Cash flow is the lifeblood of most businesses. As operations grow increasingly global, today’s organizations face the increasing challenge of working capital needs. The complexity is exacerbated in cross border transactions in which trade receivables are subject to separate legal jurisdiction and payment terms tend to be longer. In this context, supply chain finance (SCF) programs could be a powerful tool to drive working capital efficiency in the supply chain, helping suppliers get cost-effective financing while allowing buyers to maintain a stable supplier base by capturing value from their payables. Indeed, SCF is now a $275bn industry, growing 30% a year . However, despite years of implementation, a growing number of buyers see SCF programs as potentially negative to their overall company debt rating. There is a growing concern that rating agencies may treat SCF programs as debt rather than trade payables. What can tilt the balance are changes in the terms of trade between the buyer and the supplier. In a report last December, Moody’s voiced its concerns about overly complex SCF programs and encouraged less enclosure when communicating engagements in SCF programs.
While SCF offers tremendous potential to dramatically improve operational and financial efficiency for organizations, debt reclassification could be the Achilles heel. It has become the top concern for CFO’s and Treasurers as they evaluate adoption of SCF within their organizations. Consider a company with $300M trade payables outstanding. A sudden reclassification of these payables would severely impact their leverage, access to additional credit and existing debt covenants. Take for example the case of the Spanish energy group Abengoa, which recently filed for bankruptcy for one of its subsidiaries. Although their large scale SCF program did not cause their decline by itself, it certainly had debt-like features and was a large contributor to their decline.
Unfortunately, the IRS has not yet addressed this issue in a satisfying manner, and existing guidelines are vague at best. IFRS rules do not fare that much better. IFRS suggests reclassification of trade payables into debt only if there is a substantial difference in the terms of the existing financial liability and the new liability. The ambiguity and subjectivity make the reclassification issue a major headache for treasury organizations considering the deployment of SCF programs, causing companies to be more conservative, slowing down the programs and making the set-up costs more expensive. 
All worries aside, we did a bit of digging and learned that there are ways to navigate the choppy waters of buyer led SCF programs. Programs that successfully have been put in place tend to have a set of recurring characteristics to comply with auditors so that transactions are kept as trade payables. First and foremost, a thorough understanding of the trade terms is required. The key question to ask: Are there any significant changes in the payables to make it look like a debt-like obligation? Trade Financing Matters provided some useful insights regarding this issue and offered the following key points:
- You should avoid a tri-party agreement between the buyer, seller and the funder. Extended payment terms for the buyer and discounted early payment for the seller should be treated as two separate events. Therefore, if the seller for some reason wants to opt out of the program, the buyer still gets his extended payment terms. The higher level of influence the buyer has in the negotiation process, the harder it becomes to convince regulators that the company is not borrowing money from a bank to pay its vendor. 
- The bank should in no way be involved in the discussions between the buyer and the supplier regarding the terms of trade. 
- The discount rate offered to the supplier should be offered by the bank and not the buyer. 
- The buyer should not guarantee payment to the bank. This point is important and in many ways the crux of the issue: If the buyer is confirming to the financial institution that it will pay on maturity regardless of any disputes or other rights of offsets it may have against the supplier, then it is giving a higher level of commitment to the bank than it gives to the supplier. As a result, the economic substance may have changed significantly as this could be constructed as a form of financing on the firm’s books. 
- The bank should not share any interest revenue from the discount with the buyer. The presence of interest is not customary in a trade payable arrangement and would suggest that the obligation is more akin to debt. 
- Peer-to-peer comparison may motivate DPO extension beyond the industry standard: Although an extension of payment terms(DPO) to better align with its peer group may not significantly change the economic substance of the arrangement, the payment terms should be consistent with other peer companies in the company’s industry. If your payment terms have extended beyond the industry standard, it may indicate that the presence of a SCF program have resulted in an obligation that is inconsistent with the customary trade payable terms and thus that the economic substance have changed. 
- Discounts are typically negotiated between the seller and buyer, and if there are disputes, the buyer normally has the ability to withhold payment. If, for any reason, the arrangement does not allow for such negotiations and abilities, the economic substance of the arrangement may have changed. This becomes relevant in cases where the vendor delivers a product defect. If the buyer is still obligated to pay the bank in full, despite the defect, then this may imply that the company no longer retains its right to negotiate terms for that specific payable. 
- Buyers should have no say in determining which party that should finance the program. 
Some buyers look towards non-bank platform providers in order to lessen the likelihood of debt reclassification. Although many successful SCF programs are orchestrated by banks, non-bank providers, (eg., PrimeRevenue), separates the buyer from the bank and do not utilize the contract between the bank and the buyer. This reduces some of the aforementioned risk, such as the tri-party agreement.
The emerging field of supply chain data science is transforming supply chains from reactive- to predictive operating models. The implications extend far beyond traditional supply chain operations. Ultimately, they will help the next generation global company – the insight driven enterprise – getting ahead of competition.
Written by August Riise, Flowcast.
*Full disclaimer: We are not auditors or accounting professionals. These are strictly based on our own research and opinion
 Is Supply Chain Finance Constricted by Accounting Rules? David Gustin, Trade Financing Matters
 Supply Chain Finance Payable Reclassification issue – dead or alive? David Gustin, Trade Financing Matters
 Dataline: A look at current financial reporting issues , No.2013-28, PwC