Hidden Debt and Accounting

Investors usually scan the liabilities section of the balance sheet for labels such as debt, notes payable and loans to gauge a company’s leverage. For retailers, many also consider operating lease liabilities, which appear on the balance sheet but are usually excluded from debt figures. However, there is another debt-like obligation that rarely carries any of these labels: the supplier finance program, also called reverse factoring or supply chain finance. If used aggressively, it can make a company look less leveraged and more cash-generative than it really is.

In such a program, a bank pays a company’s suppliers early, usually at a discount borne by the supplier, and the company pays the bank later. Recent accounting changes now require companies to disclose these programs, so let’s walk through an example.

Suppose a company buys about $600M of goods a year, with normal supplier terms of 60 days.

• Normal situation: trade payables average about $100M ($600M × 60/360), reported in current liabilities.
• With a supplier finance program: a bank pays suppliers early, and the company agrees to pay the bank in 180 days instead of 60. If all purchases run through the program, payables rise to about $300M ($600M × 180/360).
• Result: the extra $200M is effectively bank financing, but it sits in accounts payable rather than debt.

Two areas of the financial statements then look better than reality:

1. Leverage looks lower. Reported debt excludes the $200M, so debt ratios and covenant calculations look cleaner.
2. Operating cash flow looks stronger. Paying suppliers later keeps $200M in the company’s hands, and it shows up as operating cash flow. A bank loan would be classified as financing. This boost lasts only while the program continues. If the bank withdraws, the cash comes back out.

However, an accounting change (ASU 2022-04) increases the transparency. Buyers must now disclose the key terms of their programs, the amount outstanding at each period end, and an annual rollforward. The $200M can still sit in payables, but investors can see it and treat it as debt in their own judgement about balance sheet. That makes it much harder to lean on the program unnoticed.

This is a disclosure fix, not a prevention fix. The standard doesn’t cap payment terms or require days outstanding, so judgment is still needed.

The risks associated with hidden supplier finance obligations are very real. In past corporate collapses, companies reported minimal bank loans and overdrafts on their balance sheets while holding large obligations to banks under reverse factoring—often hidden under generic labels like “other creditors.” While reverse factoring wasn't the sole cause of these failures, it successfully concealed a massive share of the companies' true debt load.

It is worth noting that supplier finance is not inherently harmful. Used in moderate amounts with standard, reasonable terms, it functions as a legitimate working capital and supply chain management tool. Furthermore, the financial health and reputation of the financing bank matter immensely: there have been historical cases where major supplier finance providers collapsed after acquiring receivables from overly risky clients and subsequently losing their own funding.

To identify whether a company is masking debt through aggressive supply chain financing, investors can take the following steps:

• Compare the program balance in the supplier finance note to total accounts payable. A large share is a flag.
• Track the rollforward for balances growing faster than purchases.
• Compare payment terms in absolute terms and against peers. Long payment terms require further analysis.
• Check whether days payable stretched while operating cash flow improved.
• Read credit agreements for language that excludes supplier finance obligations from debt.
• Assess the reputation and financial health of the bank running the program.

Abhay Srivastava is the Founder and Managing Member of AS Investment Partners LLC, a value investing firm (www.asinvpartners.com).

Abhay can be reached at abhay@asinvpartners.com

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