One minute guide.
When trade finance or supply chain finance is employed, buyers need to pay attention to the accounting treatment for the arrangements that are involved.
When a supplier grants credit to a buyer by agreeing 30/60/90/120 days to pay an invoice ("ship now, pay later"), this is called a trade payable.
Trade payables exists from the date when an invoice is issued to the date when it is paid. Trade payables sit in a specific place in the balance sheet of the buyer and are not usually considered to be debt. This is good for the buyer.
So, when trade finance is used, a key question is whether the credit thereby obtained should remain a trade payable or should it be reclassified as debt?
Most companies have limitations over the amount of debt that they can take on, principally imposed on them by their lenders. High levels of debt mean that a company may struggle to borrow and may find that suppliers and lenders are reluctant to deal with them.
So if a trade finance or supply chain finance program moves trade credit out of trade payables and into short term debt - this can cause significant problems for a buyer.
The main tests to be considered are:
Does the invoice remain outstanding for the whole period that credit is provided?
Is the financier granting credit for longer than the credit period originally agreed by the supplier?
Has the buyer given up rights to recover from his supplier if things go wrong?
Is the buyer's obligation to pay the financier absolute?
Would credit have been provided to the buyer by the supplier, if the finance program was not in place?
Has the buyer given additional security, agreed specific covenants, additional reporting or provided other protections to the financier that are not available to trade creditors?
Is the arrangement organised for many suppliers of the buyer as a block (and therefore becomes material) or is it an arrangement used only by individual suppliers?
There is no set of concrete rules as it is a judgement and not all tests have to be passed to avoid recharacterisation.
There is an emerging controversy in the UK as a result of the insolvency of a Carillion.
A large supply chain finance program (SCF program) was provided by a bank lender. At the time of the insolvency, over £700m was outstanding as a result of paying suppliers early and boosting trade payables in the balance sheet - and many outside the company did not understand that this was really additional debt - taking the debt burden up to an unsustainable level.
This hidden debt meant that the company had significantly more borrowing than it appeared.
Relying upon the seemingly good credit of the buyer, many suppliers issued long-dated invoices to Carillion assuming they would be discounted by the bank providing the SCF.
The SCF provider suddenly cancelled availability. This left many suppliers sitting on long-dated invoices and these suppliers then ended up being stuck with the risk and without any material prospect of a pay-out in the bankruptcy that has followed.
PrimaDollar offers a simple import finance solution for buyers.
PrimaDollar works invoice-by-invoice and purchases each invoice individually from the respective exporter. Whilst the buyer is asked to verify each invoice, the buyer retains all of his rights against the exporter and the buyer provides no covenants, collateral, additional reporting or guarantees to PrimaDollar.
Moreover, PrimaDollar's finance is provided earlier than most SCF programs. Our finance is available at shipment - so suppliers have the time to adjust trading terms if there is a change in the credit of the buyer.
See our one minute guide to combining SCF with export finance.
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You can also read further articles on our site:
One Minute Guide What is it? Export finance helps exporters to offer credit to their buyers. This means that they can offer "ship now, pay later" terms
One minute guide. Who is PrimaDollar? PrimaDollar is a UK-based trade finance platform working with exporters
One minute guide. What is it? Dual factoring is the process of coordinating two factoring companies so that one of the companies