By Jenny Wiggins Financial Review
Coca-Cola does it. So does the global consumer goods group Procter & Gamble and discount store chain Walmart. In Australia, Telstra and construction group CIMIC are into it.
All are using an increasingly popular scheme known as "supply chain finance" to pay the companies that provide them with goods and services.
The old-fashioned method of paying invoices is simple. A company orders goods from a supplier. The supplier delivers them and issues an invoice with a due date, such as 30 days' time. The company pays the supplier within 30 days.
Suppliers who have delivered their goods but want to get paid earlier than 30 days have also for many years had another option: approach a bank and sell 80 per cent of the invoice (typically the maximum the bank is prepared to buy) before the due date. The bank later collects the invoice payment.
This is known as debt factoring; the bank or financier that buys the invoices is called a factor.
In recent years, a third option has emerged. With the help of banks and financiers, big companies take the initiative and suggest payment options to their suppliers, giving the companies more control over when and how they pay invoices.
This latter scheme is most commonly known as supply chain finance or, more specifically, "reverse factoring" – a technical term commonly used by ratings agencies to differentiate it from conventional debt factoring.
In reverse factoring, the big company hires a bank such as JPMorgan or a financier such as London-based Greensill Capital to make agreements with its suppliers. The supplier gets to choose exactly when it wants to be paid the full amount of money it is owed, with payment dates as soon as 10 days after goods and services are delivered.
Banks and financiers team up with technology groups such as Taulia and Oracle, which insert technology known as enterprise resource planning software into the accounting systems of their customers.
The higher the credit rating of the big company initiating the early payment scheme, the lower the fees charged to suppliers and the more confidence JPMorgan and Greensill have that they can collect the monies owed.
The earlier a supplier wants to be paid, the bigger the fee it must pay. But fees are still typically lower than under conventional factoring arrangements, with Greensill's effective interest rates understood to average in the low single digits.
Big companies like supply chain financing because it can allow them to stretch out formal payment terms to suppliers by giving the supplier the option to get paid earlier. The risk is that they may abuse their bargaining power.
Clive Isenberg, chief executive of Octet, which specialises in supply chain financing for smaller companies with annual revenues between $50-$300 million, says reverse factoring is a great option for suppliers when buyers extend payment terms fairly.
"It’s an excellent concept for both buyer and seller if it’s actioned properly," Mr Isenberg said. "It’s like Letters of Credit. Many years ago, before the advantages of the internet and other technology, Letters of Credit were a good B2B concept for international trade. Today, they are rarely used within the small business sector.”
But Mr Isenberg said reverse factoring was not fair when suppliers became reliant on selling goods and services to big companies and were forced into accepting their terms.
"Once you’re supplying the big end of town and you’re so reliant on that big end of town buying from you and you’re growing with them as they buy from you, you are being constantly pressurised to follow the way they’re going," he said. "You’ve got to agree to their payment terms, and if their payment terms means it’s a reverse factoring model, you take it or leave it," he said.
Suppliers also needed to watch that the banks and financiers providing the schemes did not register security over their businesses rather than just their invoices, he said.
A letter sent to the US's Financial Accounting Standards Board (FASB) in early October from the big four accounting firms said that while typical payment terms with suppliers historically might have been 60 to 90 days, some entities are now trying to negotiate payment terms with suppliers of up to 180, 210, or even 364 days.
"Suppliers are more likely to accept extended payment terms when the purchaser has arranged a structured payable program that permits the suppliers to monetise their trade receivables before its due date," the letter said.
The big four accountants pointed out that because there are no specific disclosure requirements under US accounting regulations, there has been limited disclosure of supply chain financing schemes. They have asked the FASB to require more disclosure to increase the schemes' transparency and clarify whether the owed invoices should be classified as trade payables or debt.
Under current accounting regulations in Australia and internationally, companies do not have to report the owed invoices as debt on their balance sheet and can instead account for them under trade payables, boosting cash flows.
Consequently, supply chain finance schemes are pitched by those that provide them as "win-win" arrangements.
