FASB As Michelangelo Anoints Supply Chain Finance

{I’m pleased to welcome back, by popular acclaim, Peter Lugli, fintech veteran and all-around funnyman!}

For decades now, practitioners of modern Supply Chain Finance (SCF) have optimized working capital cycles furtively and in darkness. Or as accountants would say, off-balance sheet.

As such, mysteries abound. How big is this market? Which public companies have SCF programs? How big are they relative to their total spend? Who are the big players? Where do the banks, platforms, and players rank? Are programs growing, stable or stalling? What is my competitor doing?

And of course, if you’re a publicly held company, there is the sensitive question of what you must tell the world of investors and credit agencies through your 10Ks and Qs. The typical response to the disclosure requirement hinged on the materiality test – if the overall program size could be deemed ‘material’, it should be footnoted in financial reports.

The Greensill Effect

In recent months this darkness was flooded with search dogs and fog-piercing high beam spotlights, as the Greensill Capital debacle put the industry under the disapproving glare of mainstream financial reporting. Given some of the wackiness in play with advances on make-believe invoices from potential future customers, and of course, the star-studded cast involved, there was some discussion about whether this would permanently sully the reputation of SCF. A dark chapter, indeed.

And yet in the last few months, thanks to FASB, the tireless Michelangelo of GAAP, SCF is painted in a calmer, more neutral, and dare we say, soothing light:  the light of legitimacy.

Yeah, OK, but we really don’t want to do this.

History (that is, the History Channel) tells us that Michelangelo wanted nothing to do with the Sistine Chapel. He wanted to dive into sculptures because, man, they were sooooo hot at the time. After some papal prodding he relented, and four years of work later (and probable visits to a chiropractor on the Vatican’s health plan) Michelangelo birthed masterpieces. The most famous of these was The Creation of Adam, which depicts the Almighty’s breathing of life into a lifeless, presumably soulless Adam.

To refresh. The Financial Accounting Standards Board (FASB or ‘faz-bee’) is that which leads the establishment of financial accounting and reporting standards for companies that follow Generally Accepted Accounting Principles, or GAAP. I got that from their website.

Like Michelangelo, you get the sense in the YouTube recorded meeting reviewing SCF disclosure that the FASB Chairman didn’t want to engage deeply either. Board Chairman Richard Jones pondered aloud that “[…] I still think that the most important output of this is taking out the mystery of whether these programs exist and their size”.

 

 

 

 

 

 

 

 

Yeah, OK, that’s far from a glowing endorsement of SCF, but then again, the FASB intervention here is less about enthusiastic high-fives than it is about cold sober analysis about what corporates should disclose to paint their own self-portraits of financial health. And reducing the burden on auditors, corporates, financial departments, and others from 500 other specific disclosures to be made. Still, the very act of requiring the disclosure is a legitimizing one for SCF practitioners, platforms, consultants, and of course counterparties who are exploring this working capital practice.

FASB: “Roll out the rollforward!”

So, what are the details? On September 22, FASB endorsed the creation of a new reporting obligation – the ‘rollforward’, which is likely to enter every SCF practitioner’s lexicon as it supports programs with global firms and those firms’ supplier communities. (Notably, FASB’s sister organization, the IASB, argues the same for IFRS, used principally by non-US companies, per this white paper.)

“The Board decided that a buyer should disclose a rollforward of the amount confirmed by the buyer that is outstanding at the end of the reporting period.” (See here.)

The board determined in a prior meeting (June 30, 2021) that the buyer party should also disclose “the key terms of the arrangement as identified by management”, but continued in the same breath to indicate that which was not required to be disclosed, which included:

1. The amount paid early by the finance provider that is outstanding at the end of the reporting period. […]

2. The cash flow statement presentation of any of the following:

a.  The amount paid early by the finance provider in the current period if that amount is considered a cash flow to the buyer

b.  The amount confirmed by the buyer in the current period or prior periods but settled in the current period 

c.  The amount paid early by the finance provider in the current period or prior periods but settled in the current period. […]

The Board decided not to pursue a potential disclosure of average payment term for participating suppliers.  (See here.)

Net-net, what’s to come likely in 2022 for GAAP-compliant companies, is a rollforward disclosure requirement in a company’s filings related to SCF programs. The rollforward SCF (or FASB’s preferred term ‘supplier finance’) programs and transactions will be reported annually (or 10Ks) but not (despite some internal FASB debate) quarterly.

What does this mean?

Here are some potential implications:

1. We will know how big the market is, and which buyers are in it. Finally. Data will finally be ‘audited-level reliable’ as opposed to divined by parties who may have a bias to one perspective or another. While some would like to have interim reports on SCF programs growth, decay or stasis in 10Qs, practitioners can start here at first. (Of course, the materiality test still governs, so these can be watched for in 10Qs.) Some corporates may wish to report on programs regardless.

 

2. Platforms will need to provide rollforward reports to their Buyer firms. SCF platform providers will need to develop a capability of producing reports to meet the obligor’s annual disclosure obligations regarding rollforwards. Arguably this is rather routine, but producing the report in a form and method that is timely and robust (robust enough to face auditor scrutiny) will mean platform providers should spend some time getting it right. No doubt some firms may entertain retaining an auditor to help craft the requirement, particularly given FASBs invitation to corporates to ‘adopt early’. Doing it sooner can provide a marketing benefit!

 

3. CFOs will see what competitors are doing. SCF practitioners will add a ‘this is what your competitor is doing’ or ‘what your industry is doing’ to their pitch decks if they’re not doing it already. Nice to be able to point to audited financial statements to back those statements up; CFOs are a necessarily skeptical lot.

 

4. Whither the ratings agencies? The biggest open question is what credit rating agencies will do with a rollforward disclosure. Is it an opportunity to ask management about the breadth and depth of SCF programs – particularly to the extent it may affect the credit profile of that buyer? More particularly, what happens in the event a program loses liquidity and suppliers are asking to ‘roll back’ to presumably shorter payment terms (if an SCF program, for example, was deployed in combination with, or mitigation of, a payment terms extension program)? Of course, supply chain relationships today go way beyond mere payment terms, and financial risk may happen regardless of payment timing (for example, COVID-wracked supply chain disruptions may affect production and the top line far more than liquidity provisioning for an SCF program), but ratings agencies may be blind to these. (On this, please see a thoughtful discussion of ratings agencies’ treatment of SCF programs generally: few can match Robert Kramer’s analysis here. And since the word of the day here is ‘disclosure’, the reader will know I worked with Bob back in my days at PrimeRevenue, and he helped with portions of today’s blog.)

In the room auditors come and go / Talking of Michelangelo

Congratulations to FASB, its staff, and all those involved in guiding the board to its ultimate recognition of a widely adopted, but until recently ‘a bit in the shadows’ tool for working capital optimization. This is great stuff, and an important milestone – particularly given some of the unfortunate exposure of late with outer space SCF. It’s legit. It’s real. It must be reported if it’s there.

Phew.

Now. In the age of crypto-backed stablecoins, what would Picasso do if he got a hold of SCF?