At a glance
- Many small and medium-sized enterprises (SMEs) are struggling with cash flow management amid the slowdown in business activity.
- Payment agreements based on supply chain finance arrangements can be a good option to ensure early payment and improve certainty around payment times.
- However, these arrangements must be entered into with caution and an awareness of all the potential risks.
By Gary Anders
In the world of small business, late payments and extended invoice settlement terms are more often the norm than the exception.
Some would say they go with the territory of being in business. However, that is cold comfort to the millions of enterprises regularly struggling with cash flow issues as they wait on due payments to fulfil their own obligations.
Prolonged payment delays can sometimes mean the difference between survival and default.
This is why a growing number of Australian small businesses that supply some of the very large companies in Australia have been signing up to payment agreements backed by supply chain finance (SCF) arrangements, to improve certainty around their invoice settlement times.
SCF is a term that covers a range of different loan products provided by banks and niche financiers, predominantly to large corporations.
They include reverse factoring products, whereby suppliers effectively sell their receivables to the finance provider in return for early payment.
In doing so, they agree to take a discount on what they are owed. The company that was supplied the goods or services will then pay the full amount owed to the SCF provider at a later date, effectively improving its own cash flow in the process.
When used to the benefit of both parties, SCF is a genuine choice for small business suppliers, because it can be a cheaper option for early payment than other business finance products.
Yet, a recent inquiry by the office of the Australian Small Business and Family Enterprise Ombudsman (ASBFEO) found SCF products were being “weaponised” by larger companies to pressure their suppliers into signing agreements in return for being paid on time.
According to Kate Carnell, ASBFEO, the focus of the inquiry was to expose unethical commercial behaviours, bullying and manipulation of suppliers, as well as “lift the lid” on subjugator tactics.
“One of the worst forms of supplier bullying is the example of an SME being told to ‘deal with our SCF provider or wait for your funds’,” she says. “That is, being precluded from accessing their own debtor finance solution to gain payment earlier than agreed terms and potentially sustain a higher rate of discount”.
“I have been extremely disappointed to receive numerous reports of large businesses extending payment times, or even suspending payments to small businesses in a time of significant pressure for the business community,” Carnell says.
Improving business payment times
Under the Business Council of Australia’s voluntary supplier payment code, all signatories must pay their small business suppliers on time and within 30 days of receiving their invoice.
Following its inquiry, the ASBFEO is seeking the introduction of federal legislation to require all large businesses to pay their small business suppliers within 30 days from receipt of invoice.
As part of that, it has called for a uniform definition of small business for the purpose of payment times and unfair contract terms, and for the federal government’s Payment Times Reporting Framework to be promptly implemented and enforced.
At present, the Senate is conducting a review of a payment times reporting bill that establishes new reporting obligations on the payment practices of large businesses in relation to their small business suppliers.
Several countries in the European Union have already mandated payment terms, some across the economy and some between large and small businesses.
New Zealand is considering legislating a maximum payment term of 20 days. The UK recently introduced a voluntary Prompt Payment Code based around a 30-day invoice settlement time; however, formal legislation is yet to be passed and, like in Australia, problems still remain.
Pressure on SCF suppliers and users
Carnell says she is particularly heartened by major global SCF provider Greensill Capital recently stating it will not service companies that blow out their payments to small businesses, and by a number of large companies announcing they will move to shorten their payment timeframes to suppliers.
The founder of UK-based Greensill, Lex Greensill, has gone on record to say, “We will not support big companies bullying their small and medium-sized business suppliers, and if they do, we will terminate those contracts.”
Since the beginning of this year, construction giant CIMIC Group announced it was reviewing its SCF arrangements, while iron ore miner Rio Tinto brought forward payment terms for most of its 10,000 Australian suppliers to 20 days, dumping its practice of applying payment discounts to suppliers wanting to be paid in fewer than 30 days. Telstra also cut its payment terms from 62 days, introducing new terms to pay suppliers with annual invoices of up to A$2 million within 20 days.
In addition to scrutinising large companies that have been serial offenders in dragging out their supplier payments to well beyond 30 days, the ASBFEO focused on the use of artificial intelligence (AI) software by some financiers to identify suppliers in financial stress that are more likely to accept discounts.
The ASBFEO has also called on the Australian Competition and Consumer Commission (ACCC) to look into the use of data and AI software on SCF platforms.
According to Rob Nicholls, associate professor in business law at the University of New South Wales (UNSW) Business School, and director of the UNSW Business School Cybersecurity and Data Governance Research Network, SCF providers are using machine learning software to evaluate the highest returns for the lowest risk.
“In the case of SCF, the return represents the discount that the supplier is willing to take in order to be paid in a timely fashion,” he says. “One of the outcomes of the application of all three forms of machine learning is the ability to target groups or classes of business that are more tolerant to higher margins.”
Carnell says being able to identify businesses under stress, and then to use that information to coerce businesses into accepting a discount, “is not OK, and it’s not ethical”.
A new focus on accounting standards
The ASBFEO has also examined how current accounting standards enable larger companies to move SCF liabilities off their balance sheets and effectively inflate their reported cash flow position, which can mask financial problems that are not disclosed to their shareholders.
A joint submission to the inquiry by CPA Australia and Chartered Accountants Australia and New Zealand highlighted that on SCF arrangements (including reverse factoring) could potentially contribute to a lack of understanding of corporate performance in this area.
“Although there are a number of accounting standards within the Australian Accounting Standards framework that are relevant to the disclosure of SCF arrangements, we believe there is scope for the development of guidance regarding financial statement disclosures by businesses that have entered into SCF arrangements,” the submission noted.
CPA Australia says guidance, taking into consideration relevant accounting standards, will potentially be helpful to financial statement preparers in applying professional judgement in presenting the accounting treatment of SCF arrangements.
“Further, such guidance could enable users of financial statements to form a more informed view on the impact of SCF arrangements on the financial position, performance and cash flows of the business.”
Carnell says the use of SCF can disrupt the established financial reporting practices by blurring the line between trade payables (trade creditors) and debt.
“The wide range of variations in SCF programs available further complicates the accounting and reporting of SCF transactions, meaning there cannot be a one-size-fits-all reporting guidance solution or standard,” she adds.
“Perhaps more important is the potential impact of SCF transactions and their accounting treatment on the cash flow statement of the reporting company. The decision as to whether SCF is reported as trade payables or debt is critical in determining whether SCF impacts a company’s operating or financing cash flows.”
International credit ratings agency Moody’s has said, “Companies using reverse factoring should disclose it as a liquidity risk”, due to the artificial boost it can provide to working capital metrics.
This liquidity risk manifests when, given the potential size of some SCF programs, the cancellation of the programs can lead to a sudden outflow of working capital over a short period of time, creating liquidity pressure.
The US Securities and Exchange Commission is advocating for new rules governing how companies should disclose SCF schemes, claiming their rising popularity has masked “hidden risks”.
Carnell says there is further work to be done by the Australian Accounting Standards Board (AASB) and regulators, including the Australian Securities Exchange and the Australian Securities and Investment Commission, on the disclosures by large businesses of their use and impact of SCF programs.
The AASB has recently written to the International Accounting Standards Board (IASB) to seek the development of further guidance around the disclosure of SCF liabilities in financial statements.
“Accounting standards aren’t simple things to move, and particularly with international standards being the basis of where we’re all trying to head in this space. So these sorts of process are long,” Carnell says.
“There needs to be better education on guidance notes, including companies being required to address supply chain finance in financial reporting. It isn’t a big ask. It’s not like companies don’t know