Rail services group UGL, a subsidiary of CIMIC, sent information to its suppliers in July marketing its early payment program (arranged through Greensill) as a "solution tailored to your business's cash requirements" that frees up resources and working capital.
"There are no costs other than if you choose to exercise the facility to get invoices paid early in exchange for a pre-agreed discount," UGL says.
But the arrangement raised eyebrows because UGL used it to extend payment terms to 65 days after the end of the invoice month, from 30 days.
Greensill founder and chief executive Lex Greensill says supply chain finance can help push more cash into the economy by speeding up payments while Steven Furman, executive director of TIM Finance, says the market's development in Australia is lagging other countries.
"We see it as a growth opportunity," said Mr Furman, whose firm provides supply chain finance to small companies. "It is a very valuable cash-flow funding solution for both small and large business."
Exact statistics are hard to come by, but the US research and consultancy group Aite has estimated the global supply chain finance market to be worth around US$255 billion ($376 billion).
However, ratings agencies, investors, analysts and politicians are starting to scrutinise reverse factoring schemes more closely amid concerns that companies can use them to disguise cash flow problems and pressure suppliers into accepting discounts on their invoices.
In September, Moody's Investors Service issued a report arguing companies should disclose their use of reverse factoring as "a liquidity risk" that could hurt cash flows if they lost access to the schemes.
Mr Greensill has criticised the approach taken by the ratings agencies, arguing that a dollar of liability to a trade creditor is the same as a dollar of a liability to a financial institution and that both should be considered debt.
"I am fully supportive of what the ratings agencies are saying but I think they don’t go far enough because they are proposing to perpetuate the craziness of what’s existed for all these years where rather than say, 'A dollar you owe to a supplier is actually debt', they’re saying, 'Why don’t we just identify the bit that relates to a reverse factoring or supply chain financing and we’ll call that bit debt'," Mr Greensill said.
"We should simply say the whole lot is a liability of the company and count that towards the indebtedness of the firm."
William Coley, a London-based Moody's associate managing director, said the big four accountants' letter to the FASB had echoed the agency's concerns about the difficulties of distinguishing cleanly between reverse factoring liabilities and conventional debt, and that what matters more is disclosure.
"Whether or not these arrangements are classified as trade payables or borrowings on the balance sheet is less important than sufficient disclosure as to the nature, significant terms, and quantitative measures of these arrangements,” Mr Coley said.
Anthony Flintoff, analytical manager of Standard & Poor's Australian corporate ratings team, said that while reverse factoring might be "an entirely logical" cash-flow-management decision for a company, it carried risks if financing dried up or business volumes declined.
“Investors may be unaware of the amount of the true debt leverage a company has taken on since supplier financing is not always disclosed in financial statements," Mr Flintoff said. If a company defers payment beyond the term customary for its supply chain, S&P may adjust the debt figure, he added.
Companies are also being pushed to disclose whether they use reverse factoring.
Tollroad group Transurban, which employs CIMIC and its subsidiaries to build roads, was asked at its annual general meeting on Thursday whether it used the financing scheme. Chief executive Scott Charlton said the company had signed up to the Business Council of Australia's voluntary supplier payment code, which requires companies to pay suppliers within 30 days, and did not use it.
Mr Charlton said it was up to CIMIC, which works in joint ventures with other companies on Transurban projects, to determine how they "come to terms with suppliers and their contractors".
Transurban has the ability to withhold payments from CIMIC and other contractors if they do not complete work on schedule.
Shadow small business ministers Brendan O'Connor and Matt Keogh this week said they were concerned about the increasing prevalence of reverse factoring because its use meant small businesses were not being fully reimbursed on invoices.
"The Morrison Government needs to state its position – are they on the side of small businesses or are they happy for small businesses to be penalised simply for wanting to be paid on time?" the ministers said.
The Prime Minister has promised to create an annual register of the payment times of Australia’s 3000 largest companies but still had not provided details, the ministers said. The Morrison government has also pledged to speed up payments to small businesses to help them grow and pay its own invoices within 20 days.
"If the government does eventually come around to announcing the payment times register, they must ensure it does not let big businesses misrepresent their payment times by using reverse factoring arrangements," the ministers said.