Many companies employ trade receivables sales programs to accelerate their cash flow. They sell their trade receivables to a commercial paper conduit or bank in exchange for upfront cash and a beneficial interest in the receivables sold, which is liquidated as cash is collected from the sold receivables. The beneficial interest, sometimes called a deferred purchase price (DPP), serves as a credit enhancement, which provides first loss protection to the conduit or bank on the total trades receivables sold.
Under new accounting guidance, only cash received at the time of sale is considered to be related to the trade receivables and classified as an operating cash inflow. The beneficial interest received is disclosed as a non-cash investing activity. Any subsequent cash received on the beneficial interest is not considered to be related to the trade receivables (as they are no longer owned by the company), but rather related to a contractual right to receive cash from the conduit or bank. Therefore, the cash received is classified as inflows from investing activities. This is a change from prior practice, which generally was to present all of the cash flows from these arrangements as operating cash flows no matter when the cash was received.
As a result of the new accounting guidance, because some of the cash collected will be reported as investing cash flows, operating cash flows will be lower.
Historically, these programs were structured with credit enhancements provided by the seller, which maximized the sales price while still achieving sale accounting (seller derecognition) for the sale of receivables to the bank or conduit. Some companies are relooking at the programs to evaluate whether there is an opportunity to preserve operating cash flow treatment.
One possibility that companies are considering is for the structures to be designed such that sale accounting is not achieved (i.e., no derecognition of the receivables and accounting as a secured borrowing). The cash flows upon initial transfer would be financing inflows and classified as debt on the company’s balance sheet. Collections on accounts receivable would be operating cash inflows and then reported as financing outflows when forwarded to the bank for repayment of the debt. This approach has one potential drawback. Some companies have concerns that the increase in debt balances could trigger covenant issues and ratings changes, which may make this alternative unattractive.
Another alternative is to change the form of collateral required by the conduit or bank to allow for increases in the upfront cash received, which could reduce the DPP or subsequent cash receipts. The bank and the company would need to find alternative forms of collateral that would be suitable to them while still maintaining a low cost of financing for the company. As an example, a company with $100 of receivables could sell $80 of the receivables and collect the entire purchase price in cash upfront from the conduit. The company would classify the cash received as an operating cash flow. Since the entire purchase price for the receivables sold is collected in cash, use of a DPP is eliminated. The $20 of receivables not transferred could be pledged as a guarantee for credit losses on the $80 sold receivables. Subsequent collections on the pledged receivables (which were not sold) would also be classified in operating cash flows.
There may be other arrangements that can mitigate the effect on operating cash flows as the financial markets focus on this new accounting. Companies should consider their specific structures in assessing the appropriate accounting treatment.
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