Cimic Group Ltd (ASX: CIM) is under fire again over its use of supply chain financing. A subcontractor on Perth's Casuarina prison project has told the Australian Financial Review (AFR) that they were forced to accept payment through a supply chain finance arrangement by CIMIC subsidiary Broad Construction.
Supply chain finance only payment option
Broad Construction was awarded the $96 million prison project by the Western Australian Government. One sub-contractor who tendered for work on the project and claims he was told all supplier payments on the project were being made under supply chain financing arrangements.
Speaking to the AFR, the contractor said that he wanted to be paid directly by Broad Construction, but was told this wasn't an option. If he wanted to work on the project, the only way to get paid was to sign a supply chain finance agreement with CIMIC's financier Greensill Capital.
What is supply chain finance?
Under supply chain finance agreements, the customer makes an arrangement for the supplier to sell their invoice to a financier. Once the supplier issues their invoice, they can have the financier pay it (for a fee) if they want the cash earlier than the customer's payment terms allow. The customer then pays the financier at a later date.
Small business ombudsman Kate Carnell says supply chain financing arrangements are acceptable if suppliers voluntarily enter into them to get paid earlier than government terms for construction contracts (generally 20 to 30 days). They are not, however, acceptable if forced onto suppliers, with Carnell telling the AFR; "You can't achieve 20 days by using supply chain finance because it's the contractor that pays for that."
CIMIC faces criticism
CIMIC has faced criticism for its use of reverse factoring both due to the impact on suppliers and on CIMIC's balance sheet. Greensill, which provides supply chain financing to CIMIC, has previously threatened to ditch clients who push out payment terms beyond 30 days.
CIMIC extended the payment terms for one of its subsidiaries to 65 days last September. There are fears that this amounts to a "supplier payday lending scheme" forcing suppliers to take a discount on their invoices in order to be paid promptly.
Greensill has refused to say whether it has dumped CIMIC as a client as a result of its extended payment terms. However, Federal Small Business Ombudsman Kate Carnell has said her office would seek to ensure Greensill followed through. "My office has the capacity to seek documents and will be ensuring that they follow through," Ms Carnell told The Australian.
Finances opaque
The use of supply chain financing allows companies to delay paying bills, in turn lowering reported debt and inflating cash balances. Supply chain financing arrangements are often accounted for within trade and other payables, making it difficult to tell how much money is owed to suppliers.
Proceeds from factoring receivables are treated as operating cash flow, the same as if they were collected from the payer. Amounts owed to the financial intermediary are booked as payables instead of debt, which artificially lowers reported debt and increases cash flow. Inflows from higher payables are treated as an operating rather than financing activity.
Hong Kong-based accounting and research firm GMT has previously alleged that CIMIC's disclosure regarding its reverse factoring falls short as it fails to provide information on how much is outstanding under its facilities.
You can learn more about CIMIC's history of reverse factoring in this article here.
Foolish takeaway
The controversy over CIMIC's use of supply chain financing doesn't look like dying down any time soon. The ombudsman has threatened legislation if big companies do not pay small companies within 30 days, while companies such as Telstra Corporation Ltd (ASX: TLS) and Rio Tinto Limited (ASX: RIO) have vowed to stop using supply chain financing arrangements.
