Transparency, not Regulation to Mitigate Supply Chain Finance Risk

Supply chain finance (SCF) offers companies of all sizes options to optimize working capital, reduce costs, and strengthen supply chains – all without putting strain on their suppliers’ capital or overall health. The popularity of these payment arrangements have been buoyed by increasingly sophisticated cloud-based technology solutions that have provided simpler platforms that enable faster, more transparent decision-making, payment certainty, and risk mitigation. 

The economic strains of COVID-19 have also led to increased pressure to maximize cash flow, which has led to an uptick in adoption. In fact, a November 2020 Gartner poll found 23 percent of companies relied on SCF to increase working capital for the business.

Perceived Risks of Supply Chain Finance

However, as SCF has become a more common payment arrangement for businesses globally, the practice is coming under increased regulatory scrutiny as both governments and investors attempt to ascertain risks and potential long-term impacts.

“Different types of supply chain finance have different cost, benefit and risk profiles,” said Gartner Director Analyst Miguel Cossio. “The CFO must select the type that supports broader financial strategy and discuss disclosure requirements with external auditors to avoid regulatory and reputational risks.”

That major regulatory issue and risk for companies (and future viability of the supply chain finance industry) comes down to transparency. 

The crux of the problem is that the accounting of supply chain financing arrangements and liabilities lead to poor and/or misleading disclosures that can hide financial problems. 

The Securities and Exchange Commission (SEC) warns that investors and regulators do not have adequate data to make informed decisions if a company is not spelling out its SCF arrangements in financial statements. (Learn more about understanding financial statements in our recent white paper). Moody’s Investor Service issued similar advice in 2019, warning “corporates and their investors of the possibility that supply chain financing could limit investors’ visibility into company financials.”

The Cautionary Tale

The textbook case of this lack of transparency cited by industry critics and regulatory proponents is British construction giant Carillion. Regulators assert that Carillion was extending payment terms well beyond industry standards and had not made all of its supply chain finance liabilities clear on its balance sheets, presenting a more promising financial situation than was actually the case. 

Carillion famously (or infamously) ended up collapsing in 2018 leaving a wake of questions, scrutiny, and legal wrangling.

Preventing a Repeat

So what is the answer to prevent this from happening in the future?

A 2019 letter sent to the Financial Accounting Standards Board (FASB) by the Big Four Accounting Firms: Deloitte, Ernst & Young (EY), PricewaterhouseCoopers (PwC), and Klynveld Peat Marwick Goerdeler (KPMG) provides a good start.

The letter calls upon the: “FASB to provide guidance regarding (1) the financial statement disclosures that should be provided by entities that have entered into supplier finance programs involving their trade payables and (2) the presentation of cash flows related to such programs under Accounting Standards Codification (ASC) Topic 230, Statement of Cash Flows.”

Along those lines, the SEC requested a better understanding of SCF arrangements, including:

• Dollar amounts settled via the arrangement and the balance representative of amounts due to the financial institution/intermediary;
• Analysis supporting classification of amounts settled under the arrangement as trade payables or bank financing, including classification and non-cash disclosure considerations per ASC 230; and
• The arrangement’s impact on an entity’s payment terms to its suppliers, days payable outstanding, liquidity, and risk factors.

In short, standards of disclosure. By providing more information to investors in annual reports, the Big Four and the SEC, companies can mitigate risk to themselves and investors while still reaping the benefits of SCF. 

“We just need to get clarity out there,” said Philip King, chief executive of the Chartered Institute of Credit Management, a UK-headquartered industry body that regularly works with the British government to improve poor corporate payment practices. 

Solutions for Transparency

Supply chain finance is key to navigating the pressures of economic uncertainty and business transformation – pressures that aren’t going away soon. Clearly defined standards and more clarity around best practices for proper accounting and disclosure will better serve everyone involved. While there are steps that have to be taken by way of reporting information in a timely and ethical manner, SaaS solutions like LSQ’s FastTrack® enable a more accurate assessment of counter-party risk for each customer and every invoice. The platform provides in-depth analytics, reporting, and customer credit monitoring that give detailed information and insights that can easily give investors and regulators a deeper view into a company’s true financial position. As 2021 promises a more restrictive lending environment and the tightening of credit insurance requirements, access to this type of data becomes more important than ever (even beyond changing regulatory postures) for businesses globally. 

Photo by Scott Graham on Unsplash