Payables finance has been traditionally used by large investment-grade buyers but non-investment grade companies are increasingly looking to set up their own supply chain finance instruments to protect their suppliers and improve their own liquidity. Whilst this has always been done, the turmoil of macroeconomic uncertainty is highlighting the benefits and making it a more appealing option for all business types.
Dr Rebecca Harding, CEO of Coriolis Technologies comments in the paper, “the current political landscape has raised questions as to whether the cost of doing business will remain constant. Amid the uncertainty – stemming in part from the unknown outcomes of Brexit and the US-China trade wars – we are seeing payables programmes continue to gain traction.”
After the 2008 financial crisis, many companies worked on lengthening their supplier payment terms, which put pressure on smaller businesses. As a result, concern about supplier disruptions grew. Many companies recognised the detrimental impact that this could have on their production lines, and so began to look for new ways to aid key suppliers as needed, whilst keeping their supply payment terms the same, or even extending them.
Supply chain finance is a huge cash opportunity for banks, with 2015 estimates by McKinsey assessing that of the US$2trn in financeable secure payables across the globe, there is a potential revenue pool of about US$20bn, of which only US$2bn is being captured.
And it’s not only banks that can profit from this. PwC found in its 2018/2019 Working Capital Survey that global listed companies could release €1.3trn by addressing poor working capital performance. The survey estimates that this could increase capital investment budgets by 55%.
Accounting in payables finance
The accounting practices of payables finance has also come under scrutiny since the collapse of British construction company, Carillion. This new edition explores how accounting for trade payables is having to adapt. Currently, accounting standards are flexible and left open to interpretation so that they can be used by a variety of business models. However, this means auditors are uncertain as to how they should classify trade payables.
It’s possible for auditors to reclassify trade payables as bank debt, which is something that corporates and their banks should want to avoid. In cash terms there is no difference between having a trade payable due and having a bank debt due, but on a balance sheet it’s the difference between an asset and a liability. This is worse when a large number of suppliers are covered by trade payables programmes as it gives the impression that the company is having to borrow money in order to pay their suppliers.
However, all this is not to say that trade payables should never be reclassified as debt, and British construction company, Carillion, is evidence of that. The Financial Times reported from 2011-2016 that Carillion’s published net debt increased by only £11m, but its trade payable liability increased by almost £500m. The company collapsed when it couldn’t keep up with its outstanding payments.
There are now measures that can be put in place to avoid this happening in the future, such as ensuring the financier has the same legal rights to receive payment that the supplier has. But companies must find a careful balance with this, as putting in too many safeguarding measures could imply that they are at risk of defaulting, and can get them reclassified anyway. Companies must, according to the report, “strike a balance between providing comprehensive coverage for the greatest risks and maintaining an uncompromised balance sheet.”
Sustainability is as important as ever, and companies are exploring how to implement sustainable practices in their supply chains. The new guide covers how companies can work towards making their supply chains more sustainable, specifically by incentivising suppliers. Ultimately, sustainable supply chain finance programmers are beneficial for all parties. Buyers gain an opportunity to incentivise sustainable practices in their supply chain, suppliers gain an opportunity to monetise their sustainable performances, and banks gain access to a largely untapped growth market.
Corporates must ensure that incentives are large enough for participants to want to join the programme. Michael Kobori, Chief Sustainability Officer for Levi and Strauss states in the paper, “supply chain finance is the only way to positively incentivise your suppliers to improve their sustainability performance.”
There is potential financial gain from incentivising suppliers though. In 2015, Nielsen found that consumer brands committed to sustainability grew four times faster than ones which were not, and that 66% of consumers were willing to spend more on products from sustainable brands. However, they must also strike a balance between the reputational value they’d gain by pursuing sustainable goals, and the impact of this on their profits.
It’s also worth noting that during an environmental crisis, companies with a weak environmental, social, and governance (ESG) performance saw a 3% decline in their market capitalism – equating to about US$378m per company. There is also a global market worth US$660bn for sustainable SCF, which has a revenue opportunity of US$6bn for financial service providers.
As with everything, there are some issues with sustainable SCF. For a start, it’s very hard to prove that a supply chain is sustainable, due to the sheer number of participants in any single chain. As a result, companies must determine what metrics should be used as sustainability benchmarks, and decide not just what to measure, but how to measure it.
So, is it worth it?
In short, yes.
Supply chain finance not only offers more security for both buyers and suppliers, but it can be used to build a company’s sustainability reputation whilst actually improving the environmental impact of its supply chain, meaning both the company and the Earth benefit. With the correct measures in place SCF can be beneficial to a company’s balance sheets, allowing it to extend its payment times whilst not compromising the supplier’s finances.