In the world of freight, buyers and suppliers are both seen as shippers, and a new rule change mandating the reporting of the use of supply chain finance programmes may influence how they function and how investors view them.
A short-term arrangement known as supply chain finance, sometimes known as reverse factoring, enables purchasers to use the whole payment window of a bill while ensuring that suppliers receive prompt payment. An invoice that has been authorised by the buyer is paid by a third party, primarily a bank or other financial institution, before the due date but at a reduced amount. At a later time, the buyer pays back to the financial institution the entire amount of the invoice. The spread, which is the difference between the entire amount and the amount the bank paid after being discounted at the current interest rate, is kept by the bank.
The tool helps suppliers and customers both with their cash flow.
The supplier can receive immediate payment for sales, while the buyer can defer payments for up to a year. Using the balance sheet of an outside party helps both suppliers and buyers maximise cash flow. Furthermore, big customers frequently have better credit histories than their suppliers. Through these arrangements, a smaller business that sells products to a bigger business can essentially get finance at a lower cost.
The sale of the supplier’s receivables constitutes the transaction, which the buyer does not see as a debt.
Buyers were not obligated to disclose how often they used supplier loan programmes for many years. However, a new Financial Accounting Standards Board (FASB) rule will require users to disclose the payment terms of the exchanges, verify the amounts of the invoices in the programme, disclose any guarantees or assets pledged, and provide a summary of where those obligations will appear on the balance sheet for the fiscal year beginning after December 15 under accounts payable for most.
The FASB’s decision did not, however, mandate that the sums be classified as short-term debt by users.
Programs for supply chain financing face challenges
Inventory costs went up throughout the pandemic as labour costs and warehouse rent increased. Some businesses have also expanded their facilities to accommodate greater inventory. Because of supply issues, many businesses find themselves holding onto inventory longer. This includes things that are still incomplete. Customer payment delays have resulted in longer cash conversion cycles. On the down side of the economic cycle, it is not unusual to observe an increase in customer bad debt expenses.
Increased interest rates and supplier finance programmes are adding to the cost inflation, which is already challenged. The costs of financing these transactions rise as interest rates do as well. Banks decide how much they will discount a payment to a provider by taking into account market interest rates and the buyer’s credit score.
Now that the extent of some purchasers’/ shippers’ use of supply chain finance has been revealed, the rule change may impact how they conduct business.
The lengthening of payment cycles, or days with money owing, has a positive effect on cash flow measures. According to KeyBanc analyst Adam Josephson, operating cash flow growth has actually outperformed sales growth at a significantly quicker rate during the past ten years. Some of the paper and packaging businesses he tracks, like Ball Corp., have seen operating cash flow compound annual growth rates over the past ten years that are twice as high as sales growth rates. Some of those businesses have days payable outstanding that have increased by more than three times.
As interest rates rise from their historically low levels, this type of financing is becoming more and more expensive, and the banks/financial intermediaries that provide it are not required to continue doing so; it’s an undecided line of credit, unlike other types of bank financing, said Josephson.
According to him, tightened credit markets may prompt banks to reduce their exposure to the programmes’ outstanding credit. They feel there’s a real risk that less of this financing will be accessible in the months and years ahead, said Josephson, given the tighter credit environment and the prospect that certain companies could see their credit ratings downgraded. The buyer and supplier would be obliged to renegotiate their payment arrangement if banks took that action, possibly at an inconvenient moment.
Supplier finance initiatives boost a business’ free cash flow, which is then frequently used to finance acquisitions, share repurchases, or dividend programs. When making investment decisions, many investors take a company’s capacity for cash generation into account in addition to its profit performance. Days payable outstanding and unwinding of extensions would have an impact on value multiples.
They expect investors to pay growing attention to balance sheets and cash flow statements and less attention strictly to income statements as the global economy worsens and corporate earnings decline, said Josephson. They think this is exactly the type of topic that investors should and will become increasingly attuned to.
