Several high-profile corporate collapses and initiatives from corporate accounting standard-setters have raised questions about businesses’ use of supply chain finance and whether the trade finance tool prevents investors and auditors from gaining a transparent view into company finances.
In Australia, a new debate has surfaced about the impact supply chain finance has on corporate finances, and whether auditors should be held responsible for disclosing a client’s outstanding reverse factoring agreements.
Reports in The Australian said proxy advisory firm Ownership Matters recently criticized corporate auditors for failing to expose companies’ use of supply chain financing to investors.
Critics argue that reverse factoring artificially inflates the strength of a company’s balance sheet.
Australia’s Parliamentary Joint Committee on Corporations and Financial Services is currently probing the corporate auditing industry amid recent criticism and allegations of conflicts of interest. Ownership Matters Director Dean Paatsch recently submitted a letter to the committee, in which he questioned auditors’ role in elevating transparency with regard to reverse factoring.
“In too many cases the auditors of listed entities appear open to a ‘why disclose’ approach, rather than ensuring the financial statements present a ‘true and fair’ picture of an entity’s financial performance and position,” he wrote. “As many investors rely on cash flow as a proxy for earnings quality, management teams have an incentive to use working capital financing to improve cash flow while not making the use of this ‘borrowing from the future’ explicit.”
He added that Ownership Matters has “significant concerns” about the lack of standardization of how corporates disclose their use of supply chain finance, “if at all.”
Reports noted that current accounting regulations in Australia do not require corporates to disclose owed invoices as debt, similar to other markets around the world. Businesses instead tend to mark the invoices as trade payables.
With Ownership Matters raising concerns about supply chain financing to Parliament, Australia’s government is now increasingly examining the potential risks of the financing tool. According to reports, the Australia Competition and Consumer Commission and Small Business Ombudsman Kate Carnell are each looking at reverse factoring, its potential impact on competition, and its possible consequences for small businesses and late supplier payments.
“This review will provide a clearer picture on the range of supply chain finance options available on the market and which industries are using these products,” Carnell said in a statement in October, when the probe was announced. “More large businesses are offering supply chain finance to small businesses, and we are keen to find out what’s driving that.”
Reverse Factoring, Auditing Scrutinized
High-profile corporate collapses, including that of U.K. construction giant Carillion, have raised concerns both about corporate auditing quality, as well as corporates’ use and reporting (or lack thereof) of use of supply chain finance.
The Carillion case not only called its auditor, KPMG, into question, it also raised the debate as to whether auditors should be held responsible for identifying and disclosing potential accounting fraud or signs of impending collapse.
Carillion’s demise also shed light on the company’s heavy reliance on supply chain finance, with analysts warning that its use of reverse factoring likely contributed to the company’s ability to keep its financial troubles largely under wraps from investors. At the time of Carillion’s collapse in early 2018, the firm held $2.8 billion in debts. According to Moody’s, its use of supply chain finance contributed to its collapse, although Carillion did not disclose its use of reverse factoring in its accounts.
Now, Paatsch said regulatory guidance on disclosure of supply chain finance will be key to preventing more corporate collapses in the future.
“Clarification by an external regulatory body of this matter would be beneficial given the reliance investors place upon the external auditor and the corporations act requirements around disclosure of auditor indemnities,” he said.