FreightRover’s PayEngine provides a mutually beneficial supply chain finance program for companies and their vendors. Companies benefit from extended pay terms to improve working capital while providing their suppliers with tailored options for accelerated receivables.
Despite the wins supply chain finance provides both parties, many companies hesitate to implement a structured payable program due to balance sheet concerns. Poorly managed programs can result in trade payables reclassifications to debt, which negatively impact leverage ratios and debt covenants.
PayEngine’s program meets all trade payables accounting standards to protect a company’s balance sheet and bottom line. Following is our guide to understand the difference between a trade payable and debt in a supply chain finance program.
The First Question:
Has the economic substance of the trade payable changed?
When accountants review payables classifications on the balance sheet, they look at each of the following categories to assess if the trade payable has been modified in such a way that it is creating a financing cash inflow that benefits the company. Accountants will look at the categories collectively to assess the entire supply chain finance program as well.
- Settlement of trade payables cannot take place at a date later than or for an amount other than what is stated on the original invoice upon submission to a third-party payor. Doing so would be considered borrowing, which is debt.
- A new trade payables arrangement cannot change the terms between a supplier and a third-party payor that’s inconsistent with normal trade payables terms.
- The company cannot participate in or influence term negotiations between the supplier and third-party payor. The vendor and third-party must negotiate directly.
- A trade payables arrangement must apply to a broad range of suppliers. However, the program does not need to include all suppliers. Companies can extend days to pay without all vendors accepting the new terms if most suppliers do comply.
- Supplier participation in a supply chain finance program must be voluntary. If enrolling is required to maintain a relationship with the company, a debt reclassification may be required.
- Should a large majority of suppliers impacted by extended pay terms select an accelerated pay option, which marks a significant change from the previous arrangement, this could trigger a debt reclassification. For example, if a company extends terms from 30 days to 120 days and now most of their supplier base elects to monetize receivables and did not prior to the change, this would require review as potential debt.
- Companies can extend pay terms to align days payable outstanding or other working capital ratios with peers without changing the structure of their payables to debt financing. As a reference point, the US average across the largest 1000 companies currently is 57 days.
- Trade payables should not include the accrual of interest prior to when the trade payables become due. Late payments can incur interest without reclassification impact.
- A company must retain its negotiation rights with the vendor directly and have the ability to withhold payment. Application of credits must be consistent with past practices. For example, if a company places a freight claim against a carrier, they should have the ability to withhold payment to the carrier until the issue is resolved. If a third-party payor compensates the carrier prior to the completion of the claim negotiation, and the company must arrange for a credit that’s inconsistent with how they’ve traditionally done business with the carrier, there could be a debt implication.
- Whether or not a vendor decides to monetize their receivable cannot impact the company’s cost of goods sold or services received from a vendor. The third-party’s arrangement with the vendor and company must be independent of the other party’s interests. Therefore, a company cannot pay a vendor more to offset the cost of accelerated receivables.
- Companies cannot change the legal characteristic of trade payables. Events that indicate characteristic changes include: immediate draw-down of credit lines, altering trade payable seniorities, securing trade payables through collateral, or incorporating default provisions.
- In general, trade payables cannot have guarantees. However, in the case of a parent company being “jointly and severally liable for a subsidiary’s obligation,” a reclassification may not be required if it is the sole indication of a debt trait.
Impact of Third-Party Payor:
- Implementing a structured payables program may be part of a larger accounting outsourcing strategy. This could include using a third-party platform like FreightRover’s PayEngine, which includes posting invoices and assigning accounts for fund withdrawals as payables reach their maturity date.
- Rates paid to the third-party payor by the company cannot vary based on things like the number of vendors selecting a quick pay option or number of invoices sold to the third-party.
- Red flags for debt reclassifications include: the third-party receiving new rights, if the third-party has influence on which invoices get paid, or if the third-party can withdraw funds from the company’s other accounts without consent if sufficient funds become unavailable.
If you are interested in learning more on trade payables or modifying your vendor payments using PayEngine’s technology and supply chain finance program, visit www.freightrover.com/pay, email firstname.lastname@example.org, or call 866-621-4145.