Companies would have to disclose on their balance sheet any supply chain-related supplier financing arrangements they’ve made with lenders under a new standard the Financial Accounting Standards Board (FASB) discussed at its meeting this week.
Requiring companies to disclose the arrangements has been a goal of equity analysts and accounting firms, which say the arrangements can leave companies exposed to a liquidity risk that investors should know about.
"These arrangements can carry more risks than the participants or their investors might expect," Moody’s said in a research brief.
These arrangements differ from traditional supply-chain trade payable arrangements in their point of origin. Rather than being initiated by suppliers, who make arrangements with lenders to generate steady payment, they’re initiated by buyers, who want better cash management.
Although some companies disclose the arrangements, more typically they're treated as part of their accounts payable function, potentially leaving investors in the dark about how much liquidity risk the company faces if the lender goes bankrupt or otherwise ends the arrangement suddenly.
In the wake of such upheaval, the company must make payments sooner, and possibly in larger amounts than it otherwise would, a big problem if it doesn’t have the cash.
Companies like the arrangements because they let them avoid supply disruptions and better control their cash outlays, and suppliers like them because they’re more assured of receiving steady payments, even though they typically get paid less. Lenders make money by pocketing the arbitrage.
Although problems don’t appear to be that common, the sudden disruption of one of these arrangements can be consequential. The 2018 bankruptcy of Carillion, a big U.K. construction management firm buried under some $2 billion of debt — a significant portion of that disguised in seller financing arrangements — is considered the poster child of what can happen when these arrangements go bad.
Balance sheet presentation
Under the FASB standard, expected to be finalized in the fourth quarter, companies would have to disclose the size and key terms of the arrangements in their reporting.
“I think balance sheet classification will be a very low-cost disclosure, with potential benefit,” FASB board member Christine Botosan said.