Accounting Standards Codification (ASC), also available on Thomson Reuters Checkpoint, together with the proposed rulemaking discussed below. Before making this move, the FASB considered a letter by the Big Four requesting more accounting transparency, as well as feedback from other auditors and financial statement users, including analysts and rating agencies.
After months of deliberation, the FASB issued a disclosure proposal on December 20, 2021 with a 90-day comment period (i.e., Proposed Accounting Standards Update (ASU) No. 2021-007, Liabilities—Supplier Finance Programs (Subtopic 405-50): Disclosure of Supplier Finance Program Obligations), and expects to issue a final ASU during the second half of next year.
The proposal covers scope, disclosures and transition guidance, suggesting, for example, that:
- The scope should apply to those of you using supplier finance programs for the purchase of goods and services and to obligations covered by these arrangements.
- You should disclose the key terms of the arrangements as identified by management.
- Instead of consistent interim disclosure of information about these arrangements, you should disclose only if there’s a related significant event or transaction that materially impacts you, consistent with guidance in FASB ASC Topic 270, Interim Reporting.
- Disclosures should be provided for each period in which a balance sheet is presented, with early adoption allowed.
The FASB plans to use feedback on this proposal to better inform its final ASU and believes that its efforts will help ensure that the financing tool is used to improve cash flow responsibly.
With the SEC using the review and comment letter process to monitor companies’ disclosures about supply-chain finance and the FASB in the process of crafting related disclosure guidance, it’s important to stay abreast of what’s going on if you engage or plan to engage in this type of financing. With that said, it would behoove you not to wait for formal rulemaking before revisiting the adequacy of your disclosures. Now’s the time for you to ensure that you’re well-prepared to satisfy enhanced disclosure requirements and doing so may go a long way in strengthening your relationships with investors, suppliers and customers.
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