Reverse factoring: chronicle of a death foretold?

June 26, 2023

The impact of accounting rules on business..

Factoring belongs to a family of financial products that share the presence of a plurality of counterparties within the single transaction and, therefore, present specific problems of representation from the perspectives of accounting records and risk. It is a family that includes most forms of working capital financing, such as confirming, reverse factoring, the use of credit cards in business, and so on. 

These products lend themselves to different modes of representation - alternatively, of a more commercial or more financial slant - none of which is, a priori, entirely correct. Hence the continuing challenge they pose in the application of accounting standards and the recurrent debate they provoke within the accounting professions. 

A now dated example is that of the treatment of assignments of receivables under international accounting standards, which marked the transition from a model based on the legal effect of the legal transaction used (transfer of ownership of the asset and then writing it off the balance sheet of the assigning entity) to a model based on the criterion of the actual transfer of all risks and rewards associated with the asset, in which writing off the balance sheet requires a potentially complex assessment and whose operational result is the splitting of the receivables assignment transactions into three different families

  • Assignments with recourse, for which the derecognition of the receivable from the assignor's balance sheet is never made;
  • "effective" non-recourse assignments, which are based on contracts that provide for the transfer of all risks and rewards and allow the asset to be derecognized from the transferor's balance sheet (and recognized in the transferee's balance sheet);
  • "formal" non-recourse assignments, in which the transfer of risk may not be complete and which are treated for accounting purposes as if they were with recourse, although they are not.

The longstanding diatribe on the treatment of assignments of receivables in the financial statements of assigning companies has, to some extent, been replicated in recent years with reference to the representation of reverse factoring or, more generally, supplier financing transactions in the financial statements of debtor companies. In this case, the underlying issue of the possible reclassification of supply debt into financial debt, as a result of the placement of the assignment transaction between supplier and assignee within an agreement between debtor company and assignee, has given birth to a non-solution, with the introduction of a disclosure requirement in the financial statements for companies implementing supplier financing agreements.

This outcome represents the renunciation of expressing a rule and opens the way for the free interpretation of analysts and stakeholders, who will be assured of the availability of the information needed to reclassify or not reclassify the debts covered by this type of agreement. 

What will be the effects of this "non-solution"?

A first phenomenon, the first signs of which are already being reported, is the abandonment by companies of the use of these types of tools, considering the risk of having to deal with a proliferation of conflicting interpretations of financial statement data to be unacceptable.

A second phenomenon, consistent with the historical evolution of criteria on active operations, could be the development in practice of a set of operational criteria leading to a distinction between supplier financing structures intended for debt reclassification and structures neutral in this respect.

What seems fairly certain as of now is that traditional reverse factoring solutions, based on a framework of direct agreement between debtor company and bank or financial intermediary are bound to be increasingly less attractive to companies, as well as potentially risky in terms of their impact on the net financial position. 

Is it the death of reverse factoring? Perhaps as a product label, certainly not as an efficient way of responding to the liquidity demands of supply chains. Once again, it is a matter of imagining solutions that allow liquidity to be offered to suppliers without the debtor company having to commit to doing anything more than what arises from its commercial obligation: paying what is owed on the agreed due date.

Polaris has been making this effort for some time now and proposes an accounting-neutral solution, as well as one that is more efficient and scalable than all traditional solutions.