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Tuesday, February 14, 2012

Supply Chain Finance-a new version of off balance sheet liabilities?

In the ICWAI Feb12 edition of 'The Management Accountant', I read the description of supply chain financing in an article on transaction banking. The description reads as follows
However during the last few years, there has been an increasing reliance by corporates to adopt the recent innovation in the industry called ‘Supply  Chain Finance’ to cater to their open account transactions with their counterparts. One of the typical trends in the industry is to adopt a ‘anchor-supplier’ model. One variant of this model involves the large global player having a tripartite arrangement among the global player, their trade partners and the bank wherein the banks can finance the large global player’s counterparties at a cheaper interest rate by relying on the ‘balance sheet strength’ of the global player. This arrangement would act as an effective ‘cost optimization’ strategy for the large global player besides ‘win-win’ situation for all the three parties.

Stripped of the jargon, it means that the global player is lending its balance sheet to guarantee the dues of its counterparties, in return for favourable terms. An explicit way to account for this transaction is to recognize the resultant discount as 'financing income'/'Guarantee Fee', and take some provisions for that till the loans are repaid. However, companies would not prefer this model because it reduces operating profit(as finance income is considered in 'other incomes') unless they redefine their proforma metrics to include financing income as done by some consumer durables firms which book their lending subvention income as operating profit. Also, in that model, investor multiples based on EBITDA etc would assign lower valuation to the firm, and investors may assign negative value for the added financial risk.

Hence, unless IFRS specifically puts the spotlight on these transactions, it is feared that companies's trade payables will assume the nature of debt, without being characterized as such.
 Update
Mr Robert Kramer's comment would indicate that the buyer merely confirms its own payables(which may then be reclassified as short term debt etc). But that would not entail taking on any additional liabilities outside the amounts anyway due. So I stand corrected to that extent. But some financial risk would remain because in case of supply disputes, the question stands to whether the bank will invoke the guarantee or adjudicate itself. 

2 comments:

Robert Kramer said...

What “dues” of which “counterparties” is the large global player guaranteeing?

Supply Chain Finance involves a buyer, their suppliers, a technology and services provider and a funder (e.g. a bank). It helps organizations optimize cash flows within their supply chains. The buyer (the “large global player”) does not guarantee the “dues of its counterparties” (i.e. suppliers). At most, the buyer is confirming or guaranteeing its own pre-existing obligation to pay its suppliers. This may make it easier for suppliers to sell those obligations to banks but they are still the buyer’s obligations. There may be a question of reclassification of the buyer’s obligation from the original trade payable to bank “payables” (i.e. bank debt) depending on the nature of the guarantee and whether or not the guarantee is provided to a bank, but the buyer is not taking on the obligations of its suppliers or anyone else.

Robert Kramer
Vice President, Working Capital Solutions
PrimeRevenue, Inc.

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